VSE Corporation — Q1 2020 Form 10-Q Summary
Business Context and Reporting Period
VSE Corporation provides aftermarket distribution, repair, maintenance, logistics, supply-chain, engineering, and consulting services to government and commercial customers through its Aviation, Fleet, and Federal and Defense segments. This unaudited report covers the three months ended March 31, 2020, with comparison to the three months ended March 31, 2019.
The company completed the sale of Prime Turbines in February 2020 and identified COVID-19 as a significant emerging risk, particularly for Aviation demand and receivables collections.
Key Financial Metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Total revenue | $177.4 million | $169.9 million | +4.4% |
| Operating income | $9.7 million | $11.8 million | -17.6% |
| Operating margin | 5.5% | 7.0% | Down 150 bps |
| Adjusted operating income, excluding divestiture loss and property gain | $16.2 million | $11.8 million | +37% |
| Income before taxes | $6.2 million | $8.7 million | -27.8% |
| Net income | $3.3 million | $6.6 million | -49.5% |
| Diluted EPS | $0.30 | $0.60 | -50.0% |
| Cash flow from operations | $6.8 million | $1.1 million | Increase of $5.7 million |
Products revenue was $76.3 million and services revenue was $101.1 million. Net income was reduced by a $7.5 million loss on the Prime Turbines divestiture and a higher effective tax rate of 46.7%, versus 23.7% in the prior-year quarter. The higher tax rate primarily reflected a valuation allowance related to the capital loss from the divestiture.
Segment revenue and operating income were:
| Segment | Revenue | Year-over-year change | Operating income | Operating margin |
|---|---|---|---|---|
| Aviation | $58.1 million | +17.6% | $(1.9) million | (3.2)% |
| Fleet | $53.2 million | +2.9% | $6.9 million | 13.0% |
| Federal and Defense | $66.1 million | -3.9% | $4.9 million | 7.4% |
Cash Flow, Debt, and Liquidity
- Cash and cash equivalents declined from $734,000 at December 31, 2019 to $543,000 at March 31, 2020.
- Operating cash flow was $6.8 million. Investing activities provided $22.8 million, principally from $20.7 million of cash proceeds from the Prime Turbines sale and $2.4 million from the Miami property sale.
- Financing activities used $29.8 million, including $31.7 million paid to satisfy the 2019 Prime Turbines acquisition earn-out obligation, partially offset by borrowings.
- Total long-term debt, net of issuance costs, was $273.7 million, including $102.1 million of term debt and $174.2 million of revolving borrowings before debt issuance costs.
- The revolving facility had maximum availability of $350 million, and management reported approximately $176 million of unused bank commitments at March 31, 2020. No letters of credit were outstanding.
- The effective interest rate on aggregate debt was 4.06%. Interest-rate swaps covered $145 million of debt.
- The company was in compliance with its debt covenants at March 31, 2020, including a maximum funded debt-to-EBITDA ratio of 3.50 to 1.00 and a minimum fixed-charge coverage ratio of 1.20 to 1.00.
- Term-loan payments after March 31, 2020 totaled approximately $14.1 million in 2020, $21.6 million in 2021, $22.5 million in 2022, and $43.9 million in 2023.
Material Changes Versus the Prior Comparable Period
- Revenue increased $7.5 million, led by Aviation growth of $8.7 million and Fleet growth of $1.5 million, partly offset by a $2.7 million Federal and Defense decline.
- Aviation operating income fell $4.9 million, primarily because of the $7.5 million Prime Turbines divestiture loss, despite a $1.1 million gain on the sale-leaseback of Miami property. Excluding these items, Aviation operating income increased approximately 49%.
- Fleet revenue increased modestly, but operating income declined $82,000 because of a less favorable customer and product mix.
- Federal and Defense operating income increased $1.5 million despite lower revenue, reflecting the expiration of a lower-margin U.S. Army contract and a greater proportion of more profitable fixed-price work.
- Federal and Defense bookings increased 31% to $67 million, while funded backlog declined 28% to $201 million, primarily because of contract expiration.
- Total debt increased approximately $3.5 million, while the acquisition earn-out obligation declined approximately $31.4 million after the $31.7 million payment.
- The quarterly dividend increased to $0.09 per share from $0.08 per share. The credit agreement limits annual cash dividends to $6 million, subject to covenant conditions.
Guidance, Outlook, Risks, and Unusual Items
- Management stated that COVID-19 had not materially disrupted operations through the first quarter, and all repair, distribution, and base-operations facilities remained open.
- Management expects Aviation demand to decline during the remainder of 2020 because of reduced global air travel. The severity and duration of the impact could not be estimated.
- Fleet and Federal and Defense demand was expected to experience limited disruption because of essential-service and government customer exposure.
- A cost-reduction plan completed in April 2020, including workforce reductions, is expected to reduce annualized expenses by approximately $13 million beginning in the second quarter.
- Management reported sufficient near-term cash flow and unused borrowing capacity, but warned that Aviation receivables collections may be delayed and bad-debt expense may increase.
- Future earnings declines could pressure debt covenant compliance. The company was working with its bank group on potential mitigations, but no assurance was provided that waivers or amendments would be available on acceptable terms.
- Goodwill was approximately $269 million at March 31, 2020. The Aviation reporting unit, with approximately $175 million of goodwill, had fair value approximating carrying value and therefore has heightened impairment sensitivity if the downturn persists. No goodwill impairment was recorded in the quarter.
- The company reported no material legal proceedings and no material off-balance-sheet arrangements. Government contract audits and investigations could nevertheless result in repayment obligations, penalties, or other liabilities.
Most Important Facts for Investors to Verify
- Whether the Aviation downturn produces sustained revenue declines, receivables losses, or future goodwill impairment.
- Whether the $13 million annualized cost-reduction plan is achieved beginning in the second quarter.
- Future debt covenant headroom, borrowing availability, interest expense, and required term-loan repayments.
- Federal and Defense backlog conversion and whether increased bookings offset the 28% year-over-year backlog decline.
- Cash generation after inventory investment, delayed Aviation collections, dividends, and debt service.
- The final tax rate for 2020, given the first-quarter discrete tax charge and management’s expectation of a lower full-year effective rate.