Vse Corp (VSEC) Q1 2022 Earnings Call Transcript

Greetings, and welcome to the VSE Corporation First Quarter 2022 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the call over to Noel Ryan of Investor Relations. Thank you. You may begin.

Thank you, operator. Welcome to VSE Corporation's First Quarter 2022 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 materially from the projections 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 presentations 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'd like to turn the call over to John Cuomo for his prepared remarks.

Thank you, Noel and welcome to everyone joining us on the call today. We are off to a solid start to 2022 with the strongest revenue quarter for VSE in over 10 years, including revenue growth in all segments and the highest revenue on record for our Aviation segment. Not only was the first quarter a strong revenue quarter for the business but one where we delivered growth in adjusted EBITDA and profitability as well. We've started the year strong with a combination of new contract wins and execution excellence on existing legacy programs. Our business transformation continues as we make progress on our team, systems, and processes. We're on track with our integration activity for both legacy VSE businesses and recent acquisitions, which will support our mission of creating scalable businesses able to capture more of their growing end markets. Three key strategic focus areas will enable us to deliver value for shareholders. First, we are building long-term, higher margin, sustainable revenue channels that capitalize on the strength of the VSE assets and enable us to support our customers in growing end markets. Second, we remain focused on growing profit as we drive scale with our recent and ongoing investments and improve our operations through continuous improvement. Third, we are building on our strong legacy customer relationships to strengthen core revenue channels with our industry-leading customer service and breadth of product and service offerings. The company's first-quarter results demonstrate substantial progress across these strategic initiatives. I'll start by highlighting some of the progress in our Aviation segment. Our Aviation segment reported record first quarter results, highlighted by strong organic revenue growth across both our distribution and repair businesses. Distribution revenue has now exceeded pre-pandemic levels for the sixth consecutive quarter. While repair revenue continues to accelerate, supported by ongoing commercial market recovery and share gains within the business and general aviation market. Aviation segment adjusted EBITDA increased by over 600 basis points on a year-over-year basis to 11.6%, driven by an increased mix of higher-margin repair activity. While commercial air travel levels continue to recover, we expect 2022 commercial MRO market recovery to be slower than initially anticipated. As we look towards 2023, we see incremental growth in commercial MRO activity, which we contribute to further margin expansion in 2023 and beyond. Within Aviation, we continue to build a business in general aviation platform that encompasses a full breadth of products and services, a tip-to-tail approach that builds upon our established MRO capabilities and industry-leading parts distribution business. In March, VSE Aviation through our Global Parts Group acquisition was awarded an early renewal of a three-year distribution agreement with a global OEM valued at approximately $180 million. Under the terms of this agreement, we will remain the global distributor for approximately 30,000 airframe parts, serving approximately 1,000 businesses in general aviation aircraft. The renewal provides for increased multiyear revenue confidence through 2025. We believe our customer-focused performance-based culture, depth of experience managing complex supply chains, and proven technical expertise led the OEM to