VSE (NASDAQ:VSEC) reported second-quarter financial results on Thursday. The transcript from the company's second-quarter earnings call has been provided below.
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Summary
VSE Corporation reported a record revenue of $449 million, an increase of 65% year-over-year, driven by strategic acquisitions, organic growth, and expanded capabilities in the aviation aftermarket.
The company completed two major acquisitions: PAG and Northstar, which are expected to enhance global reach and capabilities, and contribute to record adjusted EBITDA margins of 19.2%.
VSE raised its full-year 2026 guidance for revenue growth to 61% to 64% and adjusted EBITDA margin to 18.7% to 19%, citing strong first-half execution and healthy customer demand.
Integration of recent acquisitions is progressing well, with a focus on realizing synergies through insourcing, joint sales, and efficiency improvements.
Management expressed confidence in the resilience of the business despite dynamic macroeconomic conditions, highlighting the strength of the aviation aftermarket and the company's strategic positioning.
Full Transcript
OPERATOR
Good day and thank you for standing by. Welcome to the VSE Corporation's second quarter 2026 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again.
Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Michael Pearlman. Please go ahead.
Michael Pearlman, Investor Relations
Thank you. Welcome to VSE Corporation second quarter 2026 results conference call. We will begin with remarks from John Cuomo, President and CEO, followed by a financial update from Adam Cohn, our Chief Financial Officer. The presentation we are sharing today is on our website and we encourage you to follow along accordingly. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including those 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're using non-GAAP financial measures in our presentation. Where available, the appropriate GAAP financial reconciliations are incorporated into our presentation and posted on our website. All percentages in today's discussion refer to year-over-year progress except where noted. Before we begin, I'd like to highlight that VSE will host an Investor Day on Wednesday, December 9th at Current, Pier 59 in New York City.
We look forward to sharing more on our strategy and long-term outlook there. Save the date. Invitations will be sent out later this month with full details following September. At the conclusion of our prepared remarks, we will open the line for questions. With that, I'd like to turn the call over to John.
John Cuomo, Chief Executive Officer, President and Board Director
Good morning everyone and thank you for joining us today. Let's begin on slide 3 where I will review our second quarter highlights. This second quarter marked a defining step forward for VSE. We closed two strategic acquisitions, delivered record revenue and profitability including a record consolidated adjusted EBITDA margin, and launched integration and synergy capture work streams across the combined platform. Importantly, the quarter demonstrated the underlying strength of our core business and the earnings power of the platform we're building.
Let me now walk through our second quarter highlights. First, we completed the acquisition of PAG, the largest transaction in VSE's history and a major milestone in our transformation. Together, PAG, Northstar, and our legacy VSE Aviation businesses create a differentiated global aviation aftermarket platform with greater scale, broader capabilities, and deeper customer relevance. We are advancing our strategy to become the world's leading independent provider of aviation aftermarket distribution and repair services while remaining firmly grounded in the OEM-centric strategy that has guided our transformation.
Second, the strength of the platform is already evident in our financial performance and progress. We delivered record revenue and profitability in the second quarter with results above prior expectations. Organic revenue grew approximately 14% with strength across both repair and distribution, supported by strength in the commercial engine aftermarket, new business wins, expanded capabilities, market share gains, and increased share of wallet. Adjusted EBITDA nearly doubled year over year, significantly outpacing revenue growth, and adjusted EBITDA margins reached a record 19.2% in the quarter.
This performance represents meaningful progress towards our long-term objective of consolidated adjusted EBITDA margins above 20% and supports our decision to raise both revenue and margin guidance for the full year. Finally, integration, execution, and synergy capture are underway. We have established clear business plans, integration governance, and executive-owned work streams across the combined platform. Integration is a core VSE capability and an important competitive differentiator.
In the short time since closing, our teams have already begun advancing tangible opportunities in insourcing, joint sales, sales channel alignment, and operating efficiency. It remains early, but the pace of execution and the quality of the opportunities identified reinforce our confidence in the revenue synergy and margin expansion potential of the combined platform. Let's now move to slide 4 where I will highlight our recent acquisitions in greater detail.
Let me start with the acquisition of PAG, which we closed on May 5th. We completed the acquisition from GenX 360 Capital Partners in a transaction valued at approximately $2 billion in cash and equity. The acquisition materially expands VSE scale, global reach, proprietary content, and repair capabilities across commercial, business, general aviation, rotorcraft, OEM, and defense end markets. We recently hosted our first Employee Connection Summit, bringing together leaders from VSE and PAG to accelerate integration planning and commercial collaboration.
The team is aligned on sales channel strategy, systems priorities, insourcing, and joint commercial opportunities. Execution is now underway across these work streams. While we are still early in the integration, we are encouraged by both the breadth of the opportunities identified and the engagement of the combined teams. Just as important, PAG brings an exceptional team, highly complementary capabilities, and a strong customer-focused culture. This combination is strengthening VSE strategically, operationally, and commercially.
