VSE (VSEC) 10-Q2024 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, acquisition and disposition 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, 2023 filed with the SEC on March 8, 2024 (“2023 Form 10-K") and in Item 1A. Risk Factors of this report. 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 (collectively, with its consolidated subsidiaries), "VSE," the "Company," "us," "we," or "our" is a leading provider of aftermarket parts distribution and maintenance, repair and overhaul ("MRO") services for air and land transportation assets for commercial and government markets. We operate in two reportable segments aligned with our operating segments: Aviation and Fleet.

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 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, 2023 ("2023 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, 2024, are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2024. 

In February 2024, we entered into two separate agreements to sell substantially all of the Federal and Defense segment assets. See Note (3) "Discontinued Operations" for further information. The consolidated financial statements reflect the Federal and Defense segment's results of operations as discontinued operations for all periods presented, and the related assets and liabilities as held-for-sale as of 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, valuation allowances on deferred tax assets, fair value of goodwill and other intangible assets and contingencies.

In May 2024, we entered into an underwriting agreement with certain underwriters, relating to the issuance and sale of up to 2,429,577 shares of the Company's common stock at a public offering price of $71.00 per share. On May 17, 2024, the Company issued 2,429,577 shares pursuant to the agreement, which included the exercise by the underwriters of their option to purchase additional shares. We received proceeds of approximately $162.0 million in connection with the offerings, net of issuance costs. We used substantially all of the proceeds of the public offering to repay outstanding borrowings under our revolving credit facility, including amounts borrowed to pay the purchase price of the acquisition of Turbine Controls, LLC ("TCI"), and for general corporate purposes.

On April 24, 2024, we completed the acquisition of TCI for a total consideration of $122.2 million, consisting of cash consideration of $113.7 million, which included $1.57 million as an estimated net working capital adjustment, and in-kind payment in the form of shares of the Company's common stock with a value equal to $10.0 million. The purchase price of this acquisition was funded by borrowings under our revolving credit facility. TCI is a leading provider of aftermarket maintenance, repair and overhaul ("MRO") support services for complex engine components, as well as engine and airframe accessories, across commercial and military applications. The acquisition presents an opportunity for VSE's Aviation segment to accelerate its MRO strategy, including expanding our repair capability offerings and adding several new OEM relationships.

The purchase price for TCI was allocated on a preliminary basis, among assets acquired and liabilities assumed at fair value based on the best available information on the acquisition date, with the excess purchase price recorded as goodwill. The fair values of the non-financial assets acquired, and liabilities assumed, were determined based on preliminary estimates, assumptions, and other information compiled by management, including independent valuations utilizing established industry valuation techniques. We have not yet finalized the determination of the fair values allocated to various assets and liabilities, including, but not limited to, working capital and income taxes. Therefore, the allocation of the total consideration for the acquisition to the tangible and identifiable intangible assets acquired, and liabilities assumed, is preliminary until we obtain final information regarding their fair values, which could potentially result in changes to the TCI opening balance sheet.

Goodwill resulting from the acquisition of TCI reflects the strategic advantage of expanding our MRO services to new customers. The value attributed to goodwill and customer relationships is deductible for income tax purposes. The estimated value attributed to the customer relationship intangible assets is being amortized on a straight-line basis using a useful life of 10 years.

We incurred $0.5 million and $2.0 million of acquisition-related expenses related to the TCI acquisition during the three and six months ended June 30, 2024, respectively, which are included in selling, general and administrative expenses.

The operating results of TCI were included in our consolidated results of operations from the date of acquisition. Our consolidated revenues and operating income include $23.5 million and $1.8 million, respectively, for the three and six months ended June 30, 2024, from the acquisition of TCI. Operating income does not include the impact of acquisition-related expenses incurred by VSE Corporation.

The following unaudited pro forma financial information presents the combined results of operations for TCI and VSE Corporation for the three and six months ended June 30, 2024, and 2023, respectively. The unaudited consolidated pro forma results of operations are as follows (in thousands):

The unaudited pro forma combined financial information presented above has been prepared from historical financial statements that have been adjusted to give effect to the acquisition of TCI as though it had occurred on January 1, 2023 and includes adjustments for intangible asset amortization; interest expense and debt issuance costs on long-term debt; and acquisition and other transaction costs. The unaudited pro forma financial information is not intended to reflect the actual results of operations that would have occurred if the acquisition had occurred on January 1, 2023, nor is it indicative of future operating results.

On February 1, 2023, our Aviation segment acquired Precision Fuel Components, LLC ("Precision Fuel") for a purchase price of $11.7 million. Precision Fuel operating results are included in our Aviation segment beginning on the acquisition date. The acquisition was not material to our consolidated financial statements.

We completed the purchase accounting valuation for Desser Aerospace during the second quarter of 2024. The final purchase price allocation is as follows (in thousands):

Goodwill resulting from the acquisition of Desser Aerospace reflects the strategic advantage of expanding our specialty distribution and MRO services to new customers. The value attributed to goodwill and customer relationships is not fully deductible for income tax purposes. The estimated value attributed to the customer relationship intangible assets is being amortized on a straight-line basis using a weighted average useful life of 8.3 years.