support an early renewal of this important agreement. Also during the first quarter, our Aviation segment reached an agreement with Honeywell to provide new, commercial OEM authorized repair capabilities, which will expand service offerings and support both legacy and next-generation avionics in commercial markets. As a further example, VSE Aviation distribution was recently awarded the 2021 Regional Channel Partner of the Year for the Europe, Middle East, Africa, and India market by Honeywell in recognition of our high performance and service levels, particularly with respect to the Honeywell fuel control product lines. We are honored by this recognition and remain committed to building upon this long-standing relationship with Honeywell and other global OEM partners, as we grow our scale and expertise across our core commercial and B&GA market. Turning to our fleet segment. Fleet segment revenue increased 22% on a year-over-year basis in the first quarter, driven by strong growth with commercial fleet customers and e-commerce fulfillment sales, together with stable contributions from the U.S. Postal Service. We continued to experience strong demand for aftermarket parts servicing Class 4 through 8 vehicles and heavy-duty trucks across both our commercial fleet and e-commerce fulfillment channels. Fleet commercial revenue increased to 42% of segment revenue at the end of the first quarter, up from 10% at the end of 2019 consistent with our multiyear revenue diversification strategy. Our legacy USPS business was flat on both a sequential and year-over-year basis in the first quarter, given consistent customer spending on the LLV and more importantly, other commercial off-the-shelf fleet vehicles used by the USPS. The USPS has transitioned from the LLV to its planned next-generation vehicle remains a multiyear process, one that our fleet segment is well positioned to support. Importantly, in addition to the LLV, we continue to support and further develop comprehensive part solutions for non-LLV vehicles in the USPS fleet, which remains a significant long-term opportunity for us. Looking ahead, we anticipate further growth within commercial channels. While product cost inflation and higher freight costs remain headwinds within this segment, we continue to invest in labor and facilities to fully capitalize on further anticipated commercial demand growth while optimizing growth in EBITDA dollars. Turning to our Federal & Defense segment. Revenue increased to 8% on a year-over-year basis, supported by contributions from the HAECO Special Services acquisition completed in the first quarter of 2021. In both the fourth quarter of 2021 and the first quarter of 2022, Federal & Defense segment margins declined versus prior year levels, driven by an increased shift in our contract mix from fixed price to cost plus contracts. The Federal & Defense segment continued to build a robust multiyear backlog of new opportunities during the first quarter. Total funded backlog increased by 5% on a year-over-year basis in the first quarter while bookings increased by 46% in the period, given increased customer demand stemming from aircraft maintenance and modernization activities and awards for logistics and distribution services. In March, we were awarded a $100 million 12-month contract by Naval Sea Systems Command or NAVSEA. VSE is the current contractor providing foreign military sales, follow-on technical support to NAVSEA. Under the terms of this contract award and in conjunction with NAVSEA's international fleet support program office, VSE will continue to support eligible foreign navies with a broad range of aftermarket services. Our first-quarter results demonstrate the great progress our teams are making. I am proud of the work of the VSE team, how we supported our customers and partners, and the strong results we produced in the quarter. I will now turn the call over to Steve for a detailed review of our financial performance.