Moving now to our Northstar acquisition, which closed on April 1, this acquisition adds engine-related MRO, third-party logistics, and component support capabilities to our aftermarket offering. Northstar's teardown, kitting, and component-level capabilities span multiple engine platforms and deepen our role within the OEM aftermarket supply chains. Since completing the acquisition, we have already rebranded the business as VSE Aviation Services, aligned its leadership structure, and launched key integration initiatives to expand logistics, repair capacity, and engine component support.
With that, let me provide an update on the current aviation aftermarket environment. Overall, the fundamentals supporting our business remain healthy and continue to reinforce our confidence in the long-term demand environment. The broader macroeconomic and geopolitical environment remains dynamic, including volatility in energy prices. We continue to monitor these conditions closely and remain disciplined in our planning. Our updated guidance reflects what we are seeing in the business today: strong first half execution, healthy customer demand, and solid program visibility.
To date, we have not seen any recent uncertainty translate into any meaningful change in customer demand or operator behavior. Customer activity remains healthy across our platforms, and the demand signals we see support confidence in the durability of our business. At the same time, we will continue to stay close to our customers and respond quickly if market conditions should change. Global air traffic and fleet utilization remain resilient. An aging installed base, continued constraints on new aircraft and engine availability, and the need to keep existing assets operating are sustaining demand for aftermarket parts and repair services.
These are durable demand drivers across our platform. In business and general aviation, conditions also remain unchanged. The diversity of this customer base and the mission-critical nature support the aftermarket demand. This market provides an important and complementary source of revenue alongside the strength we continue to see in commercial aviation. Taken together, the breadth of our markets, customers, capabilities, and revenue streams give us confidence in the resilience of our business.
As we enter the second half, we remain optimistic about the opportunity ahead while maintaining discipline around execution and external risk. Let's now turn to slide 5 where I'll briefly walk through our second quarter 2026 financial highlights. We delivered an outstanding quarter, headlined by record revenue and profitability. The results reflect strong execution in our core aviation businesses, continued organic momentum, and contributions from our recent acquisitions.
Our revenue of $449 million increased 65% year over year, including 14% organic growth. Revenue growth was driven by new business wins, expanded product and repair capabilities, market share gains, increased share of wallet, and contributions from recent acquisitions. Adjusted EBITDA reached a record $86 million in the quarter, increasing 98% year over year and significantly outpacing revenue growth. Adjusted EBITDA margin expanded approximately 320 basis points to a record 19.2% in the quarter.
The result reflects favorable product and repair mix, strong operating execution, synergies from prior acquisitions, and contributions from PAG. The level of profitability exceeded our expectations for the quarter and demonstrates the earning power of the platform, although quarterly mix and timing can create variability from period to period. Adjusted net income of $55 million increased 101%, while adjusted diluted earnings per share of $1.75 increased 33% year over year.
Our record profitability reinforces our confidence in the long-term earnings potential of VSE and our path toward consolidated adjusted EBITDA margins above 20% over time. I'll now turn the call over to Adam to walk through the financial details.
Adam Cohn, Chief Financial Officer
Thank you, John. Let's turn to slide six of the conference call materials where I will provide a detailed overview of our second quarter consolidated financial results. For the second quarter of 2026 we generated $449 million of revenue, an increase of 65% year over year. Both MRO and Distribution delivered strong results with MRO revenue increasing 149% and Distribution revenue increasing 17% year over year. The 149% increase in MRO revenue was driven by expanded repair capabilities and capacity, strong growth in engine content, market share gains, increased share of wallet with existing OEM partners and contributions from recent acquisitions, primarily PAG and Arrow 3. The 17% increase in Distribution revenue was driven by solid execution on new business wins, product line expansion, market share gains, strong commercial engine end-market demand and contributions from the Arrow 3 acquisition. Excluding recent acquisitions, organic revenue increased approximately 14% year over year, reflecting strong underlying demand and execution across the business. This growth rate is net of intercompany eliminations between VSE and PAG.
Since the May 5 closing, consolidated adjusted EBITDA increased 98% to $86 million. Adjusted EBITDA margin was 19.2%, an increase of approximately 320 basis points from the prior year period. The expansion was driven primarily by a greater mix of higher margin product and repair activity, synergies from previously completed acquisitions and contributions from PAG. Adjusted net income was $55 million and adjusted diluted earnings per share was $1.75 per share.
For the current and prior year periods, adjusted net income and adjusted diluted earnings per share have been updated to exclude amortization of intangible assets and stock-based compensation. Turning to slide seven and our balance sheet: during the quarter, we closed on a $900 million Term Loan B and upsized our revolving credit facility to $500 million. These new facilities replace our prior Term Loan A and revolver structure and together they strengthen our balance sheet and give us the flexibility to execute against our strategic priorities.
