Greetings. Welcome to the VSE Corporation Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I will now turn the call over to Mr. Noel Ryan, Head of Investor Relations. Thank you. You may now begin.

Thank you. Welcome to VSE Corporation's second quarter 2020 results conference call. Leading the call today are our President and CEO, John Cuomo; and Chief Financial Officer, Tom Loftus. Presentation we are sharing today is on our website, and we encourage you to follow along accordingly. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in our periodic reports filed with the SEC. Except as required by law we undertake no obligation to update our forward-looking statements. We are using non-GAAP financial measures in our presentation. The appropriate GAAP financial reconciliations are incorporated into our presentation where available, which is posted on our website. All percentages in today's discussion refer to year-over-year progress, except as noted. At the conclusion of our prepared remarks, we will open for questions. With that, I would like to turn the call over to John Cuomo for his prepared remarks.

Thank you, Noel. Welcome everyone and thank you for taking the time to join our call today. We are now halfway through the year that will long be known as one of great challenge and resilience. During a period of uncertain macroeconomic conditions and more specifically one in which commercial air traffic fell to historic lows. Our team quickly adapted to rapidly evolving market dynamics with a series of targeted divestitures cost reductions and new business development initiatives. Despite the market conditions, VSE delivered $0.60 of adjusted EPS and strong free cash flow of $14.9 million continuing to pay both our quarterly dividend and reduce debt within the quarter. Our VSE results first culture led to our second quarter not only being about responding to the market during a global pandemic, but one where we exceeded our internal forecast sees new business opportunities and continue to execute on our focused strategy. As expected, our second quarter results were impacted by the ongoing effects of the COVID-19 pandemic particularly within our Aviation segment which reported a 31% year-over-year decline in revenue excluding the impact of the prime turbines divestiture. This decline in commercial aviation activity was partially offset by comparatively stable demand from our government customers who on a combined basis represented about 75% of total revenue in the second quarter. Turning now to slide three of the conference call presentation. Before we move into a detailed review of our second quarter results, I'd like to begin with an update on our corporate strategy and specifically the actions taken to execute on this strategy since our last quarterly update. New business development remains the top priority across all of our operating segments. During the first half of 2020, our Federal & Defense Services Group reported $116 million in new awards up…

Thanks, John. Turning to slide 5, our second quarter revenue of $168.7 million, decreased 10.8% year-over-year, primarily driven by decreases in our Aviation and Federal & Defense Segments. For the trailing 12-months, our revenue was up $30.7 million or 4.3%. As illustrated on slide 6 and 7, our total adjusted EBITDA was $17.2 million, down 27% year-over-year in Q2 and our trailing 12-months adjusted EBITDA was approximately $88 million, up 5% year-over-year. In the face of global pandemic, our Aviation segment was adversely impacted by lower revenue passenger miles, which resulted in lower demand for aftermarket parts supply as well as MRO support. Additionally, revenue from our Federal & Defense segment decreased due to the completion of a contract with the Department of Defense in January 2020. Our Fleet segment benefited from $19.5 million of revenue from a non-recurrent order for COVID related PPE supplies from a government customer. Despite the challenges we've experienced this quarter, we expect to be both adjusted net income and free cash flow positive for the full year 2020. Now, I will discuss each of the three operating segments starting with slide 8. Excluding the sale of Prime Turbines, Aviation segment revenue declined 31% year-over-year to $32.2 million in the second quarter. Our operating income decreased approximately $39.6 million for the second quarter of 2020 compared to the same period of the prior year. The primary components of the decrease were $33.7 million of non-cash impairment charges of $678,000 loss on the sale of CT Aerospace assets and a decline in revenue and profits precipitated by the pandemic. Adjusted EBITDA decreased to $1.2 million in the second quarter of 2020. Turning to slide 9, revenue from our fleet segment increased 32.4% year-over-year to $71.2 million in the second quarter, while operating income decreased approximately 8%…

Thank you, Tom. In closing, I'd like to thank our investors and employees for their ongoing support of VSE. During periods of great uncertainty, strong businesses find a way to capitalize on market inefficiencies while creating new opportunities for profitable growth. Against the market adversities, I am proud of what the VSE teams accomplished during the first half of this year. We are well-positioned to manage through challenging times with our balanced customer product and service portfolio solid vision for a long-term growth and a strong balance sheet. We are confident in our ability to emerge from the current crisis even stronger, more profitable and better positioned in our markets. Operator, we are now ready for the question and answer portion of our call.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Michael Ciarmoli with SunTrust. Please state your question.