Thanks, John. Now let's turn to Slides 4 and 5 of the conference call materials for an overview of our first quarter performance. We reported $231.2 million in revenue in the first quarter, an increase of 40% versus the prior year period, our strongest revenue quarter in 10 years and revenue growth in all three of our operating segments. Aviation recorded its highest revenue quarter ever, driven by a combination of strong new program execution, share gains within the business and general aviation market and continued commercial end market recovery. Fleet segment growth was supported by commercial fleet and e-commerce fulfillment revenue. Federal & Defense segment growth was driven by inorganic contributions and new business awards, partially offset by the completion of a certain DoD contract in 2021. During the first quarter of 2022, we generated adjusted EBITDA of $22.2 million, an increase of 43% on a year-over-year basis. Adjusted EBITDA margin rate increased to 9.6% in the first quarter as margin expansion across both the Aviation and fleet segments offset margin compression within the Federal & Defense segment. Turning to Slide 6. Aviation segment revenue increased 110% year-over-year in the first quarter. Both our distribution and repair businesses grew on a year-over-year basis, up 172% and 22%, respectively. Distribution revenue excluding $22.5 million of revenue contribution from our Global Parts acquisition is approximately 118% above pre-pandemic levels as a result of recent new awards and strong program execution. Repair revenues remain approximately 20% below pre-pandemic levels, in line with the overall market. Consistent with recent market trends, we see a more moderate commercial MRO recovery in the second half of 2022 than originally anticipated, but continue to expect commercial MRO to recover to pre-pandemic levels by 2024. Throughout this year, we will continue to invest in new capabilities and expand our integrated solutions across a growing base of new business and general aviation customers and commercial customers, including MRO capabilities in support of the recently announced Honeywell Aerospace agreement for Avionics product repair. Aviation adjusted EBITDA increased by more than 389% year-over-year, while adjusted EBITDA margins increased by 664 basis points year-over-year to 11.6%. For the remainder of the year, we're anticipating growth in quarterly revenue year-over-year and an adjusted EBITDA rate of approximately 10% to 11%, driven by more moderate repair recovery and organic investments that support continued growth in 2023 and beyond. We maintain our longer-term, mid-teen adjusted EBITDA margin rate targets, in line with pre-pandemic levels. Turning to Slide 7. Fleet segment revenue increased 22% versus the prior year period, driven by higher commercial and e-commerce fulfillment revenue. USPS revenues were flat on both a sequential and year-over-year basis. Commercial revenues were $27.9 million in the first quarter, an increase of 93% versus the prior year period and now represent 42% of total segment revenue, a new record. Segment adjusted EBITDA of $8.8 million increased 9% versus the prior year period while adjusted EBITDA margins declined as anticipated 160 basis points year-over-year, given a higher mix of commercial revenue. For the remainder of the year, we're anticipating flat to modestly higher quarterly revenue year-over-year as commercial revenues offset flat to modestly lower USPS revenue. We expect Fleet's adjusted EBITDA rate to be approximately 12% to 13%. We remain focused on driving higher EBITDA dollar contribution year-over-year as this segment continues to drive revenue diversification as a key strategic initiative. Turning to Slide 8. Federal & Defense segment revenue increased 8% on a year-over-year basis, driven by contributions from the HAECO Special Services acquisition and new program wins offset by the expiration of a contract with the U.S. Army. Federal & Defense adjusted EBITDA was $3.8 million in the first quarter, a decline of 35% year-over-year. Adjusted EBITDA margins declined 350 basis points on a year-over-year basis to 5.3%, given a higher mix of cost-plus contracts. The Federal & Defense segment reported an operating loss of $700,000 in the first quarter of 2022 due to a $3.5 million provision for a loss contract recognized in the quarter. The charge represents the expected loss driven primarily by higher material and labor supply chain costs related to a specific fixed-price, non-DoD contract with a foreign customer that is not considered indicative of ongoing business operations and strategy. For the remainder of the year, we're anticipating flat quarterly revenue year-over-year as new awards under our NAVSEA program offset the expiration of a contract with the U.S. Army. We expect Federal & Defense's adjusted EBITDA rate to be approximately 4% to 5%, driven by the contract mix of cost-plus versus fixed-price awards. Turning to Slide 9. At the end of the first quarter, we had $100 million in cash and unused commitment availability under our $350 million credit facility. Our existing credit facility includes a $100 million accordion provision, subject to customary lender commitment approvals. As expected, we used $19 million of cash in the quarter, primarily driven by the completion of new aviation distribution awards and timing of purchases to support 2022 sales. Looking to the remainder of 2022, we expect sequential improvements in free cash flow and maintain our outlook for positive free cash flow for the year. At the end of the first quarter, we had total net debt outstanding of $303 million. Adjusted EBITDA for the trailing 12-month period ended March 31st was $80.3 million and excludes full year EBITDA contributions from the Global Parts acquisition. At the conclusion of the first quarter, net leverage was 3.8 times. With that, operator, we are now ready for the question-and-answer portion of our call.

