VSE Corporation 10-Q Summary
Business Context and Reporting Period
VSE Corporation provides sustainment, logistics, engineering, supply-chain, information technology, energy, infrastructure, 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 quarter and six months ended June 30, 2012; financial statements are unaudited.
Operations are reported through five 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.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2012 | Three Months Ended June 30, 2011 | Six Months Ended June 30, 2012 | Six Months Ended June 30, 2011 |
|---|---|---|---|---|
| Revenue | $139.2 million | $158.5 million | $283.5 million | $309.8 million |
| Operating income | $12.0 million | $7.3 million | $24.4 million | $14.2 million |
| Net income | $6.3 million | $4.2 million | $13.0 million | $8.4 million |
| Diluted EPS | $1.18 | $0.80 | $2.44 | $1.60 |
| Dividends declared per share | $0.08 | $0.07 | $0.15 | $0.13 |
- Six-month operating margin was approximately 8.6%, compared with 4.6% in the prior-year period. Six-month net margin was approximately 4.6%, compared with 2.7%.
- Net cash provided by operating activities was $21.9 million for the six months ended June 30, 2012, compared with $1.3 million in the prior-year period.
- Cash and cash equivalents were $0.4 million at June 30, 2012, essentially unchanged from $0.5 million at December 31, 2011.
- Total assets were $449.4 million and stockholders’ equity was $156.5 million at June 30, 2012.
- Receivables, principally from the U.S. Government, were $112.3 million; inventories were $43.1 million.
- Capital expenditures were approximately $11.1 million during the first six months, including approximately $9 million related to the corporate headquarters relocation.
Debt and Liquidity
- Total bank debt was approximately $159.5 million at June 30, 2012, consisting of approximately $101.5 million of term debt and $58 million of revolving borrowings. Letters of credit totaled approximately $5 million.
- Revolving-loan availability was $125 million, with an option to increase the facility to $175 million.
- The loan agreement expires in June 2016. Scheduled term-loan payments after June 30, 2012 are $9.4 million in 2012, $23.4 million in 2013, $25.0 million in 2014, $34.3 million in 2015 and $9.4 million in 2016.
- The effective interest rate on aggregate debt, after hedging, was 3.52%; interest rates on portions of outstanding debt ranged from 2.49% to 4.12%.
- VSE was in compliance with its debt covenants. Actual ratios were 2.93x Total Funded Debt/EBITDA versus a 3.25x maximum, 1.66x Fixed Charge Coverage versus a 1.20x minimum, and 0.87x Asset Coverage versus a 0.80x minimum.
- Cash used in investing activities was $15.7 million, while cash used in financing activities was $6.2 million. Net cash decreased by approximately $9 thousand during the six months.
Material Changes Versus the Prior Comparable Period
- Six-month revenue declined 8.5%, primarily because the Army R2 program had expired. Federal Group revenue declined 47%, International Group revenue declined 17%, IT, Energy and Management Consulting revenue declined 9%, and Infrastructure revenue declined 58%.
- Despite lower revenue, six-month operating income increased 72% and net income increased 55%, primarily because of the contribution from WBI, lower corporate expenses, and improved operating leverage.
- Supply Chain Management generated $74.2 million of six-month revenue and $12.4 million of operating income, compared with only $10.7 million of revenue and $2.0 million of operating income in the prior-year comparison, which included only a partial period after the WBI acquisition.
- Infrastructure reported a six-month operating loss of $0.7 million, compared with income of $0.4 million in the prior-year period, reflecting reduced work on the Port of Anchorage Intermodal Expansion Project. The related contract ended in May 2012.
- Revenue mix shifted materially toward fixed-price contracts, which represented 42% of six-month revenue versus 17% in the prior-year period. Time-and-materials revenue fell to 35% from 53%.
- USPS Managed Inventory Program revenue increased to $67.5 million, or 24% of six-month revenue, from $9.6 million, or 3%, in the prior-year period.
- The company recorded a $0.75 million expense in the second quarter for an expected shortfall under a subcontractor work-share agreement.
- Interest expense increased to $3.4 million for the first six months from $0.6 million, reflecting debt incurred primarily to finance the WBI acquisition.
Guidance, Outlook, Risks and Unusual Items
- Management expected challenging operating conditions through most of 2012 because of federal budget and spending changes, delayed contract awards and funding, increased competition, and contract protests.
- Potential growth opportunities cited include expanded vehicle and equipment refurbishment, increased Foreign Military Sales activity, and expansion of supply-chain services to DoD and commercial customers.
- Management identified sequestration as a risk that could delay, postpone or cancel federal awards. It stated that several major programs are funded through foreign-government payments, postage collections or asset-sale proceeds and may be less exposed, although the ultimate impact was uncertain.
- Revenue concentration remained significant: USPS MIP represented 24% of six-month revenue, the Foreign Military Sales program 16%, and the U.S. Army Reserve program 12%.
- Management was pursuing potential additional fee income of approximately $1.8 million to $2.4 million related to prior Infrastructure work, but funding and realization remained uncertain.
- WBI earn-out obligations could require additional payments of up to $40 million over four years. The recorded WBI earn-out liability was approximately $16.6 million, including current and long-term portions; total recorded earn-out obligations, including other acquisitions, were $19.9 million.
- The company capitalized approximately $27.3 million of construction costs and related liability for its headquarters financing lease, which began in May 2012. The arrangement produces depreciation and interest expense rather than conventional rent expense.
- Four Hawaii lawsuits allege negligence related to an April 2011 fireworks and diesel-fuel explosion involving a VSE vendor. Plaintiffs seek unspecified damages. VSE denied the allegations and stated that management did not believe the proceedings would be material, although outcomes could not be predicted with certainty.
- Substantially all contracts involve government agencies or government prime contractors, exposing VSE to federal budget priorities, funding delays, protests, contract renewals and changes in military activity.
Important Facts for Investors to Verify
- Whether revenue growth from WBI and the USPS MIP can offset continued declines from expired or reduced defense programs, particularly R2 and overseas servicing work.
- The sustainability of improved margins and operating income given lower total revenue, higher fixed-price revenue, and unusual earn-out adjustments.
- Government funding, contract-award timing, sequestration effects, and the renewal or expansion of major programs.
- Liquidity and covenant headroom as scheduled term-loan amortization continues and revolving borrowings fluctuate with working-capital needs.
- The ultimate outcome of the Infrastructure fee discussions and the Hawaii litigation.
- Future WBI earn-out payments, interest-rate exposure after swap maturities, and the financial impact of the headquarters financing lease.