Vse Corp Q1 FY2020 Earnings Call

Greetings. Welcome to the VSE Corporation First Quarter 2020 Results Conference Call. All participants are currently in a listen-only mode. I will now turn the call over to Elizabeth Huggins, Corporate Vice President of Strategy, and Chief of Staff. You may now begin.

Thank you. Hello, and welcome to VSE Corporation's first quarter 2020 results conference call. Leading the call today are our President and CEO, John Cuomo; and Chief Financial Officer, Tom Loftus. Thank you in advance for bearing with us as we make this all from remote working locations and for your patience with any delays we may experience in the transition to Q&A. The financial performance and strategic overview presentation we are sharing today is on our website, and I encourage you to follow along accordingly. Please note, that during the first quarter of 2020 the company renamed its reporting segment to reflect the strategic focus to each business moving forward. The Aviation Group was renamed Aviation segment, the Supply Chain Management Group was renamed Fleet segment, and the Federal Services Group was renamed Federal & Defense segment. 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 as noted. At the conclusion of our prepared remarks, we will open for questions. Please email your questions to questions@vsecorp.com, and we will answer as many as possible during the allotted time. Again, that's questions@vsecorp.com. With that, I would like to turn the call over to John Cuomo for his prepared remark.

Thank you, Elizabeth, and welcome everyone and thank you for taking the time to join our call. Today, we will begin by providing an overview of our recent results, including an update on our COVID-19 mitigation strategy. Tom Loftus, our CFO, will then provide a detailed update on our financial performance. I will then introduce our new corporate strategy, a framework that we believe positions our company for long-term profitable growth. As Elizabeth noted, we will conclude with a question-and-answer session. We will begin on slide three of the conference call presentation. VSE reported strong first quarter results highlighted by year-over-year growth in revenue, margin capture, and profitability. Total revenue increased 4.4% year-over-year, ending the quarter at $177.4 million. Our total adjusted net income increased 32% year-over-year to $9.8 million or $0.89 per adjusted diluted share. Adjusted net income excludes $6.5 million or $0.59 per share of nonrecurring items related to the sale of Prime Turbines, the sale of a property, and a performance earn-out related to our 1st Choice acquisition. We ended the quarter with total adjusted EBITDA at $22.7 million, up 15.4% year-over-year. Despite the market challenges resulting from COVID-19, we expect to be both profitable and free cash flow positive for the full-year 2020. At the end of Q1, we had $176 million in cash and liquidity, and total net debt of $273 million or 2.9 times trailing 12-month adjusted EBITDA. Before we discuss our first quarter financial and operational performance in more detail, I'd like to share the recent actions taken by our management team in response to the COVID-19 pandemic. Turning to slide four, during this global health crisis the health and safety of our employees remains our top priority. Our team has adapted to ensure business continuity and operational readiness at our facilities. All of our operations are considered critical and essential services, and our operational facilities remain open for business. To date, we experienced very limited disruption to operations or to our supply chain. We are regularly monitoring the specific needs of each of our business segments and responding accordingly. We have implemented remote working everywhere feasible, created social distancing, adhered to personal protective equipment guidelines, and changed our work shifts as we continue to follow the guidance of federal, state, and local health authorities. In spite of COVID-19 we anticipate customer demand to remain relatively stable within our Fleet and Federal & Defense sites. That said, we are already seeing a decline in demand for our aviation products and services, reflective of the decrease in global air travel. As you see on page four, we have taken decisive actions to reduce costs throughout the organization. Importantly, most of these reductions have targeted our Aviation segment given expectations for continued weakening demand for aftermarket parts and MRO services for the remainder of 2020. In April, we implemented a reduction in force and broad-based cuts in discretionary spending, resulting in annualized cost savings of approximately $13 million. We expect to realize partial benefits from these reductions beginning in the second quarter, with the full benefit of more than $3 million quarterly, beginning in Q3 2020. Along with our recent reductions in cost, we have also taken steps to reduce inventory and capital expenditures while continuing to reduce working capital requirements. As previously announced, Paul Goffredi, President of the Aviation segment, will leave the company on May 1. Effective today I will step in as interim president of that segment. This is a business I know well given my nearly two decades as a senior leader of a publicly traded aerospace company. As we will highlight later on the call, we believe aviation remains a significant area of opportunity for VSE, one that we expect will become a core growth engine for the business in years to come. I am supported by a deep bench of experienced executives who understand both the near-term challenges and the longer-term opportunities for our business. As we look to the remainder of 2020, both our Federal & Defense and Fleet segments, which represent approximately 70% of trailing 12-month revenue, are expected to provide a stable base of business that should offset near-term softness in the Aviation segment's performance. These businesses serve a combination of federal and military agencies, and heavy-duty cycle commercial trucking customers, all of whom represent a steady book of business for VSE. To that end, within the last 30 days, we have announced more than $115 million in contracts and awards with customers in both segments, which will contribute to results beginning in Q2 2020. Although our Aviation segment achieved significant market share gains in the first quarter, we anticipate the performance of this segment to be adversely impacted for the balance of the year. Bookings and inputs have declined since March, and we do not anticipate a recovery in 2020. That said, even though we are a market leader in terms of performance and quality, we currently own a very small piece of a very large market. Looking ahead, we see the opportunity to grow our global market share within both aviation product distribution and repair. With that, I turn the call over to our CFO, Tom Loftus, to discuss our first quarter financial performance. Tom?

