VSE (VSEC) 10-Q2022 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2022

For the Transition Period from _____ to _____

(Exact Name of Registrant as Specified in its Charter)

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

This quarterly report on Form 10-Q (“Form 10-Q”) contains statements that, to the extent they are not recitations of historical fact, constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All such statements are intended to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and includes this statement for purposes of such safe harbor provisions.

“Forward-looking” statements, as such term is defined by the Securities Exchange Commission (the “SEC”) in its rules, regulations and releases, represent our expectations or beliefs, including, but not limited to, statements concerning our operations, economic performance, financial condition, the impact of widespread health developments, such as the ongoing COVID-19 outbreak, the health and economic impact thereof and the governmental, commercial, consumer and other responses thereto, growth and acquisition strategies, investments and future operational plans. Without limiting the generality of the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “forecast,” “seek,” “plan,” “predict,” “project,” “could,” “estimate,” “might,” “continue,” “seeking” or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. These statements, by their nature, involve substantial risks and uncertainties, certain of which are beyond our control, and actual results may differ materially depending on a variety of important factors, including, but not limited to, those identified elsewhere in this document, including in Item 1A, Risk Factors, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 3, Quantitative and Qualitative Disclosures About Market Risk, as well as with respect to the risks described in Item 1A, Risk Factors, to our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 filed with the SEC on March 11, 2022 (“2021 Form 10-K"). All forward-looking statements made herein are qualified by these cautionary statements and risk factors and there can be no assurance that the actual results, events or developments referenced herein will occur or be realized.

Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that occur or arise after the date hereof.

(in thousands except share and per share amounts)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

(in thousands except share and per share amounts)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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The accompanying notes are an integral part of these unaudited consolidated financial statements.

(in thousands except per share data)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

(in thousands except per share data)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

(in thousands)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

VSE Corporation (“VSE,” the “Company,” “we,” “us,” or “our”) is a diversified aftermarket products and services company providing repair services, parts distribution, logistics, supply chain management and consulting services for land, sea and air transportation assets to commercial and government markets. Our operations are conducted under three reporting units aligned with our operating segments: (1) Aviation; (2) Fleet; and (3) Federal and Defense.

Our accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") for interim financial information and in accordance with the instructions to SEC Form 10-Q and Article 10 of SEC Regulation S-X. Therefore, such financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements and should be read in conjunction with the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 ("2021 Form 10-K"). In our opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2022 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2022. 

The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates affecting the financial statements include fair value measurements, inventory provisions, collectability of receivables, estimated profitability of long-term contracts, valuation allowances on deferred tax assets, fair value of goodwill and other intangible assets and contingencies.

On March 1, 2021, we acquired HAECO Special Services, LLC ("HSS") from HAECO Airframe Services, LLC, a division of HAECO Americas ("HAECO") for the purchase price of $14.8 million. HSS operating results are included in our Federal and Defense segment. The acquisition was not material to our consolidated financial statements.

During the six months ended June 30, 2021, we incurred $0.3 million of acquisition-related expenses, which are included in selling, general and administrative expenses.

Our revenues are derived from the delivery of products to our customers and from services performed for commercial customers, various government agencies, the United States Department of Defense ("DoD") or federal civilian agencies.

Revenues by customer for our each of our operating segments for the three and six months ended June 30, 2022 were as follows (in thousands):

Revenues by customer for our each of our operating segments for the three and six months ended June 30, 2021 were as follows (in thousands):

Revenues by type for our each of our operating segments for the three and six months ended June 30, 2021 were as follows (in thousands):

Unbilled receivables (contract assets) represent our right to consideration in exchange for goods or services that we have transferred to the customer prior to us having the right to payment for such goods or services. Contract liabilities are recorded when customers remit contractual cash payments in advance of us satisfying related performance obligations under contractual arrangements, including those with performance obligations to be satisfied over a period of time.

We present our unbilled receivables and contract liabilities on a contract-by-contract basis. If a contract liability exists, it is netted against the unbilled receivables balance for that contract. Unbilled receivables were $41.3 million as of June 30, 2022 and $31.9 million as of December 31, 2021. Contract liabilities, which are included in accrued expenses and other current liabilities in our consolidated balance sheets, were $5.5 million as of June 30, 2022 and $7.1 million as of December 31, 2021. For the six months ended June 30, 2022 and 2021, we recognized revenue that was previously included in the beginning balance of contract liabilities of $2.6 million and $1.7 million, respectively.

