VSE Corporation Form 10-Q Summary
Business Context and Reporting Period
VSE Corporation provides sustainment, logistics, engineering, information technology, health-care IT, construction management, consulting, and vehicle-parts supply services primarily to U.S. Department of Defense and other federal government agencies, including the U.S. Postal Service. The report covers the three and nine months ended September 30, 2011. The financial statements are unaudited.
VSE operated through five reportable segments: Federal, International, IT, Energy and Management Consulting, Infrastructure, and Supply Chain Management. The Supply Chain Management segment began contributing following the June 6, 2011 acquisition of Wheeler Bros., Inc. (WBI).
Key Financial Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Revenue | $159.9 million, versus $212.9 million | $469.7 million, versus $653.6 million |
| Operating income | $11.4 million, versus $11.8 million | $25.6 million, versus $30.4 million |
| Operating margin | 7.1%, versus 5.6% | 5.4%, versus 4.7% |
| Net income | $6.1 million, versus $7.2 million | $14.5 million, versus $18.7 million |
| Net margin | 3.8%, versus 3.4% | 3.1%, versus 2.9% |
| Diluted EPS | $1.17, versus $1.39 | $2.77, versus $3.61 |
| Dividends declared per share | $0.07, versus $0.06 | $0.20, versus $0.17 |
Cash provided by operating activities for the nine months was $30.7 million, compared with $10.1 million in the prior-year period. Investing activities used $180.1 million, primarily reflecting approximately $174.9 million of cash paid for acquisitions. Financing activities provided $143.9 million, principally from borrowings used to finance WBI. Cash and cash equivalents declined to $316,000 from $5.8 million at December 31, 2010.
At September 30, 2011, total assets were $439.0 million, compared with $288.4 million at year-end 2010. Receivables were $114.4 million and inventories were $40.5 million. Total debt was approximately $164.4 million, consisting of approximately $115.6 million of term borrowings and $48.8 million of revolving borrowings. Total liabilities were $301.5 million and stockholders’ equity was $137.6 million.
The effective interest rate on aggregate debt was 2.87%, with reported rates ranging from 2.48% to 3.75%. VSE had $5.0 million of letters of credit outstanding and revolving credit availability of up to $125 million, with an option to increase total availability to $175 million. The company was in compliance with its debt covenants, including a 2.56x Total Funded Debt/EBITDA ratio versus a 3.50x maximum and a 2.12x Fixed Charge Coverage ratio versus a 1.20x minimum.
Material Changes Versus the Prior Comparable Period
- Revenue declined 25% in the third quarter and 28% for the first nine months, principally because of the expiration and phase-down of the Federal Group’s R2 program and lower activity on other government contracts.
- Operating income declined 4% in the third quarter and 16% for the first nine months; however, operating margins improved because lower-margin subcontractor pass-through revenue decreased and the company added higher-margin direct labor and WBI operations.
- Interest expense increased substantially to $1.4 million in the third quarter and $2.0 million for the first nine months, compared with $61,000 and $75,000, respectively, due to acquisition-related debt.
- WBI contributed $47.1 million of revenue and $8.8 million of operating income from the acquisition date through September 30, 2011. The acquisition added approximately $55.7 million of goodwill and $89.4 million of amortizable intangible assets.
- The Federal Group’s nine-month revenue declined $206.2 million and operating income declined $10.5 million. International Group revenue declined $29.2 million and operating income declined $3.6 million.
- The IT, Energy and Management Consulting Group increased nine-month revenue by $13.4 million and operating income by $1.2 million, aided by the inclusion of Akimeka for a full comparable period.
- Bookings declined to approximately $396 million from $673 million, and funded contract backlog declined to approximately $305 million from $493 million. Approximately $21 million of 2011 contract funding under protest was excluded from these amounts.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management did not provide formal numerical revenue or earnings guidance. It cited constrained federal budgets, changing spending priorities, delayed awards and funding, increased contract protests, and heightened competition as continuing challenges.
- VSE expects diversification through WBI, expanded IT and consulting capabilities, and focus on DoD legacy-system sustainment, information technology, energy, and management consulting markets.
- A protest was filed in October 2011 against the successor GLOBAL Foreign Military Sales contract, which has a potential value of $277 million for the base year and up to $1.5 billion over five years. Performance is subject to an automatic stay, while work continues under the predecessor contract at potentially constrained levels.
- Political and security conditions in Egypt suspended most GLOBAL FMS work there during January 2011. Management cannot predict whether future disruptions will occur or their financial impact.
- VSE recorded a $750,000 expense related to a subcontractor work-share agreement because contract delays and protests made it probable that first-period work requirements would not be met. Up to $750,000 could also be payable for the second period if requirements are not satisfied; $1.5 million was placed in escrow.
- VSE may owe up to $40 million in additional WBI earn-out payments over four years, subject to performance targets. Earn-out liabilities totaled $21.5 million at September 30, 2011.
- The Infrastructure Group is pursuing potential recovery of up to approximately $2.2 million in base and award fees related to the Port of Anchorage project, but timing and realization remain uncertain.
- Variable-rate debt exposes VSE to interest-rate risk. The company entered into swaps covering portions of its term and revolving debt; the swaps had a fair-value liability of approximately $1.4 million at September 30, 2011 and generated an $830,000 reduction in comprehensive income.
- The company reported no material adverse effect from other claims or governmental investigations, although outcomes cannot be predicted with certainty. The WBI purchase-price allocation remained preliminary.
Most Important Facts for Investors to Verify
- Whether federal contract awards, funding delays, and protests cause further reductions in revenue and backlog.
- The status and ultimate outcome of the GLOBAL FMS contract protest and the effect on International Group revenue.
- WBI’s post-acquisition revenue, margins, integration benefits, and performance against earn-out targets.
- VSE’s ability to meet accelerating term-loan amortization requirements while maintaining liquidity and covenant compliance.
- The sustainability of improved consolidated margins as lower-margin R2 pass-through work declines.
- The collectability and timing of receivables, particularly those dependent on government funding and billing schedules.
- Whether the potential $2.2 million Infrastructure Group fee recovery and other contingent amounts are ultimately realized.