Welcome to the VSE Corporation Third Quarter 2020 Earnings Conference Call. As a reminder, all participants are in listen-only mode. The conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]. I will now like to turn the conference over to Noel Ryan, Investor Relations.

Please go ahead, sir..

Thank you, operator. Welcome to VSE Corporation's third quarter 2020 results conference call. Leading the call today are our President and CEO, John Cuomo; and Chief Financial Officer, Tom Loftus. The presentation we are sharing today is on our Web site, 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 Web site.

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 would like to turn the call over to John Cuomo for his prepared remarks..

Thank you, Noel. Welcome everyone and thank you for taking the time to join our call today. During the third quarter, each business segment's revenue grew sequentially over the second quarter, supporting strong execution on our long-term strategies during tough market conditions.

We continue to advance our multiyear business transformation plan while effectively navigating the near-term pandemic-related disruption to our global market.

This year, we've taken decisive action to streamline our organizational structure, improve systems and processes to support business expansion, win new customer awards and re-compete, introduce new products and service lines in underserved niche markets and remove fixed overhead from nonessential operations, consistent with cost reductions announced earlier this year.

During a period of market disruption and uncertainty, our customers continue to focus on reducing cost and working capital requirements. As a trusted, well-capitalized business with proven global supply chain and MRO solutions, companies and government agencies are partnering with us to help and support them in achieving these goals.

As exemplified by our Aviation award announced this week, in some respects, the current environment has actually contributed to increased long-term opportunities for VSE as organizations seek to find new partners to leverage the solution that we provide.

Before we move into a detailed review of our third quarter results, I want to provide an update on our corporate strategy and specifically, the actions we've taken to execute on this strategy since our last quarterly update. Let's start with Slide 3 of the conference call presentation. Let's begin with a discussion of business development activities.

During the quarter, each of our three business segments reported new business wins. Within Aviation, we announced a $100 million, five-year exclusive distribution agreement with a major landing gear component manufacturer. It represents a transformational growth opportunity in a newer market for us.

Under the terms of the agreement, which is scheduled to commence in early 2021, VSE is the exclusive global distributor for more than 150 line-replaceable units and 1,600 landing gear accessories, supporting current and in-production Boeing and Airbus platforms.

Our unique value proposition, including our OEM-centric supply model, technical expertise and ability to manage complex global distribution programs positions us as the ideal partner and provided us with a significant win following a highly competitive process.

Within Federal & Defense, we won multiple new contract and re-compete awards during the third quarter, supported by increased bidding activity and business development. To that end, contract bidding activity increased 46% for the nine months ended 2020 versus the same period in the prior year.

Within our Fleet segment, we continue to build our commercial and e-commerce fulfillment strategy during the third quarter, which realized exceptional growth in the period. While our U.S. Postal Service revenue declined, both commercial and other government customer revenue increased during the quarter.

More specifically, commercial revenue increased by more than 100% on a year-over-year basis. Looking ahead, we intend to continue to expand our non-government customer base through a multiyear strategy driven largely by distribution to support commercial fleet sales and e-commerce fulfillment.

The introduction of new product and service lines in niche markets remains an integral part of our long-term organic growth strategy. Earlier this year, we launched our new multiyear landing gear initiative. Under this initiative, VSE developed a comprehensive landing gear suite of solutions for global, airline and MRO customers.

This suite includes services such as gear sales, exchanges and repair management as well as the distribution of proprietary and specialty products, kitting and other just-in-time value-added services.

We believe this solution suite will be unique in the market and one that simplifies the supply chain process and reduces working capital requirements for customers. Our recently announced $100 million distribution contract will serve to accelerate this initiative.

In addition to the organic growth initiatives under way, we have also begun to evaluate inorganic growth opportunities. We recently launched a disciplined acquisition divestiture initiative to identify assets with the potential to expand our product, customer and service capabilities.

Under this initiative, we will seek to acquire high-quality accretive assets that fit within our current business structure and that help us advance our previously communicated strategies.

We currently have an active pipeline of potential targets that are under evaluation, and we believe that the current market volatility has the potential to create opportunities. Now moving on to slides 4 through 7 for a review of our third quarter results.

Our Aviation, Federal & Defense and Fleet segments each reported sequential quarter revenue growth in Q3, excluding the previously announced divestitures and a nonrecurring PPP order for a government customer.

We generated strong adjusted net income and free cash flow from operations for the third consecutive quarter, supporting a $10.4 million reduction in our debt outstanding during the quarter.

