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Edited Transcript of VSEC earnings conference call or presentation 28-Feb-20 1:30pm GMT

Q4 2019 VSE Corp Earnings Call

ALEXANDRIA Mar 17, 2020 (Thomson StreetEvents) -- Edited Transcript of VSE Corp earnings conference call or presentation Friday, February 28, 2020 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christine Kaineg

VSE Corporation - Director of IR & Assistant Corporate Secretary

* John A. Cuomo

VSE Corporation - CEO, President & Director

* Thomas R. Loftus

VSE Corporation - Executive VP & CFO

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Presentation

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Operator [1]

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Greetings, and welcome to the VSE Corporation Fourth Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Christine Kaineg, Head of Investor Relations. Thank you. You may begin.

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Christine Kaineg, VSE Corporation - Director of IR & Assistant Corporate Secretary [2]

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Hello, and welcome to VSE Corporation's Fourth Quarter and Full Year 2019 Results Conference Call. Leading the call today are President and CEO, John Cuomo; and Tom Loftus, our Chief Financial Officer. 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 up the call for questions. Please e-mail your questions to questions@vsecorp.com. That's questions@vsecorp.com. And we will answer as many as possible during the allotted time.

With that, I would like to turn the call over to John Cuomo for his prepared remarks.

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John A. Cuomo, VSE Corporation - CEO, President & Director [3]

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Thank you, Christine. Welcome, everyone, and thank you for taking the time to join our fourth quarter earnings call. We will begin with an overview of our business and operating segments, followed by a summary of our 2019 financials. Tom will provide more detail on our fourth quarter and fiscal year 2019 financial performance, and I will finish our call with additional detail on our operating segments and an overview of our strategy for 2020 before turning the call back to Christine to facilitate our question-and-answer session.

As this is the first-ever quarterly earnings call in the company's history, I'd like to take a moment to introduce myself while providing a high-level overview of our company and operating segment. I joined VSE as CEO just over 9 months ago, having previously led a division of a public aerospace and defense company. Under my leadership, VSE intends to take a more active role in engaging with our key stakeholders, including our institutional investors and the broader analyst community. Consistent with this mandate, you can expect to see increased transparency and consistency in our public communications going forward.

With that, let's turn to Slide 3 of the investor presentation. At its core, VSE is a global aftermarket provider of distribution, repair and consulting services for land, sea and air transportation assets. We report and operate under 3 business segments: Our Aviation Group, our Supply Chain Management Group and our Federal Services Group.

Our Aviation Group provides component and engine accessory repair, parts supply and distribution and supply chain solution for a global aftermarket commercial and business and general aviation customers. Aviation represented 30% of 2019 revenue.

Our Supply Chain Management Group provides parts supply, inventory management, e-commerce fulfillment, logistics, data management and other services to support the U.S. Postal Service, the United States Department of Defense and commercial aftermarket high-duty cycle truck and fleet customers. Supply Chain Management Group represented 28% of 2019 revenue.

Our Federal Services Group, which represented 42% of 2019 revenue, provides aftermarket refurbishment services to extend and maintain the life cycle of military vehicles, ships and aircraft for the U.S. Armed Forces, federal agencies and international military and defense customers as well as provides energy consulting services, health care IT and IT data solutions.

Early in my tenure as CEO, our objective has been to refocus each of the business groups on improved operational performance, market differentiation and targeted business development, all while investing in each business to establish a clear value proposition and firm foothold within our served markets. Looking ahead, the collective focus of our leadership team is to generate above-market revenue growth and total returns over the long term.

Turning to Slide 4. Our financial performance reflects stable year-over-year growth in revenue, margin capture and profitability. Our revenue for 2019 was $752.6 million, up approximately 8% over 2018. We ended the year with net income at $37 million, up 5.5% year-over-year; and our diluted EPS was $3.35 per share, which was a 4.4% increase over 2018. For the fourth quarter, our revenue was $195 million, up approximately 8% compared to the same period of 2018. We recorded net income of $10 million, up 8% compared to the fourth quarter of 2018. Finally, we ended the fourth quarter with diluted EPS of $0.90 per share, up 7% as compared to the same period of 2018. We'll go into more detail on our operating segment shortly, but you can find a general overview of the segment performance on Slide 5.

I will now turn the call over to our CFO, Tom Loftus, to discuss our 2019 financial performance.

