VSE CORPORATION General Overview
Our Business
We are a diversified aftermarket products and services company providing repair services, parts distribution, logistics, supply chain management and consulting services for land, sea and air transportation assets to government and commercial markets. We provide logistics and distribution services for legacy systems and equipment and professional and technical services to the government, including theDepartment of Defense ("DoD"), federal civilian agencies, and to commercial and other customers. Our operations include supply chain management solutions, parts supply and distribution, and maintenance, repair and overhaul ("MRO") services for vehicle fleet, aviation, and other customers. We also provide vehicle and equipment maintenance and refurbishment, logistics, engineering support, energy services, IT and health care IT solutions, and consulting services.
Acquisitions and Divestitures
InJuly 2021 , we acquiredGlobal Parts Group, Inc. ("Global Parts"), a privately owned company with operations inAugusta, Kansas . Global Parts provides distribution and MRO services for business and general aviation ("B&GA") aircraft families. The acquisition expands our existing B&GA focus and further diversifies our product and platform offerings to include additional airframe components, while expanding our customer base of regional and global B&GA customers. Global Parts is a subsidiary ofVSE Aviation, Inc. under our Aviation segment. InMarch 2021 , we acquiredHAECO Special Services, LLC ("HSS"), in an all-cash transaction. HSS is a leading provider of fully integrated MRO support solutions for military and government aircraft. HSS offers scheduled depot maintenance, contract field deployment and unscheduled drop-in maintenance for theDoD primarily for the sustainment of theU.S. Air Force ("USAF") KC-10 fleet. The experienced workforce of HSS includes approximately 250 employees operating from two hangar locations inGreensboro, North Carolina . HSS is a subsidiary ofVSE Corporation under our Federal & Defense Services segment. InFebruary 2020 , we sold our subsidiaryPrime Turbines, LLC ("Prime Turbines") and certain related inventory assets for$20.0 million in cash and a$8.3 million note receivable to be paid over a period from 2020 through 2024. Our Aviation segment discontinued turboprop engine MRO services, and will concentrate on higher growth potential component/accessory repair and parts distribution while further expanding our presence within the global commercial and general aviation markets. Prime Turbines' revenues totaled less than 1% of our revenue for 2020. InJune 2020 , we sold all the inventory of our subsidiaryCT Aerospace, LLC ("CT Aerospace ") for a$6.9 million note receivable to be paid to us over a period from 2020 through 2025. Our Aviation segment discontinued sales and leasing of engines and supply of used serviceable engine parts.CT Aerospace's revenues totaled less than 1% of our revenue for 2020.
See Note (2) "Acquisitions and Divestitures" to our Consolidated Financial Statements included in Item 1 of this filing for additional information regarding our acquisitions and divestitures.
Public Offering of Common Stock
InFebruary 2021 , we completed an underwritten public offering of common stock through the issuance of 1,599,097 shares of common stock, including an additional 170,497 shares that were issued pursuant to the underwriters' exercise of their option to purchase additional shares, at a public offering price of$35.00 per share. We received net proceeds of approximately$52 million , after deducting underwriting discounts and other offering expenses of approximately$4 million . The net proceeds will be used for general corporate purposes, including financing strategic acquisitions and working capital requirements for new program launches. -22- -------------------------------------------------------------------------------- Table of Contents Organization and Segments Our operations are conducted within three reportable segments aligned with our operating segments: (1) Aviation; (2) Fleet; and (3) Federal and Defense. We provide more information about each of these reportable segments under Item 1, "Business-History and Organization " of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2020 ("2020 Form 10-K").