On balance, we performed well in a period of continued market disruption while remaining focused on new business development, cost controls and disciplined capital management.

As we look ahead to the fourth quarter, Aviation is expected to achieve a second consecutive quarter of revenue growth driven by share gains and a gradual recovery in the business and general aviation market.

It is anticipated that our Fleet segment will perform in line with its Q3 performance, excluding the nonrecurring PPP order from earlier this year, coupled with a stronger Q4 for our core USPS business. Within Federal & Defense, we anticipate a mid-single digit sequential percentage decline in revenue for the quarter.

Overall, as shared previously, we anticipate that VSE will generate positive net income. And, although there are significant working capital requirements in Q4 to support our newly awarded landing gear contract, we anticipate positive free cash flow for the full year 2020.

As previously announced, our longtime CFO, Tom Loftus, intends to retire at year-end. Tom has experienced a long career with VSE, having joined the company in 1978. And during his more than four years of service, Tom was integral to the growth and development of the organization.

Although his work is not yet done, on behalf of the entire team, we wish him a long, happy and well-deserved retirement. In October, we announced the appointment of Steve Griffin as our incoming CFO.

Steve comes to us from GE Aviation where he spent more than a decade in senior finance leadership roles, most recently as Chief Financial Officer of Engine Services. In this role, Steve led the financial organization for a $15 billion engine overhaul repair and parts sales division.

Steve will officially join VSE mid-November to ensure a seamless transition, ahead of Tom's retirement. Also in October, we announced the appointment of Ben Thomas as our new President of the Aviation segment, a role I've managed on an interim basis since April.

Ben is an aviation industry veteran with deep experience in the aftermarket distribution and services sectors, having previously led a $2 billion global product line strategy and integration team at Boeing Global Services and KLX Aerospace Solutions.

I welcome Steve and Ben to VSE, and I look forward to the leadership and experience they bring to our organization to support our company as we enter our next phase of growth. With that, I'll turn the call over to Tom Loftus to discuss our third quarter financial performance in more detail..

Thanks, John. Turning to Slide 5. Our third quarter revenue of 165.5 million decreased 16.5% year-over-year as revenue declines in Aviation and Federal & Defense were partially offset by growth in our Fleet segment.

Excluding the previously announced divestiture in our Aviation segment and the nonrecurring COVID-related PPE order in Fleet, each segment reported sequential quarter revenue growth in Q3 2020. Slide 6. We reported adjusted net income of 6.8 million or $0.62 adjusted EPS this quarter compared to 10.9 million or $0.99 adjusted EPS in Q3 of 2019.

Adjusted EBITDA declined to 18 million in the third quarter 2020 versus 24.5 million for the same period in 2019. We generated 11.3 million in free cash flow during Q3 and paid down 10.4 million in debt this quarter. Now turning to Slide 7.

During the third quarter, our Aviation segment revenue was impacted by lower revenue passenger miles given the pandemic-related decline in air travel, which resulted in lower demand for aftermarket parts supply and MRO support.

Federal & Defense revenue declined in the third quarter due to the expiration of a contract with the DoD in the first quarter of 2020, while Fleet's revenue increased due to higher sales in the commercial and e-commerce fulfillment markets, together with the completion of the nonrecurring PPE order from a government customer.

Now I will discuss each of the three operating segments, starting with Slide 8. Excluding the divestitures of Prime Turbines and CT Aerospace, Aviation segment revenue declined 26% year-over-year to 36.2 million in Q3, but on a sequential basis increased 16% when compared to the second quarter 2020.

The Aviation segment recorded operating income of 1.6 million in the third quarter versus operating income of 6.6 million in Q3 2019. Segment adjusted EBITDA declined 76% to 2.4 million in the third quarter of 2020.

On a sequential quarter basis, Aviation's adjusted EBITDA increased 1.2 million, doubling the adjusted EBITDA for the second quarter of 2020. Turning to Slide 9. Revenue from our Fleet segment increased 15% year-over-year to 63.7 million in the third quarter, while operating income decreased 16% year-over-year to 6.6 million.

This segment continues to successfully execute on its customer diversification strategy with commercial revenue growing 6.5 million or 107% in the third quarter on a year-over-year basis. Fleet segment adjusted EBITDA decreased 15% year-over-year in the third quarter to $9 million due to a change in the mix of products sold.

Excluding one-time PPE order, adjusted EBITDA margin was 15.9% for the quarter. Slide 10. Our Federal & Defense segment revenue declined 22% year-over-year to 65.6 million in Q3, while operating income increased 49% year-over-year to 6.7 million.