At the end of the second quarter, total debt outstanding was $967 million, including our new Term Loan B and the debt portion of the tangible equity units. Debt issuance costs were approximately $20 million and we had approximately $75 million of cash and cash equivalents on hand, resulting in net debt of approximately $872 million. We had no borrowings under our recently upsized $500 million revolving credit facility. During the second quarter we generated approximately $19 million of free cash flow, a significant improvement from the first quarter and from the second quarter of last year.
The improvements were driven by strong profitability, better working capital performance and a continued shift in portfolio mix towards MRO. Second quarter free cash flow was also absorbed by approximately $10 million of PAG-related cash transaction expenses. Excluding those expenses, free cash flow conversion was approximately 34% of adjusted EBITDA. We expect cash generation to strengthen in the second half as earnings grow, integration progresses and working capital investments begin to scale.
At quarter end, our adjusted net leverage ratio was 2.4 times, stronger than the pro forma guidance we outlined at the time of the PAG closing. We expect leverage to continue to improve in the second half of the year supported by stronger free cash flow generation. This will increase our financial flexibility as we execute integration priorities and maintain a disciplined approach to capital allocation. Let's now turn to slide eight to review our updated consolidated company guidance for full year 2026.
Starting with revenue: based on the strength of our first half execution, continued double-digit organic growth and increasing visibility into customer demand and program activity, we are raising our full year 2026 revenue guidance. We now expect full year revenue growth of 61% to 64%, up from our prior outlook of 57% to 61%. We are also increasing our full year 2026 adjusted EBITDA margin outlook reflecting record first half profitability, continued operating execution and the early benefits from our recent acquisitions.
We now expect full year adjusted EBITDA margin of 18.7% to 19%, compared with prior outlook of 18.1% to 18.5% on free cash flow inclusive of PAG. We expect meaningful improvement in the second half driven by earnings growth, lower transaction-related cash costs and improved working capital efficiency as investments in programs scale. Stronger cash generation remains an important priority and is expected to support continued deleveraging. I would now like to provide an update on several additional modeling assumptions post-PAG acquisition, which are also detailed in the appendix of the presentation.
For full year 2026, interest expense, net of interest income, is projected at approximately $36 to $39 million. Depreciation and amortization is expected to be approximately $96 to $100 million. In aggregate, the effective tax rate is projected at approximately 25%. Stock-based compensation is expected to be approximately $18 to $19 million and capital expenditures are expected to be approximately 2% to 2.5% of revenue. With that, I'll turn the call back over to John.
John Cuomo, Chief Executive Officer, President and Board Director
Thanks, Adam. I'd like to conclude by briefly reviewing our 2026 priorities on slide nine. First, we are focused on executing acquisition integrations and accelerating the realization of synergies. Second, we are implementing newly awarded distribution programs across our core platforms. The recently launched Pratt & Whitney Canada APU agreement ramped ahead of our expectations in the second quarter. We are also advancing our CFM engine initiatives.
We took delivery of seven CFM56 engines during the quarter and began processing those assets through our in-house repair and tear down operations. Third, we are expanding our MRO capacity and technical capabilities to capture incremental demand, specifically across the engine aftermarket. Fourth, we are advancing and converting our organic pipeline into revenue and margin contribution. Fifth, we are continuing to enhance our systems and our processes to support scale, integration and efficient growth, including the targeted use of AI and data-driven tools to improve operational efficiency, optimize workflows and support decision-making across the platform. And finally, with the PAG acquisition now closed, we are advancing integration across sales channels, insourcing systems, organizational alignment and joint commercial opportunities. We are confident in the combined strength of the platform and see meaningful revenue synergy and margin expansion potential as the integration progresses. We remain disciplined, measure progress against clear milestones and prioritize actions that create durable value for customers and shareholders.
In closing, this was an exceptional quarter for VSE. We delivered record revenue, record profitability including record adjusted EBITDA margins, generated approximately 14% organic growth, improved free cash flow, advanced integrations and raised both revenue and adjusted EBITDA margin guidance. More importantly than any single quarter, these results demonstrate that our strategy continues to work, our core businesses are performing exceptionally well, our market position continues to strengthen and our expanded platform is creating new opportunities for growth, efficiency and long-term value creation.
While we remain disciplined in managing the business through an evolving external environment, I have never been more confident in VSE's long-term competitive position, the quality of our team and the long-term opportunity to create value for our shareholders. Thank you for your continued support and confidence in VSE. Operator, we are now ready to take questions.
OPERATOR
Thank you. At this time, we'll conduct a question-and-answer session. As a reminder, to ask a question, you will need to press star-1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star-1-1 again. Please stand by while we compile the Q&A roster, and our first question will come from Ken Herbert from RBC Capital Markets. Your line is open.
Ken Herbert, Analyst at RBC Capital Markets
Yeah, hi, good morning, John and Adam and Michael. Nice results.