Concentration of Revenues
(in thousands)
Three months ended September 30, Nine months ended September 30,
Source of Revenues 2021 % 2020 % 2021 % 2020 %
Commercial $ 94,163 47 $ 48,974 30 $ 218,544 41 $ 156,430 31
DoD 60,862 30 56,935 34 173,501 32 185,956 36
Other government 45,557 23 59,596 36 148,630 27 169,252 33
Total $ 200,582 100 $ 165,505 100 $ 540,675 100 $ 511,638 100
COVID-19 Discussion
Forward-Looking Information
Disclosures that address business and operating considerations associated with
the COVID-19 pandemic are made under highly uncertain conditions and may involve
forward-looking information that is based on assumptions and expectations
regarding future events. For additional discussion on the uncertainties and
business risks associated with the COVID-19 pandemic, refer to Item 1A, "Risk
Factors" of our 2020 Form 10-K.
Demand for Products and Services, Operating Results, and Financial Condition
All of our businesses have remained operational since the onset of the COVID-19 pandemic through the end of the third quarter of 2021, and we continue to operate with limited disruption. We have experienced varying levels of reduction in demand for our products and services, and have adjusted our cost structure to support the current and near-term forecasted demand environment. The majority of the cost reductions occurred within our Aviation segment, as a decline in commercial airline revenue passenger miles contributed to a reduction in demand for aftermarket parts and MRO services. The length and severity of lower customer demand due to the COVID-19 pandemic remains uncertain; however, if travel restrictions continue to ease, we expect demand will continue to recover, leading to increased demand for our products and services for the remainder of 2021. While current conditions raise the potential for a decline in performance for our Fleet segment and our Federal and Defense segment, we anticipate limited disruption in demand for the products and services they offer, as compared to other industries, due to the nature of their government, defense and e-commerce customer bases. Our parts supply for truck fleets, including theUnited States Postal Service ("USPS") delivery vehicles and ourDoD program services, provide support for the essential services conducted by our customers. We have not experienced a material adverse change in our financial condition at this time as a result of the COVID-19 pandemic; however, a prolonged disruption in the demand for our products and services could have an adverse impact on our operating results and cause a material adverse change in our financial condition. We will continue to evaluate the nature and extent of future impacts of the COVID-19 pandemic on our business.
Capital, Financial Resources, Credit Losses, and Liquidity
Our debt capital and liquidity position have not experienced a material adverse
change resulting from the COVID-19 pandemic at this time, and we are satisfying
our debt and other liability obligations in a timely manner. We currently have
sufficient cash flows and unused loan commitments to meet these obligations in
the near term. Weakness in our Aviation segment customer markets has caused a
delay in receivables collections and an increase in bad debt expense. This trend
may continue in future periods. We do not anticipate receivables collections to
negatively impact our Fleet or Federal and Defense segments.
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We have a loan agreement with a bank group comprised of ten banks, including
multiple large banks and multiple regional banks. Our revolving credit facility
under this loan agreement provides $350 million in loan commitments, of which we
have currently borrowed approximately 66%. The potential for additional declines
in our earnings may impact our financial covenant ratios in future periods.
Material Impairments, Restructuring Charges
Due to the continued market volatility caused by the COVID-19 pandemic, we performed an interim impairment analysis of our goodwill during the second quarter of 2020. Our interim analysis indicated that our reporting units in our Fleet and Federal and Defense segments had fair values substantially in excess of their carrying values, and we believe the COVID-19 pandemic induced economic crisis is not likely to have a material adverse impact on customer demand for products and services provided by these two segments. Accordingly, at this time we do not anticipate any impairments in these two business segments. Our interim impairment analysis conducted in the second quarter of 2020 indicated that ourVSE Aviation reporting unit, within our Aviation segment, had a fair value less than its carrying value and had incurred an impairment. We recognized a goodwill impairment charge of$30.9 million for ourVSE Aviation reporting unit in the second quarter of 2020. Prior to the onset of the COVID-19 pandemic, our Aviation segment was performing strongly. OurVSE Aviation reporting unit experienced lower customer demand in 2020 as compared to 2019, but demand has improved throughout 2021 and we believe market opportunities will continue to increase for us in the longer term. Accordingly, at this time we do not anticipate any further material impairments in our Aviation segment. However, should the magnitude and duration of the downturn be greater than we anticipated in our analysis, there could be further impairment.
