VSE CORP annual report, FY2011

VSE Corporation — Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2011. The filing was signed March 7, 2012. Although the request references 2011 Q4, this is an annual Form 10-K; fourth-quarter data are included where disclosed.

Business Context

VSE provides logistics, engineering, equipment refurbishment, supply-chain management, information technology, construction management and consulting services, primarily to U.S. government agencies and government prime contractors. Approximately 99% of revenue came from government-related customers. Reportable segments were Federal, International, IT/Energy/Management Consulting, Infrastructure and Supply Chain Management.

VSE acquired Wheeler Bros., Inc. (WBI) on June 6, 2011 for approximately $178.1 million of initial cash consideration, plus additional consideration and earn-out obligations. WBI supplies vehicle parts primarily to the U.S. Postal Service and the Department of Defense.

Financial Performance and Key Metrics

Metric	2011	2010	Change
Revenue	$618.6 million	$866.0 million	Down 29%
Operating income	$36.7 million	$38.2 million	Down 4%
Operating margin	5.9%	4.4%	Up 150 basis points
Net income	$20.6 million	$23.7 million	Down 13%
Net margin	3.3%	2.7%	Up 60 basis points
Diluted EPS	$3.93	$4.56	Down 14%
Operating cash flow	$34.3 million	$17.8 million	Up $16.5 million
Capital expenditures	$6.6 million	$4.8 million	Up $1.8 million

Fourth-quarter 2011 revenue was $148.9 million, operating income was $11.1 million, net income was $6.0 million and diluted EPS was $1.15. Fourth-quarter revenue and net income increased sequentially from the third quarter, while revenue and net income were below fourth-quarter 2010 levels.

Revenue mix shifted materially toward products and fixed-price work following the WBI acquisition. Services revenue was $527.9 million and product revenue was $90.7 million in 2011, compared with $853.1 million and $13.0 million, respectively, in 2010.

Liquidity, Debt and Balance Sheet

Cash and cash equivalents were $0.5 million at December 31, 2011, compared with $5.8 million at December 31, 2010.
Working capital increased to $71.1 million from $54.6 million.
Total assets increased to $454.5 million from $288.4 million, primarily because of the WBI acquisition and related goodwill and intangible assets.
Total bank debt was approximately $164.2 million, including $110.9 million of term debt and $53.3 million of revolving borrowings. Long-term debt on the balance sheet was $144.8 million, excluding the current portion.
The credit facility expires in June 2016. Scheduled term-loan payments after year-end total $18.8 million in 2012, $23.4 million in 2013, $25.0 million in 2014, $34.3 million in 2015 and $9.4 million in 2016.
Available revolving credit and letters-of-credit capacity was $125 million, with an option to increase availability to $175 million. Letters of credit outstanding were approximately $5.0 million.
VSE was in compliance with its debt covenants at year-end. Actual total funded debt/EBITDA was 2.69x versus a maximum of 3.25x; fixed-charge coverage was 1.82x versus a minimum of 1.20x.
Cash dividends increased to $0.27 per share for 2011 from $0.23 per share in 2010, subject to debt-agreement restrictions.

Material Changes Versus the Prior Comparable Period

Revenue declined primarily because the large Rapid Response program expired in January 2011. Federal Group revenue fell 59% to $184.1 million, and Federal Group operating income fell 71% to $6.0 million.
International Group revenue declined 21% to $206.7 million, reflecting lower Foreign Military Sales and seized-asset activity, reduced Egypt-related work and contract funding or protest delays.
IT, Energy and Management Consulting revenue increased 13% to $106.8 million, benefiting from a full year of Akimeka operations.
Infrastructure revenue declined 31% to $37.8 million because of funding, technical, environmental and political issues affecting the Port of Anchorage project.
WBI contributed approximately $83.1 million of revenue and $16.3 million of operating income from acquisition through year-end and represented approximately 13% of consolidated 2011 revenue.
Bookings declined to approximately $535 million from $799 million, and funded backlog declined to approximately $289 million from $407 million.
Interest expense increased substantially because of the debt used to finance WBI. VSE entered into interest-rate swaps covering portions of its term and revolving borrowings.
Corporate expenses increased, partly because of WBI acquisition costs, legal fees related to protested awards and a $750,000 expense under a subcontractor work-share agreement.

Outlook, Risks and Unusual Items

Management described the 2012 operating environment as challenging but stated that diversification, successor contract awards and the WBI acquisition improved the company’s prospects. No quantitative revenue or earnings guidance was provided.

Federal budget pressure, changing spending priorities, delayed appropriations, contract protests, set-aside programs and increased competition may delay or reduce contract awards and funding.
Revenue remains concentrated: the Department of Defense accounted for 62.6% of 2011 revenue, including 38.0% from the U.S. Army and Army Reserve and 22.7% from the U.S. Navy.
The USPS Managed Inventory Program is cancellable by USPS on 60 days’ notice and has no stated expiration date.
The Treasury seized-asset contract was cancelled after a protest and corrective-action process; VSE continued under interim coverage pending further direction.
The follow-on Foreign Military Sales contract had potential value of approximately $1.5 billion over five years. A protest was denied in January 2012, allowing work to proceed under the successor contract.
Approximately $5.5 million of 2011 revenue related to work performed before formal government funding was received. Management expected reimbursement but acknowledged exposure to loss if funding is not obtained.
WBI acquisition-related earn-out obligations totaled approximately $20.6 million at year-end, and additional payments of up to $40 million may be required if performance targets are achieved.
Goodwill and indefinite-lived intangible assets totaled approximately $101.3 million; no impairment was identified in the 2011 testing.
The company recorded approximately $26.4 million of construction assets and corresponding liabilities related to its new headquarters lease, which begins in May 2012 and carries a 15-year commitment.
VSE corrected the interim presentation of four WBI building leases in the fourth quarter. Assets and liabilities had been understated by approximately $6.7 million at June 30, 2011; management concluded the error was not material and its income and cash-flow impact was inconsequential.
Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.

Facts Investors Should Verify

Whether the R2-3G and other successor contract awards replace the revenue and margin lost from the expired R2 program.
The timing and funding of the successor Foreign Military Sales contract and the resolution of the Treasury seized-asset program.
WBI revenue, margins, working-capital requirements and performance relative to acquisition assumptions and earn-out thresholds.
Debt repayment capacity, covenant headroom, refinancing requirements and sensitivity to variable interest rates.
Whether funded backlog continues to decline and how government appropriations affect bookings and revenue conversion.
Recoverability of approximately $101.3 million of goodwill and indefinite-lived intangible assets amid lower revenue and government spending uncertainty.
Collection and funding status of the $5.5 million of revenue recognized for work performed without formal funding.
Potential effects of the Port of Anchorage project, Egypt-related operations, contract protests and other government investigations or audits.