John Cuomo, Chief Executive Officer, President and Board Director
Thanks, Ken.
Ken Herbert, Analyst at RBC Capital Markets
Maybe, John, just to kick off the guidance raise in terms of the revenues, can you provide any more specifics around was that maybe better execution on recent acquisitions that you're expecting? Is it legacy business, Distribution, MRO? What should we think about underlying the increased confidence in the second half and full year revenue outlook?
John Cuomo, Chief Executive Officer, President and Board Director
Yeah, I mean, it's honestly kind of a little bit of everything. So if you look at our first quarter, really our stronger phase of our organic growth was actually on the Distribution side in the legacy business. Second quarter, it kind of flipped a little bit and our MRO businesses were slightly stronger. Our acquisitions are all performing well. The teams continue to perform. We had business wins in late last year that are kind of ramping slightly ahead of schedule.
So I'd say it's a little puts and takes from across the board rather than one strong initiative. But I would say on the revenue side, it's more the core business confidence than anything. Our modeling on our acquisitions is pretty firm, but I'd say our confidence on the core business is driving the revenue guidance.
Ken Herbert, Analyst at RBC Capital Markets
Okay, very helpful. And maybe really nice gross margins in the second quarter, and maybe, Adam, as we think about moving forward, how do we think about incremental gross margin opportunities both within PAG and across the organization as we think about that underpinning what should be continued margin expansion? But what are you looking at today as you look at some of the opportunities on gross margins, and how do we think about the right run rate there for the margins in the second half of this year, but more importantly exiting '26?
Adam Cohn, Chief Financial Officer
Yes, thanks for the question, Ken. Yes, the margin performance was exceptionally strong in the quarter, really driven by the strong organic growth that John alluded to, especially in some of our higher-margin, engine-focused businesses. So we saw very strong incrementals in the second quarter. I think right now, just given the organic growth visibility, we feel strongly about the margins heading into the second half of the year. And you see that embedded into our updated guidance for 18.7% to 19% for the full year.
But we continue to see very strong margins, especially in the engine-focused businesses.
Ken Herbert, Analyst at RBC Capital Markets
Great, thanks. I'll pass it back there.
John Cuomo, Chief Executive Officer, President and Board Director
Thanks, Ken.
OPERATOR
Thank you. And our next question comes from Sheila Kahyaoglu from Jefferies. Your line is open.
Sheila Kahyaoglu, Analyst at Jefferies
Good morning, John and Adam. How are you guys? John, you're now 90 days into owning PAG, so maybe can you update us on how that integration is going? I know you're very thorough with those. How much of the synergy realization is contributing to the full-year margin raise versus organic improvements?
John Cuomo, Chief Executive Officer, President and Board Director
Yeah, I mean, Sheila, like Mike, it's funny because I read some of the free notes last night about kind of acceleration of synergies and that's really not what drove the margin. You know, we really let businesses run for a solid 90, 100 days. I kind of call it the 100-day plan. You watch the business that you acquire and then you validate some of your initial integration assumptions. So we really haven't kicked off. We've got things in action. But you'll see the synergy realization more in 27 than you are going to see in 26.
We had this is mostly our core business. Obviously we're trying to start some insourcing earlier which will drive some margin improvement. But I'd say the majority of the confidence in our raise is really based on the core business. At this point, I feel very good about the business that we've acquired. I'm not finding anything that's concerning at all that's going to deviate from our plans. But that's not what's driving the back end of the year guidance increase.
Sheila Kahyaoglu, Analyst at Jefferies
Okay, great. Maybe I'll stick with a follow up on PAG. In that case, can you talk about what part of the business has been better than you expected versus when you first bought it and how do you think about the opportunities within the business?
John Cuomo, Chief Executive Officer, President and Board Director
Yeah, I think the part that's better is, and it's interesting, the CEO of PAG was very excited during the diligence of how the businesses can come together and where all of the insourcing and other opportunities can come. I think that is, you know, I think we'll be able to accelerate that to a faster and greater pace than I had initially thought. I think some of the core technical capabilities of where we can drive proprietary content over time, I think some of those areas are greater than probably I had anticipated.
But all in all, it's an outstanding team. I love the culture, extremely customer centric. The nimbleness and the agility of what they bring to the table is absolutely just second to none. So very excited about what's ahead and excited about accelerating some of our kind of themes around integration on some of those proprietary content concepts sooner than later.
Sheila Kahyaoglu, Analyst at Jefferies
Great, thank you.
OPERATOR
Thank you. Our next question comes from Louis DePalma from William Blair. Your line is open.
Louis DePalma, Analyst at William Blair
John, Adam and Michael, good morning.
John Cuomo, Chief Executive Officer, President and Board Director
Morning, Lou.
Louis DePalma, Analyst at William Blair
To clarify, the previous answer is the updated margin expansion outlook mostly related to operating leverage and the upside on the revenue line?