Balance Sheet Asset Valuation
Our goodwill and intangible assets could be impacted by changes in economic conditions affecting our revenue projections and the market valuation of public companies. See "Material Impairments" above for further details. We do not believe that there are or will be significant changes in judgments in determining the fair value of other assets on our balance sheet or that our ability to timely account for them will be negatively impacted. While the COVID-19 pandemic may cause some delays in collecting some of our accounts receivable and potentially give rise to some bad debt write offs, we do not expect this to have a material impact on our accounts receivable.
We have made opportunistic purchases of aviation parts, resulting in an increase in our inventory levels. During the second quarter of 2021, we reviewed the assumptions and calculations utilized in the valuation of excess and obsolete inventory and recorded an additional reserve of$24.4 million . The inventory reserve increase was primarily due to excess and slow-moving quantities of certain Aviation segment inventory, including inventory supporting specific international region distribution programs entered into prior to 2019 at levels higher than our updated forecasts of future demand. The increase in our inventory valuation reserves in the second quarter takes into consideration slower than anticipated air travel recovery in certain regions, primarily in theAsia Pacific region, impacted by the COVID-19 pandemic. While some countries have removed or eased travel restrictions, others have maintained international testing requirements and travel restrictions due to recent rebounds in the number of cases and low vaccination rates within those countries, which has lowered demand for our products. While the COVID-19 pandemic has slowed demand for certain aviation products in international regions, we do not expect any additional material adverse impact to the carrying value of our inventory. Additionally, we do not anticipate the lower international demand to materially impact the recovery of our Aviation segment, where our distribution business revenues have exceeded pre-pandemic levels during the third quarter of 2021. If we experience further slowness in demand or if the lower level of demand lasts significantly longer than we anticipate, our inventory may be subject to further valuation adjustments.
Administrative Continuity and Reporting Systems
We have modified our workforce policies, procedures and capabilities for most of our administrative personnel to work remotely, including our financial reporting personnel. This remote work arrangement is working as intended and has not had any adverse effect on our ability to maintain financial operations, including financial reporting systems, internal control over financial reporting, and disclosure controls and procedures.
Business Continuity Plans
As the COVID-19 pandemic continues to drive global uncertainty, we remain focused on protecting the safety of our employees, continuing to serve our customers with the highest quality product and repair services, and on upholding the strength of the business.
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Our business operations are deemed critical and essential by the Federal and
State governments. All of our repair, distribution and base operations
facilities remain open and operational, and we continue to deliver products and
services to customers without interruption. We implemented virus prevention
protocols consistent with guidelines issued by the U.S. Centers for Disease
Control and Prevention , and offered remote working where practicable.
We do not anticipate any material expenditures or resource constraints in supporting our operations at this time.
Impact on Supply Chain
Major customers and suppliers of our Fleet, Federal and Defense, and Aviation segments remain open and continue to operate. Our Fleet segment customers provide essential services, and we, along with our suppliers, play a key role in keeping truck fleets operable. Our Federal and Defense segment customers continue their mission critical essential services. Our Aviation segment customers continue to operate, albeit at lower rates. We continue to monitor the supply chain macroeconomic constraints. The environment continues to face persistent supply chain challenges as the sourcing environment for materials continues to be constrained, logistics capacity remains strained and labor availability becomes more challenging; the results of which could potentially drive constraints in operating and inflationary pressures. While we have been mitigating the overall risk, these issues could have a future adverse effect on our business, financial condition, and results of operations.
