Good morning and welcome to the VSE Corporation Third Quarter 2023 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Michael Perlman, VP of Investor Relations and Communications. Please go ahead.

Thank you. Welcome to VSE Corporation's third 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 the future business and financial expectations. Actual results may significantly from those projected in today's forward-looking statements, due to various risks and uncertainties, including those 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. Where available, the GAAP financial reconciliations are incorporated into our presentation, which is posted on our website. All percentages in today's discussion refer to year-over-year progress, except where noted. As a reminder, the Federal & Defense business segment has been excluded from our results and had to move to discontinued operations, as we pursue the divestiture of the business. We also look forward to welcoming you all to our first Investor Day. Scheduled for November 14th, 2023, in New York City at NASDAQ MarketSite and broadcast virtually. You can register for the event on our IR website at ir.vsecorp.com. Please feel free to contact me directly with any questions. 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. Good morning everyone and welcome. Thanks for joining our call today. Let's begin with Slide 3, where I will provide an update on the performance of our business segments. Third quarter 2023 results were highlighted by record revenue and financial performance in our Aviation segment, strong revenue growth in our Fleet segment, and the closing of both the Desser acquisition and a transformational asset and Intellectual Property License agreement with Honeywell. Aviation segment revenue increased 48% in the quarter. This strong performance was driven by strong program execution, market share gains, the expansion of our products and repair capabilities and positive end market activity. We continue to experience great success from our Aviation segment organic and inorganic investment. Aviation distribution revenue growth of 46% was driven by strong program execution on new and existing distribution awards, the entrance into new markets and an expansion of product offerings, along with improved pricing and product mix. Aviation MRO revenue growth of 54% was driven by strong end market activity, market share gains, and expansion of repair capabilities, and contributions from new customers. The Fleet segment experienced solid revenue growth across all channels, with 22% total revenue growth in the quarter. Our fleet segment revenue and profit dollar contribution improved year-over-year. The Fleet segment sales increase was led by revenue contributions from our new Memphis, Tennessee distribution facility. As we continue to ramp our new e-commerce fulfillment business. The increase in USPS revenue in the quarter was supported by an expansion of the installed base of their vehicles and continued maintenance investments in both legacy and new vehicles. Let's now move to Slide 4, where I will provide a strategic update. First, on July 3rd, we acquired Desser Aerospace, a global aftermarket solutions provider of specialty distribution and MRO services.…

Thanks John. As a reminder, our results exclude the Federal and Defense segment, which remains in discontinued operations as it is held for sale. I'll now turn to Slide 6 and 7 of the conference call materials, to provide an overview of our third quarter performance. As John mentioned, we reported record revenue in our Aviation segment and strong year-over-year performance within our Fleet segment. Our results across both segments were driven by strong program execution, expanded capabilities and offerings, market share gains and robust demand across all end markets. We generated $231 million in revenue in the third quarter, an increase of 38% versus the prior year period. Aviation reported another record quarter driven by strong program execution of new and existing distribution awards and expansion of product offerings and repair capabilities, increased commercial and business and general aviation MRO activity, strengthened customer and supplier relationships, all of which have led to market share gains and new profitable revenue opportunities. And lastly, contributions from the recent Desser Aerospace acquisition. Fleet segment growth was driven by solid e-commerce fulfillment and commercial fleet sales, together with higher contributions from the USPS program. We generated $32 million of adjusted EBITDA and $14 million of adjusted net income, an increase of 56% and 75%, respectively. Adjusted EBITDA increased $11.5 million, driven by an $11.7 million contribution from Aviation and a $500,000 contribution from Fleet. Partially offset by the GAAP accounting impact on corporate expenses from discontinued operations. Now, turning to Slide 8. We'll cover our Aviation segment results. Revenue increased 48% versus the third quarter last year to a record $152 million. Both distribution and MRO businesses were strong contributors, up 46% and 54%, respectively. Aviation grew 24%, excluding the Desser acquisition, driven by strong execution of recent investments and growth initiatives and…