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Thomas R. Loftus, VSE Corporation - Executive VP & CFO [4]

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Thanks, John. Welcome, everyone, on the call today.

Turning to Slide 6, 7 and 8. Our business generated stable revenue and operating income growth for the fourth quarter as compared to the fourth quarter of 2018. Revenue grew approximately 8% in the period, driven by both organic and inorganic growth in our Aviation Group. For the quarter, our total adjusted EBITDA was $23 million, up approximately 16% compared to the same period of 2018, driven by contract mix in our Federal Service Group. For the full year, we had an increase of 8% primarily driven by the Aviation Group, which I just previously mentioned.

Aviation Group was up 54% year-over-year, partially offset by a decline of 7% in our Federal Services Group. Our Supply Chain Management Group was essentially flat year-over-year. Our adjusted EBITDA margin improved 90 basis points year-over-year to 12.1% in 2019.

Now I will give a little more detail on each of our 3 operating segments, starting with Slide 10. Aviation Group revenue increased 42% year-over-year to $61 million in Q4 of '19, while full year 2019 revenue increased 54% to $224.5 million. After adjusting for the increase in the earn-out obligation of $1.9 million in the fourth quarter of '19 related to the success of our 1st Choice acquisition, operating income increased $1.2 million or 32%, and the full year operating income increased 62% to $17.9 million. Aviation Group EBITDA declined 3% year-over-year in the fourth quarter to $5.8 million due to product and customer mix, while full year 2019 EBITDA increased 53% to $30.3 million.

The year-over-year increase and full year 2019 operating income was attributable to a combination of contributions resulting from our 1st Choice acquisition closed in January 2019, together with organic growth in our global aviation distribution business. This week, we closed the divestiture of our Prime Turbines subsidiary in Texas, a move that is expected to position us to focus on higher growth, aftermarket component and accessory repair and parts distribution opportunities to serve the global commercial and general aviation market.

Turning to Slide 11 and 12. Supply Chain Management Group revenue increased 2% year-over-year to $53.6 million in Q4 of '19, while the full year 2019 group revenue was essentially flat at $214.5 million. Operating income increased 5% year-over-year to $7.4 million in Q4 2019, while full year 2019 operating income declined 3% to approximately $30 million. Supply Chain Management EBITDA increased 2% year-over-year in Q4 to approximately $10 million, while full year 2019 EBITDA declined 3% to approximately $41 million. The decrease in the full year 2019 operating income was mainly attributable to a decline in demand related to the U.S. Postal Service. This group continues to focus on diversification beyond the U.S. Postal Service managed inventory program with non-USPS group revenue growing nearly 20%, as John mentioned earlier, on a year-over-year basis in 2019, supported by increased activity in e-commerce and commercial parts distribution.

Turning to Slide 13. Our Federal Services Group revenue declined 5% year-over-year to $80.6 million in Q4 of 2019, while full year 2019 group revenue declined 7% year-over-year to $313.6 million. Operating income increased 47% year-over-year to $5.2 million in Q4 of '19, while full year 2019 operating income increased 15% to $18.1 million. Federal Services Group EBITDA increased 28% year-over-year in Q4 to approximately $6 million, while the full year 2019 EBITDA increased 5% to approximately $21 million. The year-over-year increase in operating income for the fourth quarter and the full year 2019 was related to improved sales mix resulting from more fixed-price work with government agencies.

In 2019, Federal Services Group bookings declined 29% year-over-year to $228 million, while funded backlog declined 27% year-over-year to $213 million. The decline in bookings and funded backlog was attributable to a combination of minimal new business development activity together with the loss of a contract. As John will cover shortly, we are actively engaged in building both bookings and backlog in this segment through new business development initiatives. We recently hired a new Group President, who is highly focused on adding BD staff and revitalizing this business with an emphasis on developing the pipeline and customer activity in the near term.

Turning to Slide 14. At December 31, 2019, we had net debt of approximately $270 million and trailing 12-month adjusted EBITDA of $91 million implying a net leverage ratio of 2.9. Net leverage has now declined for the fourth consecutive quarter following the completion of the 1st Choice acquisition in January 2019. In December, we announced an amended loan agreement with our bank group. Under the terms of the amended agreement, our bank group increased total availability on the company's term loan and revolving credit facility by a combined $100 million. Following the close of the transaction, the total committed capital under the amended loan agreement increased from $373 million to $473 million. At year-end, we had a total cash and unused commitment on our credit facility of nearly $200 million.

