VSE Q2 2023 Earnings Call Transcript

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July 27, 2023

There are 7 speakers on the call.

Operator

Welcome to the VEC Corporation Second 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. As a reminder, this conference is being recorded. I will now turn the call over to Michael Perlman.

Operator

Please go ahead.

Speaker 1

Thank you. Welcome to DSC's Corporation's 2nd 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.

Speaker 1

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.

Speaker 1

As a reminder, beginning in the Q2 of 2023, our results exclude the Federal Defense Business segment, which has been moved to discontinued operations due to the announced sale of the business segment. We look forward to welcoming you to our 1st Investor Day scheduled for November 14, 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.

Speaker 2

Thank you, Michael. Welcome, everyone, and thank you for joining our call today. The 2nd quarter was highlighted by record company revenue, This grew 21% in the quarter, driven by contributions and growth in both our Aviation and Fleet segments. Let's begin with Slide 3, where I will provide an update on the performance of our business segments. We delivered another Record setting performance in the 2nd quarter, setting the stage for an exceptional year.

Speaker 2

Operational performance And attractive market conditions supported double digit revenue growth and improved profitability in both our Aviation and Fleet segments. Aviation segment revenue increased 19% in the quarter. We continue to see robust end market activity across all channels. The aviation distribution revenue increase was driven by new product additions, expansion of existing OEM partnerships and improved pricing. Aviation MRO revenue increased 37% in the quarter.

Speaker 2

This increase was supported by strong commercial flight activity, Market share gains and an expanded portfolio of service capabilities. The Fleet segment also experienced a record revenue quarter. Clean segment revenue increased 24% in the 2nd quarter. The growth was led by contributions from all revenue channels within the segment, including increased throughput at our recently launched Memphis distribution facility. United States Postal Service revenue increase in the quarter We're supported by demand from the growth in the total installed base of USPS vehicles and the continued investment Of the legacy USPS fleet, we continue to see increased spend on both legacy and newer vehicles As the fleet segment expands product offerings for all vehicles in the USPS installed base.

Speaker 2

Moving now to Slide 4 and recent announcements and strategic updates. It's been a productive quarter As we continue to advance our business transformation strategy. Last week, we completed an oversubscribed follow on equity offering, Optimizing our balance sheet and improving the liquidity in our stock. The $113,000,000 of net proceeds From the offering supports accelerating our deleveraging commitments and increases balance sheet flexibility to support current and future growth opportunities. Early in the Q2, we announced the repositioning of our business by signing a definitive agreement to sell our federal and defense business segment.

Speaker 2

The total cash consideration for the transaction of $100,000,000 includes an earn out of up to $50,000,000 subject to the achievement of certain milestones. With this repositioning, VSC is now a 100% Sure play 2 segment aftermarket business with focused distribution and MRO capabilities, Serving high growth and high margin aviation and fleet aftermarket. This creates a distinct and compelling aftermarket Services' investment profile, one which will drive long term shareholder value and appeal to a broader and deeper investor base. The pre closing and transition work related to the sale of FDS is progressing well, supporting the closing of this transaction in late 2023 or early 2024. Lastly, on July 3, we completed the acquisition of Desir Aerospace, A global aftermarket solutions provider of specialty distribution and MRO services.

Speaker 2

Desert Aerospace is the world's leading independent distributor of aircraft tires and tubes, a leading global distributor of brakes and batteries and a component MRO services provider For capabilities like wheel and brake repair, Tesler's global locations in the U. S, the United Kingdom and Australia serve a diverse and attractive aftermarket customer base across all aviation industry segments, including commercial, business and general aviation and military aftermarket customers. The acquisition supports our tip to tail aircraft distribution and MRO service strategy In the highly fragmented aftermarket, Desir and their family of businesses also provide a platform for geographic expansion in high growth international markets. This value enhancing acquisition is consistent with BSE's capital allocation And return on investment priorities. We will begin integration activities immediately, starting with the U.