Health and Safety
The health and safety of our employees, customers and communities are of primary concern. We have taken significant steps to protect our workforce including but not limited to, working remotely. For our locations with an active on-site workforce, we implemented virus prevention protocols consistent with guidelines issued by theU.S. Centers for Disease Control and Prevention and are following local ordinances and guidance. We have taken steps at our facilities to ensure additional employee safety, including implementing separate operational shifts, strict social distancing requirements, providing personal protective equipment and stringent requirements for cleaning and sanitizing at our work sites. Our operations have not been materially impacted by any constraints or other impacts on our human capital resources and productivity. OnSeptember 24, 2021 , in furtherance of an executive order, theU.S. Safer Federal Workforce Task Force ("Task Force ") issued guidance requiring federal contractors and subcontractors to comply with COVID-19 safety protocols, including requiring certain employees to be fully vaccinated against COVID-19 byDecember 8, 2021 , except in limited circumstances. The vaccination requirements will be incorporated in new government contracts, renewals, extensions, and other modifications signed on and afterOctober 15, 2021 . In addition, onSeptember 9, 2021 ,President Biden announced that he has directed theOccupational Safety and Health Administration ("OSHA") to develop an Emergency Temporary Standard ("ETS") mandating either the full vaccination or weekly testing of employees for employers with 100 or more employees. As of the date hereof, OSHA has not issued the ETS nor provided any additional information on its contents or requirements. It is currently not possible to predict with any certainty the impact that the executive order establishing theTask Force or that the forthcomingOSHA ETS will have on our workforce. As aU.S. Government contractor, we are requiring allU.S. based Federal and Defense segment employees that service or support ourU.S. Government contracts to be fully vaccinated byDecember 8, 2021 . Our implementation of these requirements may result in attrition and difficulty securing future labor needs, which could have an adverse effect on our business, financial condition, and results of operations.
Travel Restrictions
Travel restrictions and border closures may limit the manner in which our sales and support staff service our customers. We do not anticipate this will have a material impact on our ability to continue to operate.
Business Trends
The following discussion provides a brief description of some of the key business factors impacting our results of operations detailed by segment.
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Aviation Segment
Our Aviation segment was significantly impacted by the COVID-19 pandemic as
reduced global demand for air travel and decreased revenue passenger miles had
an adverse impact on demand for our Aviation products and services. Despite the
challenges faced during the COVID-19 pandemic, we have seen sustained sequential
quarterly revenue increases due to the recovery in demand since the peak of the
negative COVID-19 pandemic impact during the second quarter of 2020. Our 2021
third quarter results reflect changes in our revenue profile as new distribution
programs in our Aviation segment and our acquisition of Global Parts have
increased and broadened our revenue base. Our growth initiatives have resulted
in a 83% year over year distribution revenue increase during the first nine
months of 2021 compared to the same period for the prior year.
Our July 2021 acquisition of Global Parts expands our existing B&GA focus and
further diversifies our product and platform offerings to include additional
airframe components, while expanding our customer base of regional and global
B&GA customers.
During the second quarter of 2021, we reviewed the assumptions and calculations
utilized in the valuation of excess and obsolete inventory and recorded an
additional reserve of $23.7 million primarily due to excess and slow moving
quantities of certain Aviation segment inventory, including inventory supporting
specific international region distribution programs entered into prior to 2019
at levels higher than our updated forecasts of future demand. The increase in
our inventory valuation reserves in the second quarter takes into consideration
slower than anticipated air travel recovery in certain regions, primarily in the
Asia Pacific region, impacted by the COVID-19 pandemic. While some countries
have removed or eased travel restrictions, others have maintained international
testing requirements and travel restrictions due to recent rebounds in the
number of cases and low vaccination rates within those countries, which has
lowered demand for our products. While the COVID-19 pandemic has slowed demand
for certain aviation products in international regions, we do not expect any
additional material adverse impact to the carrying value of our inventory.
Additionally, we do not anticipate the lower international demand to materially
impact the recovery of our Aviation segment, where our distribution business
continues to operate with revenues in excess of pre-pandemic levels during the
third quarter of 2021.
In the first quarter of 2020, we divested our Prime Turbines subsidiary, a
business offering turboprop engine MRO services. In the second quarter of 2020,
we sold all the inventory assets of our CT Aerospace subsidiary, a business
offering turboprop engine and engine parts sales. We will no longer offer these
services, focusing instead on higher-growth component and accessory repair and
parts distribution.