Hey, good morning, guys. Nice results here given the current operating environment. John just on Aviation, maybe can you give us an update on what the trends sort of looked like. It seems like across the industry April might have been benefited a little bit from a backlog of repair work. What did you see into May and June, and do you think that sort of weekends before it gets better just given the reduced flying hours and utilization of the Fleet?

Thanks, Mike. Let me break it out by MRO and distribution. So, if we look at MRO we definitely benefited from some backlog in our MRO businesses in April. So we had a definitely a little bit of a benefit upfront there. So if I break that up, a little further, if you look at business in general aviation, our MRO position is there, May and early June really represented a bottom for us although, we're really far from pre-COVID revenue levels, the end of June in July recovery trends, appear to be holding. For the commercial MRO, just as we had more backlog in April to start the decline we do see that recovery coming a little slower, but we were looking at kind of the bottom there being June, July and we're starting to see inputs increase towards the end of July, which will bode for a stronger recovery in month of August. From our distribution business, we have a really short book to ship, so virtually all the revenues somewhat organic in that quarter. So for that business, there was no benefit of drill backlog in April, and we are seeing consistent improvement in the month of June and July in that business as well.

Got it. And then even on there from like, if I were to look at an inventory standpoint inventory for you guys up, sequentially on the distribution side, I guess specifically what are you seeing in sort of, I guess the product velocity out there in the marketplace. Do you think, there is going to be a lot of destocking that happens for some of your customers across the commercial biz jet general aviation, do you think it's going to be a little bit harder to move that inventory and convert it to cash?

A couple of things, first, when it comes to the inventory, we have on hand, we did do a significant amount of rescheduling in the quarter, pushing as much work out into 2021 beyond as possible obviously there is some with – with the manufacturers that we have some commitments, so we did receive it the significant amount of inventory in the quarter based on trends that were trending much higher in Q1. The good thing here in this business is that, most of our inventory really very heavily OEM proprietary part-centric and it's not – products that customers traditionally stock heavily. So what that means is they are not sitting on a lot of inventory regardless of the trend and we should recover faster and have much less of the destocking risk than many of our competitors or other suppliers out there.

Got it. And then just some shifting quickly to Federal, you guys talked about the new bookings the new wins here in July, and it's sounded like you're getting out there more into the marketplace. I think the number you threw out your bidding activity was up 30% focusing on our pipeline, what else aside from maybe blanketing the market with more bidding activity, what else is kind of helping you win this business, can you talk maybe about your value proposition or what else is attracting customers do you guys?

Yeah. So it's a business that as the former leadership really focused on creating these three segment aftermarket business, it's a business that suffered a little bit with the lack of investment. So when we look at kind of the phase strategy over the next three years Phase one was revitalizing the team, we have such tremendous core competencies in technical engineering, maintenance repair and overhaul and other type of capabilities inside the team and making sure that we were getting those capabilities out in the marketplace. So candidly, the first phase of it was all about just taking that these operations work and the sustainment work, and make sure we're bidding more to win more. The second phase of it is now extending those value propositions. Specifically, you'll see us focus over the next six to nine months on the supply chain capability and doing a much deeper dive we restructure that team in the quarter, brought on a new leader in that team, and you will see us that will be a core focus of ours. On the maintenance and sustainment programs, we were traditionally more on kind of the army and the naval vessel type work and we launched greater initiative to focus on that aircraft sustainment work, for Air Force that even for the other armed forces that are flying aircraft and we just we had one win earlier in the year and that Naval program went live officially in the month of July in Jacksonville.

Got it. Perfect. And then, I know you're not going to give last one, I know you're not going to give guidance, you did talk kind of directionally about some of the trend improving as you're exiting the year. And anything else you can give us from a revenue standpoint, obviously, I'm assuming fleet is going to have the fall off of the one-time order but any other color maybe you could provide on 3Q or 4Q from a growth or even profitability perspective?