Thank you, Steve. I would like to conclude our prepared remarks by reviewing the opportunities ahead and priorities for our business. Our focus remains on driving sustainable, profitable growth while enhancing the operational performance of our two business segments. Please advance to Slide 11. First, continue to pursue the near-term sale of the Federal and Defense business. As I stated earlier, we remain confident in our ability to monetize these assets and will work towards an expedited sale of this business. We expect to provide an update in the coming months. Second, transition and implement our newly acquired Honeywell fuel controls product line and associated subcomponents program. Third, complete the integration of our Precision fuel MRO acquisition, which will happen this quarter and continued the integration of our Desser Aerospace acquisition. We remain focused on our model to fully integrate all acquired assets into our systems, processes and organizational structure, in order to provide our customers with a single source for our products and services and drive synergies and greater combined value and investment returns for our shareholders. Fourth, continue to expand our full-service unique product distribution and MRO repair capabilities within high-growth underserved portions of the Aviation aftermarket. We remain focused on offering a bespoke solutions-oriented approach that addresses our customer needs. We look forward to sharing more about growth opportunities and 2024 pipeline in the coming weeks. Fifth, drive commercial growth, while supporting legacy programs within our Fleet business. This includes scaling and growing revenue and improving profitability at our Memphis distribution and e-commerce fulfillment center, to address robust and commercial fleet customer demand. And finally, deliver accelerated free cash flow, specifically in the fourth quarter, driven by disciplined cash management and strong operating results. I'm very proud of our third quarter operating performance and the tremendous progress, we have made year-to-date to advance both our Aviation and Fleet business strategies. I'm very thankful to our teams and the results that they have been able to deliver. The culture and teams at VSE continues to be our greatest asset and our greatest differentiator. I look forward to sharing what's ahead for VSE at our November Investor Day in less than two weeks. Operator, we are now ready for the question-and-answer portion of our call.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Louie DiPalma with William Blair.

Good morning Louie

John, Steve, and Michael, good morning.

Good morning.

The Aviation aftermarket remained very strong. It appears that there's really robust industry growth and you've also gained share. But, as we look to the fourth quarter, how should we think about seasonality relative to the third quarter?

Yes, I think I mentioned it in my prepared remarks, Louie, but obviously, we're extremely pleased with the results of the Aviation business in the third quarter. When we look towards the fourth quarter, there is an element of seasonality, so a little bit lighter on revenue is what we would anticipate. And probably some of that mostly coming from the most recent Desser acquisition. I referenced that it's above our expectations as we initially set out for, but it will have a seasonality effect. I think when we look for the full year, we're very pleased with the contributions for the Aviation business. We've increased our revenue guidance range, now for the full year, 30% to 35%. And we look forward to talking more about 2024 and beyond when we get to the Investor Day. But very, very pleased with the results thus far.

Thanks Steve and sorry that I missed that. For the Federal and Defense segment, despite some of it struggles, it still seems as though it has some attractive assets with the Energetics Consulting business, and you also have a $565 million in C5 aircraft IDIQ, have you seen interest to buy these assets on a stand-alone basis, as opposed to potential acquirers for the whole business?

Yes, Louie. So, the way you're looking at it exactly correct. So, we're obviously looking for most expedited process. It's possible that can monetize the asset with the highest value. That could include selling the segment in totality or selling pieces or contracts independently. And we are pursuing both paths simultaneously.

Great. And one final question. Earlier this year, you expanded your Pratt & Whitney Canada partnership into Asia. And it appears that the execution for that geographic expansion has been going well. Are there opportunities for you with your other OEM partners in Asia and other geographies?

There are. We hope to be in a position to share a little bit more detail about that at our Investor Day coming up. We're really focused on Europe for 2024, with the acquisition of Desser, which gives us a strong solid team in Europe. But that team is very UK-centric. We have plans to expand outside of the UK and both leveraging the Desser business. and some of our OEM partnerships to do so. And we'll be in a position to share some more detail about that at the Investor Day.

Awesome. Thanks John. Steve and Michael. Looking forward our the Analyst Day.

Thanks Louie. Look forward talking to you.

Thank you. The next question comes from Michael Ciarmoli with Truist. Please go ahead.

Morning Mike.

Hey good morning. Thanks for taking the questions. Just to close the loop on that on Fed and trying to sell that. I mean, do you guys have to realistically lower your expectations, in terms of what you think the assets could fetch now? I know it was kind of with that earnout $100 million. I mean, are you just trying to do this as quick as possible. And obviously, you're still trying to monetize it in the most efficient fashion and get the most value. But do you think you've got to lower your expectations for sale price?

We are very focused on -- we believe we can manage both value and time. I think it's important to highlight that the majority of the earn-out was associated with one contract, which we were not successful with. We are under protest at this time. So, if you look at the $50 million base purchase price, we're very focused on the core asset at that value and doing our best to manage both, getting to that value, as well as doing it in the most expedited time line possible. We had anticipated a first quarter closing. So, we're very focused on what can we do within the same time period.