Adjusted EBITDA for this segment increased 41% year-over-year in the third quarter to 7.4 million due to a more favorable contract mix. In the third quarter, our Federal & Defense bookings increased 24% year-over-year to $83 million, resulting in a book-to-bill ratio for Q3 of 1.3 with total backlog of $177 million.

The decline in funded backlog was attributable to the expiration of a previously referenced DoD contract in January, together with delays in new business awards.

We continue to focus on revitalizing this business with an emphasis on growing backlog and developing a channel of new customer activities in the current year, as is evidenced by the year-over-year increase in bidding activity John referenced earlier. Turning to Slide 11.

At September 30, 2020, we had $190 million in unused commitments available under our $350 million revolving credit facility that matures in January 2023. Our existing credit facility includes a $100 million accordion provision.

We continue to pay down debt during the quarter and ended Q3 with total net debt outstanding of 249 million and 81 million of trailing 12 months adjusted EBITDA. With that, I'll turn it back over to John..

Thank you, Tom. You have been a great partner to me in my brief time here, and I'd like to publicly thank you for everything you've done to support the team and me and this business for so many years and for your support with the transition over the months to come. On behalf of all of us at VSE, we wish you all the best in your retirement.

In closing, I want to thank our investors and employees for their ongoing support of VSE. During periods of great uncertainty, strong businesses find a way to capitalize on market inefficiencies while creating new opportunities for profitable growth.

Today, VSE is a stronger and more competitive organization than it was a year ago, and I am proud of what our team accomplished. During the third quarter, we generated strong results and clear progress on our long-term strategy, specifically with regard to new business wins, which will support us in 2021 and beyond.

Operator, we are now ready for the question-and-answer portion of our call..

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions]. Our first question is from Mike Ciarmoli with Truist Securities. Please go ahead..

Good evening. This is Pete Osterland on for Mike. Thanks for taking my questions. A couple questions on the Aviation segment.

Could you break out the sequential change you had during the quarter for repair as well as distribution sales within Aviation? And then what are your expectations for booking trends near term just based on the latest you've seen from order patterns and customer inquiries?.

Sure. First, thanks for the flexibility today. That outage this morning was obviously quite unplanned and unfortunate, but I appreciate you making the time this evening for us. Tom, if you want to – we're going to file the Q tomorrow, I believe, and that has the disaggregated revenue from both distribution and the MRO business.

But Tom, do you want to walk through the changes we saw quarter-over-quarter, and then I'll talk a little bit about the trends?.

Yes. In fact, the 10-Q we filed it just about – I think about an hour ago, half hour ago. So it should be out there. But the repair and distribution split for Aviation, the 36.2 million was pretty much 50-50 for Q3. Comparing it to June of the second quarter, we were about 52% repair and 48% distribution.

So of the 32.2 million we had in Q2, it was like 52-48 and we're pretty much 50-50 in Q3 of 2020..

Thanks, Tom. So essentially, we're up about 27% from Q2 to Q3 in distribution and about 7% on the MRO side.

From a bookings perspective, we're seeing similar trends in – as Q4 kicks off to what we saw in Q3, which is stronger bookings from our business in general Aviation customers and slightly weaker bookings in comparison to our commercial aerospace customers.

We're also seeing the distribution business continuing to have stronger backlog and bookings than the MRO businesses at this time..

Great. Thanks. And then just one more.

How should we think about the new five-year $100 million landing gear contract? Is it – the timing be like 20 million per year that would support some pretty strong growth in 2021, or if not just what are the mechanics of the deal and the timing of realizing that 100 million?.

Sure. Yes. We've got to go through a transition and implementation, so I would not expect to see that 20 million run rate in year one. I would expect to see kind of a mid – more of a mid-teens run rate for the revenue to start picking up, obviously scaling up throughout the year.

So expect a small number in Q1 and do it to start to scale up from Q2 and throughout the rest of the year. But essentially, that 20 million run rate is about right, but the back years will be a little stronger just because of implementation..

Great. Thank you very much..

Our next question is from Josh Sullivan with Benchmark. Please go ahead..

Hi. Good evening..

Hi, Josh..

Just a follow up on the landing gear contract. It seems like a perfect fit for you guys. Can you just talk a little bit how that came together, maybe how it's a model for some other verticals you might get into? Obviously, you're probably going to build a network here.

