VSE Corporation: 2015 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
VSE Corporation reported unaudited consolidated results for the three months ended March 31, 2015. The company provides supply-chain management, aviation maintenance, repair and overhaul (MRO), parts distribution, logistics, engineering, information technology, energy, and consulting services to government and commercial customers. Reportable segments are Supply Chain Management, Aviation, Federal Services, and IT, Energy and Management Consulting.
On January 28, 2015, VSE acquired four aviation businesses for approximately $189 million at closing, subject to adjustments, and formed VSE Aviation, Inc. The Aviation Group contributed $22.8 million of revenue and $2.1 million of operating income from the acquisition date through March 31, 2015.
Financial Performance and Key Metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Total revenue | $120.8 million | $119.4 million | +$1.4 million, 1% |
| Services revenue | $51.1 million | $78.8 million | Down $27.7 million |
| Products revenue | $69.7 million | $40.6 million | Up $29.1 million |
| Operating income | $10.7 million | $11.4 million | Down $0.7 million, 6% |
| Operating margin | 8.8% | 9.5% | Down approximately 70 basis points |
| Income from continuing operations | $5.2 million | $6.3 million | Down $1.0 million, 17% |
| Net income | $5.2 million | $5.7 million | Down $0.4 million, 8% |
| Diluted EPS | $0.97 | $1.05 | Down $0.08 |
| Net cash from operating activities | $(0.6) million | $13.8 million | Down $14.4 million |
Net income benefited from the absence of a $615 thousand after-tax loss from discontinued operations recorded in the prior-year quarter. The effective tax rate was 38.9%, compared with 38.3% in Q1 2014. Dividends declared increased to $0.10 per share from $0.09.
Segment revenue and operating income were:
| Segment | Revenue | Operating income | Operating margin |
|---|---|---|---|
| Supply Chain Management | $46.2 million | $8.3 million | 18.0% |
| Aviation | $22.8 million | $2.1 million | 9.3% |
| Federal Services | $37.8 million | $(0.3) million | (0.7%) |
| IT, Energy and Management Consulting | $14.0 million | $1.2 million | 8.7% |
Balance Sheet, Debt, Liquidity, and Cash Flow
- Cash and cash equivalents were $0.5 million at March 31, 2015, compared with $0.3 million at December 31, 2014.
- Total assets increased to $643.5 million from $355.3 million, primarily because of the Aviation acquisition. Inventory increased to $106.2 million from $49.4 million, and receivables increased to $79.7 million from $59.4 million.
- Total bank debt was approximately $244.8 million, consisting of a $150.0 million term loan and $94.8 million of revolving borrowings, compared with $48.6 million at December 31, 2014.
- The revolving facility provided up to $150 million of availability at March 31, 2015, with no outstanding letters of credit. The agreement permits up to an additional $75 million of aggregate facility capacity, subject to conditions.
- Scheduled term-loan payments after March 31, 2015 total $11.2 million in 2015, $17.8 million in 2016, $21.6 million in 2017, $28.1 million in 2018, $30.0 million in 2019, and $41.3 million thereafter.
- The effective interest rate on aggregate debt was 2.97%, with rates on portions of debt ranging from 2.43% to 4.25%. Interest-rate swaps covered $125 million of debt.
- Operating cash flow was negative $0.6 million, reflecting increased receivables and other working-capital needs. Investing cash flow was negative $191.9 million, including $188.8 million paid for acquisitions. Financing activities provided $192.7 million, primarily from new borrowings.
- The company was in compliance with its debt covenants. The actual Total Funded Debt/EBITDA ratio was 3.30 to 1 versus a maximum of 3.50 to 1; the Fixed Charge Coverage Ratio was 2.09 to 1 versus a minimum of 1.20 to 1.
Material Changes Versus the Prior Comparable Period
- Supply Chain Management revenue increased 14%, primarily from a $4.3 million increase in USPS Managed Inventory Program revenue; operating income increased 6%. Results included approximately $413 thousand of non-recurring research and development costs and a $310 thousand increase in the WBI earn-out obligation.
- The new Aviation Group added $22.8 million of revenue and $2.1 million of operating income, but included approximately $1.2 million of acquired-intangible amortization and $0.9 million of allocated corporate costs in contract costs.
- Federal Services revenue declined 40% and the segment moved to an operating loss. The decline reflected completion of the U.S. Treasury Seized Assets Program, absence of a prior-year military parts order, lower Army Reserve refurbishment activity, and lower Foreign Military Sales revenue.
- IT, Energy and Management Consulting revenue declined 10% and operating income declined 16%, primarily due to contract expirations, lower client orders, and lower margins on replacement contracts.
- Government-related revenue declined to 43% of consolidated revenue from 66%, while Supply Chain Management and Aviation revenue increased to 57% from 34%. Commercial revenue rose to $24.0 million from $0.8 million, primarily reflecting the Aviation acquisition.
- Bookings for Federal Services and IT, Energy and Management Consulting were $45 million versus $49 million, and funded backlog declined to $185 million from $204 million.
Outlook, Commentary, Risks, and Unusual Items
Management expects diversification from the Aviation acquisition and continued Supply Chain Management growth to reduce reliance on federal procurement and budgeting. Management identified potential aviation growth through additional engine platforms and product lines, geographic expansion, and military-market opportunities.
Management expects U.S. Navy Foreign Military Sales revenue to improve after legislation enacted in December 2014, with related revenue expected to begin in late 2015 and 2016. However, Egyptian political conditions continue to affect follow-on technical-support revenue. Army Reserve refurbishment revenue is expected to remain lower year over year for the next several quarters, although management believes activity has stabilized.
- The Aviation acquisition included contingent consideration of up to $40 million based on financial targets, plus a possible additional $5 million payment. The recorded earn-out obligation was $44.8 million at March 31, 2015.
- Goodwill increased by $101.7 million and net intangible assets increased to $161.8 million from $72.2 million. The acquisition valuation remains provisional.
- Variable-rate debt creates interest-rate exposure despite the company’s hedges. The loan agreement includes collateral requirements, dividend limitations, and financial and other restrictive covenants.
- Two bonded projects totaling approximately $4 million remained incomplete and involved subcontractor claims and disputes; accrued related claims were approximately $169 thousand.
- Material litigation includes a Hawaii wrongful-death action expected to proceed to trial in 2016, an Alaska contract-related lawsuit also expected to proceed to trial in 2016, and a Nebraska lawsuit filed in February 2015 concerning fireworks-related storage services. The company states that it cannot predict the outcomes of certain matters.
- The company is assessing the impact of the new revenue-recognition standard, expected to become effective January 1, 2017 unless delayed.
Important Facts for Investors to Verify
- Final purchase accounting for the Aviation acquisition, including goodwill, intangible assets, deferred taxes, working-capital adjustments, and contingent consideration.
- Post-acquisition revenue, margins, integration costs, inventory levels, and cash generation of the Aviation Group.
- Debt repayment capacity, revolver utilization, covenant headroom, interest-rate exposure, and scheduled amortization.
- Whether Federal Services revenue and margins stabilize, particularly for the FMS and Army Reserve programs.
- USPS program performance, customer concentration, and the sustainability of Supply Chain Management growth.
- Funded backlog conversion, government funding timing, contract expirations, and potential de-obligations.
- Developments and potential financial exposure from the disclosed litigation, claims, earn-outs, and other contingencies.