Good morning. And welcome to the VSE Corporation Fourth Quarter Results Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host, Noel Ryan, Investor Relations. Please go ahead, sir.

Thank you. And welcome to VSE Corporation's Fourth Quarter 2022 Results Conference Call. Leading the call today are our President and CEO, John Cuomo; and Chief Financial Officer, Steve Griffin. The presentation we are sharing today is on our website, and we encourage you to follow along accordingly. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in our periodic reports filed with the SEC. Except as required by law, we undertake no obligation to update our forward-looking statements. We are using non-GAAP financial measures in our presentation. The appropriate GAAP financial reconciliations are incorporated into our presentation where available, which is posted on our website. All percentages in today's discussion refer to year-over-year progress, except where noted. At the conclusion of our prepared remarks, we will open the line for questions. And with that, I would like to turn the call over to John Cuomo for his prepared remarks.

Thank you, Noel. Welcome everyone, and thank you for joining our call today. 2022 was a defining milestone year in VSE company history. One where we delivered record results and one in which we effectively advanced our multiyear business transformation strategy. During the year, we executed new business awards with industry leading customer service and strong revenue and profit contributions. We were awarded more than $450 million in new program wins. We added to our portfolio with both new market leading distribution products and new service and MRO capability offerings. We invested in our businesses with new and upgraded facilities and IT systems to support scalability for future growth. Also, in 2022, we proud celebrated our 40th year as a Nasdaq listed company and most importantly, we continue to invest in and upgrade our talented team to drive our company culture. I'm incredibly proud of the VSE team in 2022 all of this culminated in significant year-over-year revenue and profit growth and record full year revenue for both our Aviation and Fleet segments. Let's now advance to slide 3 of our conference call presentation. We delivered record full year 2022 results highlighted by $949 million of revenue or growth of 26% year-over-year with 27% growth in adjusted EBITDA and 34% growth in adjusted net income. Our Aviation segment posted an outstanding year with record segment revenues of $408 million or 65% growth over prior year. Adjusted EBITDA for the segment up $52 million increased 145% versus the prior year. Aviation segment adjusted EBITDA margin increased by 420 basis points year-over-year to 12.8% given a more favorable mix of higher margin repair revenue. Aviation segment adjusted EBITDA represented over 50% of total company 2022 adjusted EBITDA versus 29% in the prior year, supported by balanced growth across both commercial and business…

Thanks, John. I will now turn to slides 5 and 6 of the conference call materials to provide an overview of our fourth quarter and full year 2022 performance. The fourth quarter was strong and capped a year of new records for many of our businesses. We recorded $234 million of revenue, an increase of 11% versus the prior year period. Aviation recorded another record quarter driven by organic growth from the execution of new distribution awards, continued recovery of commercial MRO activities and strength in business and general aviation end markets. Fleet segment growth was supported by commercial fleet and e-commerce fulfillment together with modestly higher contributions from the US Postal Service. Federal and Defense revenue was lower, driven by the completion of certain US Army contracts offset partially by growth in US Navy programs, specifically foreign military sales and support of ongoing aftermarket services. We generated $22.9 million and $8.7 million of adjusted EBITDA and adjusted net income, respectively, an increase of 29% for both measurements. Fourth quarter interest expense was higher than anticipated, driven by the recent Federal Reserve rate hikes and timing of cash flow in the quarter. We anticipate this higher interest expense to continue throughout 2023. For the full year 2022, we recorded $949 million in revenue, up 26% versus 2021, driven by growth in all business segments, but primarily driven by the $160 million of new aviation business. Total adjusted EBITDA for the year was $92 million, an increase of 27% versus 2021, and adjusted net income was $37 million, an increase of 34% versus 2021. Aviation segment adjusted EBITDA drove over $30 million of growth and helped to offset declines in the Federal and Defense segment. Now turning to slide 7, we'll cover the Aviation segment results. Revenue increased 29% versus the…

[Operator Instructions] The first question we have is from Ken Herbert from RBC.