What do you think the bigger opportunity is here for landing gear and then using that as a model maybe for some of the other things you're going to do?.

Yes, I appreciate the question, Josh. There's two elements that I kind of like to highlight. First is we've spoken about the value proposition and where we fit in, in kind of the supply chain.

And our goal is not to just be another commoditized distributor or MRO provider, but it's to provide something different in terms of what we can provide in the market. And from a distribution perspective, that's solely focused on the aftermarket and it's a little bit more technical in nature and not a PMA house.

I think we've got a unique value proposition in what we can offer. With regard specifically to landing gear, we kind of did a soft launch earlier this year, built a small team which we're continuing to expand on kind of an organic strategy to support where we saw some gaps in the landing gear market.

And we had some successes with some revenue in the third quarter as well. We launched this earlier in Q2.

So this, coupled with this new agreement, we feel will give us new opportunities both for additional parts sales outside of this – the contract that we announced here, some repair opportunities, not to do full landing gear repair but to do some more component type prepare and then to do some of the other kind of value-added services that we see some gaps into the market.

So expect us to communicate more. In a marketing term, we will put out a full press release earlier in the year of kind of what this looks like and what the market kind of expect for us in terms of not just this deal but how we couple in other products and services to support the landing gear market..

And then just as far as kind of working capital needs for that 20 million a year, what should we be thinking about as you build it up through this year and maybe at an annual run rate?.

Yes. I don't want to give the annual number because I don't want to give out the margins, but I'd say it's a double-digit margin, operating margin business that we're going to be operating here. But say in the near term, we do have some initial ramp, so expect a working capital need in the fourth quarter but more likely in Q1.

I'd say expect us to – we really want to perform well through this transition. So I'd expect about a $20 million purchase between, let's just say Q4 and Q2 in terms of the initial ramp to get the program running..

Got it. And then just switching over to Fleet. You obviously had some pretty significant growth on the commercial opportunity there.

Can you just talk about the types of customers you're finding who are finding value in this offering? And maybe has that changed at all when you initially launched, or just how is that program coming together?.

Yes. The Fleet business is and was an outstanding business prior to my arrival here. They were really focused mostly on the U.S. Postal Service and the Department of Defense. So they were just starting this commercial expansion.

So they've got the infrastructure both from a supply chain and logistics perspective to expand in – and the systems perspective to expand into this commercial market. Really there's three elements to it. There's a full just-in-time program where we manage kind of a full supply chain solution for a customer.

There's more of an e-commerce and e-commerce fulfillment-type model. And then there's pure transactional sales. I'd say where we see the biggest area of growth right now is on the traditional distribution and on the e-commerce-type model. Our just-in-time model, really it's difficult to get inside of a customer today to do implementations.

But we really feel that value proposition now more than ever is because it's much more cost of capital base, not just piece price-focused. It's something that our core customers really will gravitate towards and we expect to see more movement on that in 2021.

But the majority of the growth here you saw is from the traditional distribution and more e-commerce side of the house..

Got it. And then just one last one on – go ahead..

No, I was just going to make another comment about customers. To highlight the customers there and the way it operates is our just-in-time model is really to the larger fleet customers, people who really have a larger fleet of vehicles and where you see the e-commerce and more pure distribution if you think of a tail, the longer tail of customers.

So the different customers kind of are attracted to a different model..

Got it. And then just one last one on the Aviation outlook. We're looking at some COVID numbers that are picking up here.

How do you think that plays out in a business jet and general aviation market? Do you think we might actually see some more utilization there as people want to get off commercial flights or just how are you guys thinking about a resurgence of COVID?.

Yes. I think the market is – what we're seeing is it's a plateau that's slowly, slowly just organically improving, but it's not a dramatic curve of improvement. We do see – continue to see business in general aviation perform stronger than commercial. We're looking at the end of October here.

Our bookings in business and general aviation, both on the MRO side and on the distribution side, continue to be strong and are improving from the third quarter in comparison to the commercial business.

So we feel comfortable that we will perform stronger in Q4 than we did in Q3, still trying to get our arms around what we think will happen in the market in 2021..

Got it. Thanks for the time..

Thank you..

This concludes the question-and-answer session. I would like to turn the conference back over to John Cuomo for any closing remarks..

Yes. Thank you so much for making the time today, especially this evening. Sorry, again, about the difficulties this morning. I appreciate your continued interest in VSE, and wish you all a good evening. Thank you..

This concludes today’s conference call. You may disconnect your lines. Thank you for participating and have a pleasant day..