Thanks, John. Turning to slide five, our first quarter revenue grew 4.4% year-over-year primarily driven by organic growth in our Aviation and Fleet segments. For the trailing 12 months, our revenue is up $70 million or 10%. As illustrated on slides six and seven, our total adjusted EBITDA was $22.7 million, up 15.4% in Q1 2020 compared to the same period of 2019, and our trailing 12-month adjusted EBITDA was $94 million, up 17%, driven by growth from aviation and improved profit margins in our Federal & Defense segment. Now, I will discuss each of our three operating segments starting with slide eight. Aviation segment revenue increased 18% to $58 million in the first quarter of 2020 through balance contribution from both our distribution, product sales, and MRO services. Excluding non-cash, non-recurring costs related to the sale of prime turbine and other assets, Aviation operating income increased 49% to $4.5 million in Q1, while Aviation segment adjusted EBITDA increased 21% to $7.6 million. Year-over-year increase in the first quarter adjusted EBITDA was attributable to organic revenue growth in both the aviation distribution and repair entity. Turning to slide nine, revenue for our Fleet segment increased 3% to $53.2 million in the first quarter of 2020 while operating income decreased 1% to $6.9 million. This segment continues to successfully execute on its customer diversification strategy with commercial revenue growing $4.8 million or 122% in the first quarter on a year-over-year basis. Fleet segment EBITDA decreased 2% in Q1 2020 to $9.6 million. The decrease in operating income and EBITDA was primarily attributable to lower margin, customer and product mix, and investment associated with the expansion of our commercial portfolio. Slide 10, our Federal & Defense segment revenue declined 4% year-over-year to $66 million in Q1 2020 while our operating income increased 45% to $4.9 million. EBITDA for this segment increased 34% in the first quarter to $5.7 million. The increase in operating income and EBITDA in the period resulted from improved performance on existing contracts and an increase in fixed price work for our government client. In the first quarter, total Federal & Defense segment bookings increased 31% year-over-year to $67 million while total funded backlog declined 28% year-over-year to $201 million. The decline in funded backlog was attributable to the expiration of a large army contract in January. For the quarter, our book-to-bill ratio was 1.0. The new segment President and Business development team are already revitalizing this business with an emphasis on growing backlog and developing a channel of new customer activity in the current year. There has been good progress in the first quarter including our recent announcement of approximately $90 million in award on contract and delivery orders with the department of defense. Turning to slide 11, as of March 31st 2020, we have $176 million in cash and unused commitment available under our $350 million revolving credit facility that matures in January 2023. Our existing credit facility includes $100 million of accordion provision. We ended the quarter with total net debt outstanding of $273 million and $94 million of trailing 12-month adjusted EBITDA. As John highlighted earlier, despite the current economic environment we remain highly focused on liquidity, conservation, and debt reduction for 2020. We finished Q1 strong by paying down our debt by $30 million in March 2020. With that, I will turn it back over to John.