Got it. Got it. Okay, that's helpful. And then just on Aviation, obviously, very strong, strong demand backdrop there. Just can you help me reconcile it? I think, Steve, you called out the organic growth, maybe 24% ex-Desser, I don't know if I have the math correct, but that seemingly implies maybe a $25 million contribution. Do I have that right? And I know you said $35 million for the year, but I didn't know if there was anything else sort of incorporated in that organic.

You have the math correct. And so it does contribute $25 million in the quarter, and that's why I referenced that the business is performing better than expectations for the second half of the year. But to be super candid with you, as we get to know the business better and work with the teams more, I referenced the seasonality effect. Their third quarter does tend to be quite strong given the flight dynamics in the Europe region specifically, which is where they've got a large business. And we expect to see some level of decline there headed into the fourth quarter, hence, the commentary. But yes, we're very pleased with the business's performance thus far and excited about working through the integration efforts.

Got it. Can you help us out? I know you called out the distribution of 46% and MRO of 54%. What can you parse out maybe the organic in those two lines?

Yes, I'm happy to the distribution side of the business is up 23% on an organic basis, and the repair business was up 26% on an organic basis. Repair tends to still kind of lead at this point. It's still driven a little bit by the commercial recovery dynamics. But I'd say, in both sides, distribution and repair, we still continue to see better than overall market results from an organic basis, so we're pleased.

Got it. And then I think you called out pricing as well. I mean we've heard from some other suppliers out there. They've gotten double-digit last year, high single this year. Can you maybe talk to what you're seeing on pricing maybe across both distribution and kind of MRO?

Yes, I think, Mike, so I'd say that obviously, 2023, we're not -- we're done. So what we have experienced is some results of some of the pricing efforts from the OEMs. We're starting to get the catalogs in now for 2024. My anticipation is that it's going to be a little bit more muted than we've seen in 2023 and 2022. So, we're just getting initial kind of data in. Ask me that question in two weeks at the -- at Investor Day, and I'll probably have more detail once we start going through the data, but I would anticipate 2024 price being less of an impact than we've seen in the last two years.

Okay, got it. Last one, then I'll get out of the way here. Any implications for you guys on the positive side, given what's going on with the GTF and obviously, airlines may be being forced to fly older equipment longer, not having enough lift. And I guess the same holds true for just where the MAX is. I mean, what are you guys seeing potential tailwinds there?

Yes, I'd say direct corollary not a ton. Obviously, we don't support that forum today. But I'd say to the second part of your question, will that lead to a longer life on some of these legacy assets and, therefore, more repair opportunities. We believe the answer is yes. And we continue to want to make sure that we're there to support our programs, whether it may be on the newer side or on the end of life side. So, we're kind of trying to support all legs of the aircraft. And I think at this point, we continue to see robust demand. I think when we get to the Investor Day, we'll share more about our outlook headed in the 2024 and 2025, give you a sense of where we think the markets are headed. They're certainly going to slow down from a year-over-year comp perspective, commercial at this point has seen such a strong 2023, it will start to moderate. We're seeing that in our business even in the third quarter on a year-over-year comp basis.

Yes, of course. Got it. All right. I'll jump back in the queue. Thanks guys.

Thanks Mike.

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

Good morning Josh.

Good morning. Just as far as the Honeywell IP acquisition, what does that ramp look like? You talked about expanding the supply chain. Is there a qualification time line or a hiring need that we should think about?

There is both actually, you're thinking about it the right way. So, to say is this is a great entry for us into this market. We -- I highlighted that we both have been distributing the product and repairing the product. This is much more of an assembly than a pure manufacturing. So, we're working with the supply base and essentially assembling the fuel controls, that's our portion of the manufacturing. So, if you think about it in our repair business today, we disassemble it, and we assemble it. So, we've got tremendous experience but we do need the FAA approvals, from a manufacturing perspective. That takes weeks and months, not years. And then we have a very strong team who understands this product line, but obviously, we're increasing staffing around that. The second thing I would add, because you see the revenue and earnings forecast, that we had put out with the initial release and that Steve highlighted again today, is that we're sitting on legacy inventory. So, we acquired inventory from Honeywell with obviously a Honeywell markup on it. We have to burn through that inventory and then that margin capture that went to them now will come to us in the future. So, as you look at the ramp, those are the steps to us getting to kind of the full ramp of both revenue and earnings potential on this program.