Adam Cohn, Chief Financial Officer
Yeah, it's really from a multitude of factors, Louie. Obviously very strong margins in the second quarter and we feel good about the organic growth in the second half of the year. I think we continue to see more insourcing opportunities, especially on the repair side, and that's really having an impact on our margins. And then we feel good about the PAG acquisition as well. It's performing in line with our expectations, but obviously you're going to get a margin uplift in the third quarter as you have full quarter contributions from PAG.
Louis DePalma, Analyst at William Blair
Adam, can you remind investors what were the original synergy expectations for the PAG acquisition? If none of them have been realized
Adam Cohn, Chief Financial Officer
yet, we had about 15 million of run rate synergies was our initial expectation.
Louis DePalma, Analyst at William Blair
Okay. And one other question. In terms of the strong organic growth, organic growth actually accelerated from last year even though industry travel volumes and aircraft retirements have been pretty flattish versus 2025. How do you explain that outperformance? In terms of the organic growth acceleration, would most of it be attributed to the new business wins such as the Pratt & Whitney Canada APU win and the CFM56? Or I guess how in general do you explain the acceleration versus last year?
John Cuomo, Chief Executive Officer, President and Board Director
Yeah, I appreciate the question. And Louis, the one thing I'd add on top of it is we had a contract that expired, so we had a hole to fill on top of the growth. So if you actually carve out the core, organic growth is actually even stronger when you look at it. It's really what drives the growth. It's price and volume we are still seeing. Remember, our business mix is slightly different than a lot of our competitors that are out there. Everyone talks about the commercial markets.
You know, half of our business is business and general aviation as well. And 50% of our business is engine-related in totality. So first of all, the commercial markets are still very healthy. Are they growing at as fast of a rate as last year? No, but they're still quite healthy and robust. It's not a zero point growth gain. The second is our business in general aviation markets are continuing to grow at a nice pace. The third is the engine side of both markets is growing faster than the component side and that's 50% of our business.
And then we have new business wins. And then there's a little bit of price element in there as well. So you kind of break it down into all those individual buckets and it's a little par for me. But it's just nice to see the core business starting to come together and perform as we had planned.
Louis DePalma, Analyst at William Blair
Great. And are there expected to be any changes to that trend in the second half of the year?
John Cuomo, Chief Executive Officer, President and Board Director
No, not at this time.
Louis DePalma, Analyst at William Blair
Great. Thanks, John. Thanks, Ed.
OPERATOR
Thank you. Our next question will come from John Godden from Citi. Your line is open.
John Godden, Analyst at Citi
Hey guys. Thanks for taking my question. John, in the prepared remarks you described the long-term vision as being the world's leading provider of aftermarket distribution and aftermarket services. And I know this isn't the first quarter you've had that sentence in there. But when I just take a step back and I think about what that means, it doesn't feel like that's a seven billion dollar enterprise value company. When I think of what that means across the coverage of A and D, I can easily brainstorm companies that are 10 times larger that might kind of fit that category and are still growing.
So maybe you can just kind of reflect on that vision for a moment and where this all goes from here in the fullness of time. It does kind of feel like we're at the beginning of the beginning.
John Cuomo, Chief Executive Officer, President and Board Director
Yeah. I appreciate the question and I'll answer half of it because I got to leave a little bit for my investor day in December. But I look at life in terms of chapters and as you start a new chapter, you're continuing the story from the chapter before. But the reason you start a new chapter is there is kind of an impetus for some change and for what's next. When we look at our market, which is centered in OEM centricity, and you look at a $200 billion aftermarket, that's still 75% or so OEM direct to end user.
And that's where we're gaining most of our share. We still see a tremendous amount of upside in the opportunity sets in our distribution business, our maintenance, repair and overhaul business. And equally or more important is our newer and more growing proportions proprietary solutions business where we own IP in kind of a few different ways. So I think you're looking at it the right way. I look at things in terms of kind of three-year buckets, but I like how you look even bigger than that.
And we just see the enormous kind of firepower in the market, the opportunities, regardless of little blips and ups and downs. I mean, markets take those. That's not overly concerning to us. We're looking long term of where there are gaps in markets that need to be filled and how we at VSE have something unique to go and fill those markets. So appreciate the question and you'll see a lot more clarity around the puts and takes and what will financially and kind of from a forecast perspective over the next three plus years help kind of solidify the confidence in that story as we get into December.
John Godden, Analyst at Citi
We'll look out for that. If I could ask one more on PAG, you know, after the deal was announced, one of the things that, you know, we chatted a bit about, but I felt like was underappreciated was the value of the earn out in motivating the team. I recall you describing as the earn out objectives being kind of a very high bar. It does seem like we're executing quite well toward that. Any thoughts on the achievability of the earn out this year and if that view has changed?
