VSE (VSEC) 10-Q2023 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2023

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).

Number of shares of Common Stock outstanding as of April 21, 2023: 12,885,937

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, 2022 filed with the SEC on March 9, 2023 (“2022 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.

(in thousands)

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 operating segments: Aviation, Fleet, and 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 year ended December 31, 2022 ("2022 Form 10-K"). In our opinion, all adjustments, including normal recurring items, considered necessary for a fair presentation of results for the interim periods have been included in the accompanying unaudited consolidated financial statements. Operating results for the three months ended March 31, 2023 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2023. 

Certain reclassifications have been made to the prior period financial information in order to conform to the current period's presentation, which include reclassifications within the disaggregated revenue disclosure of revenue by type as further described in Note (3) "Revenue." These reclassifications had no effect on the reported results of operations.

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 February 1, 2023, our Aviation segment acquired Precision Fuel Components, LLC ("Precision Fuel") for a preliminary cash purchase price of $11.8 million, subject to post-closing adjustments. Precision Fuel is a market-leading provider of maintenance, repair and overhaul ("MRO") services for engine accessory and fuel systems supporting the business and general aviation ("B&GA") market. The acquisition is intended to expand the Aviation segment's repair capabilities across a diverse base of global rotorcraft, fixed wing, and B&GA customers and complement our existing service capabilities. Precision Fuel operating results are included in the accompanying consolidated financial statements beginning on the acquisition date. The acquisition was not material to our consolidated financial statements.

The allocation of the preliminary purchase price resulted in net tangible assets of $3.1 million, goodwill of $4.7 million, and contract and customer-related intangible asset of $3.8 million, which is being amortized over a period of five years. During the three months ended March 31, 2023, we incurred $0.2 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, the United States Department of Defense ("DoD"), and various other government agencies.

A summary of revenues by customer for our each of our operating segments for the three months ended March 31, 2023 and 2022 is as follows (in thousands):

A summary of revenues by type for our each of our operating segments for the three months ended March 31, 2023 and 2022 is as follows (in thousands):

For the three months ended March 31, 2023 and 2022, we recognized revenue that was previously included in the beginning balance of contract liabilities of $1.4 million and $2.1 million, respectively.

During the three months ended March 31, 2023 and 2022, revenue recognized from performance obligations satisfied in prior periods was not material.

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

Borrowings under our term and revolving credit facilities mature in October 2025. As of March 31, 2023, the interest rate on our outstanding term debt and weighted average interest rate on our aggregate outstanding revolver debt was 7.51% and 7.69%, respectively. Interest expense incurred on bank credit facilities was approximately $6.4 million and $3.4 million for the three months ended March 31, 2023 and 2022, respectively. We had letters of credit outstanding of $0.7 million and $1.0 million as of March 31, 2023 and December 31, 2022, respectively.

Future required term and revolver loan payments as of March 31, 2023 are as follows (in thousands):

We were in compliance with required ratios and other terms and conditions under our loan agreement as of March 31, 2023.

Our derivative instruments designated as cash flow hedges as of March 31, 2023 were (in thousands):

We are party to fixed interest rate swap instruments that are designated and accounted for as cash flow hedges to manage risks associated with interest rate fluctuations on a portion of our floating rate debt. For the three months ended March 31, 2023, we reclassified $0.6 million from accumulated other comprehensive income to interest expense, net. We estimate that we will reclassify $2.6 million of unrealized gains from accumulated other comprehensive income into earnings in the twelve months following March 31, 2023.

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. There were no antidilutive common stock equivalents excluded from the diluted per share calculation.

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

We may have certain claims in the normal course of business, including legal proceedings, against us and against other parties. In our opinion, the resolution of these claims will not have a material adverse effect on our results of operations, financial position 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 three 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 and sustainment 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 base operations support; procurement; supply chain management; vehicle, maritime and aircraft sustainment services; 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):

Changes in the carrying amount of goodwill by segment for the three months ended March 31, 2023 were as follows (in thousands):

Goodwill increased during the three months ended March 31, 2023 in connection with the acquisition during the period as discussed in Note (2) "Acquisitions."

Intangible assets consisted of the following (in thousands):

The gross carrying amount of contract and customer-related intangibles increased during the three months ended March 31, 2023 in connection with the acquisition during the period as discussed in Note (2) "Acquisitions."