And then curious if the deal has driven any incoming from other aerospace OEMs looking at the transaction is attractive or is this still in the outgoing effort?

Yes, what I would say is that -- and I'll highlight this more on the Investor Day. When you look at the life cycle of the product, you have at some point in time, many times an OEM says, okay, this is still in production, but it's a majority of the uses in the aftermarket. I want to use my R&D dollars and my shop floor space, to focus on newer production products that they're looking for an alternative source for that production. And there are suppliers and companies in the industry that do this. . I think we have pleasantly surprised the market with our ability to additionally support this. And this, coupled with our ability to distribute the product successfully and repair the products successfully, which is what our core business is, this really just adds an additional channel for us. And we are having dialogue with OEMs at this point. What I would tell you though is don't expect -- and I don't normally give forecast on deals. Don't expect us to announce another deal like this in the coming months. We really want to make sure we do this right. This is the first time we're doing this, and we're going to do this right and really impress the market before we consider another transaction of this type. But there are definitely others out there for the future.

Got it. And then maybe just switching over to fleet. The expansion of the installed USPS fleet. We've seen some large auto OEMs pull back on some EV development plans. How is the post office looking at its existing ICE fleet at this point?

Yes, I think the numbers -- the forecasts that have been previously shared, there doesn't appear to be any tremendous shift in that forecast. So, there will be a small portion of their fleet that will be EV. But the biggest thing that's happened is, number one, they've grown the fleet size, and that's a permanent growth to the fleet size. The second thing is how they've grown that is not through the NGDV, the next-generation vehicle. Whether electric or combustible engine, what they're doing is buying commercial off-the-shelf vehicles. So, whether they're Mercedes metrics, whether they're some other types of commercial off-the-shelf vehicles. So they're building a more complex fleet type, that will continue to have a tremendous amount of non-EV type vehicles. That said, our plan is to support all fleet types. And we look at the Postal Service is a really launch pilot customer to us in supporting EV medium-duty fleet vehicles. So, continue to see strong activity there for the near term. And we don't have the real forecast yet of when that NGDV will be delivered as we get that, we'll share any impacts we think that may have to the business.

Great. Thank you for the time.

Thanks Josh.

Thank you. [Operator Instructions] The next question comes from Jeff Van Sinderen with B. Riley. Please go ahead.

Good morning everyone. Just wanted to follow-up on the [Indiscernible] facility. Just wondering, maybe if you can touch on incremental efficiencies to be realized there in the future.

Yes. Thanks Jeff. Good morning. The way that we've built this this kind of model. Remember, we started literally from zero in January. We launched in the middle of the first quarter, completely new IT system, new facility, new infrastructure. So, we're essentially, if you look at a chart, you're kind of increasing productivity and revenue out of the site, then we're plateauing and stabilizing and then we're doing the same thing again, plateauing and stabilizing. So, what you in the third quarter was really a more plateau period. And what you'll see in the fourth quarter, is the next phase of kind of revenue ramp and then, again, plateau again. So, as we go through that ramp, we continue to look at where we're going to have productivity improvements. What is going to drive margin improvement over time. There's an element on supply chain on cost and pricing. But the other element is just a scale through that facility; and b, then we look at continuous improvement, both in terms of processes. And really in late 2024, we'll talk about automation and the impacts that will make. But we've got to get the facility stabilized before we add the automation in. But you can expect this to be a continuous improvement in margin improvement plan over the next two years.

Okay, that's helpful. And then I know you mentioned some seasonality at Desser for Q4. Just I guess anything else you're learning about Desser, as you're integrating there?

I mean, as thrilled with the acquisitions, thrilled with the diligence that my team did, it's exactly as expected to see a point where they outperformed in the first quarter, a great culture, great level of alignment. It's a great addition to the VSE Aviation portfolio. So, their business wasn't fully integrated, so they were running the business under different IT platforms. So we basically are breaking it up into a number of smaller integrations. But integrations are on track or slightly ahead of pace and very excited for what's ahead for 2024.

Okay, terrific. Thanks for taking my questions and continued success.

Thanks. Appreciate that.

Thanks.

Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. John Cuomo for any closing remarks. Over to you sir.

Thank you, everybody, for joining our conference call today. We look forward to seeing many of you on November 14th in New York at our First investor Day and appreciate the continued support and interest in VSE. Have a great rest of your day.

Thank you. The conference has now concluded. Thanks for attending today's presentation. You may now disconnect.