Thank you, Tom. As I complete my first journey in this organization, I want to spend the remainder of today talking about our business strategy. You can follow on beginning on slide 17. VSE is a 60-year-old aftermarket business with proven past performance and service excellence. Our new strategy will seek to take the core of that service excellence and expand on it with a unique differentiated value proposition, capable of driving above-market growth in return in each of our segments. Turning to slide 18, we report and operate under three business segments: Aviation, which includes part distribution and MRO services; Fleet, which includes part distribution and supply chain management services; and Federal & Defense, which provides logistics and sustainment services along with MRO services and IT and energy consulting. All of our business segments support aftermarket activities that are associated with supporting customers with extending the life of their critical aging transportation assets. We have a strong balance of stable multi-year government contracts and long-term customer relationships representing approximately two-thirds of revenue, balanced with higher growth potential commercial customers. Turning now to slide 19, VSE offers a unique value proposition to the market. First, we are a pure play independent aftermarket provider of parts and services. That is important because our singular focus is supporting our customers and suppliers. Our attention of resources and capital are not diverted to other strategies, for example, as a core manufacturing company may be. Second, we are specialists, not generalists. We have a highly technical team to support all the transportation assets. We help sustain and provide parts and repair capabilities. We further specialize in end-of-life assets, which provide higher margin opportunities. Third, we've created business units that are agile, lean, and empowered to quickly support both customers and suppliers with industry-leading service and bespoke offerings. Turning to slide 20, a key component of our strategy and growth comes from organic activity. For VSE, this organic growth will be driven by increased market penetration of our current offerings to new customers, specifically new region, product and service expansion with existing customers, targeted new product additions to our distribution portfolios, and expanding our repair logistics and capability service offering. We will speak about inorganic growth at a later date. For now it's important to highlight how we will migrate from the historic practice of acquiring portfolio companies to a model of focused, disciplined acquisition strategy targeting product customer service or geographic expansion, and fully integrating into existing business segments with a financially accretive approach and process. Turning to slide 21 through 23, which includes a deep dive on both strategic and tactical elements for each segment, VSE Aviation provides MRO services and parts distribution, supply chain services, component engine accessory repair services, and roadable to the global aftermarket aviation customer base. Our Aviation segment brings a unique value proposition for independent aftermarket repair and distribution, which allows for greater agility without compromising capacity, quality, or support. Our distribution product offerings represent the strongest OEM partners in the market. Our repair capabilities range from low technical interior repair to highly technical and accessory repair with a full range of component repair capabilities in between. Through this segment's recovery and beyond, our growth will come from service expansion through the addition of new MRO capabilities, distribution product expansion through the addition of new OEM and commodity product offerings and market expansion through targeting new international and defense customers. Turning now to slide 24 through 26, our Fleet segment through our Wheeler Bros subsidiary provides part, inventory management, e-commerce fulfillment, logistics, supply chain support, and other services to support commercial and aftermarket truck fleet, the U.S. Postal Service, and the U.S. Department of Defense. Wheeler is uniquely positioned to provide stocking distribution services, proprietary technology solutions, and just-in-time part delivery to a wide range of high duty cycle and vocational vehicle and fleet owners. Wheeler offers high margin private label parts and utilizes the technical expertise of in-house engineers for reverse engineering, design analysis, short run production, and testing. While this segment continues to progress on its customer diversification strategy with strong commercial growth, we continue to maintain high service excellence with our government customers and remain prepared to support these customers in every way possible to ensure their success. Our growth of this segment will come from the expansion of our just-in-time inventory management solutions and e-commerce fulfillment for new commercial customers, product line expansion including expansion of our private label products, and focus on U.S. geographic expansion, as our commercial distribution is highly regionalized today. This segment continues to successfully execute on the customer diversification strategy. For example, in the full-year 2019 and the first quarter of 2020, commercial customer revenue increased approximately 20% and 50% respectively, supported by increased activity with e-commerce and commercial parts distribution customers. In 2020, you will see us refresh our brand identity for this business as we target clearly segmented commercial markets with our renewed value proposition. Turning now to slide 27 through 29, our Federal & Defense segment provides aftermarket maintenance, repair, and overhaul, or MRO, and logistics services to improve operational readiness and extend the lifecycle of military vehicles, ships, and aircraft to the U.S. Armed Forces, federal agencies, and international defense customers. We also provide both IT and energy consulting services. This segment brings more than 60 years of proven past performance and program execution across land, sea, and air platforms. We offer deep subject matter and technical experience in legacy transportation assets. This year, we are focusing on broadening our offerings and customer base. We are focused on building our backlog while improving our contract mix and balancing our traditional costs-plus contracts with higher margin fixed price contracts. Our two consulting businesses within the segment, Energy and IT services, are focused on aggressive organic growth. In closing, VSE remains a stable investment opportunity in an otherwise volatile market. Our diversified revenue mix includes stable long-term government contracts and higher growth potential customers. That, coupled with our strong balance sheet and ability to generate positive free cash flow in the current year, will help us weather the current environment. Despite the market challenges, we expect to be both profitable and free cash flow positive for the full-year 2020. This strong foundation together with the opportunities outlined today position us for profitable growth in the years ahead. Operator, we are now ready for the question-and-answer portion of our call.