John Cuomo, Chief Executive Officer, President and Board Director
Yes, I think the top end is the high bar we expect. I have high expectations and want them to achieve some element of the earn out because it means the business is performing at or better than we had forecast. Adam, do you want to kind of share how you modeled it in the Q?
Adam Cohn, Chief Financial Officer
Yeah, yeah. I mean, if you look in the balance sheet within the earnings release, you can see there's about $34 million of fair value on the earn out in terms of total expectation. You know, total opportunity, about 125 million. So I think we're well aligned based on 2026 adjusted EBITDA. And, you know, that's kind of where our expectations are right now.
John Godden, Analyst at Citi
Yeah. So the bottom line is it sounds like you're on track to achieve it.
Adam Cohn, Chief Financial Officer
A portion of it at this point.
John Godden, Analyst at Citi
Yeah. All right. Thanks, guys.
John Cuomo, Chief Executive Officer, President and Board Director
Thanks, Joe.
OPERATOR
Thank you. Our next question will come from Kristine Liwag from Morgan Stanley. Your line is open.
Kristine Liwag, Analyst at Morgan Stanley
Hey, good morning, everyone. John, there's clear momentum in revenue growth and margin expansion from the core and you've got the incrementals from acquisition. And I think those questions are fairly well asked. I was wondering if you could talk about how you think about the free cash flow generation strength of the company and that free cash flow conversion to EBITDA. What are the puts and takes in working capital with this combined entity? And when you compare your business to other aerospace, defense kind of suppliers in that ecosystem, is there a path for you to get to a free cash flow to EBITDA conversion north of 70% over time?
John Cuomo, Chief Executive Officer, President and Board Director
Oh, big target there. I mean, yes. I'll just talk anecdotally and then I'll let Adam kind of walk through the math for you and, you know, we'll work on again some three-year guidance towards the back end of the year as we've owned the business for 100 days. So I don't always like to overstate kind of my expectations until I just kind of continue to watch it perform. Our businesses from a capex perspective are quite light. In our distribution business, which is about $700 to $800 million of the business, it's only about 1% of sales at the top end.
You know, our MRO businesses tend to be 2 to 3% depending on how much investment we're making in the capacity expansion on the organic side and the inventory on the working capital is really what drives the free cash flow generation. Because of all the supply chain constraints in the market, we have been pretty prudent. You see some others talk about kind of missing a quarter because of inventory. So we're trying to hedge ourselves on core parts and make sure we're ahead of the curve.
That said, as the business continues to grow, as those markets start to stabilize and the business mix continues to shift more towards our proprietary solutions and our MRO businesses, what that does is just naturally drive a stronger free cash flow generation. So you want to talk a little bit about the back end of the year, Adam?
Adam Cohn, Chief Financial Officer
Yeah, no, I mean you answered it really well. There's going to be less working capital intensity in the back half of the year, and that's just in line with the seasonality of our business. Especially this year where we had a couple of new programs occur in the first quarter and you saw heavy inventory use, you saw less use in the second quarter, and we talked about a conversion in the low 30s, particularly if you exclude some of the PAG-related cash transaction costs.
And we're even expecting stronger free cash flow in the second half of the year as the working capital intensity continues to reduce. We have full quarter contributions from PAG. There's obviously going to be some offset with interest expense as we have the full run-rate from the Term Loan B that we issued in the second quarter. But overall we feel good about the conversion in the back half of the year, and then as John said during the investor day, we'll share some more about longer-term free cash flow conversion targets.
But we feel really good about the outlook.
UNKNOWN, Analyst
Great. Super helpful. And following up on that inventory comment, how much of that inventory increase is driven by part availability to support your MRO business versus filling up the distribution channels? And also following up on that distribution—sorry, I guess it's a three-part question—yesterday we saw Honeywell take an inventory obsolescence charge. Is there a risk in your distribution side of potential obsolescence risk?
John Cuomo, Chief Executive Officer, President and Board Director
Good questions, Adam?
Adam Cohn, Chief Financial Officer
Yeah, yeah, good question. I would say in terms of inventory intensity, probably double in distribution than it is from an MRO perspective. So more of the organic growth in distribution is driving the inventory build, especially in the first half of the year. And then I would say in terms of obsolete—no, we feel really good about it. We have very rigid, strict policies around the health of our inventory. We're constantly assessing our programs and demand.
So no, we feel very good. We don't feel like there's any risk.
John Cuomo, Chief Executive Officer, President and Board Director
And I know, I kind of joke, Kristine, that we talk fast, we kind of move fast, but there's a tremendous amount of discipline in our business, and some of our sales teams struggle where we don't take a distribution opportunity because, exactly to your point, we feel like it has some obsolescence risk. When you look at our core distribution business, we are on real modern, solid platforms that have a lot of longevity in them, and we are not doing kind of one-off programs.
