VSE Corporation 2018 Form 10-K Summary
Business Context and Reporting Period
VSE Corporation is a diversified supply-chain, maintenance, repair and overhaul, logistics, engineering, information technology, energy, and consulting services provider. Its principal customers are the U.S. Department of Defense, U.S. Postal Service and other government and commercial entities. The filing covers the fiscal year ended December 31, 2018; fourth-quarter data is presented in the filing but this is an annual Form 10-K.
Reportable segments were Supply Chain Management, Aviation and Federal Services. Revenue mix was approximately 31%, 21% and 48%, respectively. Government customers represented approximately 78% of total revenue, while USPS revenue represented 25.1%.
Financial Performance and Key Metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $697.2 million | $760.1 million | Down 8% |
| Operating income | $54.2 million | $54.3 million | Essentially unchanged |
| Operating margin | 7.8% | 7.1% | Up 70 basis points |
| Net income | $35.1 million | $39.1 million | Down 10% |
| Net margin | 5.0% | 5.1% | Down 10 basis points |
| Diluted EPS | $3.21 | $3.60 | Down 11% |
| Cash flow from operations | $18.9 million | $50.4 million | Down $31.6 million |
| Cash and cash equivalents | $0.2 million | $0.6 million | Down $0.5 million |
Income before taxes was $45.2 million, compared with $45.1 million in 2017. Net income was reduced by a higher effective tax rate of 22.5%, compared with 13.3% in 2017. The 2017 rate benefited from an approximately $10.6 million non-cash deferred-tax benefit related to the Tax Cuts and Jobs Act.
- Supply Chain Management: Revenue was $214.8 million, essentially flat, while operating income declined 9% to $30.6 million. Management attributed the margin pressure to competition and a less profitable product mix.
- Aviation: Revenue increased 8% to $145.4 million and operating income increased 14% to $11.1 million, supported primarily by the Singapore distribution operation and new parts and MRO activity.
- Federal Services: Revenue declined 18% to $337.0 million, but operating income increased 18% to $15.8 million. Results included a $1.7 million gain from the sale of an NIH IT services contract.
Balance Sheet, Cash Flow, Debt and Liquidity
- Working capital increased to $176.3 million from $134.6 million. Inventory increased to $166.4 million from $132.6 million, primarily reflecting Aviation growth initiatives and other inventory purchases.
- Total assets were $638.8 million and stockholders’ equity was $328.4 million at year-end.
- Total bank borrowings were $162.7 million, down from $173.7 million. The debt comprised an $80.8 million term loan and $81.9 million of revolving borrowings.
- The credit facility expires in January 2023 and provides up to $300 million of revolving loan and letter-of-credit capacity, plus potential incremental commitments of up to $100 million. Approximately $57 thousand of letters of credit were outstanding at year-end.
- The effective interest rate on aggregate debt was 4.17%; interest rates on portions of debt ranged from 3.00% to 6.00%. Interest-rate hedges covered $50 million of debt at year-end.
- Required term-loan payments after year-end total $80.8 million through 2023, including $10.0 million due in 2019. Total contractual obligations, including debt and leases, were $211.0 million.
- Cash flow from operations was pressured by $35.6 million of cash used for inventory increases and $7.4 million used through decreases in accounts payable and deferred compensation. Capital expenditures were $3.1 million, and dividends paid were $3.3 million.
- The company was in compliance with its debt covenants, reporting a Total Funded Debt/EBITDA ratio of 1.89x against a 3.00x maximum and a Fixed Charge Coverage ratio of 3.78x against a 1.20x minimum.
Material Changes Versus the Prior Comparable Period
- Revenue declined $62.9 million, driven primarily by a $74 million reduction in Federal Services revenue. The decline reflected lower FMS activity, completion of two Army programs, reduced RRAD ERS work and lower energy and consulting revenue.
- FMS Program revenue declined approximately $36 million to $147.9 million. Funded Federal Services backlog declined to approximately $290 million from $324 million, and bookings declined to $321 million from $430 million.
- Operating income remained stable despite lower revenue because of Federal Services margin improvements, the $1.7 million contract-sale gain, and the absence of a $1.9 million contract loss recorded in 2017.
- Cash from operations fell substantially, principally because of inventory investment and working-capital movements.
- VSE adopted ASC 606 revenue recognition effective January 1, 2018 using the modified retrospective method, increasing opening retained earnings by approximately $1.5 million. The filing states that 2018 results and prior-period results are not directly comparable in all respects.
- In January 2019, VSE acquired 1st Choice Aerospace for approximately $112 million in cash, funded through the revolving credit facility, subject to working-capital adjustments. Additional earn-out payments of up to $40 million may be required based on 2019 and 2020 performance.
Guidance, Outlook, Risks and Unusual Items
Management expressed optimism about Aviation, citing the 1st Choice Aerospace acquisition, Singapore operations, expanded distribution agreements and expected commercial aerospace growth. Management expects Supply Chain Management to become more diversified through DoD, commercial and e-commerce customers, but noted uncertainty surrounding the USPS next-generation delivery vehicle program and the retirement of older vehicles.
Management expects Federal Services performance to remain affected by government funding, contract awards, program priorities and the timing of FMS work. The filing does not provide formal consolidated revenue or earnings guidance.
- Revenue concentration is significant: USPS, U.S. Navy and U.S. Army together generated approximately 70.7% of 2018 revenue. The USPS MIP and Navy FMS Program are individually material.
- Government budgets, funding delays, contract protests, terminations for convenience or default, set-asides, insourcing and shifting procurement priorities could reduce revenue and margins.
- The USPS fleet transition and delayed NGDV procurement could materially affect parts demand and future revenue.
- VSE Aviation and Akimeka were identified as relatively close to goodwill impairment thresholds. VSE Aviation’s fair value exceeded carrying value by approximately 6%; its goodwill carrying amount was approximately $104.5 million. Akimeka’s fair value exceeded carrying value by approximately 30%, with approximately $30.9 million of goodwill.
- Approximately $4.7 million of 2018 revenue related to work performed at risk without formalized government funding. Management expects reimbursement but remains exposed if funding is not received.
- A collective-action overtime lawsuit related to unpaid work breaks at Red River Army Depot is considered probable to result in a loss. An immaterial provision was accrued, and management does not expect material additional exposure.
- Cybersecurity, foreign operations, regulatory compliance, government audits, labor availability, environmental matters and variable interest rates remain material risk areas.
Most Important Facts to Verify
- Whether the 1st Choice Aerospace acquisition achieves expected growth and profitability and whether the potential $40 million earn-out is incurred.
- The sustainability of Federal Services revenue, bookings and funded backlog following the FMS and Army program declines.
- The effect of USPS fleet replacement, COTS vehicle retirements and NGDV timing on Supply Chain Management revenue and margins.
- Inventory conversion and operating cash flow after the $35.6 million 2018 inventory investment.
- Debt repayment capacity, covenant headroom and exposure to variable interest rates following acquisition-related borrowing.
- Goodwill impairment sensitivity, particularly for VSE Aviation, including projected growth, discount rates and market multiples.
- The outcome of the overtime litigation and any government audits, investigations or contract-related disputes.
- The accounting and balance-sheet effects of ASC 606 adoption and the January 1, 2019 lease-accounting adoption.