Thank you. I'll now turn the call over to Elizabeth Huggins for today's Q&A session.

Thank you. So we've received several questions about the COVID-19 impact, let's start there. For each segment, could you provide an overview of the COVID-19 impact you currently see? In each segment, what part of your work is considered essential and what isn't?

Thanks, Elizabeth. All of our business units are currently operational. Our consulting services are being conducted remotely, except when they are needed on-site for clients. Our core operations in repair and distribution have maintained continuous functioning without interruptions, ensuring we are supporting our customers. Though we will not provide guidance broken down by segment, I can share some insights on each area. To begin with Federal & Defense, this was intended to be a transformative year for us, marked by new leadership and a renewed focus on enhancing our brand, business development backlog, and future opportunities. Business has remained relatively stable, and importantly, performance has surpassed our internal expectations. We had some new business wins announced this quarter and expect to continue showcasing new wins throughout the year. Our Fleet business, including our Wheeler Bros. subsidiary, as well as our DoD and USPS ventures are performing steadily as anticipated. Additionally, we announced a unique opportunity this quarter to assist one of our customers during this crisis. We project ongoing growth for our organic commercial customers in 2020. Our first quarter was strong, and although we expect Q2 to be slightly weaker, most of our customers—including 3PL truck providers, utility services, and sanitization services—are doing quite well. A complete recovery is anticipated by the third quarter. In Aviation, the impact is evident; airlines globally have grounded their fleets and suspended routes. Our commercial business is directly linked to revenue passenger miles, but we also have significant engagements with general aviation customers. Since we support these customers rather than generating demand ourselves, our focus is on gaining market share. In the first quarter, we achieved an 18% organic growth in that sector. Thus, as we navigate this downturn, we are bolstering our repair capabilities, gaining market share, and introducing new products in our distribution business to help offset the inevitable decline.

Thank you, John. Next question, have you encountered any material parts shortages within your supply chain? Do you have sufficient inventory on hand?

Yes, the first answer is no, there's been no material part shortages. And yes, we have sufficient inventory on hand. You know, as always, there's a few minor parts that we're closely managing. We are a stocking distributor with industry-leading planning organizations. We did procure additional product and we were pretty proactive at the beginning of the year to get ahead of any supply chain concerns. So we do not see supply chain issues or any product shortages impacting our operations going forward.

With regard to the $13 million or so in cost reductions that you mentioned, can you help us understand (a) the types of cost reductions, and (b) where most of the cuts landed by segment?

Yes, Tom, why don't you jump in and answer this question for us?

Okay, sure, John. Of the $13 million in annualized cost reductions, unfortunately most of the reductions came from our existing workforce, about 65%. The rest is from travel, consultants, and other incentive compensation reductions. Part two of that question, our Aviation segment was impacted the most with about half of the workforce reductions coming from that segment. Our other two segments were also impacted as well as the corporate team. We will start to realize the benefits of these reductions in Q2.