And that's where I think people get into inventory obsolescence risk. When you're supporting whether it's LEAP or geared turbofan or CFM56 or PT6 engine work, or you're on the airframes of 737 MAX, A350, and you're on core product lines, you have a lot of confidence in your inventory that's on the balance sheet.
UNKNOWN, Analyst
Great. Thank you very much.
OPERATOR
Thank you. Our next question will come from Louis Ruffeto from Wolfe Research. Your line is open.
Louis Ruffeto, Analyst at Wolfe Research
Good morning, gentlemen.
John Cuomo, Chief Executive Officer, President and Board Director
Good morning. Good morning, John.
Louis Ruffeto, Analyst at Wolfe Research
I think when you talked about PAG initially, one of the things that you like most about it was kind of how they leverage the repair distribution model, and I think you would say maybe they even do it better than you guys can. Could you just sort of expand on what you see them do and sort of maybe the difference between what you do and they do and how you can leverage what you're learning from them?
John Cuomo, Chief Executive Officer, President and Board Director
Yeah, I think what they do very, very well is how they tie inside of their MRO shops their exchange pool. So, yes, there are a number of the larger customers who have inventory on the shelf. And this has been a period post-COVID where holding inventory has not been a bad thing. But for 90% of the cycles I've been through, your end users don't want to hold inventory. So having those exchanges very closely tied with the MRO shop is helping them get the order, and I think that there's just a tremendous opportunity in how we tie the exchange pool to the MRO shops.
The second thing is, I think as we continue to expand our DER repair capabilities, how do we utilize our in-house alternative sourcing models—whether it's creating our own products or using USM to create repairs where we have gaps in supply chain. I think they do both of those really, really well and look forward to kind of expanding on that inside of our core business.
Louis Ruffeto, Analyst at Wolfe Research
Great, thank you. And maybe just your latest thoughts on M&A—not trying to rush anything, obviously—but you've done several deals now, you're certainly on track to be below, I think, two times leverage by the end of the year, and I know you've got a list of other things you'd still like to do.
John Cuomo, Chief Executive Officer, President and Board Director
Yeah, it is a very, very active market. The back end of the year has a tremendous amount of opportunities, so it'll be an interesting back end of the year to see how those opportunities kind of fall out. There are a number that are interesting to us. The bid and ask is an interesting model as well. I think valuations are very, very high; multiples are expanding and not contracting. The competitive landscape has kind of increased as well. So there's a lot of factors to look into: does the capability fit, how confident do we feel about '27 and '28, and then can a valuation work?
There are certain deals that I think we're able to absorb in our organization today while we're integrating PAG, and there might be a few others that might be a little bit too complex for us right now. So we'll stay with things that we feel like we can absorb and definitely not risk anything in the franchise or anything in our integration plan. But it doesn't preclude us from doing another deal.
Louis Ruffeto, Analyst at Wolfe Research
Thank you very much.
John Cuomo, Chief Executive Officer, President and Board Director
Thank you.
OPERATOR
Thanks. Thank you. Our next question comes from Jeff Van Sinderen from B. Riley Securities. Your line is open.
Jeff Van Sinderen, Analyst at B. Riley Securities
Hi, good morning everyone. In your prepared comments, John, I think you mentioned expanding MRO capacity and capabilities for the engine aftermarket, which obviously is a really strong market right now. Can you speak more about some of the initiatives you're planning and working on toward that end?
John Cuomo, Chief Executive Officer, President and Board Director
Yeah, I mean from an organic perspective, we have three facilities that we're building a new facility for one of our engine shops, and we'll move that shop and that will give us probably a 50% increase in capacity. And then for our other two stronger engine-focused shops, we're working on expanding existing facilities. The other thing, as we get into 2027, we'll talk more about kind of that new capability add at those shops when we both have the labor, the space, and the equipment to support those.
So as we look at kind of the next generation of engines, specifically on the commercial side, and we want to support our OEM partners with back-shop work, we need to make sure we've got both the capacity and the labor to be able to step in and support that. So there are some strong organic initiatives in front of us right now.
Jeff Van Sinderen, Analyst at B. Riley Securities
Okay, great. And then maybe if we can just touch on supply chain for a moment. Just wondering the latest you're seeing there, how you feel like it's evolving, and any impact you expect on inventory management around supply chain?
John Cuomo, Chief Executive Officer, President and Board Director
Yeah, I'd say let's start with the VSE side of things. I don't expect any—Adam spoke about kind of stronger free cash flow generation in the back end of the year—so nothing really different on our side. I think from what's happening in the market, it continues to be kind of a whack-a-mole: one area gets fixed and another area has an element of concern. As OEM production continues to ramp, which is a good thing for the market in general, it also creates—since it's the same supply base—a little bit more constraints as well.
So I'd say in total, the puts and takes, there's not much of a difference from my perspective over the last 12 months. There's improvement in some areas and weakness in others, so you just have to be ahead of the curve. But nothing that's materially changing any of our forecasting at this point.
