VSE Corporation — Q1 2013 Form 10-Q Summary
Business context and reporting period
VSE provides sustainment, logistics, engineering, information technology, health care IT, energy, supply-chain and consulting services primarily to the U.S. Department of Defense, federal civilian agencies and the U.S. Postal Service. The report covers the three months ended March 31, 2013, with comparisons to the three months ended March 31, 2012. The financial statements are unaudited.
The company reports four operating segments: Supply Chain Management, Federal, International, and IT, Energy and Management Consulting. Substantially all contracts are with government agencies or government prime contractors.
Key financial metrics
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenue | $119.2 million | $140.0 million | Down $20.8 million, or 15% |
| Operating income | $9.9 million | $12.5 million | Down $2.6 million, or 20% |
| Operating margin | 8.3% | 8.9% | Down approximately 60 basis points |
| Income from continuing operations | $5.3 million | $6.8 million | Down $1.5 million, or 22% |
| Net income | $5.3 million | $6.7 million | Down $1.4 million, or 21% |
| Diluted EPS | $0.99 | $1.26 | Down $0.27 |
| Net margin | 4.4% | 4.8% | Down approximately 30 basis points |
| Operating cash flow | $14.9 million | $6.7 million | Up $8.2 million |
| Capital expenditures | $1.6 million | $8.6 million | Down $7.0 million |
| Cash and equivalents at March 31 | $1.4 million | $0.4 million | Prior-year comparison |
Revenue consisted of $81.2 million of services and $37.9 million of products. Cost-type, time-and-materials and fixed-price contracts represented 21%, 30% and 49% of revenue, respectively.
VSE declared quarterly dividends of $0.08 per share, compared with $0.07 per share in the prior-year quarter. The bank agreement permits dividends of up to $0.60 per share annually, subject to compliance with the agreement.
Material changes versus the prior comparable period
- Supply Chain Management revenue was essentially stable at $38.1 million, but operating income declined 10% to $6.1 million; the segment margin decreased to 16.0% from 17.9%.
- Federal Group revenue declined 11% to $27.2 million, principally because of the expiration of a Kuwait MRAP maintenance contract. Higher Army Reserve refurbishment revenue partially offset the decline. Operating income fell 16% to $1.2 million.
- International Group revenue declined 23% to $35.4 million, primarily because of approximately $9 million less low-margin pass-through materials revenue and lower FMS and Contract Field Teams activity. Operating income increased 12% to $1.7 million, and the segment margin improved to 4.8% from 3.3%.
- IT, Energy and Management Consulting revenue declined 28% to $18.5 million because of contract expirations and lower IT services ordered by clients. Operating income fell 60% to $1.2 million. The prior-year period included a $964 thousand reduction in an Akimeka earn-out obligation that did not recur.
- Operating income was also pressured by approximately $1.6 million of higher facility costs related to the new headquarters building, including approximately $432 thousand of related interest expense.
- Operating cash flow improved substantially because of favorable working-capital movements, including a $9.9 million reduction in receivables and a $0.9 million reduction in inventories.
- Investing cash outflows decreased because the prior-year period included approximately $8 million of headquarters-related capital expenditures and $4.6 million of acquisition spending.
- Employees decreased to 2,240 at March 31, 2013 from 2,472 at December 31, 2012.
Debt, liquidity and financial condition
- Total bank borrowings were approximately $127.4 million at March 31, 2013, down from $140.2 million at December 31, 2012. This consisted of approximately $78.1 million of term debt and $49.3 million of revolving debt.
- Total debt, including the current portion of long-term debt, was approximately $126.9 million on the balance sheet. Long-term lease obligations were $27.2 million.
- The company repaid approximately $12.8 million of bank debt during the quarter. Scheduled term-loan payments after March 31, 2013 are $18.8 million in 2013, $25.0 million in 2014 and $34.3 million in 2015.
- The revolving facility provided maximum availability of $125 million, with an option to increase availability to $175 million. Letters of credit outstanding totaled approximately $573 thousand.
- The effective interest rate on aggregate debt was 3.08% at March 31, 2013. Interest-rate swaps hedged portions of the borrowings; the revolving-loan swap was scheduled to expire in June 2013.
- VSE was in compliance with its debt covenants. Actual versus required covenant levels were 2.02x versus a maximum 2.75x Total Funded Debt/EBITDA ratio, 1.44x versus a minimum 1.20x Fixed Charge Coverage Ratio, and 0.95x versus a minimum 0.90x Asset Coverage Ratio.
- Cash declined by $72 thousand during the quarter to $1.4 million. Operating cash flow largely funded capital expenditures, dividends and debt repayment.
Outlook, risks, contingencies and unusual items
Management cited continuing pressure from federal budget uncertainty, changing government spending priorities and sequestration. Some energy and IT programs were adversely affected, while USPS Managed Inventory, Treasury and ATF seized-asset programs and the Foreign Military Sales program were described as largely self-funded or supported by foreign-government clients.
Management is pursuing a transition away from lower-margin work and expects staff reductions and other actions announced in April 2013 to reduce indirect labor and related costs by an estimated $6 million in 2013. The filing does not provide formal revenue or earnings guidance.
Bookings were $154 million in the quarter, compared with $165 million in the prior-year period. Funded contract backlog was $264 million at March 31, 2013, compared with $299 million at March 31, 2012. The Army Reserve vehicle-refurbishment contract was being recompeted, creating uncertainty regarding future program activity.
VSE planned to sell ICRC and eliminate its Infrastructure Group. ICRC assets of $2.8 million and liabilities of $0.5 million were classified as held for sale, and management expected the sale to close during the second quarter of 2013. ICRC generated only $71 thousand of revenue and a $13 thousand net loss in Q1 2013, compared with $4.4 million of revenue and a $101 thousand net loss in Q1 2012.
The company was a primary defendant in Hawaii wrongful-death litigation arising from a 2011 fireworks explosion involving a subcontractor. Management did not anticipate a material adverse effect at that time. A separate lawsuit filed by the Municipality of Anchorage against ICRC and former subcontractors was in an early stage, and the potential financial impact could not be determined.
The company recorded a $277 thousand increase in the estimated WBI earn-out obligation during the quarter, resulting in a $9.4 million long-term earn-out liability at March 31, 2013. Goodwill was unchanged at $92.1 million. VSE adopted new accumulated-other-comprehensive-income disclosure guidance with no effect on financial position or results of operations.
Important facts for investors to verify
- Whether sequestration, federal budget reductions and contract funding delays further reduce revenue, bookings or backlog.
- The outcome and timing of the Army Reserve contract recompete and the sustainability of the FMS and other major programs.
- Whether the announced workforce and indirect-cost reductions deliver the estimated $6 million of 2013 savings.
- The timing, proceeds and any gain or loss from the planned ICRC sale.
- Debt repayment capacity, scheduled amortization and compliance with the increasingly restrictive debt covenants.
- Exposure to variable interest rates after the revolving-loan hedge expiration and the effect of future refinancing needs.
- The ultimate cost of the Hawaii and Anchorage legal proceedings and other government claims or investigations.
- The collectability and timing of receivables, given the company’s reliance on government funding and payment cycles.