VSE Corporation

Greetings.

Welcome to the VSE Corporation fourth quarter and full year 2021 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note, this conference is being recorded. I will now turn the conference over to your host, Noel Ryan. You may begin.

Thank you. Welcome to VSC Corporation's fourth quarter and full year 2021 results conference call. Leading the call today are our President and CEO, John Cuomo, and Chief Financial Officer, Steve Griffin. The presentation we're sharing today is on our website. We encourage you to follow along accordingly. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements. due to various risks and uncertainties, including the risks described in our periodic reports filed with the SEC. Except as required by law, we undertake no obligation to update our forward-looking statements. We are using non-GAAP financial measures in our presentation. The appropriate GAAP financial reconciliations are incorporated into our presentation where available, which is posted on our website. All percentages in today's discussion refer to year-over-year progress, except where noted. At the conclusion of our prepared remarks, we'll open the line for questions. And with that, I'd like to turn the call over to John Cuomo for his prepared remarks.

Thank you, Noel. Welcome, everyone. Thank you for taking the time to join our call today. During the fourth quarter and full year 2021, we continued to successfully execute on our multi-year business transformation plan. One engineer to develop a market-leading global aftermarket distribution, repair, and services company, positioned for long-term value creation. Last year, we moved closer to the end user, identifying new and varied ways to support complex customer requirements. We also aligned ourselves with both new and existing global Tier 1 OEM supplier partners while expanding our diverse portfolio of products and capabilities. During the fourth quarter, our VSC aviation segment continued building backlog with new business wins. Most notably, we entered into an agreement with a major U.S. airline to become the exclusive end-of-life solutions provider for their 737NG aircraft and surplus materials. Under the terms of this agreement, we will support this major domestic airline with the dismantling and disposition of retired aircraft. The program allows for the refurbishment of used parts for fleet support and the sale of used spares to airlines, OEMs, brokers, and other third parties. During the fourth quarter, we began making investments in the program management infrastructure to support the launch of this agreement. This program requires limited capital commitment as VSE is not purchasing any aircraft. Most importantly, through this agreement, VSC Aviation will now become one of the largest global suppliers of refurbished 737 engine materials. In our aviation segment, we are building a business and general aviation platform that encompasses a full breadth of products and services, a tip-to-tail approach to support the requirements of B and GA customers, a strategy that builds upon our established MRO capabilities an industry-leading parts distribution business. Our 15-year, $1 billion engine accessories agreement with Pratt & Whitney Canada remains our most significant B&GA contract executed to date. In 2022, we estimate approximately $45 million of revenue from this contract, representing the first full year of revenue contribution. Once this program is fully developed, we anticipate contract revenue in excess of $60 million annually. Our aviation markets continue to recover. In 2022, we anticipate distribution will remain strong within business and general aviation and commercial market activity, and recovery to continue to accelerate throughout the year. Within MRO, we expect increased demand for spares and component repairs in all markets supported by market share gains, robust B and GA flight activity, and increased commercial aviation flight hours. Looking ahead, we see multiple avenues for profitable growth across each of our operating segments. We have streamlined our value propositions while placing more emphasis on niche market opportunities. We maintain our bidding discipline even as we enter new markets. Our fleet segment continues to successfully execute upon our commercial customer growth and diversification strategy, specifically with focused growth and success in e-commerce. Our federal and defense segment launched new divisions in 2021 to support MRO and distribution capabilities as it continued to focus on a long-term pivot to more technical capabilities in higher margin niche markets. Entering 2022, VSE is in a strong position to accelerate our strategies and drive profitable growth as we continue to build a leading global aftermarket distribution, MRO, and services brand. Aviation finished 2021 as the largest segment for the first time in our history. As we continue to execute on our long-term company strategy, prioritize the deployment of capital and other resources across the business, Aviation will increasingly become our growth engine. We will continue to use a disciplined approach to M&A transactions as we did in 2021 with our acquisitions of HSS in March and Global Parts in July. 2021 represented strong upgrades of systems, talent, facilities, processes, and capabilities to drive the ability to scale our businesses as we grow in 2022 and beyond. We continue to focus on the VSE culture and brand. We are building a high-performance, customer-focused culture that will allow us to develop a leading global aftermarket distribution, repair, exchange, and solutions single go-to-market brand. Additionally, Wheeler Fleet Solutions is continuing its path to become a market-leading vehicle distribution and e-commerce brand. We finished 2021 on a strong note. as the fourth quarter revenue increased by 40% versus the prior year, contributing to growth in both net income and adjusted EBITDA. This was driven by a combination of new contract wins, strong performance from core programs, the addition of new MRO capabilities, and continued growth within our distribution and e-commerce platforms. Within our aviation segment, fourth quarter revenue increased 115% year-over-year to a record $82.8 million, the sixth consecutive quarter of sequential revenue improvement, driven by both new program execution and contributions from the global parts acquisition. More specifically, aviation MRO revenue increased 27% versus the prior year period, while aviation distribution revenue increased 174% in the fourth quarter driven by a combination of organic share gains within the B and GA markets, together with acquisition related contributions. Aviation distribution revenues remain above pre-pandemic levels, supported by organic contributions from new distribution awards. Turning now to a review of our fleet and federal segments. Fleet revenue increased 12% on a year-over-year basis in the fourth quarter. driven by continued growth in our commercial e-commerce fulfillment business. Commercial revenue increased by 61% on a year-over-year basis in Q4 2021, representing 32% of total revenue in the period. Our federal defense business had a solid quarter, with revenue up 16% on a year-over-year basis, driven by a combination of organic growth contributions and the recently completed HACO special services acquisition. Federal segment backlog increased 1% year-over-year during the fourth quarter as supported by increased new business development activities. In summary, the fourth quarter was a solid finish to a transformational year for BSE. In 2021, we acquired two strong businesses to add products and service offerings, added MRO and other technical capabilities to our portfolio, expanded our e-commerce solutions, enhanced our distribution product offerings with market transforming agreements and product additions, and improved internal processes, systems, centers of excellence, and talent to support all that is ahead for VSE. I am incredibly proud of the VSE team, the culture we are building, and all that was accomplished in 2021. This year, we will continue to execute on our winning strategy and playbook, solving customer problems, winning new business, adding new service capabilities, and expanding product offerings to our customers. We are off to a strong start to 2022. We remain in the early phase of an exciting multi-year transformation. During the third quarter of 2022, we intend to host our first ever Investor Day. During this event, we will outline our strategy and multi-year roadmap for growth in greater detail. Stay tuned for additional information on this event in the coming months. With that, I now turn the call over to Steve for a detailed review of our financial performance.