Our performance obligations are satisfied either at a point in time or over time as work progresses. Revenues from products and services transferred to customers at a point in time accounted for approximately 59% for the three and six months ended June 30, 2022 and 49% of our revenues for the three and six months ended June 30, 2021, primarily related to the sale of vehicle and aircraft parts in our Fleet and Aviation segments. Revenues from products and services transferred to customers over time accounted for approximately 41% for the three and six months ended June 30, 2022 and 51% of our revenues for the three and six months ended June 30, 2021, primarily related to revenues in our Federal and Defense segment and MRO services in our Aviation segment.

As of June 30, 2022, the aggregate amount of transaction prices allocated to unsatisfied or partially unsatisfied performance obligations was $183 million. The performance obligations expected to be satisfied within one year and greater than one year are 94% and 6%, respectively. We have applied the practical expedient for certain parts sales and MRO services to exclude the amount of remaining performance obligations for (i) contracts with an original expected term of one year or less or (ii) contracts for which we recognize revenue in proportion to the amount we have the right to invoice for services performed.

During the six months ended June 30, 2022 and 2021, revenue recognized from performance obligations satisfied in prior periods was not material.

Long-term debt consisted of the following (in thousands):

We had letters of credit outstanding totaling $1.2 million and $1.0 million as of June 30, 2022 and December 31, 2021, respectively.

We pay interest on the term and revolving loan borrowings at LIBOR plus a base margin or at a base rate (typically the prime rate) plus a base margin. As of June 30, 2022, the LIBOR margin was 2.25% and the base margin was 4.75%. The margins increase or decrease in increments as our Total Funded Debt/EBITDA Ratio increases or decreases. As of June 30, 2022, interest rates on our outstanding debt ranged from 4.62% to 7.00%, and the effective interest rate on our aggregate outstanding debt was 5.06%.

Interest expense incurred on bank loan borrowings and interest rate hedges was $3.7 million and $2.4 million for the three months ended June 30, 2022 and 2021, respectively, and $7.1 million and $5.1 million for the six months ended June 30, 2022 and 2021, respectively. As of June 30, 2022, there was no hedged portion of our debt as our 2 remaining hedges expired in February and March of 2022. As of December 31, 2021, the portion of our debt with interest rate swap agreements was $75 million.

Our required term and revolver loan principal payments after June 30, 2022 are as follows (in thousands):

We were in compliance with required ratios and other terms and conditions under our loan agreement as of June 30, 2022.

Basic earnings per share ("EPS") is computed by dividing net income by the weighted average number of shares of common stock outstanding during each period. Shares issued during the period are weighted for the portion of the period that they were outstanding. Our calculation of diluted earnings per common share includes the dilutive effects for the assumed vesting of outstanding stock-based awards. For the three and six month ended June 30, 2021, diluted earnings per share did not include an adjustment for the potential dilutive effect of the dilutive securities as the effect would have been anti-dilutive to the Company's net loss. The anti-dilutive common stock equivalents excluded from the diluted per share calculation were not material. Antidilutive common stock equivalents excluded from the diluted earnings per share calculation for the three and six month ended June 30, 2022 were not material.

The weighted-average number of shares outstanding used to compute basic and diluted EPS were as follows:

We are involved in various claims and lawsuits arising in the normal conduct of its business, none of which we believe, based on current information, is expected to have a material adverse effect on our financial position, results of operations or cash flows.

Further, from time-to-time, government agencies audit or investigate whether our operations are being conducted in accordance with applicable contractual and regulatory requirements. Government audits or investigations of us, whether relating to government contracts or conducted for other reasons, could result in administrative, civil or criminal liabilities, including repayments, fines or penalties being imposed upon us, or could lead to suspension or debarment from future government contracting. Government investigations often take years to complete and many result in no adverse action against us. We believe, based upon current information, that the outcome of any such government disputes, audits and investigations will not have a material adverse effect on our results of operations, financial condition or cash flows.

Management of our business operations is conducted under 3 reportable operating segments:

Our Aviation segment provides aftermarket repair and distribution services to commercial, business and general aviation, cargo, military and defense, and rotorcraft customers globally. Core services include parts distribution, engine accessory maintenance, MRO services, rotable exchange and supply chain services.

Our Fleet segment provides parts, inventory management, e-commerce fulfillment, logistics, supply chain support and other services to support the commercial aftermarket medium- and heavy-duty truck market, the United States Postal Service ("USPS"), and the DoD. Core services include vehicle parts distribution, sourcing, IT solutions, customized fleet logistics, warehousing, kitting, just-in-time supply chain management, alternative product sourcing, and engineering and technical support.

