VSE (VSEC) 10-Q2023 Q2 Quarterly report

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.

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 this statement is included 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, the health and economic impact thereof and the governmental, commercial, consumer and other responses thereto, such as 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.

VSE Corporation (“VSE,” the “Company,” “we,” “us,” or “our”) is a diversified aftermarket products and services company providing maintenance, repair and overhaul ("MRO") services, parts distribution, logistics, supply chain management and consulting services for transportation assets to commercial and government markets.

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 and six months ended June 30, 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 to reflect discontinued operations classification. Unless otherwise noted, amounts and disclosures throughout these Notes to Consolidated Financial Statements relate solely to continuing operations and exclude all discontinued 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 purchase price of $11.7 million. Precision Fuel provides MRO services for engine accessory and fuel systems supporting the business and general aviation ("B&GA") market. Our acquisition of Precision Fuel expanded our MRO capabilities and client base. 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 preliminary allocation of the purchase price resulted in net tangible assets of $3.1 million, goodwill of $4.8 million, and contract and customer-related intangible asset of $3.8 million, which is being amortized over a period of five years. During the six months ended June 30, 2023, we incurred $0.2 million of acquisition-related expenses, which are included in selling, general and administrative expenses.

On May 1, 2023, we entered into a definitive agreement to sell our Federal and Defense business to Bernhard Capital Partners Management LP for total consideration of up to $100.0 million, consisting of a $50.0 million cash payment at the closing of the transaction and an earn-out payment of up to $50.0 million subject to the achievement of certain milestones. The transaction is expected to close in late 2023 to early 2024 and is subject to customary closing conditions and approvals.

The results of operations from discontinued operations for the three and six months ended June 30, 2023 and 2022, consist of the following (in thousands):

Our revenues are derived from the delivery of products to our customers and from services performed for commercial and governmental customers.

A summary of revenues by customer for each of our operating segments for the three and six months ended June 30, 2023 and 2022 is as follows (in thousands):

A summary of revenues by type for each of our operating segments for the three and six months ended June 30, 2023 and 2022 is as follows (in thousands):

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

Borrowings under our term loan and revolving facility mature in October 2025. As of June 30, 2023, the interest rate on our outstanding term loan borrowings and weighted average interest rate on our aggregate outstanding revolving facility was 7.51% and 7.62%, respectively. Interest expense incurred on our term loan and revolving facility was $7.9 million and $14.3 million for the three and six months ended June 30, 2023, respectively, and $3.7 million and $7.1 million for the three and six months ended June 30, 2022, respectively. We had letters of credit outstanding of $0.7 million and $1.0 million as of June 30, 2023 and December 31, 2022, respectively.

Future required term loan and revolving facility payments as of June 30, 2023 are as follows (in thousands):

We were in compliance with required ratios and other terms and conditions under our credit agreement as of June 30, 2023.

In July 2023, we entered into a fifth amendment to our credit agreement. Refer to Note (13) "Subsequent Events" for further details. After the amendment, our scheduled term loan payments are approximately $9.5 million for the remainder of 2023, $19.0 million in 2024, and $156.5 million in 2025.

Our derivative instruments designated as cash flow hedges as of June 30, 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 and six months ended June 30, 2023, we reclassified $0.8 million and $1.5 million, respectively, from accumulated other comprehensive income to interest expense, net. We estimate that we will reclassify $3.6 million of unrealized gains from accumulated other comprehensive income into earnings in the twelve months following June 30, 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.

The sale of the Federal and Defense segment is intended to allow us to advance our focus on long-term strategic growth areas. Following the completion of the sale transaction, management of our business operations is conducted under two 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, and the United States Postal Service ("USPS"). 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.

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 six months ended June 30, 2023 were as follows (in thousands):

Goodwill increased during the six months ended June 30, 2023 in connection with the acquisition during the period as discussed in Note (2) "Acquisitions."

The following table summarizes the financial assets and liabilities measured at fair value on a recurring basis as of June 30, 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 for continued operations was 24.0% and 24.3% for the three and six months ended June 30, 2023, respectively, and 28.6% and 26.7% for the three and six months ended June 30, 2022, respectively. The effective tax rate was lower for the three and six months ended June 30, 2023 compared to the same period of prior year primarily due to book income in connection with the fair market value increase in our COLI plan in the period ended June 30, 2023 that was reversed for tax purposes as opposed to book expense in the same period in 2022.

In July 2023, we completed our previously announced acquisition of Desser-Graham Partnership, L.P. ("Desser Aerospace"), pursuant to the terms of the purchase agreement dated May 3, 2023, for a preliminary purchase price of $124.0 million, subject to post-closing adjustments. Concurrent with the closing of the transaction, we sold, in a separate transaction, Desser Aerospace’s propriety solutions businesses to Loar Group Inc. (“Loar”) for cash consideration of $30.0 million (the “Loar Sale”). During the three and six months ended June 30, 2023, we incurred $0.6 million and $1.7 million, respectively, of acquisition-related expenses, which are included in selling, general and administrative expenses.