With that, I'll turn it back over to John for his closing remarks.

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John A. Cuomo, VSE Corporation - CEO, President & Director [5]

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Thank you, Tom. Turning now to Slide 15 and 16. 2020 will be a transformational year for VSE. We are focused on creating a lean corporate structure to support each business group. We are refocusing each business unit strategy to provide sustainable and differentiated value proposition in their respective markets. We are investing in each business group, including business development, in order to support the execution of our strategies and to generate above-market organic growth and return in 2021 and beyond. We are focused on increasing free cash flow to both pay down debt and support strategic investments and growth.

In addition to our investments in organic growth, we will consider inorganic growth opportunities for each business. Our acquisition strategy will be different than what you've seen previously. We will no longer look to add portfolio companies to our business. You can expect to see us deploy a disciplined approach to M&A focusing on bolt-on accretive transactions that seek to expand our customer base, our product offerings, our service capabilities or geographic presence within the existing business groups. As it relates to our go-forward strategy, I intend to provide greater detail during our first quarter earnings call. However, I will touch on a few high-level points today.

Our Federal Services Group's revenue and backlog decline is from an underdeveloped business channel. This year, you will see us be more intentional as we allocate resources towards growing this business. We will seek to build backlog while focusing on a combination of traditional cost-plus contracts, balanced with higher margin fixed-price contracts. As Tom mentioned, we have a new group President, Rob Moore, on board for about 100 days. Rob has made significant organization changes, renew the team's focus on pipeline growth and business development, and we're already seeing progress and win.

With regard to our Supply Chain Management Group, in 2019, we grew non-U. S. Postal Service revenue by approximately 20%, and we will continue to focus on diversifying our customer concentration in 2020 with incremental revenue growth in the commercial space.

In our Aviation Group, we grew our business 54% in 2019 or 11% organically and anticipate continuing to outgrow our markets organically in 2020 while staying highly focused on quality component and engine accessory repair and aftermarket distribution services. I'm very pleased with the overall performance for 2019 and look forward to sharing more granularity on our strategy with you on our first quarter 2020 call. I'm excited about the future of VSE and the significant opportunity that we have for value creation for our customers, suppliers, employees and shareholders.

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

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Questions and Answers

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Operator [1]

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We will now begin our question-and-answer session. Ms. Kaineg, please go ahead.

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Christine Kaineg, VSE Corporation - Director of IR & Assistant Corporate Secretary [2]

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Thank you. As a reminder, please e-mail questions to vse@ -- questions@vsecorp.com, and the management team will answer them in the order they are received. We've received our first question. Can you provide an update on the U.S. Postal Service fleet replacement impacting your Supply Chain Group? A new fleet requires far fewer parts than an older one. So how do you see the impact on market share as the old fleet is replaced? Is the primary growth in this segment coming from commercial vehicle parts support?

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John A. Cuomo, VSE Corporation - CEO, President & Director [3]

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Thank you, Christine. A few points of clarification before I actually answer the question. First, there is no specific timing yet on the completion of the RFP process or on the fleet replacement vehicle. Further, once the process is complete, production needs to begin, and then the USPS is estimating about a time line of 7 years for the rollout of the vehicle. More importantly, I think it's important to highlight that when we talk about fleet replacement, we're only talking about the LLVs, which is the long-life vehicle. 40% of the USPS fleet has already been replaced over the last number of years. You can see from our public filings, the consistency of revenue and profit from our supply chain business over that time. So once these new vehicles are out of their warranty period, the parts supply through VSE continues.

Finally, I encourage you to refer to Slide 12 of our investor deck with regard to our commercial business growth and our successful customer diversification strategy to replace both revenue and earnings from any decline in the USPS business. And you will hear much more about how we plan to accelerate this growth during our Q1 earnings and strategy rollout.

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Christine Kaineg, VSE Corporation - Director of IR & Assistant Corporate Secretary [4]

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In previous quarters, you used free cash flow to repay debt and invest in inventory. What sort of return on equity do you think you can get in the current inventory investment? What are the risks associated with us holding inventory longer than planned?

