VSE Corporation — Form 10-Q Summary
Business Context and Reporting Period
VSE Corporation provides sustainment, logistics, engineering, refurbishment, supply-chain, information technology, health-care IT, construction-management and consulting services primarily to U.S. Department of Defense and Federal Civilian agencies, including the U.S. Postal Service. The filing covers the three months ended March 31, 2012; financial statements are unaudited.
VSE reported five operating segments: Federal, International, IT, Energy and Management Consulting, Infrastructure, and Supply Chain Management. The Supply Chain Management segment includes Wheeler Bros., Inc. (WBI), acquired in June 2011.
Financial Performance and Position
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenue | $144.3 million | $151.2 million | Down 5% |
| Operating income | $12.3 million | $6.9 million | Up 79% |
| Operating margin | 8.6% | 4.6% | Up 4.0 percentage points |
| Net income | $6.7 million | $4.2 million | Up 60% |
| Diluted EPS | $1.26 | $0.80 | Up 58% |
| Operating cash flow | $6.7 million | $(0.3) million | Improved |
| Dividends declared per share | $0.07 | $0.06 | Up $0.01 |
Services revenue was $106.0 million, down from $148.2 million, while product revenue was $38.4 million, up from $3.0 million, primarily reflecting WBI. Contract costs declined to $131.4 million from $143.5 million. The effective tax rate was 38.3% in both periods.
At March 31, 2012, cash and cash equivalents were $0.4 million, compared with $0.5 million at December 31, 2011. Receivables were $112.9 million, inventories were $42.5 million, and total assets were $455.8 million. Stockholders’ equity was $150.7 million, compared with $143.6 million at year-end 2011.
Total bank borrowings were approximately $171.4 million at March 31, 2012, consisting of approximately $106.3 million of term debt and $65.2 million of revolving borrowings. Letters of credit totaled approximately $5.0 million. The effective interest rate on aggregate debt, after hedging, was 2.86%. The company had $125 million of revolving-loan and letter-of-credit capacity, with the ability to increase that maximum to $175 million.
VSE invested $8.6 million in property and equipment and paid $4.6 million for acquisitions during the quarter. Net cash used in investing activities was $13.5 million, while financing activities provided $6.8 million. The company’s term loan requires scheduled payments of $14.1 million in the remainder of 2012, $23.4 million in 2013, $25.0 million in 2014, $34.3 million in 2015 and $9.4 million in 2016.
Material Changes Versus the Prior Comparable Period
- Revenue declined $6.9 million, primarily because the Federal Group’s R2 contract expired and activity declined on other programs.
- Federal Group revenue fell 54% to $30.8 million, while operating income declined 45% to $1.4 million.
- International Group revenue declined 11% to $45.8 million and operating income declined 21% to $1.5 million, principally because of lower Foreign Military Sales and seized-asset program activity.
- IT, Energy and Management Consulting revenue declined 6%, but operating income increased 31% to $3.1 million, aided partly by a $0.96 million reduction in an Akimeka earn-out obligation.
- Infrastructure revenue declined 25% to $4.4 million, and the segment reported a $0.15 million operating loss versus $0.23 million of income. The decline reflected lower Port of Anchorage project activity and funding delays.
- WBI contributed $37.7 million of revenue and $6.8 million of operating income in the Supply Chain Management Group. Year-over-year comparisons for this segment are not meaningful because it was acquired after the first quarter of 2011.
- Bookings increased to $168 million from $107 million, while funded backlog declined to $307 million from $357 million.
- Depreciation and amortization increased to $4.9 million from $2.4 million, and interest expense increased to $1.5 million from $0.1 million, primarily because of acquisition-related debt.
Guidance, Outlook, Risks and Unusual Items
Management stated that the federal contracting environment remained challenging and expected conditions to continue through most of 2012. Budget pressures, changing government spending priorities, slower contract awards and funding, increased competition, and a higher frequency of contract protests were affecting revenue and contract execution.
Specific near-term challenges included the slower-than-expected ramp-up of the follow-on Foreign Military Sales program and reduced overseas equipment-servicing opportunities as U.S. military involvement in Southwest Asia declined. Management identified potential longer-term opportunities in Army Reserve and other vehicle-refurbishment programs, Foreign Military Sales, and expansion of Supply Chain Management services to DoD, commercial and other customers.
The Infrastructure Group had not recognized fees for certain Port of Anchorage work pending resolution of environmental and technical issues. If the fees are funded, the company estimated potential additional revenue and operating income of $1.8 million to $2.3 million.
WBI may require additional earn-out payments of up to $40 million over four years if specified performance targets are achieved. Recorded earn-out obligations totaled approximately $20.0 million at March 31, 2012. VSE also had approximately $6.6 million of capital-lease obligations related to four facilities and a $1.5 million escrow arrangement associated with subcontractor work-share requirements.
Interest-rate exposure arises from variable-rate bank debt. VSE used interest-rate swaps covering portions of its term and revolving debt. The filing states that the company was in compliance with its debt covenants at March 31, 2012: actual Total Funded Debt/EBITDA was 3.05 to 1 against a maximum of 3.25 to 1, and actual Fixed Charge Coverage was 1.55 to 1 against a minimum of 1.20 to 1.
Management concluded that disclosure controls and procedures were effective, and no material change in internal control over financial reporting occurred during the quarter. The filing states that ordinary claims and governmental investigations were not expected to have a material adverse effect, although outcomes cannot be predicted with certainty.
Important Facts for Investors to Verify
- Whether federal budget, award, funding and protest delays further reduce revenue or funded backlog.
- The sustainability of improved operating margins, particularly the contribution and margins of WBI.
- Progress and funding resolution for the Port of Anchorage project and the potential $1.8 million to $2.3 million benefit.
- Debt reduction, revolving-borrowing requirements, covenant headroom and scheduled term-loan amortization.
- Future WBI and other acquisition-related earn-out payments, including the recorded $20.0 million obligation and potential additional consideration.
- Execution of the Foreign Military Sales follow-on work, Army vehicle-refurbishment programs and Supply Chain Management expansion.
- Cash requirements associated with headquarters relocation, capital expenditures, leases, dividends and working-capital fluctuations.