Greetings, and welcome to the VSE Corporation First Quarter 2021 Conference. 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, Noel Ryan, Investor Relations. Thank you, Noel. You may begin..

Thank you. Welcome to VSE Corporation's first quarter 2021 results conference call. Leading the call today are our President and CEO, John Cuomo and Chief Financial Officer, Steve Griffin. The presentation we are sharing today is on our website and we encourage you to follow along accordingly.

Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in our periodic reports filed with the SEC.

Except as required by law, we undertake no obligation to update our forward-looking statements. We are using non-GAAP financial measures in our presentation. The appropriate GAAP financial reconciliations are incorporated into our presentation where available, which is posted on our website.

All percentages in today's discussion refer to year-over-year progress, except where noted. At the conclusion of our prepared remarks, we will open the line for questions. And with that, I would like to turn the call over to John Cuomo for his prepared remarks..

Thank you, Noel. Welcome everyone and thank you for taking the time to join our call today. Let's begin on slide three of our conference call materials. During the first quarter, we continued to successfully advance our business transformation.

We had strong progress through organic market share gains, including new wins in all three of our business segments, expanding our products and service offering as well as inorganic growth from our HAECO Special Services acquisition.

Our change management and business transformation initiatives have begun to yield tangible results, as evidenced by these new business wins, expanded relationships with commercial and government customers, and improved organizational and operational efficiency.

We generated sequential revenue growth across all three business segments during the first quarter, while achieving another consecutive quarter of profitability. Recovery in Aviation remains ongoing.

Aviation segment revenue grew 15% on a quarter-over-quarter basis, outpacing the market recovery and represented our third consecutive quarter of growth in the segment. Aviation distribution revenue returned to pre-pandemic levels during the first quarter. Turning now to slide four.

Earlier this month, our Aviation segment announced a major engine accessories and distribution agreement building on our partnership with one of the leading global aircraft engine manufacturers serving the business in general aviation market.

Under the terms of this $1 billion, 15-year agreement, VSC will be the distributor for more than 6000 flight critical engine components. We expect to service more than 5000 US base aircraft with on demand flight critical components on a 24/7 basis to support scheduled line maintenance and aircraft on ground events.

This agreement is transformational for VSE Aviation for a number of reasons.

First, it affords us the opportunity to deal directly with a large phase of business jet owners, operators and maintenance providers supplying critical engine components and on-demand part and repair solutions, which further advances our business in general aviation market focused strategy.

This direct-to-consumer approach will position us to provide complimentary product and service offering and support long-term market share gains within this attractive customer vertical. Once this program is implemented, there will be new cross-selling opportunities within the fragmented and underserved business ship market.

Second, this agreement significantly expands our scope of services to include more than 100 business in general aviation and regionally aviation engine platforms. With this OEM partnership, we intend to expand our existing business in general aviation repair capabilities to service additional engine accessory exchange units.

Finally, the agreement provides long-term contract revenue at attractive margins, consistent with our strategic focus on building a pipeline of higher value flight critical business. We currently expect program revenue from the agreement to be approximately $12 million in 2021 and $45 million in 2022.

Once fully implemented, this program is anticipated to generate more than $60 million in annual revenue. Implementation work is underway, and initial deliveries under the program will begin in June of this year.

On a strategic level, this agreement is similar to the acquisition of a new business, one that requires full integration into our existing operations. However, unlike a new business acquisition where integration, customer and supplier risk is always a factor, this agreement brings a stable long-term relationship with a major engine OEM through 2036.

Additionally, it's a transaction with strong historical financials and a low-risk profile.

VSE Aviation was selected for this agreement because of our unique business in general aviation market focus, and value proposition that combines proven distribution capabilities, and experience managing complex global supply chain for highly technical products, together with our extensive business in general aviation MRO capabilities.

I want to take a moment to recognize the Aviation team for its many efforts in winning this contract, and I look forward to building upon the current momentum evident in this business.

Turning to a review of our Fleet segment, Fleet revenue increased approximately 3% in the first quarter, driven by continued growth in commercial fleet demand, and our e-commerce fulfillment business.

Total commercial revenue, which excludes US Postal Service and government-related revenue, increased 64% on a year-over-year basis in the first quarter of 2021, driven by increased sales in the e-commerce fulfillment and commercial fleet channels.

Commercial revenue represented 26% of total Fleet revenue in the first quarter of 2021 versus 17% in the prior year period, testimony to our customer diversification strategy for this segment.

Our Federal and Defense business had a solid quarter with revenue up about 1% versus the prior year, as new wins served to offset previously announced contract expiration.