Thank you. Our first question is from Ken Herbert with RBC. Please proceed with your questions. Ken, could you confirm if you are on mute? Are you there? Our next question is from Austin Moeller with Canaccord. Please go ahead with your questions.

Good morning John and Steve. Awesome quarter.

Thanks Austin, how are you?

Good. So my first question here, I understand the commercial fleet sales are lower margin. But does the exceptional demand for commercial trucking right now, just with all of the China lockdowns and port delays mean that the average margin on these products might start to go up soon?

As we continue to grow the business, we have not made any acquisitions and are focusing solely on organic investments. We have established a strong infrastructure with the necessary people, systems, processes, and facilities to support the launch of this commercial revenue channel. We still have investments to make by the end of this year, and as we move into 2023 and beyond, we expect to scale this business to a higher level and see some margin improvement in that sector. However, I wouldn't anticipate any significant changes in the short term.

Okay. That's helpful. And then for the Federal & Defense business bookings and backlog, can you discuss what countries or geographic regions for the allies were the largest portion of the bookings for the quarter?

Yes, I mean the largest portion is probably Egypt through our Navy program. That's probably the largest country. Steve, any other color that you think you want to give there?

Yes, I would say the main reason for the increase in bookings is the NAVSEA program, which serves several countries. As John mentioned, Egypt is a significant contributor, along with Bahrain and Iraq. We are seeing a rise in award activity for that program, which we are pleased about. However, there are no new countries that we haven't already announced.

Okay, that's helpful. And then just one last question. So I understand the company's goal to achieve positive free cash flow this year. Do you think that inflection point happens next quarter or sort of in the second half of the year?

We haven't necessarily given the guidance. All we've mentioned is that we expect sequential improvement from here on out. I think what you see is that we made some investments early in the start of this year as it relates to preparing for 2022 sales. Also related to some of the distribution deals that we have previously announced. So I think we've gone with sequential guidance at this point and we look forward to being able to share more as the quarter comes out.

Okay, thanks for the color.

Thank you. Our next question is coming from the line of Ken Herbert with RBC. Please proceed with your questions.

Good morning, John and Steve. I apologize for the technical issues earlier. It was a good quarter. I'd like to start with Aviation. As you analyze the market and consider the business from the first to the second quarter, particularly the $10 million increase from the fourth quarter to the first, could you elaborate on what you're observing in terms of distribution? I understand we'll receive that information with the filings, but I'm more interested in the activity levels and margin contributions. You've previously mentioned MRO as essential for ongoing margin growth in this segment; what trends did you notice from the fourth to the first quarter, and are these trends continuing into the second quarter?

Yes, thanks for the question. I think we've seen improvement from the fourth quarter to the first quarter both in distribution and in repair. And so you'll see when you kind of see the complete filings, but you'll see there's sequential growth in both sides of the business. And at the end of the day, as we mentioned, one of the key drivers from a margin rate improvement standpoint is the repair recovery from a revenue standpoint because it does drive higher incremental margins, just given the nature of the cost structure of the business. I think from a market trend standpoint, we will still continue to see positive improvements. But what we have communicated is that I think there's a slightly more moderate recovery within the repair space than what we had initially anticipated, which is in some ways, driving some of our assumptions as we look to the back half of this year in terms of when we think repair will recover and likely out into 2023 and 2024.

Yes. Okay. That's helpful. And with the recent distribution and other agreements you put in place, how much would you say of your business within aviation is sort of under long-term or recurring contracts versus sort of spot market or what I would call sort of point-of-sale or book and ship type businesses?

Our distribution business is currently close to having 90% of its revenue secured under long-term supply agreements. However, the demand and backlog are more transactional in nature, meaning we have many exclusive arrangements with suppliers, but that doesn't guarantee a firm backlog. The backlog is influenced by the demand from end customers. To ensure consistent revenue as we advance our business transformation strategy, a significant focus has been on securing our core programs for long-term stability in those revenue streams. This effort was crucial as we wrapped up last year and began this year. In distribution, we are working to finalize a renewal on one program, which will solidify our legacy programs and provide consistent long-term revenue moving forward.

Okay, very helpful. And then just finally, as you think about sort of the capital structure and we think about capital allocation, two questions here. First, is there any sort of near-term risk around floating or fixed rate on the debt and is that anything that you might be able to address this year? And then second, as we just look at leverage in the aggregate, how do we think about that moving through the year as ideally the cash flow profile starts to improve?

Yes. Good questions. So I think there obviously is risk as we are in a floating rate structure from our debt standpoint. So I think what we have internally assumed is that we would expect the back half of this year to continue to be at levels from an interest rate expense similar to where we're at right now. Even though we expect the free cash flow to drive down the balances, we do anticipate rates to continue to rise, which will drive an offset to that reduction. And then in terms of the capital structure long term, we continue to evaluate options. I think you know last year, we did an amend and extend for 18 months of our existing facility, really so that we could support the recovery within our businesses and get to a stabilized level of new performance because we're such a different business than where we were about three years ago. We really want to be in a sound footing when we go to have conversations about what we want our capital structure to look like long term. So I'd say it remains something that we'll look at over the course of this year and evaluate whether or not there's something to move differently in terms of the capital structure, whether it be this year or early next year.