The following unaudited pro forma financial information presents the combined results of operations for Desser Aerospace and VSE Corporation for the three and six months ended June 30, 2024 and 2023, respectively. The unaudited consolidated pro forma results of operations are as follows (in thousands):

The unaudited pro forma combined financial information presented above has been prepared from historical financial statements that have been adjusted to give effect to the acquisition of Desser Aerospace as though it had occurred on January 1, 2023 and includes adjustments for intangible asset amortization; interest expense and debt issuance costs on long-term debt; acquisition and other transaction costs; and certain costs allocated from the former parent. The unaudited pro forma financial information is not intended to reflect the actual results of operations that would have occurred if the acquisition had occurred on January 1, 2023, nor is it indicative of future operating results.

On September 27, 2023, our Aviation segment entered into an Asset Purchase and License Agreement with Honeywell International Inc., for a purchase price of $105.0 million, to exclusively manufacture, sell, market, distribute, and repair certain Honeywell fuel control systems (the "Honeywell FCS Acquisition"). The purchase price of this acquisition was funded by borrowings under our revolving credit facility. This agreement expands existing distribution and MRO capabilities supporting certain Honeywell’s fuel control systems and associated subcomponents.

The acquisition was accounted for as a business combination under ASC 805, Business Combinations. The purchase price for the acquisition was allocated on a preliminary basis, among assets acquired, at fair value based on the best available information on the acquisition date, with the excess purchase price recorded as goodwill. The fair values of the non-financial assets acquired were determined based on preliminary estimates, assumptions, and other information compiled by management, including independent valuations utilizing established industry valuation techniques. We have not yet finalized the purchase price allocation related to this acquisition due to the fact that while legal control has occurred, we have not received physical possession of the prepaid inventory and property and equipment, and thus these assets will be subject to settlement adjustments upon transfer as outlined in the Asset Purchase and License Agreement with Honeywell. Therefore, the allocation of the total consideration for the acquisition is preliminary until we obtain final information regarding their fair values, which could potentially result in changes in the fair values and an adjustment to goodwill. There were no changes in the preliminary purchase price allocation for the three and six months ended June 30, 2024.

The adjusted preliminary purchase price allocation is as follows (in thousands):

In February 2024, we entered into two separate agreements to sell substantially all the Federal and Defense segment's operational assets ("FDS Sale") for a cash consideration of $44.0 million, including amounts in escrow, subject to post-closing adjustments. The FDS Sale is consistent with our long-term strategic growth strategy focused on higher margin and higher growth aftermarket parts distribution and MRO businesses.

We recorded a pre-tax loss on the FDS sale of $12.7 million and transaction fees of $2.5 million during the first quarter of 2024, which are included in loss from discontinued operations, net of tax in the consolidated statements of (loss) income.

The components of loss from discontinued operations, net of tax for the three and six months ended June 30, 2024 and 2023, consist of the following (in thousands):

Certain assets and liabilities previously reported as held-for-sale were excluded from the FDS sale and were reclassified as held and used, at their respective fair values, on the consolidated balance sheets during the first quarter of 2024. The reclassification related to our Alexandria, VA headquarters office space and consisted of an operating lease right-of-use-asset of $7.1 million, property and equipment of $2.6 million, and an operating lease obligation of $11.0 million. During the second quarter of 2024, we vacated the headquarters office space and, as a result, wrote down the associated lease right-of-use asset and property and equipment. See Note (13) "Lease Abandonment and Other Restructuring Costs" for further information.

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

A summary of revenues by customer for each of our operating segments for the three and six months ended June 30, 2024 and 2023 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, 2024 and 2023 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 2026. As of June 30, 2024, the interest rate on our outstanding term loan borrowings and weighted average interest rate on our aggregate outstanding revolving facility was 8.18% and 8.20%, respectively. We had letters of credit outstanding of $0.8 million as of June 30, 2024 and December 31, 2023.

Future required term loan and revolving facility payments as of June 30, 2024 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, 2024.

Our derivative instruments designated as cash flow hedges as of June 30, 2024 were as follows (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, 2024, we reclassified $1.2 million and $2.3 million, respectively, from accumulated other comprehensive income to interest expense, net. We estimate that we will reclassify $3.5 million of unrealized gains from accumulated other comprehensive income into earnings in the twelve months following June 30, 2024.

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. The antidilutive common stock equivalents excluded from the diluted per share calculation are not material.

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 condition, 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 our Federal and Defense segment allows us to focus on a long-term strategic growth strategy focused on higher margin and higher growth aftermarket parts distribution and MRO businesses. Following the sale of our Federal and Defense segment, management of our business operations is conducted under two reportable operating segments:

Our Aviation segment provides aftermarket MRO and distribution services to commercial, business and general aviation, cargo, military and defense, and rotorcraft customers globally. Core services include parts distribution, MRO services including engine components and accessories, fuel controls, avionics, pneumatics, hydraulics, wheel and brake, and 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, 2024 were as follows (in thousands):

Goodwill increased during the six months ended June 30, 2024 in connection with the acquisition of TCI during the period, offset by a decrease in connection with a measurement period adjustment for the Desser Aerospace acquisition. See Note (2) "Acquisitions" for further information on these acquisitions.

The gross carrying amount of contract and customer-related intangibles decreased during the six months ended June 30, 2024 due to intangible assets with a cost of $69.4 million being fully amortized and no longer reflected in the intangible asset values as of June 30, 2024, partially offset by an increase in connection with the acquisition during the period as discussed in Note (2) "Acquisitions."