In April FDS, announced $37 million in combined new contract awards with the US Air Force and an allied foreign military, as the business continues to make steady progress on filling its pipeline with new multi-year contracts.

These contract award reflect the continuous execution of our Federal and Defense segments vehicle and Aviation MRO strategy introduced last year, one that emphasizes multi-year growth and higher margin segment backlog.

We are pursuing additional niche MRO opportunities, as we leverage our technical expertise and proven project management capabilities with new and existing customers. As mentioned last quarter, we closed on the acquisition of HAECO Special Services or HSS on March 1.

In the first 60 days since closing the transaction, the integration of this business has moved forward quickly and seamlessly. It's a 275 HSS team members performing ahead of plan as part of the VSE family.

We currently anticipate this business, which historically has achieved an operating margin profile above that of the Federal and Defense segments average, will be a strong contributor to revenue and profit for the segment. I will now turn it over to Steve Griffin for a review of our financials..

Thanks, John. We will now turn to slide five of the conference call materials for a review of our first quarter results. We reported $165 million in revenue for the first quarter, down 7% from the prior year period. However, excluding the 2020 divestitures within our Aviation segment, revenue declined less than 3% on a year-over-year basis.

Importantly, VSE revenue grew 10% as compared to the fourth quarter 2020, as all three segments grew in a sequential quarter-over-quarter basis. This growth was propelled by both continued market share gains with existing customers and new business wins, particularly as we expand both our distribution and MRO capabilities.

On slide six, we detail the revenue and adjusted EBITDA walk sequentially from fourth quarter 2020 and versus the prior year period.

Sequentially, Aviation segment revenue and profit improved total company margins, while Federal and Defense segment margins drove a reduction and our adjusted EBITDA rate, as expected driven by favorable contract close outs in the fourth quarter of 2020.

Versus the prior year period, our adjusted EBITDA margin rates declined primarily by COVID-19's impact on global revenue passenger miles. We anticipate that the Aviation segment will continue to improve its profitability throughout 2021.

Turning to slide seven, Aviation segment revenue increased 15% on a sequential quarter-over-quarter basis, representing the third straight quarter of revenue growth. Segment adjusted EBITDA improved 61% sequentially.

Aviation segment revenue was approximately 12% below pre-pandemic levels in the first quarter, when excluding previously announced divestitures.

Aviation distribution revenue increased on both a sequential and year-over-year basis, driven by improved business in general aviation and narrow-body demand while our aviation repair business grew 18% versus fourth quarter 2020.

Turning to slide eight, Fleet segment revenue increased 3% year-over-year and was up 1% versus the fourth quarter 2020, as higher commercial revenue offset the decline in the Department of Defense and other government work. Commercial revenue increased 64% versus the first quarter 2020, driven by a 115% increase in e-commerce fulfillment revenue.

While our commercial revenues are, on average, slightly lower margin than the USPS business, we remain focused on driving absolute growth in EBITDA dollars through commercial markets, given what we believe remains a significant growth opportunity for us.

Turning to slide nine, Federal and Defense segment revenue was flat year-over-year, but increased 15% for the fourth quarter 2021. First quarter revenue benefited from a combination of US Department of Justice task orders and the recently acquired HSS business that we acquired on March 1.

HSS contributed approximately $3 million to the Federal and Defense business in the first quarter of 2021. Consistent with the strategy outlined last year, we remain focused on growing both bookings and backlog within the segment, particularly within higher margin value-added offerings such as those provided by HSS to military customers.

Turning to slide 10, given our recent new business wins, including the $1 billion engine accessories agreement John referenced, the current year will be a period of significant working capital investment, as we purchase inventory to support new customer programs.

During the first quarter, we invested approximately $35 million in inventory to support new programs, including $20 million related to the engine accessories agreement and $15 million related to new distribution deals previously announced.

As we look to the remainder of 2021, we anticipate investing an additional 35 to $40 million in new inventory to support the new engine accessories program, as disclosed in our press release. Given the extent of our planned investment in new programs, we expect to be free cash flow negative for the full year 2021.

However, as we look ahead to 2022, we anticipate cash conversion will accelerate meaningfully positioning us to reap the benefits of these initial investments. At the end of the first quarter, we had $167 million in cash and unused commitments under our $350 million credit facility.

Net leverage ratio increased to 3.7, as strong first quarter Aviation 2020 EBITDA was replaced with 2021 results. This metric does not take into consideration the prior period EBITDA from our recently acquired HSS business. And as we continue to recover our Aviation business, we expect net leverage to return towards 2020 levels by year end 2021.

With that, I'll turn the call back over to John..