Okay, perfect. Thanks, Steve, for the insights.

Thank you. Our next question is coming from the line of Michael Ciarmoli with Truist. Please proceed with your questions.

Hey, good morning guys. Nice results. Just before I wanted to get into aviation, just on the federal and defense, you took the charge this quarter calling out, I guess, the nature of that fixed-price contract. But I guess as you look about within the current mix of contracts and dealing with the inflation environment, do you expect more pressure on some of your existing fixed-price contracts? Do you have to wait for those to renew to kind of deal with the current, whether it's labor or raw materials, I guess I'm just trying to figure out how much risk is in that federal segment from a contracting standpoint?

It's a good question. I believe there's very little risk. Over the past three years, my focus has been on cleaning up legacy assets and aligning our value proposition across the three business segments to push the business forward. The federal segment has been the slowest to get back on track due to market conditions. This quarter, we decided to exit legacy contracts that were not core to our strategy. This marks the end of that process, and I believe the business is now at a stable point. Moving forward, we will evaluate the assets in our portfolio to determine what is core or noncore. However, I do not anticipate any additional risk regarding fixed-price contracts in the future.

How do you handle a fixed-price contract signed six months ago when the inflationary environment was quite different? Are you protected under such a contract, and did you have open negotiations with the customers? I'm trying to understand this better.

When we analyze our three business segments, both our aviation and fleet divisions operate in a highly transactional environment, allowing us to adjust prices quickly. We have very few long-term contracts in these segments, and those that exist include provisions for price increases as necessary. In our federal business, currently, the mix of contracts leans more towards cost-plus or cost-reimbursable agreements, which is reflected in our margins. The fixed-price contracts that we do hold tend to be short-term task orders, and we feel confident about our bookings in this area. As of now, we don't have any long-term fixed-price contracts that pose significant risks as we progress.

Got it. Perfect. Then just switching to Aviation, can you call out what specifically changed with the repair business, you said it's tracking a little bit below your expectations versus what you called out last quarter, what are you seeing in the marketplace?

We expected the commercial MRO side of the business to be close to a pre-pandemic recovery by the end of the year, but the recovery is happening at a slower pace. We monitor our inputs daily, and when we analyze the monthly trends, we see continuous improvement in the MRO shops month-over-month. However, the level of activity from the airlines is not as strong as we had hoped. Consequently, we now anticipate that full recovery in this segment will extend into 2023 rather than occurring at the end of 2022 as we initially thought. The market is recovering, and we believe the business is performing well, as evidenced by the margin improvement we've discussed, despite the slower-than-expected market recovery.

Understood. Just one last question for me before I step back into the queue. Regarding those margins, it seems from your guidance that we should expect a decrease in margins from this point forward. I recognize you've mentioned organic investments and the slower ramp in repairs, but it appears that you will begin to gain some leverage on new contracts and increased volume. I'm trying to understand how a decline from the current 11.6% to a range of 10% to 11% for the rest of the year represents a significant drop. I understand there will be year-over-year improvement compared to 2021, but could you provide any additional insights on the margin pressures?

Steve, do you want to go...

Yes, I was just going to mention. So as it relates to some of the newer programs that we mentioned, we continue to make these organic investments as you referenced. I do want to make sure that it's clear. Those won't necessarily turn into revenue this year, right. So these were new repair activities that we're investing in, in that business. They don't necessarily turn into revenue within a month. Like a distribution deal, you can turn around quite quickly. These are businesses that we are going to have to make investments in, in terms of technical talent to make sure that we're prepared and we really anticipate revenue to begin in 2023 hence, why was we talked about the margin rate of the business. We want to make these investments because we know what drives long-term growth of the business, but it won't drive short-term improvement in margins. In that sense some of the assumptions we've given around that margin 10% to 11% for the year.