Hi, good morning, John. Good morning, Steve. This is actually Steve [inaudible] Kent Herbert. Starting with the guidance for this year, where do you see the most conservatism within the guide, and maybe where do you see the most upside with regard to any of the segments?

I think the guidance we've given is pretty accurate as to what we expect the businesses to do this year. As we look at each one of the three business segments. The Aviation business, we've got some new execution of our Pratt Asia contract as well as the continued commercial end market recovery, which will help to drive top line, which we believe is pretty solid. As we look towards the Fleet segment, a lot of the growth that we're expecting to see is in the commercial side of our business as you'd expect, the new most recent Memphis facility launch will drive some really good improvement in terms of total commercial revenues in the business, we expect to see some modestly lower USPS revenue. And as always, that's a business is difficult for us to predict, but we do expect modestly lower revenue. And then in the Federal business, we mentioned that we expect the total top line revenue to be down on a year-over-year basis, primarily driven by the large one time vessel transfer that happened during 2022, as well as some contract completions. But we're very focused on making sure that business has a sustainable growth trajectory headed out into 2024 and beyond. But I'd say across the board, the guidance is in line with what we'd expect to see.

Yes, I think there's a level of conservatism would be at the back end of the year with Aviation and Federal. I think our Fleet business, we've been very transparent about the contributions from our new warehouse. I think when we look at the back end, Q3, Q4 for Aviation and Federal, we know we will win new business. The question is, what will we win and how much of that will contribute in the back end of the year versus 2024. And I would say there's some opportunity for upside there.

That's great. And then if I could just one more. Can you provide an update on the kind NAVSEA Federal and Defense contract? Kind of when you expect to have a long term contract in place?

Sure. The contract, the Bridge contract expires in early August of this year. Our pricing is valid on the recompete through the end of May of this year. So we do anticipate notice of an award in the second quarter and then post notice we will share a strategic update on the Federal and Defense segment with a little bit more clarity on that business.

The next question we have is from Peter Austin from Truist Securities.

Good morning. I'm on for Mike Ciarmoli this morning. Thanks for taking our questions. So first, just wanted to ask on the aviation segment, just given that your 4Q margins were higher than what you're expecting for 2023, I was just wondering, was the product mix in the fourth quarter a bit of an outlier, or are there any input cost pressures you'd call out that you're expecting the pressure margins in the coming quarters.

Yes, we saw very strong results, as you can see, in the fourth quarter, kind of returning to that pre- COVID level of mid-teens as we've explained in the past. When we look to 2023, we continue to see the opportunity for the commercial recovery to help the business and a bit more stabilization in the business in general aviation side. So rather than it being more of like an input cost dynamic, I think we look at the business and general aviation side of our total segment as being very robust in the back half of last year. And we expect to see that start to stabilize to some extent as we look into this year and therefore a bit more of a guide, as you see, to the 12% to 14% range. I think the business can vary as we go quarter-to-quarter, but we're very, very pleased with the results in the fourth quarter.

That makes sense. Thanks. And then as a follow up, just wanted to ask, how are you on labor? Do you have any significant headcount that you need to add in the coming year? And are you experiencing any issues with productivity or elevated attrition?

No, I'd say there's a level of stabilization in the markets. Technical labor in aviation is always a challenge and we continue to manage that challenge. We have a new facility in Memphis that we're standing up. We've got the ERP systems, brand new and they're running very well. We are shipping product out. We are still staffing that team up as we get ready to scale for that back end of the year, which will generate about $50 million of new revenue. But I wouldn't say there's anything material or out of the norm other than what we've previously communicated.

The next question we have is from Louie DiPalma from William Blair.

Good morning. Steve, for VSE Aviation, you showed great operating leverage. Should the long term margin exceed your pre-pandemic level because of all of the scale that you've added with the new partnerships. And just in general, how do you balance the margin and your growth? Thanks.