As of March 31, 2023, the estimated future annual amortization expense related to intangible assets is as follows (in thousands):

The following table summarizes the financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2023 and December 31, 2022 and the level they fall within the fair value hierarchy (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 23.7% and 24.8% for the three months ended March 31, 2023 and 2022, respectively. The effective tax rate was lower for the three months ended March 31, 2023 compared to the same period of prior year primarily due to (1) book income in connection with the fair market value increase in our COLI plan in the period ended March 31, 2023 that was reversed for tax purposes as opposed to book expense in the same period in 2022, and (2) higher tax deduction projected for foreign derived intangible income ("FDII") in 2023.

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 commercial and government markets. We provide logistics and distribution services for legacy systems and equipment and professional and technical services to commercial customers; the government, including the United States Department of Defense ("DoD"); and federal civilian agencies. Our operations include supply chain management solutions, parts supply and distribution, and maintenance, repair and overhaul ("MRO") services for vehicle fleet, aviation, maritime and other customers. We also provide vehicle and equipment refurbishment, logistics, engineering support, data management and healthcare IT solutions, and clean energy consulting services.

Our operations are conducted within three reportable segments aligned with our operating segments: Aviation, Fleet and Federal and Defense.

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

In the first quarter of 2023, our Aviation segment results benefited from the 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. Market growth and share gains have resulted in a 14% and 43% year-over-year increase in distribution and repair revenue, respectively, during the three months ended March 31, 2023, compared to the same period for the prior year.

As we continue to grow our operations, we see opportunities to strategically expand our platform offerings to include additional products and services that address the distinct needs of our aftermarket customers. Our acquisition of Precision Fuel in February 2023 expanded our product lines, client base and enabled cross-selling opportunities.

During the quarter, we extended key distribution agreements to secure multi-year contracts that provide stable, recurring revenue channels. We expect favorable long-term growth trends as we scale our industry-leading Aviation parts distribution and MRO platform capabilities with leading global commercial brands.

Our Fleet segment growth was driven by strong contributions from commercial fleet customers, e-commerce fulfillment volume, and the United States Postal Service ("USPS"). Our commercial client base includes companies in various industries that have vehicle fleets required to meet mission-critical delivery or service schedules. We continue to execute on our revenue diversification strategy through sustained growth in commercial revenue to expand our presence beyond the long-term relationship with the USPS. Commercial customer revenue continues to see a strong growth trend, increasing 17% during the three months ended March 31, 2023 compared to the same period in the prior year. We expect continued growth within the commercial channel, and steady contributions from the USPS and government customers.

The following table summarizes our consolidated results of operations (in thousands):

The results of operations for our Aviation segment were as follows (in thousands):

The results of operations for our Fleet segment were as follows (in thousands):

The results of operations for our Federal and Defense segment were as follows (in thousands):

maintenance contract with the U.S. Air Force. These decreases were partially offset by an increase in logistics and distribution program sales.

Our funded backlog represents the estimated remaining value of work to be performed under firm contracts. Bookings for our Aviation and Fleet segments occur at the time of sale. Accordingly, our Aviation and Fleet segments do not generally have funded contract backlog and backlog is not an indicator of their potential future revenues. Revenues for federal government contract work performed by our Federal and Defense segment depend on contract funding ("bookings”), and bookings generally occur when contract funding documentation is received. Funded contract backlog is an indicator of potential future revenue. While bookings and funded contract backlog generally result in revenue, we may occasionally have funded contract backlog that expires or is de-obligated upon contract completion and does not generate revenue.

A summary of our bookings and revenues for our Federal and Defense segment for the three months ended March 31, 2023 and 2022, and funded contract backlog as of March 31, 2023 and 2022 is as follows (in millions):

For the three months ended March 31, 2023, Federal and Defense segment bookings decreased 34% year-over-year to $61 million, while total funded backlog decreased 7% year-over-year to $185 million.

Our internal sources of liquidity are primarily from operating activities, specifically from changes in our level of revenues and associated inventory, accounts receivable and accounts payable, and from profitability. Significant increases or decreases in revenues and inventory, accounts receivable and accounts payable can affect our liquidity. Our inventory and accounts payable levels can be affected by the timing of large opportunistic inventory purchases and by distributor agreement requirements. Our accounts receivable and accounts payable levels can be affected by changes in the level of contract work we perform, by the timing of large materials purchases and subcontractor efforts used in our contracts, and by delays in the award of contractual coverage and funding and payments. In addition to operating cash flows, other significant factors that affect our overall management of liquidity include capital expenditures; and investments in the acquisition of businesses.