Thanks, John. Now let's turn to slides five and six of the conference call materials for an overview of our fourth quarter performance. We reported $210.2 million in revenue in the fourth quarter, an increase of 40% from the prior year period. Within aviation, year-over-year revenue growth was driven by a combination of new program wins, share gains, and contributions from our global parts acquisition completed in July 2021. Fleet segment growth was supported by commercial fleet and e-commerce fulfillment revenue, while the revenue from the United States Postal Service was flat year over year. Federal segment revenue growth was driven by inorganic contributions and new business awards, partially offset by the completion of certain DOD contracts in 2021. We generated adjusted EBITDA of $17.8 million in the fourth quarter, an increase of 3% on a year-over-year basis. Adjusted EBITDA margin rate declined 300 basis points year-over-year to 8.5% as margin compression within federal, and to a lesser extent within fleet, offset significant margin expansion within our aviation segment. Turning to slide seven. Aviation segment revenue increased 115% year-over-year in the fourth quarter. Both our distribution and repair businesses grew on a year-over-year basis, with distribution outperforming repair, primarily driven by improved end-market demand and new contract wins. Distribution revenue, excluding the $18.6 million of revenue contributions from our global parts acquisition, is approximately 60% above pre-pandemic levels. We continue to see commercial repair recovery in line with the overall market. We anticipate further repair revenue recovery throughout this year as we continue to invest in new capabilities and expand our integrated solutions across a growing base of business and general aviation customers and new commercial customers. Aviation adjusted EBITDA increased by more than 400% year over year, while adjusted EBITDA margins increased 580 basis points year-over-year to 9.4%. Delivering outsized revenue growth remains the top priority for this segment as we implement new programs, win new awards, and drive scale as commercial end markets recover to expand EBITDA margins. For the total year, aviation segment revenue was up 50% versus prior year, and adjusted EBITDA was up 66%. Turning to slide eight, fleet segment revenue increased 12% versus the prior year period, as higher commercial and e-commerce fulfillment offset a decline in DOD revenue. USPS revenues were flat on a year-over-year basis. Commercial revenues were $20.8 million in the fourth quarter, an increase of more than 60% versus the prior year period. commercial revenues have grown to 32% of total segment revenue, up 14 points on a year-over-year basis. Segment-adjusted EBITDA of $7.6 million was down 10% versus the prior year period, while adjusted EBITDA margins declined 310 basis points year-over-year, given a higher mix of commercial revenue. For the total year 2021, fleet segment revenue was up 8%, excluding the effect of a one-time PPE order in 2020. For the full year 2021, commercial revenues were up over 70%, which combined with the over 90% growth in 2020 continues to highlight the strong end market demand and revenue diversification opportunities for this segment. Turning to slide nine, federal and defense services segment revenue increased 16% on a year-over-year basis, driven by contributions from the HACO Special Services acquisition and new program wins, offset by the expiration of a contract with the U.S. Army, and the effects of the supply chain-related disruptions to our U.S. Navy programs. Federal adjusted EBITDA was $3.6 million in the quarter, a decline of 58% year-over-year, while segment adjusted EBITDA margins declined 9.4 points year over year to 5.3%, as some previous fixed price awards have converted to cost plus and as the business works to mitigate some of the broader supply chain related disruptions. For the full year 2021, federal segment revenue was up 6% and backlog was up 1%. Turning to slide 10, at year end, we had $122 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. In the fourth quarter, we generated $10 million of free cash flow, which with our third quarter results puts us at $31 million of free cash flow in the second half of 2021. As of year end, We have acquired the majority of the inventory for our newest aviation distribution programs. We anticipate for the first quarter 2022, we will have completed all cash outflows for these programs and expect that full year 2022 free cash flow will be positive in line with our previous guidance. As of December 31st, we had total net debt outstanding of $284 million. Adjusted EBITDA for the trailing 12-month period was $73.6 million and excludes full-year EBITDA contributions from the global parts and HSS acquisitions. At the conclusion of the fourth quarter, net leverage was 3.9 times. In 2022, we are positioned to be free cash flow positive as full-year contributions from recently launched programs and completed acquisitions support incremental growth in EBITDA. Operator, we are now ready for the question and answer portion of our call.