Speaker 2

S. Operations and look forward to sharing performance and growth updates in the quarters ahead. Let's now move to Slide 5. As mentioned, we delivered record quarterly results, highlighted by a 21% increase in revenue, A 112% increase in net income and a 44% increase in adjusted EBITDA as compared to the prior year. Our Aviation segment posted yet another record quarter with revenues of $125,000,000 a 19% year over year increase With balanced growth across both commercial and business and general aviation customers and through both distribution and MRO sales channels.

Speaker 2

Adjusted EBITDA for this segment of $19,000,000 for the quarter increased by 61% versus the prior year, yet another record for this business segment. Aviation segment adjusted EBITDA margin increased by approximately 400 basis points year over year to 15.4%. Aviation segment adjusted EBITDA represented 72% of total company's 2nd quarter adjusted EBITDA versus 65% last year. Our Fleet segment also recorded record revenue in the quarter, increasing 24% $81,000,000 driven by growth across all end markets. Fleet segment adjusted EBITDA increased 24%, driven by commercial sales growth and solid contributions from the United States Postal Service.

Speaker 2

It's been an outstanding quarter. I'm very pleased to see the VSE transformation story really taking shape. We repositioned the company with the announcement of both the Segment divestiture and a material aviation aftermarket acquisition, we optimized our balance sheet and accelerated our deleveraging efforts, And we recorded record revenue and earnings growth in the quarter and the first half of twenty twenty three, all while maintaining industry leading levels of customer service and support. I will now turn the call over to Steve for a detailed review of our Q2 financial performance. Steve?

Speaker 3

Thanks, John. Before I begin, I want to repeat Michael's earlier comments about the movement of the Federal and Defense segment to discontinued operations As it is now held for sale. The results for the quarter and prior periods reflect the Aviation and Fleet segments only moving forward. I'll now turn to Slide 67 of the conference call materials to provide an overview of our 2nd quarter performance. As John mentioned earlier, we reported record revenue in both our Aviation and Fleet segments, driven by expanded capabilities and offerings, Market share gains and robust demand across all of our end markets.

Speaker 3

We recorded $205,000,000 of revenue the Q2, an increase of 21% versus the prior year period. Aviation reported another Record quarter, driven by strong program execution of new and existing distribution awards, increased commercial and business and general aviation MRO activity and strengthen customer and supplier relationships, all of which have led to market share gains. Fleet segment growth was supported by strong e We generated $27,000,000 $11,000,000 of adjusted EBITDA and adjusted net income, an increase of 44% 59%, respectively. Adjusted EBITDA grew by $7,400,000 $1,900,000 From Aviation and Fleet Growth, respectively, 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.

Speaker 3

Revenue increased 19 versus the Q2 last year to a record $125,000,000 Both distribution and MRO businesses grew, Up 13% 37%, respectively. Distribution growth was driven by scaling existing OEM programs, Expansion into new markets and improved customer mix and pricing. MRO continues to benefit from both higher Aviation adjusted EBITDA increased by 61% in the quarter to $19,000,000 While adjusted EBITDA margins increased by 400 basis points to 15.4%. The improvement in profitability was driven by robust MRO revenue growth, scaling the new distribution programs and favorable product mix and price. Within our Aviation segment, we are increasing our full year 2023 revenue guidance range from 10% to 15% to 25% to 30% to account for our recent acquisition of Desir Aerospace and our strong first half results.

Speaker 3

We estimate Deta will contribute approximately $35,000,000 of revenue in the second half of twenty twenty three. We expect full year adjusted EBITDA margins to be at the higher end of the previously provided range of 13% to 15%, As strong segment margins are modestly offset by the anticipated impact of the Destor acquisition. Now turning to Slide 9. Fleet segment revenue increased 24% to $81,000,000 Driven by strong growth in e commerce fulfillment, commercial fleet sales, along with increased USPS demand. Total commercial revenue was $38,000,000 in the 2nd quarter, an increase of 46% versus the prior year period, And now represent 47 percent of total fleet segment revenue, a 700 basis point increase over the same period in the prior year.