Our primary source of external financing is our loan agreement with a bank group and includes a term loan facility and a revolving loan facility, with an aggregate maximum borrowing capacity of $350 million. Under the loan agreement we may elect to increase the maximum availability of the term loan facility, the revolving loan facility, or a combination of both facilities, subject to customary lender commitment approvals. The aggregate limit of increases is $100 million. Our bank debt increased approximately $65.4 million for the three months ended March 31, 2023. As of March 31, 2023, we had term loan borrowings outstanding of $97.5 million, revolving loan borrowings outstanding of $256.5 million, outstanding letters of credit of $0.7 million, and $93 million of unused bank loan commitments.

The following table summarizes our cash flows (in thousand):

Cash used in operating activities increased $30.5 million for the three months ended March 31, 2023 as compared to the same period of the prior year. The increase was primarily due to greater use of cash for inventory purchases.

Cash used in investing activities was $14.6 million for the three months ended March 31, 2023 compared to cash provided by investing activities of $1.4 million for the same period of the prior year. The change was primarily due to cash paid for the acquisition of Precision Fuel in the current period.

Cash provided by financing activities increased $46.6 million for the three months ended March 31, 2023 as compared to the same period of the prior year. The increase was primarily due to overall higher proceeds from net borrowings of our debt during the current period.

We paid cash dividends totaling $1.3 million or $0.10 per share during the three months ending March 31, 2023. Pursuant to our bank loan agreement, our payment of cash dividends is subject to annual restrictions. We have paid cash dividends each year since 1973.

There have not been any material changes to our other obligations and commitments that were included in our Annual Report on Form 10-K for the year ended December 31, 2022.

There have not been any material changes to this disclosure from those discussed in our most recently filed Annual Report on Form 10-K.

We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.

Our bank loan agreement provides available borrowing to us at variable interest rates. Our interest expense is impacted by the overall global economic and interest rate environment. The inflationary environment has also resulted in central banks raising short-term interest rates. Accordingly, future interest rate changes could potentially put us at risk for a material adverse impact on future earnings and cash flows. To mitigate the risks associated with future interest rate movements we have employed interest rate hedges to fix the rate on a portion of our outstanding borrowings for various periods.

For additional information related to our debt and interest rate swap agreements, see Note (4) and Note (5), respectively, to our Consolidated Financial Statements contained in this report.

There have been no material changes to our market risks from those discussed in our most recently filed Annual Report on Form 10-K.

Our consolidated financial statements are prepared in accordance with United States generally accepted accounting principles ("U.S. GAAP"), which require us to make estimates and assumptions. Certain critical accounting policies affect the more significant accounts, particularly those that involve judgments, estimates and assumptions used in the preparation of our consolidated financial statements, including revenue recognition, inventory valuation, business combinations, goodwill and intangible assets, and income taxes. If any of these estimates, assumptions or judgments prove to be incorrect, our reported results could be materially affected. Actual results may differ significantly from our estimates under different assumptions or conditions. See "Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations" and Note (1) "Nature of Business and Summary of Significant Accounting Policies" in our 2022 Annual Report on Form 10-K for further discussions of our significant accounting policies and estimates. There have been no significant changes in our critical accounting estimates during the three months ended March 31, 2023 from those disclosed in our most recently filed Annual Report on Form 10-K.

For a description of recently announced accounting standards, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements, see Note (1) "Nature of Business and Significant Accounting Policies — Recent Accounting Pronouncements” of the Notes to our Unaudited Consolidated Financial Statements in Item 1 of this report.

See "Disclosures About Market Risk" in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Our management has evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2023, our disclosure controls and procedures were effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

None.

The risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 ("2022 Form 10-K”) should be considered together with information included in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2023 and under "Forward-Looking Statements" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The risk factors set forth in our Annual Report on Form 10-K are updated by adding the following:

We may periodically divest businesses, including businesses that are no longer a part of our ongoing strategic plan. These divestitures may require significant investment of time and resources and may disrupt our business, distract management from other responsibilities, and may result in losses on disposal or continued financial involvement in the divested business, including through indemnification or other arrangements, for a period of time following the transaction, which could adversely affect our financial results.

We did not purchase any of our equity securities during the period covered by this report.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.