Great question, Louie. I would say long term, we would say mid-teens is our margin rate expectation for this business. If you go back to pre-COVID, right at about 15% is where they operated. I think if you look at the fourth quarter, you can see that this business is very capable of doing that even though it's double the size of what it used to be. So all the new business that we've added has been at least the margin rates that we've been at pre-COVID. So we feel that as we look to the long term, that mid-teens margin rate is absolutely the expectation in the long run. And as we continue to scale, as we acquire businesses that we think are very complementary, they're at higher margins or provide synergy opportunities. There might be opportunity to go higher than that. And it all comes down to execution and driving scale on the existing business. So at this point, we're very, very pleased with its performance and I think we are excited about driving it forward in ‘23 and ‘24 and beyond.

Great. Thanks, Steve. And for John for the Pratt and Whitney Canada Asia expansion. Is the main revenue contribution expected to be in 2024, or is that already happening right now?

It's starting to happen now. It's a slower ramp than we had in the Americas just because of the complexity of, we're working mostly out of Singapore and Australia. So you'll start to see it ramp more in the second quarter of this year.

Great. And also last October at the NBAA conference, you announced distribution partnerships, or they may have been extensions and modest expansions with Bombardier and Embraer. How are those deals progressing?

Yes, I mean, our Bombardier program, which is really the cornerstone of our global parts business, so that was a renewal of that existing business. It was a really important part of that business. And we've been able to outperform our internal forecast that we focused on. Steve, you want to share a little bit about the growth in Global, which obviously is very much related to that agreement?

Yes, I mean, the Global Parts acquisition, which came with some of the great relationships with Bombardier, grew over 30%, just on a standalone basis from ‘21 to ‘22. Not all of that was in our numbers, obviously, because ‘21, they were a separate business. But I think that highlights the execution of the teams and how well they've done in relation to those agreements you're referencing.

Great. And one last one. The business aviation market has obviously been or was very hot for the past two years in terms of bookings for the major OEMs, and it's been a very strong contributor for you. Are you seeing any signs of a slowdown in that segment?

Yes, it's a great question, because you read about kind of what's happening in that market and there's a little bit of mixed data. I'd say what we're seeing is definitely more stabilization of the market. So I would not expect, we had most of the market data that we saw was forecasting high single digit growth rate in that business for 2023. We shared I think on our last call that we were looking at more of mid-single digit growth rate. So that's a little bit of price and a little bit of volume. So definitely seeing the market get less aggressive on growth, but we still see it as 2023 as a growth year for business and general aviation for our business.

Next question we have is from Austin Moeller from Canaccord.

Hi. Good morning, John and Steve. So my question is just about the airlines. How much pent-up demand do you think there is still with the airlines for repair services, just given that MRO is higher margin than the parts distribution and do you think it will remain robust even if we go into a recession in the second half of the year?

Yes, I think it's a great question and I think from our perspective, everyone was expecting I'm drawing up with my hand, but everyone was expecting that spike in demand as the recovery from COVID happened. And what we've continued to share is our month over month inputs on repair work on the commercial business just continued to increase. We saw that through the end of last year. We are seeing that as we start 2023. We believe that more of our business is domestic than international. And we do believe that regardless of kind of recessionary impacts that we're going to see is stable to growing markets. And if you remember, if you look at most of the major airlines and look at even their summer travel, they have less airplanes than they want to have. They have less pilots than they want to have. So capacity is at a premium, and even if there is kind of some slight pullback from a recessionary impact, we're not anticipating seeing a major difference in our PKs and totality. So, yes, we're still seeing the month over month improvement. And again, it's nice and gradual, which is great because it's allowing us to staff and manage our capacity as well.

Okay, and then I think you touched on this already in your remarks, but I guess you're confident in the cash balance and the debt needed to support the inventory to ramp Memphis.

