Greetings, and welcome to the VSE Corporation First Quarter 2023 Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Michael Perlman, VP of Investor Relations and Communications at VSE Corporation. Thank you, Mr. Perlman, you may begin.

Thank you, and welcome to VSE Corporation's first quarter 2023 results conference call. Leading the call today are John Cuomo, President and CEO; and Steve Griffin, Chief Financial Officer. 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 risks described in our periodic reports filed with the SEC. Except as required by law, we undertake no obligation to update the 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. With that, I'd like to turn the call over to John.

Thank you, Michael. Welcome everyone and thank you for joining our call today. Before we begin, I would like to review yesterday's announcement, one that represents a major milestone in our company history. Let's go to slide three of our conference call presentation to review the transaction in more detail. Yesterday, we announced the sale of the Federal and Defense segment. This transaction represents a defining moment for VSE as it streamlines and repositions the business into a two segment pure-play aftermarket business supporting Aviation and Fleet markets with MRO and distribution capabilities. More specifically, the company entered into a definitive agreement to sell the Federal and Defense business segment to Bernhard Capital Partners for up to $100 million in total cash consideration, including a $50 million cash payment and an earn-out of up to $50 million subject to the achievement of certain milestones. The transaction is expected to close in late 2023 to early 2024 and is subject to customary closing conditions and approvals, including the creation of a legal entity with appropriate security clearances to support the transition of the business to Bernhard Capital Partners. The net proceeds from the transaction are intended to be used to reduce borrowings, provide balance sheet optionality, and execute strategic inorganic opportunities. The decision to sell the business concludes the strategic review undertaken by the Management Team, and Board of Directors in response to market and business dynamics with the goal of driving shareholder value. With this repositioning, VSE will become a 100% pure-play aftermarket business. This allows us to do three things: First, simplify the company to a two segment business, Aviation and Fleet with focus, distribution, and MRO service offerings. Second, tailor capital allocation strategies to the high growth Aviation and Fleet aftermarket segments to drive long-term shareholder value. And…

Thanks, John. I will now turn to slides six and seven of the conference call presentation to provide an overview of our first quarter performance. We had a strong first quarter in both our Aviation and Fleet businesses, driven by increased demand in end markets. We recorded $255 million of revenue, an increase of 10% 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 commercial and business, and general aviation end markets. Fleet segment growth was supported by commercial fleet and e-commerce fulfillment together with higher contributions from the United States Postal Service. Federal and Defense segment revenue was lower driven by the completion of certain U.S. Army contracts, partially offset by growth in the U.S. Navy programs. We generated $26 million and $11 million of adjusted EBITDA and adjusted net income, an increase of 18% and 16% respectively. Now turning to slide eight, we'll cover our Aviation segment results. Revenue increased 21% versus the first quarter last year to a record $113 million both distribution and MRO businesses grew up 14% and 43% respectively. Distribution growth was driven by a combination of new business and improved end market activity. MRO benefited from both higher commercial flight activity as it continues to track towards pre-pandemic levels and expanded capabilities in our core repair facilities. Aviation adjusted EBITDA increased by 75% in the quarter to $19 million, while adjusted EBITDA margins increased by 510 basis points to 16.8%. The improvement in profitability was driven by the implementation of new program wins, robust MRO activity, and favorable mix and price. Within our Aviation segment, we are narrowing our full-year 2023 revenue guidance range from 7% to 15% to 10% to 15%.…