Exactly. When we evaluate our product and service margins, they are aligning well with our expectations, and we are pleased with their performance. However, our SG&A as a percentage of sales is higher than you may have anticipated, and I'd like to clarify why. We aim to position ourselves well for growth, and in order to manage that growth effectively, a significant part of our market value hinges on our customer excellence. This necessitates appropriate staffing. As you know, there are challenges with labor at the Aviation conference this week. We believe we are in a better position than many in the market regarding labor availability, and we want to ensure we are adequately staffed. As the recovery progresses, the demand for technical talent will increase, and we need to be fully prepared. Consequently, SG&A is currently somewhat elevated relative to sales, but we anticipate it will naturally scale over time. We are confident in our plans for margin expansion in the mid to long term, though we want to exercise caution in the near term given the current market pressures.

Got it, makes sense. Thanks guys. I will jump back in the queue.

Thank you. Our next question is coming from the line of Louie DiPalma with William Blair. Please proceed with your questions.

John, Stephen, and Noel, good afternoon. What caused the significant increase in revenue from your fleet e-commerce fulfillment channel on a sequential basis, and are we still in the early stages of growth there? Are we entering a multiyear growth cycle, or should we expect that the exceptionally high revenue growth will taper off significantly over the next several quarters?

No, it's a great question. Two years ago or so, we launched kind of this commercial revenue channel. And we kind of go to market as a true kind of classic commercial distributor. We have our own e-commerce platform. We have what we call e-commerce fulfillment, where we're supporting products through other platforms as well. And then we have our just-in-time program. And the market is really responding well to our offerings. So we do believe we're only in the early innings of the growth here. You'll continue to expect growth. At some point in the back end of this year, we're going to move that business onto a new ERP platform, and we'll kind of communicate ahead of time. You might see just a one month kind of level off a little bit as we kind of that transition, and that will get us ready for 2023. But we believe we're in the early innings of really building something special and being able to continue to diversify that customer base within the fleet business. So really proud of what the team has done and what they've been able to deliver.

Thank you, John. Stephen, you provided guidance for the fleet EBITDA margin and mentioned additional investments to support rapid growth this year and next. Do you anticipate that the 12% to 13% margin you referenced will be the long-term low for the fleet margin, or could future investments further decrease that?

We haven't necessarily given the long-term guidance for the business yet. I think towards the back half of this year, we'll be able to provide more color for you as you look to the long-term multiyear transformation. But I'd say in and around this range is probably the right place to be. And the reason why I say that is, this year, as John mentioned, we're going to continue to make investments, and those are going to help us deliver the next round of scale because the business, as you can see, is continuing to rapidly grow which in some level, we're going to have to make investments in terms of our infrastructure to make sure that we're able to support that growth. And what you haven't necessarily completed all that modeling to be able to share with you sort of what the long-term guidance looks like in terms of that business's margin rate. But it's in and around this space. I'll go back to sort of the commentary that John used at the very beginning. We're looking at growing adjusted EBITDA of this business. The margin rate itself is obviously very important to us, but we're also trying to think about building a long-term business that's very sustainable while we go through this mix shift with the other USPS customer within the segment. And so our focus right now remains on growing EBITDA dollars, and that's where we're going to continue to drive as we go through this transformation.

Okay. So should the EBITDA dollar should that continue to grow from here?

When considering our long-term guidance on the performance of the business, that is precisely what we are aiming for.

Sounds good. And final one, back to John, can you talk about your ability to gain market share in the aviation repair business? You recently announced the Honeywell repair partnership in last quarter, the Boeing 737 partnership, if you execute on those contracts, do those showcase VSE aviation's repair abilities and should that lead to other partnerships on the repair side?

Absolutely. We're working to establish a balanced strategic vision for our aviation business, which includes commercial, business, general aviation, MRO work, and pure distribution. Over the past year and a half, we have experienced significant growth in our distribution business and introduced several new programs. This year, we are starting to scale our MRO business, including a new program with Honeywell that will support both legacy and next-generation aircraft, primarily in avionic work. We expect to complete our new test cell and authorized repair center by the end of this year. This initiative will not only attract new customers but also give us opportunities to leverage our other repair capabilities. It will demonstrate our commitment to being an OEM-centric business, and we are already initiating conversations with other OEMs to effectively represent their interests in the market. Given the current labor challenges, we believe we can build out these MRO capabilities to support OEMs more quickly. I'm very optimistic about the future potential of both our MRO and distribution businesses.