At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.

One moment please while we poll for questions. Our first question is from Michael Chiarimoli with Truist Securities.

Please proceed with your question.

Hey, good morning, guys. Thanks for taking the questions and thanks for the detail. Maybe just housekeeping. I don't know if I missed it. Did you guys give the organic growth rate in the quarter?

We didn't give the organic growth rate in the quarter, but we did give specifics associated with the global parts acquisition. And I think we gave the specifics in terms of the organic growth rate of the distribution business within the aviation portfolio, which was up 60% year-over-year organically.

Okay. Got it. Okay. And then just Can we maybe focus a bit on margins? I know you called out kind of the nice year-over-year gains, but it looked like sequentially there was significant pressure across all segments. I know you talked a little bit about mix and supply chain, but what specifically drove the sequential margin declines, and how should we be thinking about you know, recovery here into, you know, the current quarter and maybe progression through the year.

Sure. Steve, do you want to hit on it first and then I'll kind of summarize?

Yeah, absolutely. We highlighted a bit of the margin walk details on slide six of the materials. And specifically what we saw on a year-over-year basis for the fourth quarter was pressure within the federal and defense segment, which was driven by a couple different things. First off, a different mix in terms of our fixed price versus cost plus awards. We saw more of a shift towards cost plus within the quarter. And then secondly, there were disruptions within the business in terms of supply chain delinquencies, which delayed our ability to get the material to our customers and subsequently record revenue. So we're going to be working through some of those supply chain related disruptions as we start to recover the business. But what we've communicated in the past is that this business, you should expect it to be in the mid single digit, you know, over time progressing to the higher single digit range. And so we're continuing to see that business progress towards that long term. And then we saw to a lesser extent, as I mentioned, within the fleet portfolio, there is a mixed difference between the commercial work that we do versus the work that we perform for some of our government related customers. And so that pressure is something that's continued as we expected. But we're very pleased with the overall performance of the fleet business as revenue diversification is key to that portfolio. And then lastly, and probably most importantly, you saw the margin expansion on a year-over-year basis within the aviation portfolio. That helped to contribute actual overall expansion from a margin rate perspective at the total company level. But if you look at it for the fourth quarter specifically, it helped to drive over 500 basis points improvement within the segment as we continue to recover that business's overall margin rate back to its mid-teens margin rate over the long term.