Thanks, Tom. Okay, so how do your government-facing businesses perform in the next 12 months; do you anticipate additional contract wins similar to the ones that you recently announced? I know you touched on this, John, but if you'd care to elaborate.

Yes, we have mentioned that this year will be one of rebuilding, but I can assure you it will also show notable progress and results. In the first quarter, we reported a 31% year-over-year increase in bookings from new business awards. While revenues saw a decline of about 4%, operating earnings increased by approximately 45%. This mix supports a strong and profitable year for us. Our primary focus is on naval and army logistics and repair programs within the Federal & Defense sector. In 2020, we plan to expand our capabilities, including taking on more defense aircraft maintenance programs. I'm very proud of the progress our team is making and I look forward to sharing more details and announcing additional awards throughout the year.

Okay. Quite a few questions about the Aviation segment, so we'll try to group these together.

Sure.

As John assumes leadership of the Aviation segment, could he expand on his experience in the previous downturn and how VSE might take advantage of any dislocation?

Sure. I mean I was with an aviation distribution business for about 18 years. So I went through both the 9/11 and 2008 financial and aviation downturn. So I have experience in kind of the two sides of what you need to do here, which is managing the capital requirements and adjustments, if needed, to support the business and support a strong balance sheet through these times, as well as a vision on how to execute strategic initiatives so we could exit the downturn much stronger than our peers. We highlighted today in our strategy presentation the key areas of growth for our aviation business. We haven't adjusted that presentation or that strategy based on COVID-19. So we feel very grounded in the principles of our strategy, and look forward to aggressively focusing on executing them, even through this downturn.

Okay. Can you talk about how your Aviation segment is exposed to the current airline fleet? And if we do see broad-based retirements of older planes how that may affect your growth?

Sure. Our component repair business primarily serves commercial aviation, while our engine accessory repair business focuses on business and general aviation. We have a substantial cargo business within our commercial aviation segment, which is currently performing well for us. We also support all the new platforms. Like everyone else, we are monitoring the retirement of the fleet, but we do not expect it to negatively impact our business. We believe that the trends in total revenue passenger miles will drive the business effects.

Okay. Aviation again, as the airlines grapple with these cost pressures do you believe they will outsource more work to independent MROs in an effort to further cut costs or lean out their cost structure?

Yes, I think there are two reasons that the independent MROs will perform well. I think number one is, yes, they will look for opportunities on how to lean out cost structure. And independent MROs traditionally are able to do that in a more competitive way than their internal shops. The second thing I think that is important to highlight is the technical talent that the industry doesn't want to lose. So I think you're going to see both from the OEMs as well as the aftermarket, that the desire to keep independent teams both supporting stocking distribution, as well as technical repair is critical and important for the industry, and I believe our airline and aftermarket partners will continue to support us to make sure that we're around as well as our competitors in the future.

Okay, and aviation again, compared to your peers, you are in a unique position with the Aviation segment, where they are all pretty much 100% in aviation and is obviously less than a third of revenue. Do you see ways to use the situation to your advantage to grow market share when others are retrenching?

The answer is yes, but first I just want to maybe clear although we're not giving guidance, I don't want to diminish the unprecedented industry decline and the impact it will have on our business, I mean airlines are reducing capacity between 70% to 90%, everyone will feel both near and long-term, midterm I should say impact. That said, we do see a few opportunities in front of us. Not only are we well diversified with our military and truck fleet aftermarket customers, but we're also, as I mentioned earlier, a pure play aftermarket business. In recent years, many OEMs and others have entered what was at that time, a robust aftermarket opportunity. We see many of those businesses kind of contracting to focus on their core, while aftermarket is our core. In the near-term, I would say distribution represents the most and the greatest opportunities for near-term market share gains. I don't want to be kind of qualitative today in the conversations we will share these when and be more quantitative, I should say in the future. I mentioned on our last earnings call or first earnings call that will have a renewed focus on investor transparency, and you'll see some more of that both in how we communicate going forward, but also as we file our 10-Q this week, you'll see a little bit more detail on both our distribution and our repair businesses. So, you can see how they'll perform separately throughout this market downturn.