I mean, what we've consistently said is that, if you breakout the segments the Federal Group this was kind of a shrink to grow and kind of a build – keep the core and revitalize that business this year. So that business is actually performing to our internal plan and they continue to achieve our internal plan and we expect that to continue throughout the back half of the year. From a fleet perspective, we had a strong quarter in terms of commercial demand, as we focus on diversifying that customer base, but that quarter was really strong with our e-commerce customers and a little bit less strong with our just-in-time customers, so we didn't have the ability to get in front of customers and to focus on that growth. We are seeing a better performance in that commercial side of the business, the non-e-commerce side as a start to the third quarter, and then from an aviation perspective, I think we're breaking this out by one quarter at a time right now and we are comfortable to say that you will see sequential quarter-over-quarter both revenue and earnings growth Q3 over Q2, which I think I'm not sure if everybody else is saying that in the market at this point, but we feel comfortable with that guidance.

Got it. That's helpful. I'll jump back in the queue guys thanks.

Okay. Thanks, Mike.

Our next question comes from the line of Joshua Sullivan with The Benchmark. Please proceed with your question.

Hey, good morning John, nice quarter here.

Thanks, Joshua.

Just looking at the Aviation segment, can you talk about the competitive environment, are you seeing competitors struggling -- you picking up market share from them at this point?

Yeah, I mean, if I kind of break out the Aviation segment into distribution and MRO, I think that from a distribution perspective, we are seeing more opportunities, we're seeing some of our competitors who play in the distribution market, but are on pure play aftermarket distribution businesses, focusing on their core whether that be an OEM or other type of core business and that's creating some opportunities for us. We're also seeing new business opportunities where some of the traditional aftermarket players are in the financial position to invest organically in their businesses. So from a market share perspective, that's where we see the Aviation distribution business right now. From the MRO perspective, the market was -- it's going to be a little slower to recover there on the commercial side. Where we see the biggest opportunity is on is there still a segment of really fragmented smaller MRO short and there is a little bit of CARES Act support that will extend through the end of September to support some of those businesses, but we are seeing decrease in technical talent at some of those businesses, which is creating some opportunity for us as well as that rotable parts trading business that exists in those businesses, again a little bit of a change in investment strategy, which has created some opportunity for us as well.

And then, just on the fleet segment, some impressive year-over-year growth there, it sounds like it was tough on the commercial side -- sounds like it was really driven by the e-commerce offering, any particular product trends within that that's driving that growth or just what is driving e-commerce uptick here?

No, it's really just solid execution by the fleet team on the internal strategy of. We're not going down that brick-and-mortar route -- our play in the commercial space there will be predominantly around that e-commerce and what we call e-commerce fulfillment strategy as well as that just in time strategy, so we saw a stronger focus on e-commerce in the quarter, we believe predominantly because people weren't physically getting out and we do think there is a little bit of benefit from how COVID is going to help shift consumers thoughts around e-commerce and we benefited from that.

Got it. And then just on the post office some of the funding mechanics that are going on there. How are you feeling about that right now in this new leadership, some new funding and does that change your outlook at all for how you're exposed there?

We're happy to see the funding that's coming through, as expected. I mean, we're seeing more of a commercial approach right from the onset with the new leader. We're seeing slightly lower demand of maintenance activity is -- costs are controlled and cost pressures controlled, the benefit that we see is that our relationship with the USPS is very commercial in nature. It's a full just-in-time program, we manage about 70% of part content on the 231,000 vehicles that are in the supply chain and effectively it's on a consignment program where the USPS doesn't have any on hand inventory. So we believe that we're ahead of the curve where the new Postmaster General wants to take that program into more of a commercial business and we do see some potential opportunities for expansion in other type of partnership opportunities with the Postal Service as he moves forward with that transformation.

And just one last one on Aviation, with your exposure to pipeline replacement parts and as we think about how airlines are thinking about A, B, C and D checks any noticable trends you can comment on that right now?