In July 2023, we entered into a fifth amendment to our credit agreement which, among other things, provided for the following: (i) the extension of a new term loan in the aggregate principal amount of $90.0 million, which will mature on the same date as the existing term loan; (ii) a reduction in our capacity to incur incremental revolving or term loan credit facilities from $100.0 million to $25.0 million; (iii) quarterly amortization payments for the new term loan in the amount of $2.25 million; (iv) an increase in the maximum Total Funded Debt to EBITDA Ratio from 4.50x to 5.00x, with such ratios decreasing thereafter; (v) the addition of a tier to the top of the pricing grid if the Total Funded Debt to EBITDA ratio exceeds 4.50x; and (vi) expressly permitting the Desser acquisition and the Loar Sale. The net proceeds received under the new term loan were used to fund a portion of the cash consideration for the Desser Aerospace acquisition.

In July 2023, we executed a fixed interest rate swap that hedges the variability in interest payments on $100.0 million of floating rate debt. We have designated, and will account for, this fixed interest rate swap as a cash flow hedge.

In July 2023, we entered into an underwriting agreement with William Blair & Company, L.L.C and RBC Capital Markets, acting as representatives of several underwriters, relating to the issuance and sale of 2,475,000 shares of the Company's common stock at a public offering price of $48.50 per share. Under the terms of the agreement, we granted the underwriters an option, exercisable for 30 days, to purchase up to an additional 371,250 shares of common stock. The offering closed on July 24, 2023 and we received net proceeds of $112.7 million in connection with the offering, net of issuance costs.

We are a diversified aftermarket products and services company providing maintenance, repair and overhaul ("MRO") services, parts distribution, logistics, supply chain management and consulting services for transportation assets to commercial and government markets.

In May 2023, we entered into a definitive agreement to sell our Federal and Defense business to Bernhard Capital Partners Management LP for a total consideration of up to $100.0 million, consisting of a $50.0 million cash payment at the closing of the transaction and an earn-out payment of up to $50.0 million, subject to the achievement of certain milestones. The transaction is expected to close in late 2023 or early 2024. In accordance with ASC 205-20, Presentation of Financial Statements - Discontinued Operations, we determined that the criteria for discontinued operations presentation were met during the second quarter of 2023 and results for the three and six months ended June 30, 2023 and 2022 for our Federal and Defense segment are reported in income from discontinued operations within the consolidated statements of operations and the carrying value of the related assets and liabilities are presented within assets and liabilities held for sale on the consolidated balance sheets as of June 30, 2023 and December 31, 2022. See Note (3) "Discontinued Operations" to the consolidated financial statements for further information.

In July 2023, we initiated a public offering of the Company's common stock relating to the issuance and sale of 2,475,000 shares at a public offering price of $48.50 per share. The offering closed on July 24, 2023 and we received net proceeds of $112.7 million in connection with the offering, net of issuance costs. We intend to use substantially all of the net proceeds from this offering to repay outstanding borrowings under our revolving credit facility and any remaining amounts for general corporate purposes.

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

During the second quarter, our strong execution on new and existing distribution programs and increase in MRO activity produced positive results, with quarterly revenue reaching $124.7 million for the three months ended June 30, 2023, representing a 19% increase year-over-year. Market growth and share gains have resulted in a 37% and 13% year-over-year increase in repair and distribution revenue, respectively, during the three months ended June 30, 2023, compared to the same period for the prior year. Our growth has been driven by several strategic initiatives, including the introduction of new products and service capabilities to our portfolio, further strengthening our position in the market. Additionally, expanding our partnerships with Original Equipment Manufacturers has provided us with a competitive edge, allowing successful entry into new markets with an established customer base. We believe our acquisition of Desser Aerospace in July 2023 will increase our exposure to the high-growth, higher-margin aviation distribution and MRO markets. We believe that the combination of Desser Aerospace’s distribution and repair capabilities with VSE Aviation’s aftermarket business creates a platform for geographic expansion into international markets and provides opportunities to cross-sell products and services.

During the second quarter, growth in our Fleet segment was driven by strong contributions from commercial fleet customers, e-commerce fulfillment volume, and the United States Postal Service ("USPS"). The strong performance in our USPS program is supported by the expansion of our installed base of vehicles and continued support of legacy vehicles. We have made significant progress in executing our revenue diversification strategy through the successful launch of our new e-commerce fulfillment and distribution center, including the completion of initial inventory investments. These strategic initiatives have been instrumental in our ability to capture new customers and drive revenue growth within e-commerce fulfillment. Our commercial revenues were 47% of total Fleet segment revenue for the three months ended June 30, 2023 compared to 40% for the same period in the prior year, demonstrating the continued success of our diversification strategy.

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

Revenues increased for the six months ended June 30, 2023 as compared to the same period in the prior year primarily due to growth in our Aviation segment of $39.7 million and our Fleet segment of $24.1 million. See "Segment Operating Results" section below for further discussion of revenues by segment.

Operating income increased for the six months ended June 30, 2023 compared to the same period of the prior year primarily due to an increase of $17.4 million for our Aviation segment and an increase of $2.0 million for our Fleet segment. See "Segment Operating Results" for a discussion of operating income by segment. The operating income increase attributable to our segments was partially offset by an increase in corporate costs, including acquisition and integration costs incurred during the current period.

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