VSE Corporation 2017 Q1 Form 10-Q Summary
Business Context and Reporting Period
VSE Corporation is a diversified provider of supply-chain management, aviation maintenance, repair and overhaul, logistics, engineering, technical, and government services. Reported operations comprise Supply Chain Management, Aviation, and Federal Services. The former IT, Energy and Management Consulting Group was combined with Federal Services beginning in 2017, and 2016 segment information was restated accordingly.
The filing covers the unaudited three months ended March 31, 2017, compared with the three months ended March 31, 2016. The company had 10,838,435 common shares outstanding as of April 20, 2017.
Financial Performance and Position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Product revenue | $89.0 million | $85.3 million | 4% |
| Service revenue | $108.3 million | $58.4 million | 85% |
| Total revenue | $197.3 million | $143.6 million | 37% |
| Operating income | $14.2 million | $12.7 million | 11% |
| Operating margin | 7.2% | 8.9% | Down |
| Net income | $7.3 million | $6.6 million | 11% |
| Diluted EPS | $0.67 | $0.61 | 10% |
| Net margin | 3.7% | 4.6% | Down |
| Operating cash flow | $0.7 million | $15.4 million | Down $14.7 million |
Interest expense was $2.4 million, compared with $2.5 million in the prior-year quarter. The effective income tax rate increased to 38.0% from 36.0%, partly because the 2016 rate benefited from a $1.4 million fair-value adjustment to an earn-out obligation. Dividends declared increased to $0.060 per share from $0.055.
At March 31, 2017, cash and cash equivalents were $0.5 million, total assets were $645.5 million, and stockholders’ equity was $263.5 million. Total bank borrowings were approximately $217.6 million, consisting of $111.3 million of term debt and $106.3 million of revolving borrowings. Net debt reported on the balance sheet, after deferred financing costs, was approximately $216.0 million.
The revolving facility had $150 million of maximum availability, with no letters of credit outstanding. The company was in compliance with its debt covenants: Total Funded Debt/EBITDA was 2.69x versus a 3.00x maximum, and Fixed Charge Coverage was 1.65x versus a 1.20x minimum. The effective interest rate on aggregate debt was 3.41% after hedging.
Material Changes Versus the Prior Comparable Period
- Federal Services revenue increased 85% to $108.9 million, driven by higher Foreign Military Sales activity, the Red River Army Depot Equipment Related Services program, and other programs. Federal Services bookings were $148 million and funded backlog was $359 million, compared with $51 million and $229 million, respectively, in Q1 2016.
- Federal Services operating income increased to $3.9 million from $1.3 million, including approximately $1.6 million of additional Foreign Military Sales award fees.
- Supply Chain Management revenue increased 10% to $56.1 million, but operating income declined 6% to $8.5 million because of lower margins on USPS products. Segment operating margin declined to 15.1% from 17.7%.
- Aviation revenue decreased 4% to $32.4 million and operating income decreased 29% to $2.3 million. The decline primarily reflected lower distribution of new parts. Management stated that, excluding unusual 2016 items, the Aviation margin improved year over year.
- Operating cash flow fell sharply because of working-capital movements, particularly payments for prior-year inventory purchases and subcontractor work. Accounts payable declined to $71.2 million from $94.0 million at December 31, 2016.
- Cash increased by only $29 thousand during the quarter, despite net income of $7.3 million. Capital expenditures were $0.4 million, compared with $1.4 million in Q1 2016.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide formal quantitative earnings or revenue guidance. Management stated that the company began 2017 with strong revenue growth, a strong funded Federal Services backlog, and expectations that defense-spending priorities could support Department of Defense revenue. Management believes the business model and current markets position the company to sustain near-term revenue and operating-income levels while pursuing longer-term growth initiatives.
- USPS buying levels for the existing vehicle fleet have remained steady, but the timing and impact of the USPS new delivery-vehicle procurement remain uncertain. VSE will not compete to provide the new vehicles and is focusing on aftermarket parts and supply-chain services.
- Aviation is pursuing government-market synergies and original-equipment-manufacturer agreements. Advance inventory purchases made in 2016 and Q1 2017 required substantial cash outflows, with benefits expected over the next one to two years.
- Customer concentration remains significant: the Department of Defense represented 54.5% of Q1 revenue and USPS represented 23.6%. The Foreign Military Sales program represented approximately 24% of revenue.
- Akimeka’s reporting-unit fair value exceeded carrying value by approximately 7%, and management identified the unit as at risk of future goodwill impairment if projected cash flows deteriorate. Aviation’s fair-value cushion was approximately 10%.
- The company had approximately $199 million of goodwill and $122.9 million of net intangible assets at March 31, 2017, with $4.0 million of quarterly intangible amortization.
- Pending matters include Hawaii litigation expected to proceed to trial in October 2017 and aviation litigation seeking more than $1.0 million, with trial scheduled for May 2018. Management does not expect either matter to have a material adverse effect, but outcomes cannot be predicted with certainty.
- Variable-rate debt creates exposure to higher interest rates. Interest-rate swaps covered approximately $85 million of debt at March 31, 2017.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most Important Facts for Investors to Verify
- Whether Federal Services bookings and the $359 million funded backlog convert into revenue and cash flow as expected.
- The sustainability of Federal Services margins and award-fee contribution following the large Q1 revenue increase.
- Working-capital requirements, operating cash conversion, inventory levels, and reliance on revolving debt.
- Progress and timing of USPS vehicle procurement and the effect on aftermarket revenue.
- Aviation’s inventory monetization, revenue recovery, and margin performance.
- Compliance with debt covenants and required term-loan repayments of approximately $16.9 million in 2017, $28.1 million in 2018, $30.0 million in 2019, and $36.3 million in 2020.
- Potential goodwill impairment at Akimeka and the Aviation reporting unit if operating forecasts weaken.
- Developments in the disclosed litigation, government investigations, and contract-funding risks.