And Mike, one thing I'll add there is... If you look at the MRO business, the commercial MRO business, which is a higher margin business in the portfolio of aviation, the recovery is a little slower than anticipated. So we do continue to expect and we have seen month over month, quarter over quarter recovery, just not at the level of robustness that we would anticipate and that we're seeing in the other parts of the aviation business. So that will scale back and that will drive incremental margin improvement. The other thing I want to add is you're hearing from other companies out there the amount of supply chain pressure on margins. We have that pressure on our federal and defense business really because we're seeing pushouts in terms of deliveries and the distribution sales are at a higher margin than some of the services sales, which are more cost-plus in nature. But on the aviation business, it's much more about the infrastructure that we put in and we're now being ready to scale. We've invested a tremendous amount in that business in 2021 to get that business to scale. I mean, you see the year-over-year growth rate in distribution and the year-over-year growth rate in total organically in that business. There was a tremendous amount of expenses that we added, and we do anticipate as we get to the back end of this year just to start to see that business scale where we're not adding operating expenses and you're starting to see the incremental revenue in the product margin or the service margin just drop to the bottom line.

Got it. I guess, too, though, I was looking more at 3Q to 4Q. You know, I get the year over year, but, you know, you had nice sequential aviation growth of about 13%. The incrementals were weak and the EBITDA margin declined from 3Q to 4Q. And, you know, you had the steep fall off in federal sequentially as well. And it sounds like, I guess, a lot of those contracts flipped. But what happens sequentially from 3Q to 4Q in aviation to pressure the margins? Go ahead, Steve.

Yeah, sure. I'd say first and foremost is you can see that we've combined in now the global parts business. The global parts business operates at a slightly lower margin rate, so we have our first full quarter worth of margin contribution, and we've communicated that when we acquired the business. And then, as John mentioned, we continue to make investments as part of the growth. So I know he referenced it a little bit earlier in the call, but generally speaking, continue to make investments to drive the scale as we continue to grow next year. But as John mentioned, we continue to see significant opportunity to drive scale on that investment. Within the federal space, I mean, you hit it well. It was the mixed shift in the contracts.

Got it. Okay. And then let me ask one more, and then I'll jump back in the queue. But, John, I guess, what are the thoughts on pricing, you know, and what you think you can get out there? I mean, we just saw this morning's inflation number, you know, pushing 8%. Presumably, you've got the ability to price in aviation. Any thoughts there on just how you can kind of keep pace and what the pricing power of the business is?

We have a very small level of long-term fixed price contracts within our business. So we are predominantly an aftermarket business that's highly transactional in nature. And we do have the ability to – we do have pricing power in the market as we speak. you know, pricing inflation. So we do not see that as a long-term risk for our business because we do see the ability to push that pricing onto the end.

Okay. Okay. And in federal and defense too, do you think that that's a little bit more challenging? I guess it really depends on how quick the contract.

It's the same thing for that business as well. That's just really a timing issue right now. That business is the one we're seeing just, there was just a significant amount of push from, Q4 to probably more like Q2 in some of our federal and defense distribution orders that just we don't have the product and we're seeing continued delays to probably closer to mid-year.

Got it. Got it. Perfect. Thanks, guys. I'll jump back in the queue. Thanks, Mike. Thank you.

Our next question is from Ken Herbert with RBC Capital Markets. Please proceed with your question.

Morning, Ken. Good morning. Good morning. This is actually Steve Strachaus on for Ken Herbert. Morning, guys. For the recent 737-NG agreement, can you provide more detail on how this program ramps and what could be the revenue contribution for this program in 2022? And then if you could kind of, I know you detailed that the investment requirements were going to be small, but if you could detail those a little further, that'd be great.

