Business Context and Reporting Period
VSE Corporation’s Form 10-K covers the fiscal year ended December 31, 2014, with selected quarterly data for the fourth quarter. VSE provides vehicle fleet and equipment sustainment, supply-chain, logistics, engineering, information technology, health-care IT, maintenance, refurbishment, energy, and consulting services. Approximately 99% of revenue was generated from government contracts, primarily for the U.S. Department of Defense, federal civilian agencies, and the U.S. Postal Service.
2014 reportable segments were Supply Chain Management, International, Federal, and IT, Energy and Management Consulting. Supply Chain represented 40.7% of revenue, International 25.1%, Federal 19.9%, and IT, Energy and Management Consulting 14.3%.
Key Financial Metrics
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Revenue | $424.1 million | $471.6 million | Down 10% |
| Operating income | $36.9 million | $44.1 million | Down 16% |
| Operating margin | 8.7% | 9.3% | Down 0.6 points |
| Income from continuing operations | $20.5 million | $24.0 million | Down 15% |
| Continuing-operations margin | 4.8% | 5.1% | Down 0.3 points |
| Net income | $19.4 million | $22.9 million | Down 15% |
| Net margin | 4.6% | 4.9% | Down 0.3 points |
| Diluted EPS | $3.61 | $4.28 | Down 16% |
| Cash flow from operations | $49.7 million | $56.6 million | Down $6.9 million |
| Capital expenditures | $3.4 million | $4.4 million | Down $1.0 million |
| Cash and cash equivalents | $0.3 million | $0.2 million | Up $0.04 million |
| Working capital | $34.9 million | $47.7 million | Down $12.8 million |
| Total bank debt | $48.6 million | $89.7 million | Down $41.1 million |
| Funded backlog | $195 million | $236 million | Down $41 million |
VSE paid approximately $2.0 million of dividends in 2014, or $0.38 per share according to the cash-flow discussion; the annual declared dividend was $0.39 per share. The quarterly dividend increased to an annualized rate of $0.40 per share beginning June 2014.
Fourth Quarter 2014
| Metric | Q4 2014 | Q4 2013 |
|---|---|---|
| Revenue | $95.0 million | $122.4 million |
| Operating income | $7.7 million | $12.0 million |
| Income from continuing operations | $4.4 million | $6.4 million |
| Net income | $4.2 million | $5.4 million |
| Diluted EPS | $0.78 | $1.01 |
Material Changes Versus the Prior Comparable Period
- Revenue declined $47.6 million, primarily from International revenue down $40.5 million, IT, Energy and Management Consulting down $13.8 million, and Federal down $11.0 million. Supply Chain revenue increased $17.8 million.
- International revenue fell 28%, primarily because the Treasury Seized Assets Program substantially ended in March 2014 and FMS revenue declined. International operating income declined 46% to $3.8 million.
- Federal revenue fell 12% as U.S. Army Reserve refurbishment work declined; the segment recorded an operating loss of $0.3 million versus $2.4 million of income in 2013.
- IT, Energy and Management Consulting revenue declined 18% and operating income declined 27%, reflecting contract expiration, lower customer ordering, and lower margins on replacement contracts.
- Supply Chain revenue increased 11%, primarily from growth in the USPS Managed Inventory Program. Segment operating income increased 9%, despite a $3.1 million adjustment to the Wheeler Bros. earn-out obligation.
- Government customer concentration shifted: DoD revenue declined to 45.5% of total revenue from 48.5%, while USPS revenue increased to 39.4% from 30.1%.
- Funded backlog declined to $195 million from $236 million, and bookings declined to $391 million from $501 million.
- Debt reduction improved the balance sheet: total bank debt declined to $48.6 million from $89.7 million, and interest expense declined to $4.0 million from $5.8 million.
- Employees declined to 1,589 from 1,872, reflecting reductions in work levels and cost-structure actions.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- In January 2015, VSE acquired four aviation maintenance, repair, overhaul, and parts-supply businesses for approximately $189 million in cash. The acquired businesses will operate as VSE Aviation and may require earn-out payments of up to $45 million.
- The acquisition was financed through an amended credit agreement. Debt outstanding at inception was approximately $250 million, compared with $48.6 million at December 31, 2014. The amended facilities include a $150 million revolving facility and a term loan, with the agreement expiring in January 2020.
- Management expects the aviation acquisition to diversify revenue, expand commercial-market exposure, and reduce reliance on DoD procurement and federal budgets. The acquisition also creates integration, leverage, earn-out, and execution risks.
- Management expects approximately $4 million of annual savings from 2014 cost reductions, facility consolidation, and combining the International and Federal groups beginning in 2015.
- December 2014 legislation permitting certain naval vessel transfers is expected to support future FMS revenue, but management expects related revenue to ramp beginning in late 2015 and in 2016. Egyptian Navy support revenue was approximately $33 million in 2014 versus $48 million in 2013 and remains exposed to political instability.
- U.S. Army Reserve task-order coverage expired in part during the third quarter of 2014 and was extended at lower levels. Future recompetes, extensions, and funding remain uncertain.
- Approximately $2.9 million of 2014 revenue related to work performed before formal government funding had been received. Management expects reimbursement, but remains exposed to funding risk.
- Discontinued operations generated a $1.1 million after-tax loss in 2014, primarily from claims and disputes related to two remaining bonded construction projects. The projects had an aggregate bonded amount of approximately $4 million and were expected to be completed in 2015.
- VSE disclosed a Hawaii wrongful-death lawsuit related to a 2011 fireworks explosion and an Alaska lawsuit involving its ICRC subsidiary. The Hawaii matter was expected to proceed to trial in 2016; the company did not expect the Hawaii case to have a material effect, while the effect of the Alaska case could not be predicted.
- Key risks include federal budget reductions, delayed or terminated contract funding, competitive bidding and protests, concentration in the USPS MIP, FMS, and Army Reserve programs, government audits, subcontractor performance, cybersecurity, environmental liabilities, foreign political instability, and variable interest rates.
- No goodwill impairment was identified in the 2014 annual test. The company held approximately $92.1 million of goodwill and $72.2 million of net intangible assets at year-end.
Important Facts for Investors to Verify
- Post-year-end leverage: Verify the final purchase accounting, debt balances, covenant compliance, amortization schedule, interest expense, and integration performance following the $189 million aviation acquisition.
- Revenue concentration: Monitor USPS MIP performance and the sustainability of the FMS and Army Reserve programs, which together represented approximately 69% of 2014 revenue.
- Backlog and bookings: Verify whether funded backlog and new bookings recover from 2014 declines and how much backlog converts to revenue.
- FMS outlook: Track naval vessel-transfer approvals, foreign-government funding, and political conditions affecting Egyptian Navy staffing and revenue.
- Liquidity: Assess cash generation relative to scheduled debt payments, earn-out obligations, lease commitments, and the very low year-end cash balance.
- Contingencies: Follow the Hawaii and Alaska litigation, government audits, contract-claim exposure, and the remaining discontinued-operation bond claims.
- Accounting changes: Monitor the company’s assessment and implementation of the new revenue-recognition standard effective January 1, 2017.