Speaker 3

In the quarter, commercial revenue grew by $12,000,000 and year to date has grown by $17,000,000 as we remain on track to deliver an incremental $50,000,000 of commercial revenue for the year. U. S. Postal Service revenue was up approximately 13% versus the Q2 of last year, which is included within our other government channel. Postal service demand has exceeded our initial expectations for 2023, driven by demand for aftermarket products supporting all of the USPS fleet types.

Speaker 3

Segment adjusted EBITDA increased 24 percent to $10,000,000 driven by an increase in sales volume. Adjusted EBITDA margin was down 10 basis points to 11.9 percent driven by customer mix and was up 100 basis points versus the 1st quarter as we have increased throughput at our newly launched Memphis distribution facility. For the full year 2023, We are increasing our revenue growth expectation from 12% to 20% to 20% to 25% year over year, Driven by strong first half results and higher than anticipated contributions from the United States Postal Service. We are maintaining our adjusted EBITDA margin guidance range of 11% to 13%. Turning to Slide 10.

Speaker 3

At the end of the second quarter, we had $71,000,000 cash and unused commitment availability under our $350,000,000 credit facility. For the quarter, we used $16,000,000 of operating cash flow $20,000,000 of free cash flow, driven by previously announced inventory investments to support our commercial growth at our Memphis distribution facility. As of the end of the Q2, we have completed the initial inventory investments associated with launching this facility and expect Positive free cash flow to fund any future investments. At the end of the quarter, we had total net debt outstanding of $371,000,000 And trailing 12 months of adjusted EBITDA of approximately $100,000,000 Net leverage was 3.7 times at the end of the second quarter. We expect the net leverage ratio to be below 3.5 times by the end of the third quarter.

Speaker 3

This is driven by growing adjusted EBITDA And positive free cash flow in the upcoming quarter proceeds from the recently announced common stock offering, partially offset by the acquisition of Desir Aerospace. We are also maintaining our outlook for positive free cash flow in the second half of twenty twenty three. In conjunction with the DeSar acquisition in early July, We executed a $100,000,000 floating to fixed interest rate swap. In total, we now have $250,000,000 of outstanding hedges. The recent secondary offering, along with the amendments to our existing debt facility and improving second half cash flow profile, provide a solid footing for the next leg of growth and market outperformance.

Speaker 3

With that, I'll now turn it back over to John for the final remarks. Thanks, Keith. I would

Speaker 2

like to conclude our prepared remarks by reviewing the opportunities ahead for our Aviation and Fleet segments and our priorities to the business. Our focus remains on driving sustainable, profitable growth While enhancing the operating performance of these two businesses, please advance to Slide 12 to review our near term priorities. 1st, complete the sale and business separation of the Federal and Defense Business Statement. 2nd, integrate both our Precision Fuel Endesa Aerospace Acquisitions. This provides our customer base with a more comprehensive product and services offering.

Speaker 2

Our integration strategy remains 1, where we fully integrate assets into systems, processes and organization structure To provide customers with one supplier source for products and services and drive synergies and greater combined value and investment returns for our shareholders. 3rd, expand our full service, Unique product distribution and MRO capabilities within high growth, underserved portions of the aviation aftermarket. We remain focused on offering a bespoke solutions oriented approach that addresses both our customer and supplier demands. We look forward to sharing more about our organic growth opportunities and 2024 pipeline. 4th, drive commercial growth while supporting legacy programs within our fleet business.

Speaker 2

This includes continuing to scale and grow revenue at our newly launched distribution and e commerce fulfillment center to address the robust commercial fleet customer demand and finally, Deliver Q2 2023 free cash flow driven by disciplined cash management. We are incredibly proud of the work in progress made to advance our business transformation story. Since we last spoke, we announced the repositioning of the company, including the divestiture of our Federal and Defense segment, the acquisition and closing of Desser Aerospace, Another quarter of record revenue and improved profitability for both business segments and a strong and oversubscribed Equity raise to support our deleveraging efforts and balance sheet optionality. Our teams continue to flawlessly execute against our

Speaker 3

And

Speaker 2

our first question comes from the line of our VSE team. We look forward to our November Investor Day and sharing what's ahead for VSE as we enter our next chapter of growth. Operator, we are now ready for the question and answer portion of our call.