Yeah, let me start just at a high level, and then, Steve, I'll turn it over to you on the financials. So we highlighted, you know, I highlighted kind of earlier in my script that, you know, this is not a traditional USM deal where we're buying aircraft. And I want to be transparent on that. It's a very asset-light kind of partnership where we are helping to manage the total process of dismantling of the aircraft and then selling of the assets that are associated with the aircraft. So that's kind of the first thing that I want to highlight. So when we look at expenses that we added in the fourth quarter, it's really building the team that is going to manage that program and then contracting with the outside labor that's going to be doing the teardowns. As far as financial forecasts, there's not much in 2022 as we start to look at the ramp up, really going more to 2023. But Steve, I don't know if you want to jump in there and give any more color.

Yeah, I would just say I wouldn't expect too much of a material contribution from this program in 2022. As John mentioned, we're just getting the program launched right now. So we'll be able to provide more guidance for you in terms of both what to expect from a revenue standpoint as well as investments as we head into probably the first quarter and actually get some of the experience underneath our belt. But generally speaking, I think probably the most important dynamic associated with this deal is the opportunity for us to continue to embed ourselves with our deep commercial relationships and look for partnership opportunities as we continue to expand our repair capabilities. So it's further establishing us within the networks, within our customers, and continue to help provide services to them.

That's perfect. Thank you so much for the color. And then just one follow-up, if I may. How are the 2021 acquisitions with global parts and HACO performing relative to your expectations?

They're performing at or above expectations. So really pleased to see, you know, we did a small equity raise last year, put that capital to use with two deals that, you know, very favorable multiples to the business, you know, are well underway in the integration of both of those businesses into their respective segments. And the businesses are performing at or above forecast and integrations are on or accelerated from our timeline. So very, very pleased with both acquisitions, the capabilities that came on board, as well as the team that we acquired with the businesses.

Perfect. Thank you so much. I'll hop back in with you. Great.

Our next question is from Louie DePalma with William Blair. Please proceed with your question.

Good morning, John, Stephen, and Noel.

Morning, Louie.

Is the new Boeing 737 NG program with an existing U.S. airline customer? Are you able to disclose that, or is it for a new logo for you?

It's an existing customer that we support in both our distribution and our commercial MRO business. We're supporting virtually all airlines in those businesses today. We are not in a position right now where we're going to publicly announce the airline until we probably launch the program to the market. So we'll have a more marketing type announcement probably in the coming months.

Great. And for that program, I think, Steve, you mentioned how there won't be much of a revenue contribution in 2022, but will there be a negative margin impact as you ramp up the program?

I mean, there are some slight impacts associated with investments in the program, but it's not, I wouldn't call it overly material. As John mentioned, we made some investments into the team, the program management team, and, you know, that'll continue probably through the first or second quarter, and then it'll get to a point at which it pays for itself. And then I think what we're excited about is it continues to open up that cross-selling opportunity for us as we head into the end of the 2022 period and then 2023. Great.

And for the Pret and Whitney Canada partnership, I believe you announced that last April. And when you announced the deal, you targeted distributing, I think, over 6,000 engine accessories. Are we there yet in terms of you fully scaling to all 6,000? I know that, Steve, you said that outflows associated with inventory for some of your large um programs to generally end towards the end of march and so um i guess in the next few weeks should we be fully scaled for this program and and should that mean that like for the winnie cannon program that will be around the peak profitability margin for the program

Yeah, I'm happy to take it. So I think from a let's talk material first. So for the material acquisition, I'd say yes, we are at full scale in terms of ramping on the program. Obviously, there's a couple of things we're just working through towards year end and into the first quarter for the completion of all remaining piece parts. But generally speaking, yes. And then I would say in terms of as you look to this year, we've communicated guidance of $45 million this year with expectations that the program could be larger than that as it continues on into the future. But as it relates to the margin rate and the performance of the business, Yeah, midway through this year, I think we'll optimize and really get to that full scale. As we referenced last year, this is like a full business acquisition, if you really think about it. So we've set up new sales folks, new customer service representatives, and we're looking to drive scale on that as we head into this year, at which point we'll be able to really optimize the program both for the customers and for us internally.