Thank you, Steve. As we enter the next phase of VSE's transformation, we are excited about the opportunities for our Aviation and Fleet segments and for all that is ahead for our Federal business with Bernhard Capital. Our focus remains on driving sustainable, profitable growth while enhancing the operating performance of these two businesses. I would like to conclude our prepared remarks by reviewing our key priorities on slide 12. First, to complete the sale of the Federal and Defense business, the sale will allow us to simplify our operations and drive even greater focus on addressing the distinct needs of our two core businesses, Aviation and Fleet. During the transition, we plan to ensure a smooth and successful hand-off for our employees and customers to Bernhard Capital Partners. Second, to reposition the business into two segments focused 100% on aftermarket distribution and MRO services supporting Aviation and Fleet customers. Third, to expand our full-service unique product distribution in MRO capabilities within high growth, underserved portions of the aviation aftermarket. We remain focused on offering a bespoke solutions-oriented approach that addresses every ever-changing need of our customers. Fourth, to drive commercial growth while supporting legacy programs within our Fleet business. This includes scaling our newly launched distribution and e-commerce fulfillment center to address robust commercial fleet customer demand and supports both legacy and new U.S. Postal Service Vehicles. And finally, to deliver second-half 2023 positive free cash flow, driven by disciplined cash management. I'm incredibly proud of what the team has accomplished and how they serve our global customers each day. And I am excited about all the opportunities ahead. Operator, we are now ready for the question and answer portion of our call.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Michael Ciarmoli with Truist. Please sir, go ahead.

Hey, good morning, guys. Thanks for taking the questions here and nice start to the year. Hey, John, what -- I guess looking at the strong results, the guidance increase, I guess what really changed in the last two months. And maybe I'm nitpicking a little bit, right? You put up really strong aviation growth and EBITDA margins, but it does seem like the guidance still implies a step down, kind of, from the current levels? And you kind of talked about improving end markets, but maybe just some color on what kind of came through in the quarter and then kind of how you constructed this guidance for the rest of the year because it does seem like the margins will definitely kind of step back down I guess to that, call it 13% range or so mid 13s even to get you kind of that lower end.

Sure. Steve, you want to talk a little bit about guidance, and then I'll talk about the market.

Sure. So, Michael, as you know, we -- when we came out in the first quarter, we did note that we had a more bullish or I'd say more bearish estimate in terms of end-market activity. I think what we've seen through the first quarter, is stronger results including some continued strength in business and general aviation. And then second to that, I would say, we've had a really strong performance in our MRO shops. I think you can see the near 40% increase in revenue that increased demand has helped to fuel some of the margin improvements across the business. Last thing I would say that has been a benefit, maybe versus our prior expectation is there has been some benefit associated with product mix and price. So, as we kind of start the year, we have some opportunity to optimize pricing that has been a tailwind to us is going to help the first quarter and maybe start to level off as we look towards the second-half of the year. And hence, you can see sort of the lower expectations on the margin performance later in the year. That said, it's still very performed -- very pleased with the performance of the business and really do look forward to seeing it play out over the course of the year.

Got it. And then, John, maybe you want to maybe talk about the strength of the market?

Yes. So, from a market perspective, I think that a couple of things. I think the business in general aviation is continuing to perform strong, our MRO operations are quite robust and backlog is strong and the year has started out very strong. As we've continued, we've stated over the last two years as we saw commercial MRO start to recover, we would see that margin inflection point in the business. And I think that's why you say what really happened, that's a piece of it. And then candidly prices are peaceful, I mean, I think we were all to show a few weeks ago, and you saw that level of activity and discussion around price, which is something that people don't continue to talk about, but there obviously is an element of that that drove some of the margin improvement in the quarter.

Got it. And then you called out I think in the prepared commentary just maybe, kind of, some pickup expanded capabilities out of Miami and Kansas, did that contribute meaningfully in the quarter? Are you picking up share in certain areas with those capabilities?

Yes. More in Kansas, its share. We've got some work in Miami that we launched initially, but I haven’t say it's material to the quarter yet. You'll start to see more of that pickup back end of ‘23 or early into ‘24 and we announced that exclusive agreement with Honeywell to repair some avionics, but in our Kansas facility, we did have some share gain and a new program that also help contribute to the strong quarter.

Got it, got it. And then last one for me and I'll get out of the way. Steve, you mentioned on the cash, obviously, we've got the inventory investment sounds like cash will be under pressure next quarter, but I guess longer term as we look out -- how are you guys thinking about normalized cash conversion for this business, obviously you've got distribution. So, you're always going to be investing and carrying inventory. So, it might be tough to convert at 100% or better. But how should we sort of calibrate ourselves for longer-term cash conversion in this business?