Operator

Thank you. The first question is from Ken Herbert of RBC. Please go ahead.

Speaker 4

Yes. Good

Speaker 5

morning, John and Steve. Yes, congrats on all the recent activities.

Speaker 2

Thank you. Thanks.

Speaker 5

Hey, John or Steve, I wanted to first ask, within Aviation, the guidance implies sort of sequentially Down margins a little bit in second half versus first half. I know you called out the integration and the incremental costs associated with DESR. Excluding Desser, is there anything else going on in the business that you'd comment on that could be maybe a bit of a headwind to margins? Or how do we think

Speaker 3

I think the business is performing very well. As you can see from the Q2 results, the business continues to be at the longer Longer term range of mid teens margins. When we look towards the second half, we expect that to be around the same. I think the point of the question you're getting We have seen some favorability associated with pricing to start the year, and I think that has benefited us both in the first and the second quarter, and we do believe that moderates to degree in the second half of the year, but as the guidance that we just gave, you can see we're still guiding towards the high end of that range, which I think is demonstrating the strength of the business.

Speaker 5

No, that's helpful. And I know in the past, I think you've talked about sort of an ideal even split roughly between distribution and And I know in the past you've talked about repair maybe being providing a better margin profile over time. Obviously, the recent You're currently weighted more towards distribution. Should we think about that sort of rough even split as Still a long term goal? And how do you think about the path to maybe get back to those levels?

Speaker 2

Yes, Ken, I wouldn't look I think, I wouldn't look at

Speaker 3

it as fifty-fifty, But I

Speaker 2

would say the balance is something that as we look to November Investor Day and kind of share longer term strategies, Both organic and inorganic opportunities that you'll see us focused on, we look at it first in terms of the offerings that we make to our supply base. And for our supply base, we want to be in a position to support new product distribution, a small amount of rotable and exchange work for them and then be able To have a strong OEM authorized repair network. So you will you should look at the kind of mid and long term as Growth opportunities in that segment. Steve, any other color you want to add there?

Speaker 3

Yes. I think Ken, you hit on it is we do see higher margin rates MRO business, so it does benefit us in that respect over the longer term to have that balance that John just referenced.

Speaker 5

Great. And just finally, if I could, a finer point On the second half free cash, how do we think about sort of Q3 revenue to Q4 in that guidance framework?

Speaker 3

We haven't given the specifics, but I would say probably more heavily weighted towards the Q4. But as you know, as we get towards the end of the quarter, we'll see how things play out. I think The punch line is that we expect to see strong free cash flow because now we are complete with the inventory investments associated with our newly launched Asia program as well as Memphis. So By the time that we get around to reporting the 3rd quarter, I'll be able to give you more guidance on the 4th quarter.

Speaker 5

Great. Thanks, Steve. I'll pass it back to you. A great quarter.

Speaker 2

Thanks, Ken.

Operator

The next question we have is from Louis de Palma of William Blair. Please go ahead.

Speaker 6

John, Stephen and Michael, good

Speaker 3

morning. Good morning, Louis. Good morning.

Speaker 6

Aviation and fleet continued their recent momentum. With the DESER, Precision Fuel and Global Parts acquisitions, You gained more scale in aviation aftermarket and you described that market is still Highly fragmented. From a big picture perspective, is having scale a major advantage that will allow You need to differentiate from the other smaller players, is scale a big deal here?

Speaker 2

It is, Louis, for a number of reasons. So think through one of the think about a large OEM that wants us to support There are aftermarket needs in the market. The customer markets are global, and the global footprint And us being in a position to support their global aftermarket is critical. So that's one element of scale. The other piece I would add is, as you're coming to VSE for Pratt Whitney Canada engine part, We have extra level of exclusivity on that product line.

Speaker 2

It's an opportunity for the same customers to buy similar products Or tangential products that those buyers are looking for as well. So again, that scale and our ability to offer those products That supports some of the customer demand. So scale continues to be important and will both support Increased above market revenue growth as well as margin improvements, as we continue to grow the business in the next kind of chapter.