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John A. Cuomo, VSE Corporation - CEO, President & Director [5]

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Thanks, Christine. There's a few questions kind of rolled into one here. First, inventory turns are a priority for the business. I mean I want to be very clear on that. It's the largest asset in our organization and although we're not giving free cash flow guidance on this call, you will see free cash flow improvement in 2020 driving -- which is driven by better inventory management. That said, we're a stocking distributor with a disciplined approach to investing in new growth programs to support our growing aftermarket business and the fleet of aircraft. I ran a large successful public distribution business for almost 20 years. I'm confident in our approach to both improve free cash flow and drive the correct inventory stocking strategy to support our customers.

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Christine Kaineg, VSE Corporation - Director of IR & Assistant Corporate Secretary [6]

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What impact do we anticipate the coronavirus having on your business?

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John A. Cuomo, VSE Corporation - CEO, President & Director [7]

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So at this point in time, we are obviously evaluating it just as most of the market is on a daily basis. We do not see an impact to our Q1 financials, our forecast or our earnings. We have a very small portion of our business that is customers that are in the Asia Pacific region. Most of our supply for both our Federal Services business and our Aviation business are domestic sources of supply. That said, as the issue continues to become more of a global issue, we will obviously continue to reevaluate any impacts we think it may have to the business.

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Christine Kaineg, VSE Corporation - Director of IR & Assistant Corporate Secretary [8]

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We've seen several references to the success of your 1st Choice Aerospace acquisition. Can you add more detail? What did 1st Choice add to VSE from a strategic perspective? And what drove the revenue growth at 1st Choice?

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John A. Cuomo, VSE Corporation - CEO, President & Director [9]

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Sure. A little clarity on the business first. 1st Choice is an MRO business. Essentially, we repair high-flow pneumatics, like starters and valves, fuel, electronics, electromagnetic accessories, avionics, crew seats and some cargo equipment as well. So why 1st Choice? First, it fits our strategy. And we look at strategy for M&A, well, in this instance, to repair for -- aviation repair for accessories and components. The business was a market and is a market leader. It supports high-margin growing aftermarket for predominantly the commercial aviation market. 2019, as you can see from our results, was a great year. The business exceeded both our deal forecast for both revenue and profit. It grew strong double digits and well over market from 2018, and the business has been recognized for both service and repair excellence by both customers and other agencies that kind of rate these repair shops. We're very pleased with the acquisition and how it fits into our future aviation strategy.

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Christine Kaineg, VSE Corporation - Director of IR & Assistant Corporate Secretary [10]

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With debt at around 3x EBITDA, could you talk about the reason behind expanding the debt facility by $100 million? Do you see us going over 3x?

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John A. Cuomo, VSE Corporation - CEO, President & Director [11]

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I mean the balance sheet discipline remains a priority and will always be a priority to the business. That said, increasing the balance sheet optionality is always a good thing for a growing business. Currently, we remain slightly below 3x net leverage. But for the right transaction, we would -- to consider -- increase -- temporarily increasing that leverage with the long-term objective to remain at about 3x or below.

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Christine Kaineg, VSE Corporation - Director of IR & Assistant Corporate Secretary [12]

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Okay. Thank you, John. That concludes -- we have one last question. Can you tell us about the strategic rationale behind the sale of Prime Turbines?

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John A. Cuomo, VSE Corporation - CEO, President & Director [13]

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Thanks, Christine. We -- well, I mentioned a minute ago about 1st Choice and how that business fit into our strategic focus area. The Prime Turbines business did not fit our strategic kind of criteria for the business. The business was not a market leader. It didn't meet our margin expectations, and the engines we serviced were not in a high-growth market. You'll see us, again, apply a more disciplined approach to M&A and organic growth to make sure things meet our investment criteria as we move forward.

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Christine Kaineg, VSE Corporation - Director of IR & Assistant Corporate Secretary [14]

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Okay. Thank you. I believe that concludes all of the questions that we have. John, would you like to say a few closing remarks.

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John A. Cuomo, VSE Corporation - CEO, President & Director [15]

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Sure. Thank you, Christine, and thanks, everyone, for taking the time to listen to the first-ever VSE investor call and the overview of our strong Q4 and full year 2019 results. I look forward to sharing the company's go-forward strategy with you in late April when we report our Q1 2020 earnings. We have a very exciting and compelling vision for VSE's role in transportation aftermarket, distribution and services markets. And I'm confident and excited about what's ahead. Thank you, everybody.

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Operator [16]

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Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.