VSE Corporation 2016 Form 10-K Summary
Business context and reporting period
VSE Corporation is a diversified supply-chain, maintenance, repair and overhaul, logistics, engineering, information technology and consulting services provider. Its principal customers are the U.S. Department of Defense, the U.S. Postal Service and commercial aviation customers. The filing covers the fiscal year ended December 31, 2016, with comparative results for 2015 and 2014.
Reportable segments were Supply Chain Management, Aviation, Federal Services, and IT, Energy and Management Consulting. Beginning in 2017, Federal Services and IT, Energy and Management Consulting were to be combined into one management group and reportable segment.
Financial performance and key metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $691.8 million | $534.0 million | Up 30% |
| Operating income | $51.5 million | $50.5 million | Up 2% |
| Operating margin | 7.4% | 9.5% | Down 2.1 percentage points |
| Net income | $26.8 million | $24.9 million | Up 8% |
| Diluted EPS | $2.47 | $2.31 | Up 7% |
| Operating cash flow | $47.2 million | $37.6 million | Up $9.6 million |
| Capital expenditures | $6.5 million of cash purchases | $10.6 million | Down |
| Cash and equivalents | $0.4 million | $0.7 million | Down $0.3 million |
Revenue mix was approximately 49% products and 51% services. Segment revenue was $306.1 million for Federal Services, $205.5 million for Supply Chain Management, $133.5 million for Aviation and $46.7 million for IT, Energy and Management Consulting. Segment operating margins were approximately 16.9%, 9.6%, 1.4% and 7.7%, respectively.
Government customers represented approximately 80% of revenue. The USPS contributed $181.2 million, or 26.2%, while the U.S. Navy and U.S. Army contributed $190.2 million and $139.8 million, respectively. Funded backlog for the federal contracting businesses was approximately $322 million at year-end, compared with $238 million in 2015.
Liquidity, debt and balance sheet
- Working capital was $110.0 million, compared with $100.8 million at December 31, 2015.
- Total assets were $661.8 million and stockholders’ equity was $255.2 million.
- Bank debt before unamortized financing costs was approximately $216.3 million, including $115.9 million of term debt and $100.4 million of revolving borrowings.
- The revolving facility provided up to $150 million of capacity; no letters of credit were outstanding at year-end.
- The bank agreement expires in January 2020. Scheduled term-loan payments are approximately $21.6 million in 2017, $28.1 million in 2018, $30.0 million in 2019 and $36.2 million in 2020.
- The company was in compliance with its debt covenants. Actual total funded debt to EBITDA was 2.67 to 1 against a maximum of 3.00 to 1; fixed-charge coverage was 1.54 to 1 against a minimum of 1.20 to 1.
- Cash dividends were $0.235 per share for 2016, compared with $0.215 in 2015. Dividend payments remain subject to debt-agreement restrictions.
Material changes versus the prior comparable period
- Federal Services revenue increased 83% to $306.1 million, driven by higher Foreign Military Sales activity, the Red River Army Depot program and a full year of Fort Benning logistics work.
- Aviation revenue increased to $133.5 million from $119.7 million, although 2015 included only approximately 11 months of post-acquisition operations.
- Supply Chain Management revenue rose 4% to $205.5 million, but operating income declined 2% to $34.6 million because of product mix, competition and growth-related costs.
- IT, Energy and Management Consulting revenue declined 7% to $46.7 million and operating income declined 24% to $3.6 million, reflecting contract expirations, reduced customer orders and set-aside competition.
- Revenue growth outpaced operating-income growth, reducing the consolidated operating margin from 9.5% to 7.4%. Management attributed pressure partly to aggressive pricing on new federal contracts.
- Operating cash flow improved, but working-capital investment increased: inventory used approximately $27.2 million of cash and receivables used approximately $22.7 million, partly offset by a $54.7 million increase in accounts payable.
- Cash used in financing was $41.0 million, primarily reflecting debt repayment and approximately $18.5 million of final Aviation Acquisition earn-out payments. In 2015, financing activities provided $168.1 million because of acquisition-related borrowing.
Guidance, outlook, risks and unusual items
Management did not provide quantitative revenue or earnings guidance. Management expressed confidence in the 2017 federal revenue base based on 2016 bookings of approximately $458 million and funded backlog of $322 million. It also cited expected benefit from a full year of the Red River Army Depot program, continued Foreign Military Sales activity and new international relationships.
- USPS revenue remains material, and the timing and scale of the USPS new delivery-vehicle procurement program are uncertain. VSE will not compete to provide the vehicles but intends to pursue parts, supply-chain, program-management and warranty opportunities.
- Federal budgets, appropriations, procurement delays, contract cancellations, set-aside programs, contract protests and lowest-price award criteria could reduce revenue or margins.
- Large programs, especially the USPS Managed Inventory Program and the Navy Foreign Military Sales Program, create customer and contract concentration risk. FMS revenue and award fees can fluctuate significantly.
- Variable-rate debt exposes the company to interest-rate risk, partly mitigated by interest-rate swaps. The effective aggregate debt rate was approximately 3.27% at year-end.
- Goodwill totaled approximately $198.6 million. No impairment was recorded, but the Akimeka reporting unit had only approximately 7% excess fair value over carrying value, creating sensitivity to deterioration in projected cash flows.
- 2016 operating income included an approximately $1.4 million benefit primarily from the Maritime Administration contract close-out and a $3.3 million charge for settlement of the Heritage Litigation.
- Subsequent to year-end, the Anchorage-related lawsuits were settled and the government paid ICRC approximately $10.4 million for contract close-out costs. VSE also paid approximately $3.3 million to settle the Heritage Litigation.
- Other disclosed matters include Hawaii litigation related to a 2011 fireworks incident and aviation litigation arising from a 2016 aircraft crash. Management did not expect either matter to have a material adverse effect, but outcomes remain uncertain.
- Approximately $2.1 million of 2016 revenue represented work performed at risk without formalized government funding; management expected reimbursement.
Most important facts for an investor to verify
- Whether the $322 million federal funded backlog converts to revenue as expected and whether government appropriations or contract awards are delayed.
- The sustainability and margins of the sharp Federal Services revenue increase, particularly the FMS, Red River Army Depot and Fort Benning programs.
- USPS Managed Inventory Program performance and the timing, scope and impact of the USPS vehicle replacement program.
- Debt amortization, revolving-borrowing needs, covenant headroom and exposure to higher interest rates.
- Whether margin compression from competitive pricing, product mix and contract start-up losses persists.
- Potential goodwill impairment at Akimeka and Aviation if operating forecasts weaken.
- Resolution and financial impact of the Hawaii and aviation lawsuits, government audits or other contract contingencies.
- The effect of the 2017 segment reorganization and the adoption of new accounting standards, including revenue recognition and lease accounting.