Yes, I think it's right to point out the distribution nature of the business and what I would say is, this year is an anomaly, because if you remember the $70 million of investment $50 million of it is tied to the new facility launch for wheeler, which is very much so something that we will not need to repeat in the future as we grow that business more stable going forward. We haven't necessarily given guidance yet as to which you should imply for longer-term cash flow conversion. But what I would say is that as we start to gain scale, we expect to be able to generate strong free cash flow on the existing investments in the business in the last three years of investment, whether it be in the Aviation business or in the fleet business are not indicative of what we've expected to do on a go-forward basis, because those were such sizable investments, but we will remain opportunistic as we seek opportunities to grow distribution, especially in spaces where we believe we can get strong margin profile going forward.

Perfect. Thanks, guys. I'll jump back in the queue.

Thanks, Mike.

Our next question comes from Ken Herbert with RBC Capital Markets. Please go ahead.

Hey, good morning, John and Steve.

Good morning, Ken.

Good morning.

Hey, nice quarter. I wanted to maybe first start on the Fleet segment. It seems like a bit of an opposite discussion relative to Aviation the guidance implies some gradual margin improvement. How do we think about margins within Fleet sequentially into the second quarter, do you see sort of much acceleration there? And then how does this progress through the back half of the year?

Sure thing. So, we tried to be pretty specific. So, you can see where the margin is today and what the associated expenses were for the start-up of the new facility. And in the guidance range, we've given on that 11% to 13%, we've kind of clearly stated that the second quarter you should expect it to be towards the lower end of that range, with improvement towards the back end of the year on the higher end of that range, so that should give you some assumptions to use in terms of how to think about it. And really just behind the math really what you're thinking about Ken is that new facility, we've got people, we've got new systems, that are really just getting started. So, getting the training completed, getting our employees really up and running, and then they'll drive scale and drive revenue growth, which allows us to generate a stronger earnings profile in the back half of the year. So, that's what's going to drive the majority of the margin improvement in the business. And then underlying is -- sort of is the -- also the notion of commercial versus some of our other government channels in terms of the product mix. But in general, what you're going to see is improvement out of the Memphis facility driving improved margin rates in the back half of the year.

Okay, very helpful. And as we think about the Memphis facility in the $50 million, sort of, incremental revenues, if you think about this facility and investment longer term what -- like where will you be in terms of utilization out of this facility? How much more upside could there be of the existing footprint into ‘24 perhaps? And just how do we think about the run rate then exiting the year considering the investments and the growth you're seeing this year on the facility?

Yes, Ken, we talked about this with our Board yesterday, it's about -- I'd say it's about 20% to 25% of the utilization and that's without considering weekend and night shifts as well. So, we have a tremendous amount of upside. We really focus on the near-term, it's about scale. The demand is there, we need to make sure that we can perform specifically when you're dealing with aftermarket e-commerce most of that is booked and shipped the same day. So, the quality of the performance is important. So, what we're doing is, in my prepared remarks, I kind of alluded to it, we're really kind of managing the demand and each day focusing on increasing that demand as the teams can handle the work.

That's great, very helpful. And then just, John, if I could, finally, on aviation, as you look at the either within the Business GA market or commercial transport and you look at your distribution business, are there any concerns that inventory levels at either airline or Fleet levels could be inflated? Just as a result of a lot of the risk aversion by your customers to the supply chain pressures and disruptions and everything we've seen? And that then could we maybe see some risk to some of the distribution volumes, if things ever do slow on aviation, or how would you think about or talk about inventory levels at your customers within Aviation?

Yes, I think it's interesting, I had a lot of these conversations at the MRO Show a few weeks ago. I think for our specific business and our products, we don't see that. We're very focused on higher-end technical products are expensive, and our customers are not heavily stocking the products. The second thing is, our performance has been so strong and stronger than some of the incumbents, and which we've taken the business from that it's also allowed some of our airline and aftermarket customers to destock a little bit lower their inventory levels. So, we don't see that as an issue where we need to focus is making sure that the supply chain allows us to continue to get the products and that were stocked appropriately to manage the demand.