Our Federal and Defense segment provides aftermarket MRO and logistics services to improve operational readiness and extend the life cycle of military vehicles, ships and aircraft for the DoD, federal agencies and international defense customers. Core services include procurement; supply chain management; vehicle, maritime and aircraft sustainment services; base operations support; IT services and energy consulting.

We evaluate segment performance based on consolidated revenues and operating income. Net sales of our business segments exclude inter-segment sales as these activities are eliminated in consolidation. Corporate expenses are primarily selling, general and administrative expenses not allocated to segments. Our segment information is as follows (in thousands):

The following table summarizes the financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2022 and December 31, 2021 and the level they fall within the fair value hierarchy (in thousands):

Non-Company Owned Life Insurance ("COLI") assets held in our deferred supplemental compensation plan consist of equity funds with fair value based on observable inputs such as quoted prices for identical assets in active markets and changes in fair value are recorded as selling, general and administrative expenses.

We were a party to interest rate swap agreements qualifying as cash flow hedges under which we hedged a portion of our variable-rate debt until the agreements expired in February and March 2022. As of December 31, 2021, the fair value of such swap agreements was $0.2 million, a liability recorded in accrued expenses and other current liabilities in our consolidated balance sheets. As of December 31, 2021, we had $0.2 million, net of an income tax effect of $58 thousand, included in accumulated other comprehensive income in the accompanying balance sheets related to the cash flow hedges. The amounts paid and received on the swap agreements are recorded in interest expense in the period during which the related floating-rate interest is incurred.

In connection with the acquisition of Global Parts in July 2021, we may be required to pay earn-out obligation payments of up to $2.0 million should Global Parts meet certain financial targets during the twelve months following the acquisition and meet a certain milestone event on or before March 2023. Changes in the earn-out obligation measured at fair value on a recurring basis using unobservable inputs (Level 3) for the six months ended June 30, 2022 are as follows (in thousands):

The carrying amounts of cash and cash equivalents, receivables, accounts payable and amounts included in other current assets and accrued expenses and other current liabilities that meet the definition of a financial instrument approximate fair value due to their relatively short maturity. The carrying value of our outstanding debt obligations approximates its fair value. The fair value of long-term debt is calculated using Level 2 inputs based on interest rates available for debt with terms and maturities similar to our existing debt arrangements.

Income tax expense during interim periods is based on our estimated annual effective income tax rate plus any discrete items that are recorded in the period in which they occur. Our tax rate is affected by discrete items that may occur in any given year but may not be consistent from year to year.

Our effective tax rate was 26.6% and 25.8% for the three and six months ended June 30, 2022, respectively, and 19.6% and 17.6% for the three and six months ended June 30, 2021, respectively. The effective tax rate was higher for the three and six months ended June 30, 2022 compared to the same period of prior year primarily due to book expense in connection with the decline in value of our COLI assets in the period ended June 30, 2022 that was reversed for tax purposes as opposed to book income in the same period in 2021.

Subsequent to June 30, 2022, we executed forward-starting fixed interest rate swaps that hedge the variability in interest payments on $150 million of floating rate debt. The tenor of these swaps begin on October 31, 2022. We have designated, and will account for, these fixed interest rate swaps as cash flow hedges.

We are a diversified aftermarket products and services company providing repair services, parts distribution, logistics, supply chain management and consulting services for land, sea and air transportation assets to government and commercial markets. We provide logistics and distribution services for legacy systems and equipment and professional and technical services to commercial customer and to the government, including federal and civilian agencies and the Department of Defense ("DoD"). Our operations include supply chain management solutions, parts supply and distribution, and maintenance, repair and overhaul ("MRO") services for vehicle fleet, aviation, and other customers. We also provide vehicle and equipment maintenance and refurbishment, logistics, engineering support, energy services, IT and health care IT solutions, and consulting services.

Our operations are conducted within three reportable segments aligned with our operating segments: (1) Aviation; (2) Fleet; and (3) Federal and Defense. We provide more information about each of these reportable segments under Item 1, "Business-History and Organization” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 ("2021 Form 10-K").

See Note (2) "Acquisitions" to our Consolidated Financial Statements included in Item 1 of this filing and our 2021 Form 10-K for additional information regarding our recent acquisitions.