Speaker 6

Great. And in May, HEICO announced that it is in the process of acquiring WENCOR Fairly large transaction. Glencore has some overlap with you. Does this deal have any implications on VSE Aviation besides the fairly premium valuation?

Speaker 2

Well, I think, I mean, from a value let's start with the valuation. From a valuation perspective, I think it validates the what the market Thanks about aftermarket services businesses like Glencore, like VSC and like and others. So that's Validating as you're building a business for the future. I think it puts 2 great it's a great business and they put 2 great business Together, our businesses have a level of similarity in both distribution and some of our MRO capabilities. I would say the biggest difference is those both the HEICO business and the WEN Corp business have a PMA portion to their business, Where we are large differentiator compared to the 2 of them is our level of OEM centricity.

Speaker 2

So it continues to The combination of those two businesses continues to differentiate BSC in the market as an OEM centric focused Partner.

Speaker 6

Great. And for Steven, you mentioned the interest rate Swap that you entered into for July, how should we think about modeling cash interest with the Swap for the rest of the year.

Speaker 3

Well, the cash interest is going to be consistent to the Q2, but declining relative to the fact that we expect to see the free cash flow improve. I would say Some modest improvement, but at the end of the day from an interest rate perspective, I don't think the rate is going

Speaker 2

to change all that much,

Speaker 3

just primarily driven by the fact that the rates are obviously much

Speaker 6

Sounds good. And one final one, what is the timeline for the Precision Fuel Integration and potential synergies there?

Speaker 2

Yes. I mean, the integration plan is that we're In the middle of integration, it will be completed this year. And we are going to keep the facility. It's a nice niche MRO facility, there are some cost synergies. We've realized some of them and we'll realize the remainder at the back end of the year.

Speaker 6

Great.

Speaker 2

Thanks. On a relative basis, it's not material, but It's a great niche, a niche capability that we added to the business.

Speaker 6

Great. Thanks.

Operator

The next question we have is from Jeff Van Sinderen of B. Y. Securities. Please go ahead.

Speaker 4

Good morning, Jeff. Good morning, everyone. Let me add my congratulations on your strong metrics and progress on all fronts.

Speaker 2

Thank you. Kind of

Speaker 4

a multipar question. Can you give us a little more detail on the DAS and P and L metrics, maybe multiple of EBITDA paid? I think you mentioned second half revenue contribution plan. And then maybe just touch on the international opportunity there as you grow that business? Sure.

Speaker 2

Steve, you want to talk about the financials and I'll

Speaker 3

talk about the strategy on international? Yes. Jeff, I would say, we've Given the guidance range for about $35,000,000 of expected revenue in the second half of this year, implied in the guidance associated with the margins of the total business, we said that they're on the lower end of the range from the Desser business. So you use that margin rate and that revenue and then multiply that, you can get to an approximation for the EBITDA. Right around kind of 10 times from a multiple perspective, when you do that math.

Speaker 3

And I think when we look at this business, we look at it as one where It's below what the market is trading at with opportunities for us to drive both cost synergy as well as top line revenue synergy. John, do you want to share a bit more about the international sort of revenue expansion opportunities?

Speaker 2

Yes. I mean, Jeff, first, I'm pleased with the acquisition. We believe we're good acquirers of businesses in these markets. We will drive synergy off of that multiple number as well, putting us in what we believe is A very below market multiple situation driving solid returns as we integrate that business. From an international perspective, VSE is a very domestic company today and we see large opportunities for international expansion.

Speaker 2

The DESERT team has both a And we'll speak more about it in the back end of the year, but we'll probably leverage What they have and also look at how we grow in more Continental Europe for 2024 as well. So Steve and I were over in the UK About a week ago and very pleased with both the two businesses there as well as when you model things out and Due diligence, you have obviously a thesis that you're coming forward with. It's great to have even a stronger level of confidence post closing And what we believe we can do together between DSC and the DESSOR team.

Speaker 4

Okay. Great to hear. And then if we could shift to The USPS outlook for a minute, just wondering if you kind of what the outlook is there and if

Speaker 1

you think the growth is sustainable?