Great. And you recently announced an expansion for your NAVSEA contract, do you have any visibility in terms of the timing of the long-term, the potential long-term contract award?

I'm going to give you a guess. My guess would be end of Q3 would be kind of an announcement on the longer-term contract. Pleased to get the $100 million bridge contract in place. We do have task orders and backlogs on our legacy contract, plus now another $100 million commitment through next year. And then our anticipation is an award, I'd say, end of Q3.

Okay. And I know you didn't provide formal financial guidance, but are you able to provide any color on how we should think about in terms of margins trending across your aviation fleet and federal segments? I know you just about how it's essential to hit the peak margin for the Pratt & Whitney Canada program in the summer. And there's been the supply chain impact on the federal side. And there's the mixed shift with the fleet side. But is there any high-level guidance that you can provide on how we should be modeling the margin trend for 2022? Yeah, sure.

Let me start with a little bit of background noise. Let me start with the federal business. So I communicated a little bit ago that mid-single digits is where this business is, and we've communicated in the past that's where the business is working to go from mid-single digits to high single digits. I would say mid-single digits is the right place for it to be right now as we continue to drive scale and work through some of the supply chain-related disruptions that we talked about. I would say for the fleet segment, you saw some margin compression last year. as the business continues its mix shift. There'll be some continuation of that, but we are looking to the back half of this year to really drive scale within the business. As we mentioned last year, we've made big investments into the commercial growth avenues, both at the sales teams, et cetera, and we're looking forward to that in the back half of this year. And then I'd say from an aviation perspective, we just communicated that, look, we're going to expect continued improvement as we try and drive the business to scale. I mentioned some of the dynamics associated with 3Q to 4Q with the global parts business. But as we look towards this year, we're going to continue that long-term target of around mid-teens margin rate. And we'll continue to get there, but it is going to be predicated upon the commercial repair business getting back to its pre-COVID levels. And that is longer term. So I think everybody in the market has continued to see some slowness or some delays associated with that repair business getting back. And so we're going to continue to pace in line with the market. So I think you should just model out the expectation from an aviation perspective that it's going to take a while. as it relates back to the market for the commercial MRO. But as we mentioned in the distribution side, we're back to pre-pandemic levels.

Thanks for the call, Steven.

Thanks, John and Noel. Thanks, Luis. That's it for me.

Our next question is from Josh Sullivan with The Benchmark Company. Please proceed with your question.

Hey, good morning. Good morning, Josh.

Just to kind of follow up on that a little bit, you know, on the commercial narrow body activity, I know you said it's obviously going to take a while to recover here. But, you know, in the spring of 21, there was a lot of optimism for summer travel by the airlines. Curious if you could just compare how that 21 activity or behavior contrasts with what you're seeing here in 22 heading into the summer.

You know, my anticipation is we're going to continue to see month-over-month improvements. in the commercial MRO business and our parts trading business that's connected to that business. So each month we do see a level of increased activity, a level of increased backlog, and a level of increased work in our MRO shops. Is it as robust as any of us anticipated? No. I think when you look at the initial market studies that were done when COVID hit, talking about getting back to 2019 levels, you know, sometime in late 2023 to early 2024, you know, that includes international travel. I think that, you know, those statistics are probably going to come out to be quite accurate in the end. So it's the slowest part to recover. But that said, month over month, we are seeing continual improvement in that business. And that will drive the margin improvement because, again, we've got kind of a base of fixed costs that we can scale from as that recovers.

Got it. And then just on the end of service supply agreement you've got here, what are your thoughts on commercial airline fleet retirements going forward? Has the recent spike in energy caused any changing in thinking by your customers? And then just curious what pricing looks like for USM.

Yeah, we don't see any change. I think we saw that fleet shift during COVID, parking of 767s and people hoping they were going to be able to accelerate their 787 deliveries, which hasn't happened, but we don't see a major shift in retirements or how our airline customers are using their fleet. I think with regard to pricing on USM, that's why we haven't given any clear guidance on the program. We're just doing the first kind of tear down as we speak, getting our arms around the inventory, and then we'll do an analysis kind of on what we think pricing will look like and model this business out a bit more. And we'll share color on that as kind of midway through the year.

