VSE Corporation 2016 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
VSE Corporation is a diversified provider of sustainment, supply-chain, aviation maintenance, repair and overhaul, logistics, engineering, information technology, energy, and consulting services to the U.S. government, USPS, commercial aviation customers, and other commercial clients. Reported segments are Supply Chain Management, Aviation, Federal Services, and IT, Energy and Management Consulting.
This unaudited Form 10-Q covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods. The filing was signed July 29, 2016. The company had 5,399,342 common shares outstanding as of July 22, 2016, before a planned two-for-one stock split to be distributed August 3, 2016.
Financial Results and Key Metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $160.5 million | $131.1 million | $304.1 million | $251.9 million |
| Operating income | $11.9 million | $11.5 million | $24.6 million | $22.2 million |
| Net income | $6.0 million | $5.5 million | $12.5 million | $10.7 million |
| Diluted EPS, reported | $1.10 | $1.02 | $2.32 | $1.99 |
| Operating margin | 7.4% | 8.8% | 8.1% | 8.8% |
| Net margin | 3.7% | 4.2% | 4.1% | 4.2% |
Products revenue increased 2% in the second quarter and 12% year to date, while services revenue increased 54% and 34%, respectively. Federal Services was the primary growth driver, with second-quarter revenue up 76% and year-to-date revenue up 51%. The Aviation Group benefited from a full six months of contribution in 2016 compared with approximately five months in 2015.
Operating income increased only 3% in the second quarter and 11% year to date because costs and operating expenses grew approximately in line with or faster than revenue. Results included a $1.2 million reserve and related legal expenses associated with the Heritage litigation.
Cash Flow, Debt, Liquidity, and Capital Structure
- Operating cash flow was $15.1 million for the first six months of 2016, compared with $3.9 million in the prior-year period.
- Cash used in investing activities was $4.2 million, primarily capital expenditures of $4.2 million. The 2015 period included approximately $188.8 million of acquisition spending.
- Cash used in financing activities was $11.0 million, including $8.0 million of earn-out payments, $1.2 million of dividends, and net debt repayments. Cash and cash equivalents ended at $0.7 million, compared with $0.7 million at December 31, 2015.
- Total bank borrowings were approximately $234 million at June 30, 2016, consisting of approximately $125.3 million of term debt and $109 million of revolving borrowings. Reported debt, net of deferred financing costs, was approximately $232 million.
- The revolving facility had maximum availability of $150 million, with no outstanding letters of credit. The company may increase total facility commitments by up to $75 million, subject to the loan agreement.
- Debt maturities after June 30, 2016 include approximately $9.4 million in 2016, $21.6 million in 2017, $28.1 million in 2018, $30.0 million in 2019, and $36.2 million in 2020.
- The effective interest rate on aggregate debt was 3.13%. Interest-rate swaps covered portions of the term and revolving loans, reducing exposure to rising rates but creating fair-value volatility.
- The company was in compliance with its debt covenants. The Total Funded Debt/EBITDA ratio was 2.99 to 1 against a maximum of 3.25 to 1, and the Fixed Charge Coverage Ratio was 1.40 to 1 against a minimum of 1.20 to 1.
Material Changes Versus the Prior Comparable Period
- Total revenue increased 22% in Q2 and 21% for the first six months.
- Federal Services returned to profitability, reporting operating income of $1.0 million in Q2 and $1.7 million year to date, compared with losses of $0.4 million and $0.6 million, respectively, in 2015. Growth reflected Foreign Military Sales, the Fort Benning program, and the new Red River Army Depot program.
- Supply Chain Management revenue increased 4% in Q2 and 7% year to date, supported by USPS, government, commercial customers, and the December 2015 Ultra Seating acquisition. Segment profit margins were approximately 17.7% in both Q2 and year-to-date 2016, modestly below prior-year levels.
- Aviation revenue increased 1% in Q2 and 20% year to date, although the year-to-date comparison is affected by the timing of the January 2015 acquisition. Year-to-date Aviation operating income increased to $5.9 million from $4.7 million.
- IT, Energy and Management Consulting revenue declined 12% in Q2 and 16% year to date, primarily because of contract expirations, reduced client orders, and follow-on work awarded to small businesses. Year-to-date operating income declined 38% to $1.7 million.
- Funded backlog for Federal Services and IT, Energy and Management Consulting increased to $294 million from $176 million at June 30, 2015. Six-month bookings increased to $194 million from $87 million.
- The effective tax rate decreased to 36.5% from 39.3%, primarily due to earn-out fair-value changes and tax credits in 2016, compared with nondeductible transaction costs in 2015.
- The company adopted accounting changes relating to deferred taxes and debt issuance costs. These changes affected presentation only and did not affect reported financial condition, earnings, or cash flow.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management did not provide numerical revenue or earnings guidance. Management stated that year-over-year revenue growth was expected to continue through the remainder of 2016, supported by Federal Services programs, continued USPS activity, commercial supply-chain growth, Aviation expansion, and the full-year contribution of newer contracts.
- Management expects the Fort Benning and Red River Army Depot programs and increased Foreign Military Sales activity to contribute to second-half 2016 revenue.
- Potential capital investments related to USPS vehicle-fleet replacement, additional growth initiatives, and acquisitions could limit debt reduction or increase borrowings.
- The Heritage Disposal and Storage litigation produced a jury award of approximately $4.8 million, excluding interest, but the court had not issued a final judgment as of the filing date. VSE accrued $1.2 million and estimated a probable loss range of $1.2 million to $5.5 million.
- VSE voluntarily disclosed suspected overbilling of approximately $1.5 million related to inflated weights of seized fireworks. The matter was under investigation and could affect both the Heritage litigation and VSE’s claim before the U.S. Civilian Board of Contract Appeals.
- Other litigation includes the Hawaii wrongful-death action and the Anchorage litigation, both expected to proceed to trial in 2017. The company stated that the Hawaii matter was not expected to materially affect results or financial position, while the potential effect of the Anchorage matter could not be predicted.
- Goodwill totaled approximately $198.5 million. Management identified the Akimeka reporting unit as having only approximately 9% excess fair value over carrying value in the 2015 impairment analysis, creating sensitivity to deterioration in projected cash flows or other market conditions.
- Revenue is concentrated among government customers, including USPS and the Department of Defense. Government funding delays, contract expirations, de-obligations, fixed-price execution, and changes in federal spending could affect revenue and liquidity.
- Variable-rate debt creates interest-rate risk despite swaps covering portions of outstanding borrowings.
Important Facts for Investors to Verify
- Verify the final judgment, reserve requirements, and any government consequences arising from the Heritage litigation and related overbilling disclosure.
- Track Federal Services contract execution, Foreign Military Sales funding, Fort Benning and Red River Army Depot ramp-up, and the sustainability of the $294 million funded backlog.
- Monitor IT, Energy and Management Consulting revenue declines and the impairment sensitivity of the Akimeka reporting unit.
- Reconcile debt repayments, revolving borrowings, scheduled maturities, covenant headroom, and cash generation against planned growth investments.
- Adjust historical share counts and per-share results for the two-for-one stock split completed after the reporting date.
- Assess customer concentration, particularly USPS and DoD, and the effect of government funding or procurement changes on future revenue.