Jeff Van Sinderen, Analyst at B. Riley Securities
Okay, great. Thanks for taking my questions.
OPERATOR
Thank you. And as a reminder, to ask a question, please press star 11. And our next question will come from Scott Deuschle from Deutsche Bank. Your line is open.
Scott Deuschle, Analyst at Deutsche Bank
Hi, good morning. I joined a bit late, so I apologize if any of these were already addressed. But, John, the sales beat on my math was about half organic and half inorganic, so I was wondering if you could talk a bit about where that inorganic outperformance came from, and then maybe what's most surprising you on the upside on some of these recent deals.
John Cuomo, Chief Executive Officer, President and Board Director
I'm trying to do the math on your inorganic/organic. I think that organic growth is about 14%. We had contribution from the acquisitions. I'd say the acquisitions performed relatively in line with our expectations. Did they slightly beat? Yes. The core business was the bigger beat than the M&A side of the beat on the top line.
Scott Deuschle, Analyst at Deutsche Bank
I don't know if that answers the question—no, that's helpful, yeah. And then, John, Honeywell is having some challenges with its supply chain now, and it looks like they're needing to make some sacrifices on meeting their aftermarket demand in order to support their OE customers. And so I guess the question I have for you is whether that might create an inroad for you to be able to do more for them, given their constraints in serving the aftermarket, given your existing relationship.
And then can you say whether you've had any recent discussions to that effect?
John Cuomo, Chief Executive Officer, President and Board Director
Yeah, I mean, I think that we have certain platforms that have a lot of Honeywell content—737, the NGs. We are one of the largest providers of parts and services on that airframe. So I do hope that there's opportunities. We look at our supplier partners as customers, and I hope there's ways that we can help them solve some of those issues. As far as detailed discussions, I'd rather not speak about how we had those conversations, but we've read their releases as well and we'll see anything we can do to support them.
There are ways to take some of the used serviceable material parts from some of the part-outs of some of the 737 and hopefully put them through our repair facilities, and maybe we can provide some opportunities to Honeywell with that product. But I don't know the details specifically of where their gaps are at this point.
Scott Deuschle, Analyst at Deutsche Bank
Okay, thank you.
OPERATOR
Thank you. And our next question will come from Jonathan Siegman from Stifel. Your line is open.
Jonathan Siegman, Analyst at Stifel
Good morning. Thanks for taking my question. Good quarter. Just a lot of questions have been answered already, so forgive maybe a more general one, but we have conversations with investors that have a perception that business jet services may be a relatively less attractive part of the aerospace market. Just would really appreciate hearing your comments, John, countering why this vertical is attractive and why it's a good fit for your company's capabilities.
Thank you.
John Cuomo, Chief Executive Officer, President and Board Director
Yeah, I mean, I appreciate the question. We hear that sometimes too. And I think that the commercial market has a lot of the sexiness around the big engines. There are more PT6s flying than there are CFM56s. But everyone likes to talk about the CFM56 opportunities. We find the business in general aviation market you have a few fractionals that have a large fleet, but other than that you have 15,000 plus end users. And it goes everything from a true large-cap and business aircraft to a small GA aircraft to a rotorcraft.
And those end users tend to have very few aircraft. They tend to stock less inventory. So there's a lot of tail of end users that don't have exchanges or inventory on their shelves. And they tend to have a stronger need for a stronger platform of major overhaul and inventory-centric aftermarket support. There's a lot of so many different variants of those aircraft and engine types that, again, we find it a great opportunity for someone like ourselves to support our OEM partners, partners in managing that tail.
And then with regard to market trends, where the volume comes from is less on the large cabin and more on the mid and light cabin aircraft because those are the ones that are chartering the most, takeoffs and landings the most. And you tend to see a lot of consistency, even a little bit of ups and downs in the markets on those kind of in that sector. So we've been talking about this market for the last six years. We'll continue to talk about it for at least the next six and it will continue to be a really strong part of our business.
So appreciate the question and we see it as a tremendous opportunity for our business.
UNKNOWN, Analyst
Thank you, John.
OPERATOR
Thank you. And I'm showing no further questions from our phone lines. I'd now like to pass the conference back to John Cuomo for any closing remarks.
John Cuomo, Chief Executive Officer, President and Board Director
Thanks everybody for the support this morning for the analysts. I know it's a very busy earnings day, so I appreciate you all making time for us. To our shareholders, thanks again for the confidence and speak to you all early November. Thanks and have a great day.
OPERATOR
Thank you. And this does conclude today's conference call. Thank you for your participation. You may now disconnect.
Disclaimer: This transcript is provided for informational purposes only. While we strive for accuracy, there may be errors or omissions in this automated transcription. For official company statements and financial information, please refer to the company's SEC filings and official press releases. Corporate participants' and analysts' statements reflect their views as of the date of this call and are subject to change without notice.
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