Yes, we are. As you can see, in the fourth quarter, we generated $8 million of free cash flow. We used about $3 million in a year. Most of that was driven by, we did acquire $10 million of inventory in the fourth quarter as part of our Pratt & Whitney Canada Asia expansion. So we're very pleased with the ability for us to improve the net leverage of the business. Last year at this time was 3.9x. We ended the year at 3.1x in line with as we had communicated. Now, as we look towards this year, we do expect that net leverage to increase as we bring on the working capital required to launch the two facilities. So you should expect to see us use some cash here in the first and the second quarter with back half improvements very similar to how we've done in the last year or two. But we feel very comfortable with the current credit facility as well as the opportunities that exist in the demand profile. So we continue to trace in line with what we've communicated in the last quarter, which is that in totality, these businesses will use about $7 million of working capital and CapEx to launch both the Asia Pacific program for Pratt and the new Memphis facility. Ten of it already being spent in the fourth quarter.

And, Austin, remember, once we start to scale the shipments out of Memphis. That inventory will start to turn very quickly, so it's not a long return on that investment. By the third and fourth quarter, you're going to see that inventory really start to move and you're going to see the cash generation happen pretty quickly. So it's really just a blip, both in terms of decline in operating margin for the fleet business because all of that was done organically in the beginning of the year, as well as the cash impact, so that's business will get right back on track. It's a great growth opportunity for us and a really fast return on the investment that we're putting into that facility, both from an expense perspective and an inventory perspective.

Great. I can't wait to see the inventory fly off the shelves. Thank you.

Me too. I've seen it come in. I can't wait to see it go out.

The next question we have is from Jeff Van Sinderen from B. Riley.

Hi, everyone. Just wanted to follow up on the Memphis facility. Realize you just stood that up, but maybe you can touch on what is left to do to optimize efficiency at Memphis and then also maybe just remind us of the long term outlook for the benefits from that facility.

Yes, I mean so when we launched our commercial business, I've been with the business about four years now. We really launched the commercial business when I started. Remember, if you looked back, this business had a tremendous amount of concentration in it. And we said we've got to focus on customer diversification with through commercial customers and e-commerce customers. So if you look back at four years ago, very, very nominal revenue out of that channel this year, well, 2022, we finished it $100 million of revenue in that channel, all of that was done organically. We were at a point where we knew what the demand was. We didn't have the capacity to support it, which is why we set up the Memphis facility. So we know we can generate an additional $50 million of commercial revenue out of that site this year. And but we also know that there's further demand and further disruption that we can do in that market to support future growth and that this gives us the capacity to do it, along with standing up the facility again to build that scalable growth, which will drive lower SG&A as a percentage of sales over time. And also that perfect order coming out of that site. We launched a new ERP system, new warehouse management system. So it's like a crawl walk run model. We're only taking enough orders that we can be perfect. And that's what we did in January, February, as we kicked off March each day or each week, we're talking about record number of lines that were shipping out of that site as we're slowly starting to scale. And we're just taking a methodical approach to scaling it because we want to be perfect to our customers as we ship out of that site. So obviously, with any new ERP system you find ways to optimize, but I went and picked impact and order myself out there. It's a great system training. You can get trained on the system quickly. A lot of controls in place to drive order accuracy and timeliness of orders as well. And we feel very bullish on that investment.

Okay, great to hear. And then just wanted to touch on the USPS part of the fleet business for a minute, if we could. Just wondering what's based in yours guidance for that. Realize it's tough to predict.

Yes. We've got an expectation of modest declines in that business. We do anticipate that some of the new next-gen delivery vehicles will begin to be delivered at the end of this year. And as a result, we do expect that the total legacy repair portfolio may go down slightly. That drives sort of our assumption as to the modest declines in the top line performance for USPS, for our business. Now, all that said, it's going to be quarter-to-quarter, pretty dynamic. So as you see, just last quarter and the fourth quarter was up 6% and for the full year, last year was up 5%.

And we had a strong start to the year.

Yes, it's going to be dynamic quarter-to-quarter. But we do expect those modest declines primarily more in the back half of the year.