We expect that the current disruption in market conditions will result in strategic opportunities for near and long-term growth. We intend to continue pursuing these opportunities, which may require future investment.
Fleet Segment
Our Fleet segment continues to focus on both its coreUSPS andDoD customer base and commercial customer diversification. We are expanding our presence in both new and existing markets, including e-commerce solutions, private brand product sales, traditional parts supply, supply chain services, and just-in-time inventory programs to new commercial customers. Commercial customer revenue continues to see a strong growth trend, increasing approximately 66% during the third quarter of 2021 compared to the same period in 2020. Our e-commerce fulfillment services continued to grow in the third quarter and we anticipate continued growth of this service offering going forward as we expand into a new 60,000 square foot leased facility inPennsylvania to support further commercial market demand.
We believe the COVID-19 pandemic is likely to continue to have a limited adverse impact on revenues for this segment of our business, as demand from our commercial truck fleet customers and our e-commerce platforms continue to grow.
Federal and Defense Segment
Our Federal and Defense segment continues to focus on redefining VSE in the federal marketplace, diversifying our capability and product offerings, broadening our markets and offerings to capture new business, and investing in business development to build our contract backlog in current and new markets. Strong revenue performance inU.S Navy work and new revenues from theU.S. Air Force work performed by our HSS acquisition enabled us to successfully grow our third quarter revenue for this segment consistent with the same period of the prior year despite anticipated declines in ourU.S. Army work due to program completions. We expect that our refocused business development efforts will produce revenue growth in subsequent years. Contract funding increases have resulted in bookings of$64.0 million in the third quarter of 2021, further supporting a favorable outlook for our federal contracting revenue base. -26- -------------------------------------------------------------------------------- Table of Contents We expect the COVID-19 pandemic to continue to have a limited adverse impact on revenues for this segment, as theU.S. government is expected to maintain criticalDoD preparedness programs.
Financial Statement Presentation
The following discussion provides a brief description of certain key items that appear in our consolidated financial statements:
Revenues
Revenues are derived from the delivery of products and from professional and technical services performed through various ordering agreements and contract agreements. Our Federal and Defense segment's revenue results from services provided on longer term contracts, including cost-type, fixed-price, and time and materials. Revenues from these contract types result from work performed on these contracts and from costs for materials and other work-related contract allowable costs. Revenues from our Aviation and Fleet segment are derived from repair and distribution services primarily through shorter term purchase orders from customers. Costs and Operating Expenses Costs and operating expenses consist primarily of cost of inventory and delivery of our products sold; direct costs, including labor, material, and supplies used in the performance of our contract work; indirect costs associated with our direct contract costs; sales, general, and administrative expenses associated with our operating segments and corporate management; and certain costs and charges arising from nonrecurring events outside the ordinary course of business. These costs will generally increase or decrease in conjunction with our level of products sold or contract work performed. Costs and operating expenses also include expense for amortization of intangible assets acquired through our acquisitions. Expense for amortization of acquisition related intangible assets is included in the segment results in which the acquisition is included. Segment results also include expense for an allocation of corporate management costs. We reduced controllable costs during 2020 in line with the anticipated decrease in demand resulting from the COVID-19 pandemic.
Bookings and Funded Backlog
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.
For the first nine months of 2021, Federal and Defense segment bookings
increased 20% year-over-year to $234 million , while total funded backlog
increased 23% year-over-year to $218 million . The current management team is
focused on revitalizing this business, with an emphasis on growing backlog to
promote future revenue growth.