I think that a couple of things. I think where we kind of -- we're not large in our markets yet today, we have strong positions from a market perspective, but not from a market share perspective. So we try to break down kind of what we see in terms of demand and then how it actually relates to our business. We think our businesses are down 60% plus and we're outperforming those because of share of wallet expansion and our existing customers. What I mentioned a little bit earlier on the part sales industry and that we're a little better capitalized to support that part of the business rather than the smaller more fragmented players out there. We do see ourselves very well positioned and kind of the same logic applies to the MRO side, where we feel like our scale and the financial strength to support the business through COVID where some of the smaller competitors do not is really going to position us best to come out of this faster. We're still -- we're very aggressively focusing on that capability expansion. So the way that we're building our business model is assume that there is a plateau at some point in this "recovery" that we've seen through the bottom and how do we still grow in that plateau. And that has to come with share of wallet expansion and capability and product expansion. So it's kind of the way that we're approaching the strategy.

Got it. Nice quarter. And again, thank you for the time.

Thanks Josh.

Thanks Josh.

Our next question comes from the line of Michael Ciarmoli with SunTrust. Please proceed with your question.

Hey. Thanks for taking the follow-up guys. John, just -- can you disclose what percentage of the Postal Service was in the quarter?

I don't know, if you have that handy. We don't traditionally disclose the specific customer in the Q, you'll see kind of the federal break down and that's kind of part of the federal space, but they continue to be our largest customer.

Got it. And then, you had that nice distribution announcement with Honeywell and I know you -- VSE has had a pretty long lengthy relationship there. It sounds like this is a two-year exclusive. Can you just give a little bit more color on that? Did you win this competitively? Are there any upfront inventory requirements? And then, sort of, what can we expect from a revenue standpoint? I know it seems like a portion of those offerings are a little bit more discretionary in nature and maybe tied to sat-comm and connectivity, which I'm not really sure if there going to be a lot of spending there, but maybe just a little more color on that deal?

Sure. I mean, first, the relationship with Honeywell, when I came into VSE about a year ago, is really strong. I've had -- Honeywell's was the large customer mine in my past life as well. I had strong relationships with them back till 2008. So, very happy to continue the partnership. This wasn't a competitive offering. It was a relationship that we expanded with this specific contract. The deal is worth about $20 million over the term. We've already seen near term immediate revenue in the month of July. Although, it's discretionary, it's on platforms in the business general aviation market where upgrades are planned for 2020 and 2021. So it won't be a flat line revenue over the period, we do see it scaling up, but we're already kind of exceeding our internal forecast for the month of July, as we kick this off and from an inventory perspective it will scale in probably in three or four purchases over the term.

Okay. Last one and this is probably, maybe, it pertains to a little bit more to your commercial MRO. But as we think about the wave of retirements that are coming here, what's likely going to be a pretty big increase in used and serviceable material. How are you guys thinking about that? Obviously, you don't traffic much in the parts trading. But is there opportunity to participate from an accessory repair standpoint, if products coming off old planes, if there is USM out there from certain of your customers? I mean, just trying to think about this, is it more of a risk? Is it an opportunity, or is it just really a net neutral for you guys?

Yes. I mean, it's probably net neutral for us. I mean you're less than 5% of our parks are probably – there's some USM application out there in from a competitive perspective. But, I mean, that's me, even rounding up, it's such a small portion of where we would see an impact in the business. From an MRO perspective, we do see consistent opportunities out there, even from some of the routable pools where the 8130 tag need to be kind of refreshed in our team's ability to do that through our FAA certified shop. So we see some opportunities, but I would say, on par, it's probably net neutral.

Okay. Cool. Thanks guys.

Hey, Mike, just follow-up on your question on USPS. We disclosed in the 10-K, USPS is about 22% of the consolidated revenue for 2019 and it's -- if you exclude that one-time order, it's consistent with that number for last year.

Okay, perfect. Thank you.

Thanks Mike. End of Q&A

Ladies and Gentlemen, we have reached the end of our question-and-answer session. And I would like to turn the call back over to Mr. John Cuomo for the closing remarks.

Great. Thank you. Thanks everybody for your time and interest today. We appreciate your support of VSE. Stay safe and we look forward to connecting with you on our next quarterly call. Have a great day.

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