Speaker 2

We think it's we've continued to share we model the business over Kind of a period of time is relatively flat. A few dynamics have changed. Number 1, you have a larger installed Base. So the installed base of vehicles has increased, which means vehicles weren't parked as new vehicles came on board and They're actually being repaired as well. The second thing is the next generation delivery vehicle, there will be no deliveries this year as originally planned and we're anticipating a slow ramp up starting in the back end of next year.

Speaker 2

So we believe the current revenue and profitability of the business will remain. We haven't given any further guidance for 2024 in terms of growth, but I'd say stability at these new levels is anticipated.

Speaker 4

Okay. And then if I could just squeeze in one more On FDS, just wondering if there's anything you can touch on or anything, you can update us on in terms of the milestone contracts that would impact the earnout?

Speaker 2

Yes. We don't have any update as of now. I can tell you it's based on recompetes and all of the work is done and The recompete are submitted. We're hoping and I should say that with a level of skepticism to hear in the Q3. It's At this point, it's waiting on award dates and award updates, but we are hoping for some update in the quarter.

Speaker 2

What I can share is on closing kind of conditions that we call the step plan of actions that need to happen, So we can close. And again, we've said these are not traditional regulatory closing conditions. We have to kind of stand up a facility with a security clearance, Transfer assets over, but we are progressing on our step plan and feeling confident about Yes, the closing time that we've shared, if not bringing that a little forward.

Speaker 4

All right, Thanks for taking my questions and continued success.

Speaker 2

Thanks, Jeff. Appreciate the support.

Operator

Our next question is from Pete Osterland of Tuohy Securities. Please go ahead.

Speaker 3

Hey, good morning. Thanks for taking the question. Good morning. Good morning. So first, just as the fleet segment becomes more heavily focused on e commerce, What are you seeing from customer conversations in terms of underlying demand?

Speaker 3

Are there any signs of weakness heading into the back half of the year? And In the event that demand does soften, how does that impact your value proposition or your prospects for continuing to take market share in that business?

Speaker 2

Yes. I'm looking at Steve smiling across from me as you asked the question. We have the opposite problem. Demand is so strong, but performance has to be perfect. So I always describe it to investors if you think about how you order something on Amazon and it shows up on time.

Speaker 2

The ecosystem of e commerce and the expectation for both business to Consumer and business to business is very high. So we've set up a new facility, new ERP system, new warehouse management system, Stock it with inventory in the Q1 of the year, and we are seeing consistent month over month increases in output from that facility. So right now, we are controlling the work we take in and there is a very, very, very large opportunity set out there For two reasons. Number 1 is you're seeing this is a late in the game, later than other industries transition from brick and mortar to e commerce. The second is, we do believe we're better positioned than most in terms of our ability to And scale these businesses to support the large number of fulfillment partners out there that have a demand for our products.

Speaker 2

So I'd say that demand is not the issue or discussion at this point.

Speaker 3

Excellent. And then understand that it's in the early stages of integrating the Debtor acquisition, but how does the acquisition impact how you're thinking about free cash flow Do you have any long term targets you can share for the company there? We've not shared long yes, we've not shared long term targets around free But what I would say is in the back half of this year, it doesn't change our expectation at all. We've invested quite heavily into our business and we expect the businesses to generate strong free cash On the back half of this year, we may use the combined capability of Desser and BSNU Vision

Speaker 2

And we'll give guidance at the November Investor Day.

Speaker 1

Okay. That's helpful.

Speaker 3

And then just on your commentary around positive free cash flow in the second half, is the target just to be above breakeven? Or are you expecting that free cash flow could be more meaningful? Just any color you can share that would be helpful. We haven't given a specific dollar target necessarily, but I would say, when I say strong free cash flow, I'm not Expecting a dollar positive. We're expecting strong free cash flow from both sides, both aviation and fleet.

Speaker 3

When we get to the Q3, I'm sure we'll have a similar

Operator

There are no further questions at this time. I would like to turn the floor back over to John Guillermo for closing comments. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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