That's helpful. And where is that Honeywell repair center going to be located?

It will be in our South Florida, in our Miami, our Miramar aviation headquarters. So that's where most of our commercial hydraulic pneumatic avionic repair is. Kansas is where we do more of our business in general aviation work. And in Cincinnati, it's more kind of low tech, like interiors and things like that.

And is the Boeing 737 teardown work, is that also going to be done in Florida or is that in Texas or somewhere else?

That work is a partnership with the airline, and we have a third party handling the physical teardown. We are not performing the tear down of the aircraft ourselves. Once the aircraft is dismantled, we transport the materials to our facilities in Miami or Phoenix for distribution. If any repairs are needed, those products will be sent to our workshop or another facility for repairs before being sold in the market.

That makes sense. Thanks John. Thanks everyone.

Thank you. Our next question is coming from the line of Jeff Van Sinderen with B. Riley. Please proceed with your questions.

Hi, good morning everyone. So I wanted to circle back for a second if we could do the commercial MRO market. Just a point of clarification there. I know you mentioned that you see the recovery running slightly slower than anticipated. I'm just wondering, what do you attribute that slower rate of recovery to versus prior expectations?

At a high level, the market is recovering a bit slower than we had expected. From my perspective, there are significant labor and fuel pressures at the airline. They are deferring any maintenance they can. We are seeing consistent improvement in inputs month-over-month in our commercial MRO shop, but it's not as strong as we initially thought. However, we will continue to monitor this as we work to close the gap on the 2019 data point.

If they are deferring some maintenance, do you expect a catch-up period in the future where a significant amount of deferred maintenance will arise and benefit your business?

It's a good question. At this point, I wouldn't say that. I think you're just going to see a nice gradual increase. We may see the market heat up and kind of that trajectory kind of go more directly up rather than on a nice incremental month-over-month improvement. But at this point, we're not forecasting it that way.

Yes, Jeff, I was just going to say, just to cover sort of the impact across the other two segments because I think it is relevant. Obviously, no real impact on the fleet segment because it's quite domestic. I'd say our Aviation business, a real upside. If we look at what the potential is. There's maybe $2 million of sales in that region last year just to give you a reference in terms of the type of an impact it might have on our business this year.

Thank you. Our next question is from Michael Ciarmoli with Truist. Please go ahead with your questions.

Thank you for the follow-up. I appreciate the guidance for the rest of the year. Steve, regarding Global Parts, did you mention it was a $22.5 million contribution this quarter? I had it at a similar run rate in the fourth quarter of last year; is that correct, was it in the $21 million to $22 million range?

Let me get that information for you. We disclosed it last quarter, which was just under $19 million, and this quarter, you can see it’s under $22 million.

Yes. As we consider the remainder of the year, the sequential growth in aviation was impressive. We are examining many companies in the industry on a sequential basis to determine if this trajectory is the right one for the future of aviation. There are certainly many variables to account for, including materials, labor, and pricing. However, if traffic continues to increase and the market stays healthy, we might expect mid- to high single-digit organic sequential growth in aviation.

I would consider the business in two main areas: the commercial side and the business and general aviation side. I anticipate continuing sequential improvements for the commercial side. However, I believe the business and general aviation side may begin to slow down eventually, given the current strength and robustness of the market. At some point, we should expect it to level off. While we haven't provided sequential guidance, we've shared our year-over-year assumptions, which should give you a good sense of our outlook for the year. It's important to note the distinction between commercial aviation and business and general aviation.

Okay, got it, helpful. Thanks guys.

Thank you. There are no further questions at this time. I'd now like to turn the call back over to John Cuomo for any closing comments.

Thanks, everybody, for joining the call today. I appreciate your continued support of VSE. Wish you all a great day.

This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.