VSE Corp: Form 10-Q for the period ended Mar 31, 2024

Business Overview

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.

Recent Developments

Sale of Federal and Defense Segment

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" to the consolidated financial statements for further information.

Strategic Review

On February 29, 2024, we announced a process to explore and evaluate strategic alternatives involving our Fleet segment with a view to enhance shareholder value (the “Strategic Process”). The Strategic Process could include, among other alternatives, a possible sale of the Fleet segment. Any potential strategic alternative will be evaluated by our Board of Directors.

Acquisition of Turbine Controls, Inc

On April 24, 2024, we completed the acquisition of our previously announced definitive agreement to acquire Turbine Controls, Inc. ("TCI"), a leading provider of aftermarket MRO support services for complex engine components, as well as engine and airframe accessories, across commercial and military applications. See Note (13) "Subsequent Events" for further information.

Business Trends

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

Aviation Segment

During the first quarter of 2024, our strong program execution of new and existing distribution awards, an expansion of product offerings and MRO capabilities, increased market activity, and contributions from recent acquisitions produced strong results, with quarterly revenue reaching $162.4 million for the three months ended March 31, 2024, representing a 43% increase year-over-year. Market growth and share gains have resulted in increased repair and distribution revenue of 58% and 38%, respectively, during the three months ended March 31, 2024, compared to the same period for the prior year. Our growth has been driven by several strategic initiatives, including executing on newly awarded distribution agreements, the introduction of new products and service capabilities to our portfolio, and the launch of a new distribution facility in Europe, all of which further strengthened our position in the aviation aftermarket. Additionally, expanding our partnerships with Original Equipment Manufacturers has provided us new opportunities, including access to new markets with an established customer base.

We believe the July 2023 acquisition of Desser Aerospace and the recently completed acquisition of Turbine Controls, Inc. in April 2024 will increase our exposure to the high-growth, higher-margin aviation distribution and MRO markets. Furthermore, we believe that the Honeywell FCS Acquisition to exclusively manufacture, sell, market, distribute, and repair certain Honeywell fuel control systems expands our existing capabilities and provides access to new customers and end markets while strengthening our partnership with Honeywell.

Fleet Segment

During the first quarter, growth in our Fleet segment was driven by contributions from commercial fleet customers, e-commerce fulfillment volume which was partially offset by a decline in activity within the United States Postal Service ("USPS"). The decline in USPS revenue is the result of USPS' transition to a new Fleet Management Information System, which has led to a temporary reduction in maintenance-related activity and parts usage. We continue to make significant progress in executing our revenue diversification strategy through the successful launch of our new e-commerce fulfillment and distribution center ("Olive Branch facility"). The scaling of the Olive Branch facility has been instrumental in our ability to capture new customers and drive revenue growth within e-commerce fulfillment. Our commercial revenues were 56% of total Fleet segment revenue for the three months ended March 31, 2024, compared to 43% for the same period in the prior year, demonstrating the continued success of our diversification strategy.

Results of Operations

Consolidated Results of Operations

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

Revenues. Revenues increased for the three months ended March 31, 2024, compared to the same period in the prior year due to growth in our Aviation segment of $49.1 million and our Fleet segment of $3.8 million. See "Segment Operating Results" section below for further discussion of revenues by segment.

Costs and Operating Expenses. Costs and operating expenses increased for the three months ended March 31, 2024, compared to the same periods in the prior year primarily due to increases in revenue. Costs and operating expenses for our operating segments increase and decrease in conjunction with the level of business activity and revenues generated by each segment. See "Segment Operating Results" for discussion of cost and operating expenses by segment.

Operating Income. Operating income increased for the three months ended March 31, 2024, compared to the same period of the prior year primarily due to an increase of $6.6 million for our Aviation segment and an increase of $0.7 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.

Interest Expense. Interest expense increased for the three months ended March 31, 2024, as compared to the same periods in the prior year primarily due to an increase in our debt facility borrowings and a higher average interest rate on borrowings outstanding.

Provision for Income Taxes. Our effective tax rate for continued operations was 19.3% and 24.8% for the three months ended March 31, 2024 and 2023, respectively. Our tax rate is affected by discrete items that may occur in any given year but may not be consistent from year to year. Permanent differences such as foreign derived intangible income deduction, Section 162(m) limitation, capital gains tax treatment, state income taxes, certain federal and state tax credits and other items caused differences between our statutory U.S. federal income tax rate and our effective tax rate. The lower effective tax rate for the three months ended March 31, 2024 primarily resulted from excess stock compensation recognized for tax purposes in connection with stock vesting in the current year.

Segment Operating Results

Aviation Segment Results

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

Revenues. Revenues for our Aviation segment increased for the three months ended March 31, 2024, compared to the same period of the prior year primarily driven by contributions from our acquisition of Desser Aerospace, recently initiated distribution contract wins and improved demand for our commercial aerospace products and services resulting from strong end market activity in global commercial air travel. Aviation distribution revenue increased $30.5 million, or 38%, and repair revenue increased $18.6 million, or 58%, for the three months ended March 31, 2024, compared to the same period in the prior year.