A summary of our bookings and revenues for our Federal and Defense segment for
the nine months ended September 30, 2021 and 2020, and funded contract backlog
as of September 30, 2021 and 2020 is as follows (in millions):
2021 2020
Bookings $ 234 $ 195
Revenues $ 203 $ 197
Funded Contract Backlog $ 218 $ 177 Critical Accounting Policies, Estimates and Judgments
Our consolidated financial statements are prepared in accordance withUnited 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. The development and selection of these critical accounting policies have been determined by our management. We have reviewed our critical accounting policies and estimates with the audit committee of our board of directors. Due to the significant judgment involved in selecting certain of the assumptions used in these policies, it is possible that different parties could choose different assumptions and reach different conclusions. We consider our policies relating to the following matters to be critical accounting policies. -27- -------------------------------------------------------------------------------- Table of Contents Revenue Recognition We account for revenue in accordance with ASC 606. The unit of account in ASC 606 is a performance obligation. At the inception of each contract with a customer, we determine our performance obligations under the contract and the contract's transaction price. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is defined as the unit of account. A contract's transaction price is allocated to each distinct performance obligation and recognized as revenue when the performance obligation is satisfied. The majority of our contracts have a single performance obligation as the promise to transfer the respective goods or services is not separately identifiable from other promises in the contracts and is, therefore, not distinct. For product sales, each product sold to a customer typically represents a distinct performance obligation. Our performance obligations are satisfied over time as work progresses or at a point in time based on transfer of control of products and services to our customers. Contract modifications are routine in the performance of our contracts. Contracts are often modified to account for changes in contract specifications or requirements. In most instances, contract modifications are for goods or services that are not distinct, and therefore are accounted for as part of the existing contract.
Substantially all Fleet segment revenues from the sale of vehicle parts to customers are recognized at the point in time of the transfer of control to the customer. Sales returns and allowances for vehicle parts are not significant.
Our Aviation segment revenues result from the sale of aircraft parts and
performance of MRO services. Our Aviation segment recognizes revenues for the
sale of aircraft parts at a point in time when control is transferred to the
customer, which usually occurs when the parts are shipped. Our Aviation segment
recognizes revenues for MRO services over time as the services are transferred
to the customer. MRO services revenue recognized is measured based on the
cost-to-cost input method, as costs incurred reflect the work completed, and
therefore the services transferred to date. Sales returns and allowances are not
significant.
Our Federal and Defense segment revenues result from professional and technical
services, which we perform for customers on a contract basis. Revenue is
recognized for performance obligations over time as we transfer the services to
the customer. The three primary types of contracts used are cost-type,
fixed-price and time and materials. Revenues result from work performed on these
contracts by our employees and our subcontractors and from costs for materials
and other work-related costs allowed under our contracts.
Revenues on cost-type contracts are recorded as contract allowable costs are
incurred and fees are earned. Variable consideration, typically in the form of
award fees, is included in the estimated transaction price, to the extent that
it is probable that a significant reversal will not occur, when there is a basis
to reasonably estimate the amount of the fee. These estimates are based on
historical award experience, anticipated performance and our best judgment based
on current facts and circumstances.
Revenues on fixed-price contracts are recorded as work is performed over the
period. Revenue is recognized over time using costs incurred to date relative to
total estimated costs at completion to measure progress toward satisfying our
performance obligations. Incurred cost represents work performed, which
corresponds with the transfer of control to the customer. For such contracts, we
estimate total costs at the inception of the contract based on our assumptions
of the cost elements required to complete the associated tasks of the contract
and assess the effects of the risks on our estimates of total costs to complete
the contract. Our cost estimates are based on assumptions that include the
complexity of the work, our employee labor costs, the cost of materials and the
performance of our subcontractors. These cost estimates are subject to change as
we perform under the contract and as a result, the timing of revenues and amount
of profit on a contract may change as there are changes in estimated costs to
complete the contract. Such adjustments are recognized on a cumulative catch-up
basis in the period we identify the changes.
Revenues for time and materials contracts are recorded based on the amount for
which we have the right to invoice our customers, because the amount directly
reflects the value of our work performed for the customer. Revenues are recorded
on the basis of contract allowable labor hours worked multiplied by the contract
defined billing rates, plus the direct costs and indirect cost burdens
associated with materials and subcontract work used in performance on the
contract. Generally, profits on time and materials contracts result from the
difference between the cost of services performed and the contract defined
billing rates for these services.
