VSE Corporation Form 10-Q Summary
Business Context and Reporting Period
VSE Corporation is a diversified provider of supply-chain management, aviation maintenance, repair and overhaul, parts distribution, logistics, engineering, information technology, consulting, and federal sustainment services. Its principal customers include the U.S. Department of Defense and the U.S. Postal Service.
This unaudited report covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods. Beginning in 2017, the former IT, Energy and Management Consulting Group was combined with the Federal Services Group, and 2016 segment information was restated accordingly.
Financial Performance and Key Metrics
| Metric | Q2 2017 | Q2 2016 | Six Months 2017 | Six Months 2016 |
|---|---|---|---|---|
| Total revenue | $193.9 million | $160.5 million | $391.2 million | $304.1 million |
| Operating income | $15.0 million | $11.9 million | $29.2 million | $24.6 million |
| Operating margin | 7.7% | 7.4% | 7.5% | 8.1% |
| Net income | $7.8 million | $6.0 million | $15.1 million | $12.5 million |
| Diluted EPS | $0.72 | $0.55 | $1.39 | $1.16 |
| Operating cash flow | Not separately provided | Not separately provided | $19.0 million | $15.1 million |
Q2 revenue increased 21% and six-month revenue increased 29% year over year. Q2 net income increased 31%, while six-month net income increased 21%. The six-month effective tax rate was 38.1%, compared with 36.5% in 2016, partly because the prior-year rate benefited from a $1.3 million fair-value adjustment to an aviation earn-out obligation and tax credits.
Product revenue was $89.3 million in Q2 and $178.3 million for the six months. Service revenue was $104.6 million in Q2 and $212.9 million for the six months.
Segment Results
| Segment | Q2 Revenue | Q2 Operating Income | Six-Month Revenue | Six-Month Operating Income |
|---|---|---|---|---|
| Supply Chain Management | $56.4 million | $9.0 million | $112.5 million | $17.4 million |
| Aviation | $32.6 million | $2.6 million | $64.9 million | $4.9 million |
| Federal Services | $104.9 million | $4.0 million | $213.7 million | $7.9 million |
Federal Services was the principal growth driver. Six-month revenue rose 55%, supported by the Foreign Military Sales program, the Red River Army Depot Equipment Related Services program, and Army sustainment and refurbishment work. Supply Chain Management revenue rose 11% for the six months, but its operating income declined 2% because of USPS pricing competition and lower margins on newer DoD and commercial initiatives. Aviation six-month revenue declined 1% and operating income declined 17%, primarily because of lower demand for new parts; the comparison was also affected by unusual 2016 earn-out and settlement items.
Cash Flow, Debt and Liquidity
- Cash and cash equivalents increased from $0.4 million at December 31, 2016 to $0.7 million at June 30, 2017.
- Operating cash flow was $19.0 million, compared with $15.1 million in the first six months of 2016.
- Capital expenditures were $1.3 million, compared with $4.2 million in the prior-year period.
- Net cash used in financing activities was $17.9 million, primarily reflecting $197.1 million of loan repayments partially offset by $181.7 million of borrowings and $1.3 million of dividends paid.
- Total bank borrowings were approximately $200.8 million at June 30, 2017, down from $216.3 million at December 31, 2016. Debt net of deferred financing costs was approximately $199.4 million.
- Term-loan borrowings were approximately $105.6 million and revolving borrowings were approximately $95.2 million. The revolving facility had $150 million of maximum availability and no letters of credit outstanding.
- Required term-loan payments after June 30, 2017 are approximately $11.2 million in 2017, $28.1 million in 2018, $30.0 million in 2019, and $36.3 million in 2020. The loan agreement expires in January 2020.
- The effective interest rate on aggregate debt was 3.60%, with rates on portions of debt ranging from 3.42% to 5.25%. Interest-rate swaps had an aggregate notional amount of $85 million.
- VSE was in compliance with its debt covenants. The Total Funded Debt/EBITDA ratio was 2.28 to 1 versus a maximum of 3.00 to 1, and the Fixed Charge Coverage Ratio was 1.83 to 1 versus a minimum of 1.20 to 1.
Material Changes, Outlook and Risks
- Federal Services bookings increased to $281 million from $194 million, and funded backlog increased to $386 million from $294 million at the comparable prior-year date. Management views the backlog and defense-spending priorities as supportive of future DoD revenue.
- FMS revenue increased 72% for the six months, primarily due to completion of the transfer of two frigates to Taiwan in March 2017.
- Management expects USPS parts and services demand to remain generally stable for the next several years but is monitoring the USPS vehicle procurement transition and its potential effect on future revenue.
- Management expects continued benefits from opportunistic aviation inventory purchases over the following one to two years and is pursuing additional MRO, distribution, and government aviation opportunities.
- Management reported progress in reducing bank debt and leverage and anticipated further progress.
- Akimeka’s fair value was estimated to approximate carrying value, creating risk of future goodwill impairment if projected cash flows deteriorate. Akimeka included approximately $29.8 million of goodwill.
- VSE Aviation exceeded carrying value by approximately 10% in the 2016 impairment analysis and was identified as at risk of future impairment if revenue growth does not improve. The subsidiary included approximately $104.5 million of goodwill.
- Interest-rate increases could adversely affect earnings and cash flow because borrowings are primarily variable-rate debt, although swaps mitigate part of the exposure.
- Pending litigation includes Hawaii explosion-related claims expected to proceed to trial in October 2017 and an aviation crash lawsuit 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 litigation outcomes are uncertain.
- The company adopted certain share-based payment, inventory, and goodwill impairment accounting updates without significant effects. It expects to adopt the new revenue-recognition standard beginning January 1, 2018 using the modified retrospective method; management expects changes principally in the timing of award-fee, aviation MRO, fixed-price delivery, and fixed-price services revenue recognition.
Important Facts for Investors to Verify
- Whether Federal Services bookings and the $386 million funded backlog convert into revenue at expected margins and within expected periods.
- The sustainability of growth from the FMS program, Army programs, and new commercial supply-chain customers.
- Whether Aviation demand for new parts recovers and whether Aviation and Akimeka avoid goodwill impairment.
- Progress toward scheduled debt repayments and compliance with the declining leverage covenant through the January 2020 loan maturity.
- The effect of USPS vehicle procurement changes on the Supply Chain Management Group.
- The financial and operational impact of pending litigation, government investigations, funding delays, and potential contract de-obligations.
- The effect of adopting the new revenue-recognition standard on reported revenue, margins, backlog, and comparability beginning in 2018.