VSE Corporation: Q2 2015 Form 10-Q Summary
Business context and reporting period
VSE Corporation filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2015. The company provides supply-chain management, aviation maintenance, repair and overhaul (MRO), parts supply, logistics, engineering, information technology, energy, and management consulting services to government and commercial customers.
Reportable segments were Supply Chain Management, Aviation, Federal Services, and IT, Energy and Management Consulting. VSE completed the acquisition of four aviation businesses on January 28, 2015; their results are included from the acquisition date.
Key financial metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $131.1 million | $108.0 million | $251.9 million | $227.4 million |
| Operating income | $11.5 million | $10.7 million | $22.2 million | $22.1 million |
| Operating margin | 8.8% | 9.9% | 8.8% | 9.7% |
| Net income | $5.5 million | $5.7 million | $10.7 million | $11.3 million |
| Net margin | 4.2% | 5.2% | 4.2% | 5.0% |
| Diluted EPS | $1.02 | $1.06 | $1.99 | $2.11 |
| Dividends declared per share | $0.11 | $0.10 | $0.21 | $0.19 |
Products revenue increased to $80.2 million in the second quarter and $150.0 million for the first six months, while services revenue declined to $50.9 million and $102.0 million, respectively.
Operating cash flow was $3.9 million for the six months, compared with $25.9 million in the prior-year period. Cash used in investing was $193.8 million, including $188.8 million for acquisitions. Financing activities provided $190.0 million, primarily through acquisition-related borrowings. Cash increased modestly from $263 thousand at year-end 2014 to $444 thousand at June 30, 2015.
At June 30, 2015, total assets were $632.0 million, including $113.7 million of inventory, $76.7 million of receivables, $157.7 million of intangible assets, and $184.4 million of goodwill. Total liabilities were $415.9 million and stockholders’ equity was $216.1 million.
Material changes versus the prior comparable period
- Revenue increased 21% in Q2 and 11% for the six-month period, primarily due to the Aviation Acquisition and growth in Supply Chain Management.
- The Aviation Group contributed $31.9 million of Q2 revenue and $54.7 million for the six months, with operating income of $2.6 million and $4.7 million, respectively.
- Supply Chain Management revenue increased 13% for both Q2 and the six months, driven primarily by higher USPS Managed Inventory Program revenue. Six-month operating income increased 9%.
- Federal Services revenue declined 24% in Q2 and 33% for the six months. The segment reported operating losses of $356 thousand and $623 thousand, compared with operating income of $1.6 million and $4.4 million in the prior-year periods.
- IT, Energy and Management Consulting revenue declined 13% in Q2 and 12% for the six months, while six-month operating income declined 18%.
- Higher borrowings associated with the acquisition increased interest expense by $1.3 million in Q2 and $2.3 million for the six months.
- Net income declined 3% in Q2 and 5% for the six months, despite higher revenue, reflecting increased interest expense, lower Federal Services and consulting profitability, and higher amortization.
Debt, liquidity, outlook, risks and unusual items
VSE amended and restated its bank loan agreement in January 2015. The agreement matures in January 2020 and includes a term loan and a $150 million revolving facility. At June 30, 2015, term loan borrowings were $146.3 million, revolving borrowings were approximately $97 million, and total bank borrowings were approximately $243.2 million, compared with $48.6 million at December 31, 2014.
Effective interest rates on portions of debt ranged from 2.44% to 4.25%, with an aggregate effective rate of 2.97%. Interest-rate swaps covered $125 million of borrowings. VSE was in compliance with its debt covenants; the actual Total Funded Debt/EBITDA ratio was 3.36 to 1 versus a 3.50 to 1 maximum, and the Fixed Charge Coverage Ratio was 2.12 to 1 versus a 1.20 to 1 minimum.
Management stated that Aviation integration was proceeding well and operating results were meeting expectations. Management expects continued growth from Supply Chain Management and views Aviation as a means to diversify customers and reduce reliance on military markets. Federal Services and consulting results remained pressured by government budget reductions, program-specific declines, contract expirations, reduced Army Reserve refurbishment work, and lower Foreign Military Sales activity. Funded backlog for Federal Services and IT, Energy and Management Consulting was $176 million at June 30, 2015, compared with $177 million a year earlier.
The Aviation Acquisition involved approximately $189 million of initial consideration and a potential earn-out of up to $40 million, plus a possible additional $5 million payment tied to specified targets. The acquisition added approximately $92.3 million of goodwill and $93.2 million of identifiable intangible assets. Acquisition-related expenses were approximately $413 thousand for the six months.
Key liquidity risks include low cash balances, substantial variable-rate debt, required term-loan amortization, working-capital needs, government funding and collection timing, and covenant restrictions. Cash dividends are limited by the loan agreement to no more than $6 million annually if specified conditions are satisfied. VSE also disclosed litigation involving a fireworks-related wrongful-death action, the Port of Anchorage project, and a newly filed Nebraska lawsuit; the company could not predict the effect of certain matters, although it did not expect the Hawaii litigation to be materially adverse.
Important facts for investors to verify
- Whether Aviation integration, acquired earnings, inventory levels, and earn-out obligations develop as projected.
- Debt reduction capacity, covenant headroom, refinancing exposure, and sensitivity to variable interest rates.
- Whether Federal Services revenue and margins stabilize after Army Reserve, Foreign Military Sales, and other program declines.
- The sustainability and customer concentration of USPS-related revenue, which represented approximately 35.5% of six-month revenue.
- The impact of litigation, government funding delays, contract expirations, and potential contract disallowances.
- Whether operating cash flow improves from the unusually low $3.9 million reported for the first six months.
- The final valuation and accounting for the Aviation Acquisition, including potential purchase-price adjustments and earn-out payments.