And then just on that contract, you mentioned it's not a typical contract, but with an existing customer, So does that change your exposure to any particular service schedule, A, B, C, or D? Does it include the engine? Just curious on, you know, what types of new verticals it might open for you over time.

Yeah, it's great. It does not include the engine. Steve, I don't know if you're far more technical than I am. I don't know if you want to dive into, you know, kind of how we look at the products. But what I would say, Josh, is that from our perspective, we look at both the, you know, to be one of the largest, we can't say we're the largest, we don't know all the details in the market, but we believe we could be the largest supplier of these NG products in the market. There is an overlap, a significant percentage of overlap on some of these parts on the NG to the max, so it gives us that ability as well. These NG aircraft are going to continue to fly in other markets, and it gives us the ability to sell in those markets. And with continued supply chain disruption, we see this as being even more more lucrative probably than we thought when we had the initial dialogue. Steve, I don't know if you want to give any more color on the product.

Yeah, I would just say it includes the whole aircraft, excluding the engines, but does include the QEC kit. And so we'll be working with our partners to make sure that we optimize all the opportunities to see where that inventory can go and find the best possible place for it with customers, brokers, and repair shops.

Got it. Thank you for your time. Thanks, Josh. Thank you.

Our next question is from Jeff Van Sinderen with B. Reilly. Please proceed with your question.

Good morning, everyone. Just to clarify earlier comments, were you saying that we should see second half year-over-year inflection in the fleet segment? And that also wasn't clear if you were suggesting similar timing for year-over-year inflection on the Fed and defense segments.

I think within the fleet segment, we continue to see the top line growth accelerate within the commercial side of the business, offset by the USPS, as we've mentioned. But as I was referring to the margin rate, my point was specifically that we're at a point now where we've seen that mix shift take place. We're going to continue to see that mix shift take place. But as we drive scale towards the second half of the year, we do expect to be able to drive growth there. Within the federal and defense space, we haven't necessarily given specific guidance associated with where we expect to see the margin rates trends radically throughout the year. What John mentioned, though, is we do expect some of the supply chain-related delinquencies that have affected both the first quarter and last quarter to potentially start to free up towards the back half of this year.

Okay. And then, realizing it's early on the new 737 contract, but any sense – of expectations for margins around that particular contract?

I know it's not going to be much this year, but... The short answer is no.

I wouldn't say it's going to be materially different from where we've given the guidance for the aviation business. And as we get our arms wrapped around it, we'll be able to share more details with you in terms of magnitude and impact. But right now, I wouldn't expect it to be something substantially different than what we've communicated for the overall segment.

Okay. And then just kind of turning back to the general inflationary cost pressures out there, it seems like everybody's experiencing. Any particular areas that you feel are more vulnerable than others for that? Do you just see that as something that's going to probably just impact everything and you'll take up prices where you need to or just, I guess, anything else to call out around that?

Yeah, I mean, we're staying very close to labor. You know, we're watching our labor markets and They're very different geographically, very different by kind of work type, and we're staying close to that, but we feel we've got our arms around it and a level of control and stability in our workforce. And the other side of it is on product costs. And, again, we do feel you may see a lag from, you know, we get a price increase from vendors and we do have some backlog with customers where we're locked in and for one quarter on a price and we have some inflationary pressure, but we do feel by the next quarter we're in a position where we can quickly adapt. So we do not see long-term impact. So we see a short blip, you know, maybe one quarter or another in a product-based situation, sure, but we don't see a significant long-term impact. Again, because of the pricing power that we have, the lack of long-term fixed price contracts with our customers, which is just the nature of the business. Okay.

Okay. Thanks for taking my questions, and best of luck. Thank you. Appreciate the time. Thank you.

Our next question is from Michael Ciaramoli with Truist Securities. Please proceed with your question.

Hey, guys. Thanks for taking the follow-up. John, just, you know, maybe can you comment on kind of what you're seeing real-time from some of your, you know, airline customers as they kind of get ready here and prep for summer flying? You know, anytime I guess maybe quarter intake, maybe bookings color, and then any issues that you're seeing or you may run into with access to raw materials or turn times, just kind of dovetailing in what you've talked about with kind of labor and just supply chain.

