VSE Corporation 10-Q Summary — First Quarter 2016
Reporting period: Three months ended March 31, 2016; filed April 29, 2016. The financial statements are unaudited and prepared under U.S. GAAP. VSE is a diversified services company serving the U.S. government, USPS, Department of Defense, aviation, transportation, and commercial markets through four operating segments: Supply Chain Management, Aviation, Federal Services, and IT, Energy and Management Consulting.
Financial performance and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Products revenue | $85.3 million | $69.7 million | +$15.6 million |
| Services revenue | $58.4 million | $51.1 million | +$7.3 million |
| Total revenue | $143.6 million | $120.8 million | +19% |
| Operating income | $12.7 million | $10.7 million | +19% |
| Operating margin | 8.9% | 8.8% | Approximately +0.1 percentage points |
| Net income | $6.6 million | $5.2 million | +26% |
| Diluted EPS | $1.21 | $0.97 | +$0.24 |
| Operating cash flow | $15.4 million | $(0.6) million | Improved by $16.0 million |
| Capital expenditures | $1.4 million | $3.4 million | Decreased by $2.0 million |
Interest expense was $2.5 million, compared with $2.1 million in the prior-year quarter, primarily reflecting higher average bank borrowings. The effective tax rate declined to 36.0% from 38.9%, partly because of the $1.4 million reduction in the Aviation earn-out obligation and benefits associated with the Aviation acquisition.
Cash and cash equivalents were $0.6 million at March 31, 2016, compared with $0.7 million at December 31, 2015. Current assets were $204.3 million and current liabilities were $105.4 million. Receivables were $76.9 million and inventories were $113.6 million.
Total bank debt was approximately $222 million at quarter-end, consisting of $130 million of term debt and $92 million of revolving borrowings, down from approximately $235 million at December 31, 2015. The revolving facility had $150 million of maximum availability and no outstanding letters of credit. The loan agreement expires in January 2020, includes scheduled term-loan payments, collateral requirements, dividend restrictions, and financial covenants. VSE was in compliance with its covenants; the Total Funded Debt/EBITDA ratio was 2.92x versus a 3.25x maximum, and the Fixed Charge Coverage ratio was 1.56x versus a 1.20x minimum.
Material changes versus the prior comparable period
- Revenue growth reflected a full quarter of Aviation operations, higher Supply Chain Management activity, and increased Federal Services revenue. Aviation revenue increased 47% to $33.5 million, although the prior-year comparison included only approximately two months of Aviation results.
- Supply Chain Management revenue increased 11% to $51.1 million, supported by higher USPS Managed Inventory Program revenue and increased government and commercial fleet sales. Segment operating margin declined modestly to 17.7% from 18.0%.
- Federal Services revenue increased 26% to $47.7 million, driven by higher Foreign Military Sales revenue and the Fort Benning Logistics Support Services Program. The segment generated operating income of $0.4 million versus an operating loss of $0.3 million in Q1 2015.
- IT, Energy and Management Consulting revenue decreased 20% to $11.2 million, primarily because of lower client orders, contract expirations, and work awarded to small businesses under set-aside contracts. Operating margin declined to 7.9% from 8.7%.
- Operating cash flow improved substantially, primarily due to working-capital changes, including higher accounts payable and deferred compensation balances and favorable receivables activity.
- Q1 2015 included $188.8 million of acquisition cash payments and approximately $300.5 million of borrowings related to the Aviation acquisition; no acquisition cash payments were made in Q1 2016.
- VSE adopted accounting guidance affecting deferred-tax classification and debt-issuance-cost presentation. These changes did not affect reported earnings or cash flows.
Outlook, commentary, risks and unusual items
Management characterized 2016 as shaping up to be a good year and expects both newer businesses and traditional government sustainment businesses to contribute to growth. Federal Services and IT bookings were $51 million in Q1 2016, compared with $45 million in Q1 2015, while funded backlog increased to $229 million from $185 million.
- Management expects continued USPS fleet-support demand, growth in commercial fleet work, and potential participation in the USPS next-generation delivery vehicle program; the filing provides no assurance regarding the outcome of that prospective competition.
- Management cited the Fort Benning program, increased contract funding, Taiwan frigate-transfer authorization, and the Red River Army Depot award. The Red River work was estimated to employ more than 1,100 VSE and subcontractor employees beginning in May 2016.
- The Aviation segment’s 2016 costs included a $1.4 million reduction from a fair-value adjustment to its earn-out obligation and an approximately $0.3 million non-recurring settlement expense.
- The Aviation acquisition earn-out obligation was $18.5 million at March 31, 2016, including $8.0 million current and $10.4 million long-term. Additional payments of up to $40 million may be required if specified financial targets are achieved.
- Interest-rate exposure remains material because borrowings are primarily variable-rate. VSE had interest-rate swaps covering $100 million of debt and an effective aggregate debt rate of approximately 3.4% at quarter-end.
- VSE had one uncompleted bonded project with approximately $3 million of bonded exposure that was subject to subcontractor claims and disputes.
- Pending litigation includes a Hawaii wrongful-death action, the Anchorage lawsuit and related insurance litigation, and a Heritage Disposal and Storage contract action. The company states that outcomes cannot be predicted; it does not currently expect the Hawaii matter to be material but cannot predict the impact of the Anchorage and Heritage matters.
- Goodwill totaled approximately $198.5 million. Management reported no impairment indicators for the quarter, but the Akimeka reporting unit had only approximately 9% excess fair value over carrying value in the fourth-quarter 2015 analysis.
- The quarterly dividend was $0.11 per share. The credit agreement generally limits annual cash dividends to $6 million, subject to compliance conditions.
Most important facts for investors to verify
- Whether revenue growth and Federal Services profitability are sustained after the favorable comparison effects from the Aviation acquisition and new government programs.
- Progress, funding, margins, and execution risk associated with the Red River Army Depot and other Federal Services awards.
- USPS contract renewal and next-generation fleet opportunities, given USPS represented 32.2% of Q1 revenue.
- Cash conversion and working-capital requirements, particularly the $113.6 million inventory balance and reliance on government billings and collections.
- Debt reduction, variable-rate exposure, scheduled term-loan amortization, and continued compliance with credit covenants.
- Potential cash requirements associated with the Aviation earn-out obligation and the valuation assumptions supporting its fair value.
- Developments in the disclosed litigation, bonded-project disputes, and the potential for goodwill impairment at Akimeka.
- The filing’s warning that first-quarter results are not necessarily indicative of full-year 2016 results; no formal numerical revenue or earnings guidance is provided.