Thanks, Steve. In summary, our first quarter results were strong, particularly given lingering pandemic-related headwinds. We achieve sequential revenue growth across all business segments, while continuing to lay the groundwork required to capture additional share in higher value segments of the market.

Our leadership team has completed a successful immediately accreted bolt-on acquisition while winning several new contract awards, including a transformational business in general aviation engine components.

While 2021 will be a period of working capital investment for our company, we view these investments as foundational for what we expect will be significant, high value growth within higher margin markets for VSE in the years ahead. I am proud of the exceptional efforts put forth by our team.

I look forward to announcing additional progress as we continue to build this leading aftermarket services business. Operator, we are now ready for the question-and-answer portion of our call..

[Operator Instructions] Our first question comes from Ken Herbert with Canaccord. Please proceed with your question..

Good morning, John and Steve..

Good morning, Ken..

Good morning..

John, I first wanted to ask about the distribution agreement you just signed on the - for the business jet engine accessories. Congratulations on that.

Can you talk about the margin profile of that agreement? I appreciate all the detail on the top line implications but how do we think about the drop down of that agreement in sort of the back the rest of this year and into '22?.

Yeah, I mean, for competitive reasons, I don't want to publicly share kind of what the margin profile is. Steve, how would you kind of guide Ken a little bit on that, how to look at it..

I would say it's going to be in line with how we talked about that business in terms of its long-term profile. I think we've been pretty public about saying where that business is at and getting back to pre-COVID levels.

I think you should - we've gone out and explained a little bit more about first, the fiscal year '21 of being about $12 million in revenue. There are some costs associated with getting the business up and running.

So, just thinking about, it's not going to have meaningful contribution in the year but we're going to need to ramp a program headed into 2022 and beyond..

Okay, that's helpful.

And then second, on that agreement, can you talk about the pipeline of similar agreements? I would imagine, again, as we've talked, now's a time to maybe take share as OEMs, face a challenging marketplace, but without specifically predicting when we could hear about more of these, but what are the conversations like with OEMs now across the across the business? And how should we think about additional opportunities in the pipeline?.

Yeah, I mean, we feel very good about the backlog pipeline, and the visibility and pipeline in all three of our business segments right now. It's been a tremendous focus of mine for the last two years and starting to really see the pipeline of activity really start to build.

I would say, for Aviation, yes, we're focused on building the pipeline but we do now have a few really significant awards. And it's - you'll see a little bit more of a balanced, as we move forward this year, of new awards along with the talking about executing on these awards.

I mean, I want to start to generate the revenue and earnings that from the piece of paper that we put out in our press release. So it's it'll be a balance of execution and new awards. But we do feel very good about the pipeline of awards, I would say that they're not as large as the one that we just announced. That is a very rare size of a deal.

But there are many large awards out there with a variety of OEMs..

Great, thanks.

So just finally, Steve, is there anything we should keep in mind across the segments, as we think about sequentially here from the first to the second quarter?.

Well, Ken, we haven't given guidance, obviously, but what we've gotten back to the start of the year, I think we would hold to, which is that we're expecting the Aviation business to grow sequentially every quarter. So we demonstrated that here in the first quarter, we're expecting that to continue.

And then we broadly just said that we expect the businesses, all three of them to grow throughout. And I think if you look at the first quarter results in terms of looking at the second half the year, they're all going to have to grow to get there but we're still confident in that as our overall qualitative guidance for the year..

Okay, perfect. I'll pass it back there. Thank you. Nice quarter..

Thanks Ken..

Thank you. Our next question comes from Michael Ciarmoli with Truist. Please proceed with your question..

Hey, good morning, guys. Nice results..

Good morning, Mike..

And thanks for taking the questions. Just to stay on that last question Ken was asking. I think, you obviously have given guidance, but the qualitative from last quarter, you talked about that 40/60 EBITDA splits, some new contract acceleration.

Obviously, the only item that that seemingly changes as the free cash flow, just given the inventory investment, which is well explained, but those general EBITDA splits still hold..

Yep, we're still holding to the guidance that we gave earlier, it was 40% first half, 60% second half, and then we've given some updated information in regards to inventory most predominantly driven by this OEM deal..

Yep. Perfect.

John, simple question but I don't know, how and why did you guys win this contract? Maybe can you point us to what the value proposition was? Was there a lot of competition for this or what do you think enabled VSE to secure this deal?.

Sure, a couple of things. First, we will announce more details about the OEM and the like in the coming months. We really want to align that with the customer communication. This is a current deal that's managed in house by the OEM. They're managing the aftermarket support in house and this was a desire to outsource.

And again, as I've spoken about in the past, some of the opportunities that we found through COVID was people have time to focus on some of these strategic initiatives that they wanted to execute. It was a competitive process. There were others involved.