Excellent. Alright. Well, nice quarter, and great news on the divestiture. Thanks, guys.

Appreciate that, Ken. Thank you.

Our next question comes from Louie DiPalma with William Blair. Please go ahead.

Good morning, Louie.

Good morning to you, John, Steve, Michael, and Tarang. For you John, with the defense division pending sale, are you still interested in any aviation aftermarket services specific for the defense vertical and does the divestiture also include the Heico special services from assets that you acquired a few years ago?

Yes. So, that was -- it was Heico special services, not Heiko. But that business is the KC-10 heavy maintenance MRO program and that business with the past performance and the team is part of the Federal and Defense business. So, our Aviation business today is in MRO and distribution business, we are mostly commercial and business, and general aviation. We do support Defense customers within our business today. It's not the most core component of our business, but they are our customers and we do continue to expect to serve those markets in our existing aviation business today.

Great. And either for you, John, or Steve. Should this deal with the potential $50 million or $100 million in proceeds should it increase your appetite for M&A post-close?

Absolutely. As we've previously stated, our Fleet business is very focused, as I've just discussed with the last question on scaling that new distribution facility and growing our commercial and e-commerce business and we see a tremendous pipeline with the organic investments that we've made in that business, but we have a deep pipeline of inorganic opportunities in aerospace both in distribution and in MRO, and finding the right assets is important that makes sense for the business. But we are -- and we do have an active pipeline of potential acquisitions.

Great, great. And one final one is the difference between the $50 million in consideration and the $100 million mostly predicated upon renewing the Navy foreign military sales contract or are there other important milestones that we should be paying attention to?

Yes. Louie, we're not going to necessarily publicly state all of the different milestones, but I think it is correct to state that the earn-out is tied to milestones associated with new awards, but at this point, I don't think we're ready to share the details of it. We're going to be happy to share more as time progresses here and we worked through the process of getting to closing and setting up the entity as John referenced.

Excellent. Thanks, Steve, John, and everyone.

Yes. Thank you, Louie.

Thanks, Louie. Good to hear from you.

Our next question comes from Jeff Van Sinderen with B. Riley Securities. Please go ahead.

Good morning, Jeff.

Good morning, everyone, let me add my congratulations as well. Maybe you can speak a little bit more about what drove the strength of the USPS business, do you see a sustainable trend for growth there? And then maybe just comment on the outlook for the new Gen vehicle area?

Sure. Yes, the USPS strength I think was coupled with two things. Number one is the announced delay of the NGDB delivery until 2024. And the size of the fleet has grown and is expected to continue to be a larger fleet. So, we look at now the new installed base of vehicles. And for the next call, we'll have a little bit more detail on what we think that number will look like and what the percentage increase will be as we get little more clarity from the Postal Service customer, but we do expect the installed base to be increased, we expect retirements to be slower and we do see -- I wouldn't say the sustainable growth trend, but we do see -- again we've called this business like an annuity-type business and we still look at it very much that way but very pleased to see the strong quarter from the customer as well.

Okay, good. And then just kind of wanted to get a sense, I guess of what's left to do on the integration of Precision Fuel at this point?

So, yes, we acquired the business at the end of January, and as we've discussed our integration model is a fully integrated model, so integrating the core home back office and full system integration. So, the systems integrations we kind of take the first 90-days to learn the business, learn the capabilities, learn how they go to work, rather than kind of forcing them into our systems that work has been done and would say probably in the third quarter, you'll see the systems be fully integrated.

Okay. And then, just wanted to circle back and don't need to press on this, but just as we think more about potential acquisitions, particularly in the aviation area, now that you've got the FDA's decision somewhat behind you. Are you seeing it get easier or harder to come to terms on potential deals, I guess, any thoughts around that?

I believe that the market is more robust than it was a year ago. I think there was an element of waiting for commercial aviation recovery, I also think as a strong public company buyer someone with a team, who has a history both at this company and at the company that we've worked on in the past of transacting in a fast and efficient and providing deal certainty in uncertain markets like today, it gives us an advantageous position in this market.

Okay, great. Thanks for taking my questions. I'll take the rest offline.

