VSE Corporation — Q1 2018 Form 10-Q Summary
Business context and reporting period
VSE Corporation is a diversified services company serving the U.S. Department of Defense, U.S. Postal Service, other government agencies, and commercial customers. Its reportable segments are Supply Chain Management, Aviation, and Federal Services. The filing covers the three months ended March 31, 2018; financial statements are unaudited.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $176.9 million | $197.3 million | Down 10.3% |
| Operating income | $11.6 million | $14.2 million | Down 18.3% |
| Operating margin | 6.6% | 7.2% | Down 0.6 percentage points |
| Net income | $7.1 million | $7.3 million | Down 3.3% |
| Net margin | 4.0% | 3.7% | Up 0.3 percentage points |
| Diluted EPS | $0.65 | $0.67 | Down 3.0% |
| Operating cash flow | $13.3 million | $0.7 million | Increase of $12.6 million |
Revenue by segment was $55.9 million for Supply Chain Management, $32.8 million for Aviation, and $88.3 million for Federal Services. Segment operating margins were 13.6%, 6.9%, and 2.8%, respectively.
Cash and cash equivalents were $0.6 million at March 31, 2018. Total assets were $629.6 million and stockholders’ equity was $303.3 million. Inventory increased to $148.9 million from $132.6 million at year-end 2017, primarily reflecting strategic inventory purchases.
Bank debt was $165.0 million before deferred financing costs, comprising a $100.0 million term loan and $65.0 million of revolving borrowings. Net debt reported on the balance sheet was approximately $162.4 million. The amended credit agreement expires in January 2023 and provides up to $300 million of revolving availability, with no letters of credit outstanding at quarter-end.
The company generated $13.3 million of operating cash flow, used $1.1 million for capital expenditures, and paid $0.8 million in dividends. Cash was essentially unchanged during the quarter. The quarterly dividend was $0.07 per share, compared with $0.06 in the prior-year quarter.
Material changes versus the prior comparable period
- Federal Services revenue declined $20.6 million, or 19%, primarily because of funding delays, completion of two Army programs, and a $10.7 million decline in the Foreign Military Sales program.
- Federal Services operating income decreased $1.4 million, and its margin declined to 2.8% from 3.6%, partly due to approximately $1.6 million less award-fee income.
- Supply Chain Management revenue was essentially flat, but operating income declined $0.9 million and margin decreased to 13.6% from 15.1% because of increased USPS competition and lower-margin DoD sales.
- Aviation revenue was essentially flat and operating income decreased modestly by $0.1 million.
- Interest expense declined $0.3 million due primarily to lower average borrowings.
- The effective tax rate decreased to 25.1% from 38.0%, primarily reflecting the Tax Cuts and Jobs Act and its reduction of the U.S. corporate tax rate to 21%.
- VSE adopted ASC 606 on January 1, 2018 using the modified retrospective method, increasing opening retained earnings by $1.7 million. Reported Q1 net income was $0.2 million higher than it would have been without adoption.
- Federal Services bookings were $33 million versus $148 million in Q1 2017, while funded backlog declined to $261 million from $359 million.
Guidance, outlook, risks, contingencies, and unusual items
Management stated that federal budget uncertainty and delayed funding affected government programs, especially Foreign Military Sales. The company expects to pursue growth through Supply Chain Management diversification, Aviation revenue initiatives, maritime turbine MRO opportunities, and expansion of its Singapore operation. No specific consolidated earnings or revenue guidance was provided.
Management expects the Tax Act to benefit net income and cash flow. VSE reduced bank debt by approximately $9 million during the quarter and amended its credit agreement to extend maturity and increase borrowing commitments.
At March 31, 2018, VSE was in compliance with its debt covenants. The Total Funded Debt/EBITDA ratio was 2.16 to 1 versus a maximum of 3.00 to 1, and the Fixed Charge Coverage Ratio was 2.20 to 1 versus a minimum of 1.20 to 1. Debt bears variable interest rates, although interest-rate swaps hedge a portion of borrowings.
The company identified goodwill impairment sensitivity at the VSE Aviation and Akimeka reporting units. VSE Aviation’s fair value exceeded carrying value by approximately 2% at the December 31, 2017 interim test, and Akimeka’s excess was approximately 12%. Further declines in projected cash flows, higher discount rates, weaker market multiples, or higher carrying values could result in future impairment charges. Goodwill totaled approximately $198.6 million at March 31, 2018.
A lawsuit alleges negligence by VSE subsidiaries in maintenance and inspection work related to a 2016 aircraft crash. Plaintiffs seek more than $1.0 million; trial was scheduled for November 2018. The company and its insurer intend to defend the case, and management considered a material adverse outcome remote, although the potential loss could not be reasonably estimated.
Important facts for investors to verify
- Whether delayed government funding and the low Q1 Federal Services bookings level affect subsequent revenue and backlog.
- The sustainability of the 25.1% effective tax rate and the remaining measurement-period effects of the Tax Act.
- Progress in restoring Federal Services and Supply Chain Management margins.
- Inventory growth, working-capital requirements, and continued operating cash-flow conversion.
- Debt repayment requirements, variable-rate exposure, covenant headroom, and future refinancing needs.
- Performance of the Aviation and Akimeka reporting units and the risk of goodwill impairment.
- Developments in the aircraft-crash litigation and any government investigations or contract disputes.