Costs and operating expenses. Costs and operating expenses increased for the three months ended March 31, 2024, compared to the same period of the prior year primarily due to increased revenues. 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 $3.4 million for the three months ended March 31, 2024, compared to $2.5 million for the same period in the prior year. Allocated corporate costs were $4.3 million for the three months ended March 31, 2024, compared to $3.2 million for the same period in the prior year.

Operating income. Operating income increased for the three months ended March 31, 2024, compared to the same period of the prior year primarily due to revenue growth and a favorable shift in sales mix and pricing offset by increased amortization of intangible assets and allocated corporate costs.

Fleet Segment Results

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

Revenues. Revenues for our Fleet segment increased for the three months ended March 31, 2024, compared to the same period of the prior year primarily due to increases from commercial customers of $12.1 million, or 37%, partially offset by a decline in revenue in other government customers of $8.3 million, or 19%. Commercial customer revenue growth was driven by our commercial fleet and e-commerce fulfillment business. Revenues from other government customers decreased primarily due to lower maintenance activity within the USPS vehicle fleet program.

Costs and operating expense. Costs and operating expenses increased for the three months ended March 31, 2024, compared to the same period of the prior year primarily due to increased revenues. In addition, 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 immaterial for the three months ended March 31, 2024, compared to $1.5 million for the same period in the prior year. Allocated corporate costs were $2.1 million for the three months ended March 31, 2024, compared to $2.0 million for the same period in the prior year.

Operating income. Operating income increased for the three months ended March 31, 2024, compared to the same period of the prior year primarily driven by a reduction in the amortization of intangible assets, partially offset by a sales mix shift due to a decrease in revenues from our USPS vehicle fleet program.

Liquidity and Capital Resources

Liquidity

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 work we perform and by the timing of large purchases. 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 sources of external financing are the capital markets and our credit agreement. Our credit agreement is with a bank group and includes a term loan and a revolving facility, with an aggregate maximum borrowing capacity of our revolving facility of $350.0 million. Under the credit agreement we may elect to increase the maximum availability of the term loan, the revolving facility, or a combination of both, subject to customary lender commitment approvals. The aggregate limit of increases is $25.0 million. Our outstanding borrowings under the credit agreement increased approximately $51.9 million for the three months ended March 31, 2024. As of March 31, 2024, we had borrowings outstanding under our term loan of $300.0 million, borrowings outstanding under our revolving facility of $184.9 million, outstanding letters of credit of $0.8 million, and $164.2 million of unused commitments under the credit agreement.

We believe our existing balances of cash and cash equivalents, along with our cash flows from operations and debt instruments under our credit agreement mentioned above, will provide sufficient liquidity for our business operations as well as capital expenditures, dividends, and other capital requirements associated with our business operations over the next twelve months and thereafter for the foreseeable future.

Cash Flows

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

Cash used in operating activities increased $30.4 million for the three months ended March 31, 2024, as compared to the same period of the prior year. The increase was primarily due to greater use of cash for inventory purchases.

Cash provided by investing activities increased $48.0 million for the three months ended March 31, 2024, as compared to the same period of the prior year. The increase was primarily due to cash provided of $41.1 million related to sale of the Federal and Defense segment as discussed in Note (3) "Discontinued Operations" to the consolidated financial statements.

Cash provided by financing activities decreased $15.0 million for the three months ended March 31, 2024, as compared to the same period of the prior year. The decrease was primarily due to the overall lower proceeds from net borrowings of our debt during the current period.

We paid cash dividends totaling $1.6 million or 0.10 per share during the three months ending March 31, 2024. Pursuant to our credit agreement, our payment of cash dividends is subject to annual restrictions. We have paid cash dividends each year since 1973.

Other Obligations and Commitments

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, 2023.

Inflation and Pricing

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

Off-Balance Sheet Arrangements

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.

Disclosures About Market Risk

Interest Rate Risk

Our credit 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 (5) and Note (6), respectively, to our Consolidated Financial Statements contained in this report.

Other than as discussed above, there have been no material changes to our market risks from those discussed in our most recently filed Annual Report on Form 10-K.

Critical Accounting Policies, Estimates and Judgments

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 2023 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, 2024, from those disclosed in our most recently filed Annual Report on Form 10-K.

Recently Issued Accounting Pronouncements

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 Summary of Significant Accounting Policies — Recent Adopted Accounting Pronouncements” to our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2023.

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

Evaluation of Disclosure Controls and Procedures

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, 2024, 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.

Changes in Internal Control Over Financial Reporting

In connection with our acquisition of Desser Aerospace, certain areas of internal control over financial reporting changed. These areas are primarily related to integrating our corporate functions such as entity level controls and certain financial reporting controls. Certain control structure items remain in operation at Desser Aerospace, primarily related to information technology, inventory management, human resources, processing and billing of revenues, and collection of those revenues. The control structure at Desser Aerospace has been modified to appropriately oversee and incorporate these activities into the overall control structure. We will continue to evaluate the need for additional internal controls over financial reporting.

There have been no additional changes in our internal control over financial reporting during the quarterly period covered by this report that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes to the previously disclosed risk factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023 ("2023 Form 10-K”). The risk factors disclosed in our 2023 Form 10-K should be considered together with information included in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2024, and under "Forward-Looking Statements" and "Management's Discussion and Analysis of Financial Condition and Results of Operations."