Thank you. Speak to you later.

Our next question comes from Josh Sullivan with The Benchmark Company. Please go ahead.

Hey, good morning.

Good morning, Josh.

I mean, obviously, we hear a lot about tight MRO markets broadly, what do VSEC slots or turnaround times look like between PG&A in the commercial aftermarket at this point?

Yes. We don't really slot so much. I mean it's not like a shop visit in the same way that you might think of sort of like a whole aircraft or engine coming in. Because we work on more smaller piece of our components. But turn times, I'd say are in line with the industry norm. So, in a lot of cases, our work is -- can be in some cases 15 days to 30 days, it's usually within a shop as a timeframe. And I'd say that it's continuing to be pretty tight, I mean that's what's driving some of the opportunities we were able to drive. We're driving a lot of throughput through our facility today and hence the 40% growth that you've seen but overall, pretty tight, pretty packed in the shops, but turn-times are exactly where we would expect them to be.

And then just on the Memphis distribution facility maybe where you had a schedule and maybe what's taking a little more thought.

I'd say we're right on schedule. We put a pretty aggressive plan in place. Last year, we realized we were at capacity, probably early in the first quarter. So, by the second quarter of last year, I think was actually May, almost 12 months ago, we actually made the decision to launch that facility, we hadn't chosen a location, chose a location -- full assessment and study, got the location up and running two new IT systems started with the inventory, and started launching product out the door in January. So, it was a pretty aggressive schedule, which the team has done an outstanding job meeting, but I'd say we're right on schedule.

Got it. And then just on the divestiture, how much of a cash usage was the Federal business, less or maybe over the last 12 months?

It's not that big of a cash usage per se. I mean you can look at the overall profitability of the business and just get a sense for how quickly it falls down, it's not that heavy of a balance sheet certainly by comparison to the fleet business and aviation business, which obviously carry inventory. So, I wouldn't necessarily think of it as a significant drag over the last 12 months or so. We're excited about that business having a really strong partner now with BCP, where they can kind of continue to grow the business, where we can also refocus our attention and time and efforts around the two higher margin higher growth opportunities in Aviation and Fleet.

And then maybe just one last one, John, as you think about the long-term evolution of the company divestiture, the Federal business, what are the defining hurdles for kind of the optimal VSE assets as you go forward?

Yeah, I mean like -- on our last page of our deck, we kind of highlighted near-term true priorities. I think the divestiture is really a critical one getting the business fully divested, coating this is a 63-year-old asset that was the core of the business with an outstanding team, and getting them to that nice -- that new home that they can go drive. So, that's a two-core businesses can focus that's the near-term and then is focusing on how do we continue to scale, what we have and the focus is going to be on differentiation. We'll do an Investor Day probably later this year and walk you through in more detail some of our core components of our model, but our core -- what I believe and kind of manage these businesses, my whole career is being narrow and deep and differentiating is what's going to drive sustainability and continuity of revenue and embedded this with our customers and suppliers and it's going to drive the margin expansion that we need and our investors expect. So, continue to see us, continue to fine-tune that value proposition and what that means in terms of products, services, and types of deals that we bring on with the business.

Great. Thank you for the time.

Thank you.

Thanks, Josh. Good to talk to you.

[Operator Instructions] Our next question comes from Michael Ciarmoli with Truist. Please go ahead.

Hey guys, thanks for taking the follow-up, just a clarification. John, I think when you were answering Ken's question, the new facility in Memphis $50 million is that at 25% capacity. Did I hear that right? So, you technically got enough throughput there to do $200 million?

I think, it's -- I think the $200 million is conservative. We can put through the shop.

Okay, perfect. I just wanted to make sure I heard that right. Thank you very much.

Sure.

There are no further questions at this time. So this concludes our question-and-answer session. I would like to turn the floor back over to John Cuomo, President and CEO for closing remarks.

Thank you to our shareholders for your continued support. Thank you to all the VSE employees, it's a defining moment here and we'll spend some time with our teams today working through our communication, we appreciate it. Have a great day and look forward to speaking with you next quarter. Thank you.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.