VSE Corporation — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2018. The financial statements are unaudited. VSE operates through Supply Chain Management, Aviation, and Federal Services segments, serving primarily the U.S. government, Department of Defense, U.S. Postal Service, and commercial aviation customers.
Financial Results and Position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total revenue | $168.9 million | $174.2 million | $516.2 million | $565.3 million |
| Operating income | $15.7 million | $12.2 million | $41.1 million | $41.4 million |
| Net income | $10.0 million | $6.6 million | $25.8 million | $21.7 million |
| Diluted EPS | $0.92 | $0.61 | $2.37 | $2.00 |
| Operating margin | 9.3% | 7.0% | 8.0% | 7.3% |
| Net margin | 5.9% | 3.8% | 5.0% | 3.8% |
- Revenue mix: Q3 revenue comprised $85.9 million of products and $83.0 million of services. Nine-month revenue comprised $264.7 million of products and $251.5 million of services.
- Segment performance: Q3 revenue was $51.8 million for Supply Chain Management, $34.0 million for Aviation, and $83.1 million for Federal Services. Nine-month operating income was $23.5 million, $7.3 million, and $12.3 million, respectively.
- Cash flow: Net cash provided by operating activities was $3.4 million for the first nine months, down from $39.5 million in the prior-year period. The decline primarily reflected a $36.4 million increase in inventory, largely associated with Aviation growth initiatives and the Singapore operation.
- Cash and liquidity: Cash and cash equivalents were $0.9 million at September 30, 2018, compared with $0.6 million at December 31, 2017. The company had a $300 million revolving loan and letter-of-credit facility, with $83.8 million drawn and $57 thousand of letters of credit outstanding.
- Debt: Bank borrowings totaled $177.1 million before approximately $2.2 million of unamortized financing costs. Term-loan borrowings were $93.3 million. The effective interest rate on aggregate debt was 4.10%, with debt rates ranging from 3.25% to 6.00% after hedging.
- Debt covenants: VSE was in compliance with its covenants. Total Funded Debt/EBITDA was 2.19x versus a maximum of 3.00x, and Fixed Charge Coverage was 3.11x versus a minimum of 1.20x.
- Balance sheet: Total assets were $637.1 million and stockholders’ equity was $320.5 million at September 30, 2018. Inventory was $166.5 million, compared with $132.6 million at year-end 2017.
- Dividends: Dividends declared were $0.08 per share in Q3 and $0.23 per share for the first nine months. The loan agreement limits annual cash dividends to $6 million, subject to specified conditions.
Material Changes Versus the Prior Comparable Period
- Revenue declined 3% in Q3 and 9% for the first nine months, primarily because Federal Services revenue decreased $8.8 million and $53.9 million, respectively.
- Federal Services revenue was affected by completion of two U.S. Army programs, reduced work on the Red River Army Depot contract, lower first-half Foreign Military Sales activity, and contracting-process delays.
- Supply Chain Management revenue increased 1% in Q3 but declined 1% for the nine-month period. USPS revenue declined, while DoD and commercial revenue increased. Segment profit declined because of lower USPS sales and lower-margin DoD sales.
- Aviation revenue increased 9% in Q3 and 7% for the nine-month period, with growth in new-parts distribution and engine-accessory work. Operating margins remained approximately 6.4% for Q3 and 7.1% for the nine-month period.
- Federal Services operating income increased despite lower revenue, benefiting from a $1.7 million gain on the sale of an NIH IT-services contract, improved margins on certain Army programs, and the absence of a prior-year contract loss.
- The effective tax rate declined to 24.9% in Q3 and 25.0% for the nine-month period, compared with 32.9% and 36.6%, respectively, primarily because of the Tax Cuts and Jobs Act.
- VSE adopted ASC 606 on January 1, 2018 using the modified retrospective method, increasing opening retained earnings by $1.7 million. The adoption changed the timing of award-fee, MRO, and certain fixed-price revenue recognition.
Outlook, Risks, Contingencies, and Unusual Items
- Management reported steady foreign-client demand for the Foreign Military Sales program, but noted that 2018 Federal Services revenue remains below 2017 levels. Nine-month bookings were $284 million versus $398 million in 2017, and funded backlog was $345 million versus $403 million.
- Management is optimistic about Aviation growth, including new distribution agreements, Asian-Pacific expansion, and the Singapore operation, but acknowledged that revenue, margins, and inventory may fluctuate with market demand and product mix.
- Management continues efforts to diversify Supply Chain Management beyond USPS through DoD, commercial fleet, and e-commerce customers. The impact of the USPS next-generation delivery vehicle procurement remains uncertain.
- Approximately 57% of 2018 revenue was recognized over time and 43% at a point in time. Remaining transaction prices allocated to unsatisfied or partially unsatisfied performance obligations totaled $345 million, with 96% expected to be satisfied within one year.
- VSE expects adoption of the new lease standard on January 1, 2019 to materially increase reported assets and liabilities, although it does not expect a significant change in the expense-recognition pattern.
- VSE identifies Aviation and the Akimeka reporting unit as exposed to potential future goodwill impairment. Aviation goodwill was approximately $104.5 million and Akimeka goodwill was approximately $29.8 million at September 30, 2018.
- Variable-rate debt creates interest-rate risk; VSE uses interest-rate swaps to hedge a portion of term-loan borrowings.
- An overtime-related lawsuit involving Red River Army Depot personnel is expected to result in a loss, for which an immaterial provision was accrued. A separate aviation crash lawsuit was settled without a required financial contribution from VSE. The U.S. Air Force rescinded an approximately $27 million claim related to Prime Turbines, although the filing notes the claim could theoretically be reasserted.
- Government funding delays, contract reductions, de-obligations, award-fee estimates, fixed-price cost estimates, customer concentration, and contract-renewal risk could affect revenue, cash flow, and margins.
Important Facts for Investors to Verify
- Whether Federal Services bookings and funded backlog stabilize or continue declining after the 2018 reductions.
- Whether Aviation growth initiatives generate sufficient returns to offset the substantial inventory investment.
- Cash conversion and working-capital trends, particularly inventory growth and operating cash flow.
- Debt repayment capacity, covenant headroom, variable-rate exposure, and the impact of required term-loan payments through 2023.
- The effect of ASC 606 on future award-fee and fixed-price contract revenue timing and comparability with prior periods.
- Potential goodwill impairment at VSE Aviation and Akimeka if projected cash flows or market assumptions weaken.
- Final accounting effects of the Tax Cuts and Jobs Act and the January 1, 2019 lease-standard adoption.
- Customer concentration: DoD represented 48.4% and USPS 25.2% of nine-month 2018 revenue.