VSE Corporation — Form 10-Q Summary
Business Context and Reporting Period
VSE provides logistics, engineering, equipment refurbishment, supply-chain management, information technology, health-care IT, construction management and consulting services, principally to U.S. Department of Defense and federal civilian agencies. The filing covers the three and six months ended June 30, 2011; financial statements are unaudited.
On June 6, 2011, VSE acquired Wheeler Bros., Inc. (WBI), a vehicle-parts supply-chain company serving the U.S. Postal Service and DoD. WBI contributed results from the acquisition date through June 30, 2011.
Key Financial Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Total revenue | $158.5 million, down 25% | $309.8 million, down 30% |
| Operating income | $7.3 million, down 27% | $14.2 million, down 24% |
| Net income | $4.2 million, down 31% | $8.4 million, down 27% |
| Basic and diluted EPS | $0.80, versus $1.18 | $1.60, versus $2.22 |
| Dividends declared per share | $0.07, versus $0.06 | $0.13, versus $0.11 |
Six-month operating margin was approximately 4.6%, compared with 4.2% in the prior-year period. Six-month net margin was approximately 2.7%, compared with 2.6% previously. The reported margin improvement occurred despite lower overall revenue and includes the newly acquired WBI business.
- Six-month revenue consisted of $292.9 million of services and $16.9 million of products. WBI generated $10.7 million of revenue and $2.0 million of operating income after acquisition.
- Six-month revenue by contract type was 30% cost-type, 53% time-and-materials and 17% fixed-price, compared with 25%, 69% and 6%, respectively, in 2010.
- Net cash provided by operating activities was $1.3 million, compared with $4.0 million in the prior-year period.
- Cash used in investing activities was $178.4 million, primarily reflecting approximately $174.9 million of cash paid for the WBI acquisition.
- Cash provided by financing activities was $172.0 million, primarily from borrowings used to finance the acquisition and working capital.
- Cash and cash equivalents declined from $5.8 million at December 31, 2010 to $0.6 million at June 30, 2011.
Balance Sheet, Debt and Liquidity
| Balance Sheet Item | June 30, 2011 | December 31, 2010 |
|---|---|---|
| Total assets | $483.4 million | $288.4 million |
| Cash and cash equivalents | $0.6 million | $5.8 million |
| Total debt, including current portion | $192.2 million | Approximately $17.8 million borrowed funds |
| Stockholders’ equity | $132.7 million | $123.8 million |
The June 2011 bank agreement includes a $125 million term loan and a revolving facility with availability for loans and letters of credit of $125 million, expandable to $175 million. At June 30, 2011, approximately $120.3 million was outstanding under the term loan, $71.9 million under the revolving facility, and $5.0 million in letters of credit were outstanding. Interest rates on portions of the debt ranged from 2.44% to 3.75%, with an aggregate effective rate of 2.51%.
VSE was in compliance with its debt covenants. The Total Funded Debt-to-EBITDA ratio was 2.54 to 1 versus a maximum of 3.50 to 1, and the Fixed Charge Coverage Ratio was 2.93 to 1 versus a minimum of 1.20 to 1. Government funding and collection timing can materially affect receivables, borrowings and liquidity.
Material Changes Versus the Prior Comparable Period
- Revenue fell $130.9 million for the first six months, principally because the Federal Group’s Rapid Response contract expired in January 2011. Federal Group revenue declined 54% to $119.1 million.
- Federal Group operating income declined 47% to $5.7 million for the first six months, while its margin improved to 4.8% from 4.2%, partly because lower-margin subcontractor pass-through work declined.
- International Group revenue declined 13% for the first six months, partly because Egypt-related work was disrupted by political unrest. Second-quarter revenue nevertheless increased 3%.
- IT, Energy and Management Consulting revenue increased 32% to $55.0 million, primarily due to the August 2010 acquisition of Akimeka. Segment operating income increased 24% to $5.5 million.
- The new Supply Chain Management Group contributed $10.7 million of revenue and $2.0 million of operating income after the WBI acquisition.
- Corporate and unallocated expenses increased to $3.1 million for the first six months from $1.0 million, primarily because of WBI acquisition-related costs.
- Funded contract backlog was $310 million at June 30, 2011, compared with $491 million at June 30, 2010. Six-month bookings were $240 million versus $458 million.
Guidance, Outlook, Risks and Unusual Items
Management expects WBI to add revenue and profit, broaden VSE’s customer base, strengthen supply-chain capabilities and create opportunities in DoD and USPS markets. Management is also pursuing growth in IT, energy and management consulting and more profitable legacy-system sustainment work. No quantitative revenue or earnings guidance was provided.
- Federal budget constraints may delay contract awards and funding, increase competition and reduce work levels.
- The R2-3G replacement contract had not generated revenue as of June 30, 2011 because of delays in government task orders.
- The GLOBAL foreign military sales contract was scheduled to expire in September 2011; VSE had submitted a bid for a successor contract.
- Egypt-related disruptions reduced first-half revenue, and future disruptions cannot be predicted.
- VSE recorded a $499 thousand future-loss reserve for a USPS fuel-efficient vehicle prototype project.
- WBI acquisition consideration totaled approximately $200.9 million, including a preliminary $22.8 million earn-out liability. Additional WBI earn-out payments could reach $40 million over four years. Akimeka earn-out obligations were approximately $6.9 million, with potential additional payments of up to $11 million.
- WBI purchase-price allocations, including goodwill of approximately $63.6 million and acquired intangible assets, were preliminary and subject to change.
- VSE held $1.5 million in escrow related to a subcontractor settlement and could be required to pay that amount if specified work-share conditions are not met by August 31, 2012.
- Because debt bears variable interest rates, VSE entered into interest-rate swaps in July 2011 covering an initial $101 million of term debt and $40 million of revolving debt.
- Management stated that disclosure controls were effective and that no material change occurred in internal control over financial reporting.
Investor Verification Checklist
- Verify the sustainability of revenue and bookings following the R2 contract expiration and the decline in funded backlog.
- Assess WBI’s post-acquisition performance, integration benefits, fixed-price execution risk and final purchase-price allocation.
- Monitor debt repayment requirements, revolving borrowing needs, covenant headroom and the impact of variable-rate financing.
- Review renewal or replacement outcomes for the GLOBAL FMS and other major government contracts.
- Evaluate customer concentration, particularly Army, Navy, USPS and foreign military sales exposure.
- Track the resolution of the PIEP fee issue, the USPS prototype reserve and the $1.5 million escrow contingency.