Okay. And if I could just squeeze in one more. Just wondering kind of the latest you're seeing in terms of acquisitions. Wondering if the leverage going up a little bit as we're kind of getting to mid-year, if that might slow down the pace of acquisitions in aviation. Maybe just if you could touch on the attractiveness of potential targets, valuation metrics you're seeing, any comments on your pipeline? The availability of some of the larger deals.

Yes. We manage two pipelines. We've got deals that are kind of sub $5 million of EBITDA, kind of smaller, tuck-in deals that are less publicly marketed. And then we've got kind of larger deals for us, kind of $5 million to $10 million or so of EBITDA that are more publicly marketed. We've got a very robust pipeline. We believe when you look at let's just talk about kind of core aerospace aftermarket quality assets that are usually publicly marketed, those trade in the mid-teens. I mean, those are high multiple deals. We believe, as a publicly traded company, we have the capacity under our current facilities to do deals. And we believe that in this market, we're well positioned because our certainty of closure is stronger than potentially sponsors in this market. And that can give us an advantage to get deals done at potentially lower than historic multiples. So we continue to feel very robust about the pipeline, and we continue to look at maybe potential non-core assets as well that potential exit to help us fund things as well, that it wouldn't only be funded through our current facility, but we've got the capacity in the facility, and you won't see a slowdown in that front.

The final question we have is from Joshua Sullivan from the Benchmark Company.

Hey. Good morning. On the Memphis facility looking at that $50 million incremental. Can you just provide some insight on the customer composition? How many greater than 10% customers do you think you ultimately have?

Pretty much zero. We've got some e-commerce channels that we support, so if you look at partners that we're supporting, so like think of that business goes direct to fleet customers through our own e-commerce system, which is too long tail of end users, or through other people's e-commerce channels to their long tail of end users. So this is the business that's about the tail. That's why it's about optimizing it. We do have some large kind of e-commerce partners that who have just a website and where their funnel of inventory. But when we look at true end user demand, this is the tail, and you're not going to see concentration at that level.

Got it. And then just one on the Aviation segment, what's your view of the trajectory of shop visits for general aviation and bizjet over the next two to five years? I know you're talking about sales growth here in the kind of immediate term, but what does that longer term cycle look like?

Yes. So it's interesting because if you look back at the cycle business and general aviation, I've been in the industry for 25 years was a little bit more boom and bust in the 90s when I started in that market, and it was less of a robust and stable market. The market is truly stabilized for a number of reasons. Number one, you have major players out there that are running operations with stable bases of customers. Number two, you have a market that is sold out on larger or mid kind of mid-tier aircraft through 2024 or 2025, 2026, depending on the OEM. So in the market, used aircraft is still relatively speaking, at some of the lowest levels in history. So we look at that coupled together, and we look at it as a pretty stable market. Do I think the market is going to be double digit growth? No. Do I think it will be stable to low single digit growth? Absolutely.

Got it. And then just one last one on the distribution side in aviation, what are you seeing as far as supply chain choke points or release at this point?

They're really mixed. It's interesting. It's really either one OEM or at one factory that has either labor issues or material issues or the like. So we're not seeing like, I wouldn't say in our world, we're not seeing a consistency in a trend. So we've seen more improvement in the last six months than it's gotten better for us, not worse. The one thing I'd caveat always is that as the OEMs start to pick up new production, it's the same base of manufacturers that are building for both. And that's why sometimes we take a little bit stronger of an inventory position because we want to support our aftermarket customers. But I would say right now it's not materially impacting any of our revenue or any of our customer service.

Thank you. Ladies and gentlemen, we have reached the end of our question-and-answer session. I would now like to turn the call back over to John Cuomo for closing remarks. Please go ahead, sir.

Thanks, everybody, for joining our call today. We're very proud of our 2022 results, some great records in both our Fleet and our Aviation segment, and look forward to continuing to report on both strategic updates as well as strong financial performance in the year ahead. Have a great day.

Thank you, sir. Ladies and gentlemen, that then concludes today's conference. Thank you for joining us. You may now disconnect your lines.