Revenues related to work performed on government contracts at risk, which is
work performed at the customer's request prior to the government formalizing
funding, is not recognized until it can be reliably estimated and its
realization is probable.
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A substantial portion of contract and administrative costs are subject to audit
by the Defense Contract Audit Agency . Our indirect cost rates have been audited
and approved for 2018 and prior years with no material adjustments to our
results of operations or financial position. While we maintain reserves to cover
the risk of potential future audit adjustments based primarily on the results of
prior audits, we do not believe any future audits will have a material adverse
effect on our results of operations, financial position, or cash flows.
Business Combinations
We account for business combinations under the acquisition method of accounting. The purchase price of each business acquired is allocated to the tangible and intangible assets acquired and the liabilities assumed based on information regarding their respective fair values on the date of acquisition. Any excess of the purchase price over the fair value of the separately identifiable assets acquired and liabilities assumed is allocated to goodwill. Determining the fair value of assets acquired and liabilities assumed requires management's judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, and market multiples, among other items. We determine the fair values of intangible assets acquired generally in consultation with third-party valuation advisors. The valuation of assets acquired and liabilities assumed requires a number of judgments and is subject to revision as additional information about the fair values becomes available. We will recognize any adjustments to provisional amounts that are identified during the period not to exceed twelve months from the acquisition date (the "measurement period") in which the adjustments are determined. Acquisition costs are expensed as incurred. The results of operations of businesses acquired are included in the consolidated financial statements from their dates of acquisition. As part of the agreement to acquire certain subsidiaries, we may be obligated to pay contingent consideration should the acquired entity meet certain earnings objectives subsequent to the date of acquisition. As of the acquisition date, contingent consideration is recorded at fair value as determined through the use of a probability-based scenario analysis approach. Under this approach, a set of potential future subsidiary earnings is estimated based on various revenue growth rate assumptions for each scenario. A probability of likelihood is then assigned to each potential future earnings estimate and the resultant contingent consideration is calculated and discounted using a weighted average discount rate. The fair value is measured each reporting period subsequent to the acquisition date and any changes are recorded within cost and operating expenses within our consolidated statement of income. Changes in either the revenue growth rates, related earnings or the discount rate could result in a material change to the amount of the contingent consideration accrued.
Goodwill is subject to a review for impairment at least annually. We perform an annual review of goodwill for impairment during the fourth quarter and whenever events or other changes in circumstances indicate that the carrying value may not be fully recoverable. We estimate the fair value of our reporting units using a weighting of fair values derived from the income approach and market approach. Under the income approach, we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. Cash flow projections are based on our estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used is based on a weighted average cost of capital adjusted for the relevant risk associated with the characteristics of the business and the projected cash flows. In the second quarter of 2020, due to the significant decline in our market capitalization as well as an overall stock market decline amid market volatility as a result of the COVID-19 pandemic, we performed an interim impairment test utilizing a quantitative assessment approach. Based on the assessment, ourVSE Aviation reporting unit was determined to be impaired and a$30.9 million impairment charge was recognized. This impairment charge resulted from changes to estimates and assumptions of the expected future cash flows for the reporting unit, which were adversely impacted by reduced global air travel and decreased revenue passenger miles caused by the COVID-19 pandemic. As of the most recent annual goodwill impairment testing date in the fourth quarter of 2020, for which a qualitative assessment approach was utilized, it was determined that it is more likely than not that the fair value of our reporting units exceeded their carrying value. As described in our 2020 Form 10-K, there was uncertainty surrounding the macroeconomic factors impacting theVSE Aviation reporting unit and a downturn in these factors or a