VSE Corporation 2019 Q2 10-Q Summary
Business Context and Reporting Period
VSE Corporation is a diversified government services, supply-chain management, parts distribution, and maintenance, repair and overhaul provider serving the U.S. Department of Defense, U.S. Postal Service, federal agencies, commercial aviation, and other commercial customers. The unaudited filing covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.
The company operates through Supply Chain Management, Aviation, and Federal Services. In January 2019, VSE acquired 1st Choice Aerospace for approximately $113.1 million in cash, with potential earn-out payments of up to $40 million.
Key Financial Metrics
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Revenue | $189.1 million | $170.4 million | $359.0 million | $347.3 million |
| Operating income | $16.4 million | $13.9 million | $28.2 million | $25.4 million |
| Net income | $9.9 million | $8.8 million | $16.5 million | $15.8 million |
| Diluted EPS | $0.89 | $0.80 | $1.50 | $1.45 |
| Operating margin | 8.7% | 8.1% | 7.9% | 7.3% |
| Net margin | 5.2% | 5.1% | 4.6% | 4.6% |
| Dividends declared per share | $0.09 | $0.08 | $0.17 | $0.15 |
Q2 revenue increased 11.0%, operating income increased 18.5%, and net income increased 13.1% year over year. For the first six months, revenue increased 3.4%, operating income increased 10.9%, and net income increased 4.4%.
- Segment performance: Q2 Aviation revenue increased 53.6% to $55.0 million and operating income increased 82.9% to $5.2 million. Federal Services revenue was essentially flat at $80.3 million, while operating income increased 40.3% to $5.1 million. Supply Chain Management revenue declined 0.8% to $53.8 million and operating income declined 7.5% to $7.6 million.
- Cash flow: Operating activities provided $4.1 million in the first six months, compared with $3.6 million used in the prior-year period. Investing activities used $119.0 million, primarily reflecting the 1st Choice Aerospace acquisition and capital expenditures. Financing activities provided $115.5 million, largely from net bank borrowings.
- Liquidity: Cash and cash equivalents were $0.8 million at June 30, 2019, compared with $0.2 million at December 31, 2018. Current assets were $333.2 million and current liabilities were $135.5 million.
- Working capital: Inventories increased to $197.2 million from $166.4 million at year-end 2018. Receivables and unbilled receivables totaled approximately $120.0 million.
- Debt: Total long-term debt, net of issuance costs, was $279.1 million, including $75.8 million of term debt and $205.1 million of revolving borrowings. Debt increased from $160.6 million at December 31, 2018, primarily to finance the acquisition.
- Leverage and covenant compliance: The Total Funded Debt/EBITDA ratio was 3.19-to-1 versus a maximum of 3.50-to-1; the Fixed Charge Coverage Ratio was 3.20-to-1 versus a minimum of 1.20-to-1. The company reported compliance with its debt covenants.
- Interest rates: The effective rate on aggregate debt was 5.16%, with reported rates ranging from 4.89% to 6.75%. Interest-rate swaps had a $125 million notional amount at quarter-end.
Material Changes Versus the Prior Comparable Period
- The 1st Choice Aerospace acquisition added approximately $27.3 million of revenue and $5.9 million of operating income before amortization and allocated corporate costs through June 30, 2019.
- Aviation revenue benefited from the acquisition and international distribution initiatives in Singapore and Germany. Aviation operating margin improved to 9.5% in Q2 from 7.9% in Q2 2018.
- Federal Services first-half revenue declined 11.5%, principally because of lower Foreign Military Sales activity and reduced work on the Red River Army Depot program. Lower-margin work declined, while cost reductions and mix improvements increased operating income.
- Supply Chain Management first-half revenue declined 4.2%, reflecting lower USPS and DoD sales, partly offset by commercial customer growth. Its first-half operating margin declined to 13.8% from 14.3%.
- Interest expense increased by $2.2 million in the first six months, primarily because of higher borrowings related to the acquisition.
- Amortization expense increased to $10.0 million in the first six months from $8.0 million, primarily because of acquisition-related intangible assets.
- The company adopted ASC 842 lease accounting on January 1, 2019, recording operating lease right-of-use assets and liabilities and a cumulative after-tax retained earnings adjustment of approximately $1.9 million. Management stated that adoption did not materially affect results of operations or cash flows.
Guidance, Outlook, Risks, and Unusual Items
- Management stated that 2019 operating results were trending upward and expressed optimism regarding Aviation, supported by 1st Choice Aerospace and international distribution opportunities. No specific numerical full-year earnings or revenue guidance was provided.
- Federal Services bookings were $123 million for the first six months, compared with $189 million in 2018. Funded backlog was $269 million at June 30, 2019, compared with $339 million at June 30, 2018.
- Approximately $11.4 million of unbilled receivables represented revenue recognized under risk funding without formalized funding. The company believes reimbursement will be received but remains exposed to potential loss if funding is not obtained.
- The USPS next-generation delivery vehicle procurement is progressing more slowly than previously expected. USPS sales declined approximately 3% in 2019, and the timing and effect of the fleet transition remain uncertain.
- VSE Aviation and Akimeka were identified as reporting units at risk of future goodwill impairment. At June 30, 2019, Aviation goodwill was approximately $104.5 million and Akimeka goodwill was approximately $30.9 million.
- The 1st Choice Aerospace purchase accounting remains provisional. The earn-out obligation was recorded at $25.0 million at the acquisition date and was $25.0 million at June 30, 2019, split between current and long-term liabilities.
- The company accrued a probable loss related to an overtime lawsuit involving employees at the Red River Army Depot. Management did not believe additional liability would be material, but stated that the ultimate resolution could differ.
- Government contract funding delays, contract reductions or expirations, customer concentration, variable-rate debt, inventory levels, acquisition integration, and potential goodwill impairment are material risk considerations.
- The company reported approximately $269 million of unsatisfied or partially unsatisfied performance obligations, with 97% expected to be satisfied within one year.
Important Facts for Investors to Verify
- Confirm the final purchase-price allocation and earn-out payments for 1st Choice Aerospace as the valuation was still provisional.
- Monitor debt paydown, revolving borrowings, interest expense, covenant headroom, and the January 2023 loan maturity.
- Assess whether Aviation growth and international distribution initiatives offset Federal Services backlog and bookings declines.
- Track USPS fleet procurement and its impact on Supply Chain Management revenue and inventory requirements.
- Evaluate future goodwill impairment sensitivity for VSE Aviation and Akimeka.
- Review the outcome and potential additional exposure from the Red River Army Depot overtime litigation and any government investigations.