Our results of operations for the six months ended June 30, 2022 continued to be impacted by the COVID-19 global pandemic. We have seen continued improvement in our operating results during the six months ended June 30, 2022, which we expect to continue throughout 2022. All of our repair, distribution and base operations facilities remain open and operational, and we continue to deliver products and services to customers without interruption. We continue to closely monitor and address the pandemic and related developments, including the impact to our business, our employees, our customers, and our suppliers.

The following discussion provides a brief description of some of the key business factors impacting our results of operations detailed by segment.

The COVID-19 pandemic impacted our Aviation segment operations. We have seen continued improvement in our sequential quarterly revenue results due to the recovery in demand since the peak of the negative COVID-19 pandemic impact during the second quarter of 2020. Our Aviation segment results have benefited in the second quarter of 2022 from strong performance of both our distribution and repair businesses driven by broader recovery in commercial market activity, together with share gains within the business & general aviation (“B&GA”) market.

During the quarter, our prior investments in growth initiatives have produced positive results with quarterly revenue of $105 million, a 121% increase year-over-year. These organic investments have provided sustainable revenue sources with viable growth potential, and the associated investment in increased inventory will be beneficial to our future results. Our acquisition of Global Parts in July 2021 expanded our product lines and client base. As we continue to experience recovery and growth in our operations, we see opportunities to strategically align platform offerings to include additional airframe components with our existing offerings.

Market recovery and our growth initiatives have resulted in a 175% and 29% year-over-year increase in distribution and repair revenue, respectively, during the first six months of 2022 compared to the same period for the prior year.

Our Fleet segment continues to increase revenue from commercial fleet customers and e-commerce fulfillment sales. Our commercial client base includes companies in a wide array of businesses that have vehicle fleets required to meet mission critical delivery or service schedules. We continue to execute on our revenue diversification strategy as we capture new customers and increase revenue within e-commerce fulfillment. As a result, commercial customer revenue continues to see a strong growth

trend, increasing approximately 48% and 68% during the quarter and first six months of 2022, respectively, compared to the same periods in the prior year. Commercial revenues were 40.9% of total Fleet segment revenue for the six months ended June 30, 2022 compared to 28.4% for the same period in the prior year, demonstrating the continued success of our strategic multi-year diversification strategy.

Our Federal and Defense segment continues to focus on building our contract backlog and optimizing legacy programs. We are encouraged to see revenue growth in our Federal and Defense segment driven by strong revenue performance in Naval Sea Systems Command (NAVSEA) in providing Foreign Military Sales (FMS). Activity on our FMS Program has increased over the past year, including work to transfer a frigate to Bahrain. We expect that our focused business development efforts will drive new revenue additions in subsequent years.

Our consolidated results of operations are as follows (in thousands):

Revenues increased for the six months ended June 30, 2022 as compared to the same period in the prior year primarily attributable to revenue growth within each of our segments: $106.4 million within our Aviation segment, $19.0 million within our Fleet segment, and $7.5 million within our Federal and Defense segment. See "Segment Operating Results" section below for further discussion of revenues by segment.

Operating income increased for the six months ended June 30, 2022 as compared to the same period in the prior year attributable to increases of $36.7 million for our Aviation segment and $2.0 million for our Fleet segment, partially offset by a decrease of $10.2 million for our Federal and Defense segment. See "Segment Operating Results" for a discussion of operating income by segment.

The results of operations for our Aviation segment are (in thousands):

Revenues increased for the six months ended June 30, 2022 as compared to the same period in the prior year primarily due to distribution revenue growth of $95.4 million, or 175%, driven by contributions from recently initiated distribution contract wins and contributions from the acquisition of Global Parts, and repair revenue growth of $11 million, or 29%, driven by improved demand in end markets as a result of market recovery.

Costs and operating expenses increased for the six months ended June 30, 2022 as compared to the same period in the prior year primarily due to increased revenues and a $2.3 million non-cash charge to write down accounts receivable and inventory related to Russia and Ukrainian markets for the six months 2022, offset by a $23.7 million inventory valuation adjustment recognized in the same period in the prior year. Costs and operating expenses for this segment included expenses for amortization of intangible assets associated with acquisitions and allocated corporate costs. Expense for amortization of intangible assets was $4.7 million for the six months ended June 30, 2022 compared to $4.1 million for the same period in the prior year. Allocated corporate costs were $5.7 million for the six months ended June 30, 2022, compared to $3.8 million for the same period in the prior year.