I'd say, for us the biggest differentiator that we offer, this is predominantly business in general aviation work and we have a tremendous amount of history and success on our distribution business and managing complex DG&A programs, including engine type programs, and the life programs and the like, as well as our MRO shop in Kansas that's an OEM focused engine accessory shop for business in general aviation, that does exchanges and MRO activity.

So the combination of those two and the long history that we've had with this OEM, really enabled us, I think, to differentiate ourselves from our peers out there. And really excited about the program, the size of the program, and what it will do for our business in general aviation business, meaning now we'll have access to the entire customer base.

And to me, what I love about this deal it is very similar to the landing gear deal that we announced, it is not just we announced what the deal looks like itself but it's much more about everything that we can attach to it once we get it implemented and those opportunities for bolt-ons and add-on product lines..

Got it? And I wanted - that's a good segue. I wanted to ask about those cross-sell opportunities.

So do you think there's any, I'll call it, maybe an elephant type contract out there that you just secured or is this going to be more low hanging fruit with individual operators, individual owners or how do you think these kind of cross sell and upsell opportunities play out?.

Yeah, and I think that we've got a - you'll hear more from us in the coming months about the strategy, not just around this program, but around business in general aviation customers, and what we plan to do there.

And we definitely see an opportunity to cross sell and see an opportunity, as Ken mentioned, where are the pipeline of deals, many of the pipeline deals are coming when the OEMs understand now, exactly where we play, and how they can fit into that strategy.

So some of that is even reactive, where we're getting the calls now to say, we think our product line will fit very nicely in what you're doing..

Got it. Got it. Last one for me, and then I'll just get out of the way. It sounds like the distribution side of the business leading the recovery in the business, general aviation.

What do you think? What are you seeing? What are you hearing? Is that a lot of restocking? Were inventory levels low? Or was there a lot of deferred maintenance? What kind of color can you provide us with on that nice distribution growth that was certainly leading aviation there?.

Yeah, I mean, two things. Number one is our business is predominantly proprietary product. It's more expensive product, so it is not necessarily the amount of product out there at customer locations, which is very different than what I've done in the past. It's nice to see, it helps the recovery a little faster.

The second is obviously, it's coupled with some of the new business wins and the execution on those wins. And we've kind of said, that's a lot the normal market recovery and then our ability to outpace that with the new wins.

And we are starting to see, I've said that the MRO business was lagging a little bit and we are starting to see a lot more positive signs in that business as well..

Got it. Perfect. Thanks, guys. I will turn back in the queue..

Thanks, Mike..

Thank you. Our next question comes from Louie DiPalma with William Blair. Please proceed with your question..

John and Steve, good morning..

Good morning..

Good morning..

The engine accessories deal seems transformational from an operational perspective. You estimated how revenue can scale or will scale up to $60 million per year. Just to be clear, does that run rate include the potential revenue synergies from cross selling and bolt-on or is the cross-selling additive at $60 million -.

Yeah, cross selling as additive. So that just represents [indiscernible]..

Got you.

And when including this deal at a $60 million run rate, are you able to estimate what fraction now of your total aviation business is like business jets and general aviation versus no commercial and cargo and other segments?.

Yeah, well, we were not ready to share that information. Most likely, as we talk about 2022, we'll probably share a little bit more color on what those markets look like, as I just said a little earlier, will continue to share more details on the business generalization strategy.

And as we get towards the back end of the year, we'll share a little bit more color on - we now break out the MRO and the distribution business in the filings and we'll start to share a little bit more color on what the markets look like as well. But we're not we're not prepared to do at this point..

Sounds good. That makes sense. And switching quickly to the Federal and Defense business, a 15% sequential step up in revenue; it seems that business has stabilized after last year's turn.

Is the run rate that you achieved for revenue in the first quarter, should we expect that to be sustainable for the rest of the year?.

Yeah, Louie. So we have gone out in the first quarter, we communicated that you should expect all three of our business segments to grow year-over-year. And so I think in order for us to do that this would have to be a sustainable rate, so we feel confident in saying that.

I will say though that we've communicated it, it is a little lumpy at the top line. And we've communicated there are some larger contracts that sort of move in and out. But I think we're expecting this business to start to recover here nicely..

Great. Thanks, Steve. Thanks, John..

Thanks, Louie..

Thank you. There are no further questions at this time. I would like to turn the floor back over to John Cuomo for closing comments..

Great. Thanks, everybody for joining our call today and appreciate the continued confidence in the business and we look forward to speaking with you in July after our second quarter. Have a great day..

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful day..