Sure. Steve, you want to kind of kick it off, and then I'll give some color at the end?

Yeah, sure. I mean – I think from an overall market standpoint, we continue to see order intake being high, but I think there is some uncertainty as we receive customer orders for repairs and the like around need and readiness levels for the summer. So I think it's hard to predict at this point, just given some of the overall market uncertainty. As for access to raw materials and the impact as to our supply chain, at this point with the stocking levels that we had from last year, I think we're in a pretty healthy position from an inventory perspective. Turn times are a little bit longer than probably what they've been historically, but I wouldn't necessarily attribute that to something for VSC tied to a specific raw material. It's probably just more tied to just general supply chain delays. And then from a labor perspective, I think we're in a good spot from a labor perspective. We've invested in the teams. I think we've got a really good culture and brand that the teams are excited about. We feel like we're well positioned to capitalize as the market recovers.

Yeah, and if I break it down a little further in the revenue stream, if you look at the kind of pure distribution, we're seeing relatively consistent revenue, nice month-over-month improvement in the commercial backlog and customer activity. We are not seeing aggressive stocking from airlines. So we're not seeing them go make deep purchases. We're seeing kind of consistent order flow. Remember, our products are a little expensive, so we don't see them just, you know, it's not a consumable and expendable where they're overstocking. On the repair side, again, we're seeing consistent month-over-month improvement on input. What we are seeing is, you know, an airline will give us, you know, a repair unit to quote, and then they're saying, okay, hold it, rather than accelerate a repair and deliver it. So we're seeing a little slow, you know, there's not necessarily as much speed as I would have anticipated in the desire to get their products back. And then the third piece of the revenue stream is kind of the rotable pool that exists within our repair businesses. And I'd say that one's the slowest to recover. But in my opinion, that one is, as the market starts to pick up, you're going to see that recovery happen pretty quickly at the back end of the year.

Okay. And maybe this is too early and a bit real-time, but are you seeing any – behavioral changes yet as a result of rising oil prices and fuel costs? You know, you kind of mentioned, you know, airlines giving you units, quote, hold it rather than accelerate it. I mean, is it too soon to see those behavioral changes or how are you guys thinking about oil?

Yeah, I mean, remember, you know, we're very domestic focused. You know, we do have an international base, but the domestic U.S. airlines are and business and general aviation customers are do represent a significant portion of our revenue. We are not seeing any behavioral changes in that customer mix. And internationally, again, they've been quieter, but again, no material changes at this point.

Okay. Got it. Thanks, guys.

As a reminder, if you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. Our next question is from Chris McGinnis with Sododian Company. Please proceed with your question.

Good morning. Thanks for taking my questions. And I was jumping in and out, so if this has already been asked, I apologize. But just on capital allocation, you know, obviously you raised the dividend recently. Just wanted to ask about that. Is that more of a change in strategy or just confidence in the ability to execute? And then maybe if you could just discuss the M&A landscape, you know, in 2022 and the opportunities there. Thank you.

Sure. Thanks, Chris. The dividend, the company has historically paid a dividend and historically increased it. I would not anticipate us on a rapid path to increase the dividend at this point. We do want to put the capital to use and put it back into the business and invest in the business. But on the flip side, we have a ton of loyal shareholders that that dividend has been important and want to show them the confidence in our free cash flow forecast for 2022. Our M&A pipeline is filling up. We've got, you know, continuing to look at capability expansions in our services business and potential distribution opportunities in our parts distribution businesses, predominantly in the aviation business, and we do have, you know, a nice pipeline of deals. We remain very, very, very disciplined in our approach. So, you know, very much around it's got to meet the capability or the product requirements It's got to be a cultural and a business that can be fully integrated and one that will truly add value. So, you know, we've got a good pipeline and we'll continue to keep a disciplined approach to M&A.

Great.

I appreciate it. Thanks and good luck with your one.

Thank you.

We have reached the end of the question and answer session, and I will now turn the call over to John Cuomo, President and CEO, for closing remarks.

Thanks for the time and interest today. We appreciate all the continued support of VSE. We really have an exciting year ahead. Look forward to connecting with you all in late April to discuss our first quarter results. Have a great rest of your Thursday.

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