Okay, I'm not entirely sure if this question is segment specific. I will ask in general terms, what are you seeing in the month of April in terms of MRO and parts demand? Should we think of revenues tracking down with capacity? Do you have any repair work currently in your facilities that may provide some buffer?

Yes, I've only answered in terms of all the segments, we're not seeing any impact on the MRO activity in our federal and defense business. Our fleet business doesn't do any repair. That's a supply chain, parts distribution and logistics business. In Aviation, when you look at revenue, passenger miles on the commercial side, roughly in the month of April, we're seeing our business decline by about half of that. So we do have significant backlog, and again we also entered into that market with an 18% organic growth. So we believe that we'll we know we're performing better than the market today. It remains to be seen how long that will continue, but we do have a good pipeline, we're still winning new business. Obviously then the work is significantly impacted, but right now our business is tracking better than revenue passenger miles at this time.

Okay, thanks, John. This is about our Fleet segment. In recent quarters, we know Wheeler has grown its non-U.S. Postal Service business, which represents approximately 20% of segment revenue. Help us understand the opportunity around this commercial customer expansion and the margin profile of this business?

We are highly focused on our fleet segment, customer diversification strategy, and entering the commercial market, as we mentioned last quarter. Our distribution business operates as a stocking distributor, and we have excellent proprietary systems, including our Just in Time technology, along with significant e-commerce fulfillment opportunities. We are investing in these organic growth opportunities and are pleased with the strong margin and inventory turn profile for our Wheeler Bros Subsidiary in this new market. While it does slightly dilute our legacy business margins as we enter this space, we are increasing headcount and making other investments to support initial organic growth. This is a multibillion-dollar market where we currently hold a very small share, but we believe it will become a profitable, cash-generating growth engine for the segment.

I think we're doing great. Okay, back to cash flow, on the cash flow outlook to be positive for the year, what does the quarterly cadence of cash flow look like?

Tom, do you want to take this one?

Yes, we expect to be cash positive for the year. The timing between quarters sometimes is impacted by certain transactions. For example, like in the second quarter, our cash flow might be impacted by the timing of our recently announced $26 million award, but that will be collected in early Q3 if it's not collected at the end of Q2.

Okay, thank you. What are the foremost strategic priorities for VSE under your leadership, John, over the next 12 to 24 months? Where are you allocating capital and resources to grow the business?

Well, I highlighted a strategic plan today. I know we kind of went through that pretty quickly as we were reporting the results as well, but we will continue to be transparent and share more details with each quarter and talk about the progress on that plan as we go through quarterly results, but when I started with the VSE a year ago, the first thing I noticed is the company's outstanding program on customer execution. The near-term focus has been on how do we take those core competencies and organically grow them through three different ways. First is through a market share gain which is from new customers. And that's for all of our business segments. So, it's really a renewed effort, really targeted business development to sell what is unique about what we do in our business to new customers, our current capability. The second thing is about that capability expansion. So, if you look at what we offer in the federal and defense space again you will see us enter more into that military aftermarket, aviation aftermarket repair. In our aviation business, you will see us expand our core component repair capabilities. So, you will see us consistently focused on maybe some of ecommerce system expansion and the like. So really how do we take our service offerings and focus on core capability development there. And some of that will require some capital as well, and last but certainly not least is new products. So, this is customer we call it share vault gain. How much they are spending on either commoditized or proprietary products that fall within our market basket but are products that we don't sell today. So, how are we going to attack that market and add additional products both sole source proprietary products from new OEM partnerships as well as high-margin and fast-turning kind of commoditized products that we feel are relevant for our portfolios. So in addition, our fleet business we have our private label product growth as well. So, although we are reducing capital spending, we will continue to allocate capital to support the future whether they are products or requirements to support new services.

Okay, John, Tom, that concludes what we have time for today.

Thank you, Elizabeth, and thank you everybody. We remain available by phone and look forward to conferences and in-person meetings with you in the future. With that, thanks for your time today and your continued support and interest in VSE. Stay safe, everybody. Thank you.

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