change in the long-term revenue growth or profitability for this reporting unit could increase the likelihood of a future impairment. OurVSE Aviation reporting unit had approximately$147 million of goodwill as ofSeptember 30, 2021 . The goodwill balance of this reporting unit continues to be at risk for future impairment for the reasons discussed above. We performed a quarterly assessment to identify potential indicators of impairment for each of our reporting units during the third quarter of 2021. Based on our assessment performed, we did not identify any impairment indicators for any reporting unit during -29- -------------------------------------------------------------------------------- Table of Contents the third quarter of 2021 and determined that it was not more likely than not that the carrying value of any of the reporting units exceeded their respective fair values. We will continue to closely monitor the operational performance of these reporting units and the impacts of COVID-19 on the fair value of goodwill. We also review our long-lived assets with finite lives for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be fully recoverable. During the third quarter of 2021, we performed a quarterly assessment to identify potential indicators of impairment of the long-lived assets with finite lives. Based on our assessment, we did not identify any impairment indicators during the third quarter of 2021 that may indicate that the carrying amount of long-lived assets may not be recoverable. As ofSeptember 30, 2021 , we had no intangible assets with indefinite lives and we had an aggregate of approximately$241 million of goodwill associated with our acquisitions. Income Taxes Income taxes are accounted for under the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. This method also requires the recognition of future tax benefits, such as net operating loss and capital loss carryforwards, to the extent that realization of such benefits is more likely than not. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The carrying value of net deferred tax assets is based on assumptions regarding our ability to generate sufficient future taxable income to utilize these deferred tax assets.
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 "Recently Issued Accounting Pronouncements" in Note
(11) of the Notes to our Unaudited Consolidated Financial Statements in Item 1
of this report.
Results of Operations
The following discussion of our Results of Operations and Liquidity and Capital
Resources includes a comparison of the third quarter of 2021 to the third
quarter of 2020, and the first nine months of 2021 to the first nine months of
2020.
Three months Nine months Change
ended September 30, ended September 30, Three Nine
2021 2020 2021 2020 Months Months
Revenues $ 200,582 $ 165,505
186,690 151,320 529,894 468,789 35,370 61,105
Loss on sale of a business
entity and certain assets - - - (8,214) - 8,214
Gain on sale of property - - - 1,108 - (1,108)
Goodwill and intangible asset
impairment - - - (33,734) - 33,734
Operating income 13,892 14,185 10,781 2,009 (293) 8,772
Interest expense, net 2,780 3,530 8,476 10,088 (750) (1,612)
Income (Loss) before income
taxes 11,112 10,655 2,305 (8,079) 457 10,384
Provision for income taxes 2,091 2,547 539 3,105 (456) (2,566)
Net income (loss) $ 9,021 $ 8,108 $ 1,766 $ (11,184) $ 913 $ 12,950
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Quarter Ended
Revenues
Our revenues increased$35.1 million or 21.2% for the third quarter of 2021 compared to the same period for the prior year. The increase in revenues resulted from an increase in our Aviation segment of$36.9 million , an increase in our Federal and Defense segment of$1.6 million , and a decrease in our Fleet segment of$3.5 million . See "Segment Operating Results" for a breakdown of our results of operations by segment.
Costs and Operating Expenses
Our costs and operating expenses increased$35.4 million or 23.4% for the third quarter of 2021 compared to the same period for the prior year. 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 a breakdown of our results of operations by segment. Costs and operating expenses for 2020 included an expense reduction of$1.7 million associated with the valuation of an acquisition related earn-out obligation.
Operating Income
Our operating income decreased$293 thousand or 2.1% for the third quarter of 2021 compared to the same period for the prior year. Operating income decreased by$1.4 million for our Federal and Defense segment, decreased by$1.2 million for our Fleet segment, and was partially offset by an increase of$2.1 million for our Aviation segment,. See "Segment Operating Results" for a breakdown of our results of operations by segment.
Interest Expense
Interest expense decreased$750 thousand for the third quarter of 2021 compared to the same period for the prior year due to a lower average interest rate on borrowings outstanding. Provision for Income Taxes Our effective tax rate was 18.8% for the third quarter of 2021 and 23.9% for the same period of 2020. 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 ("FDII") deduction, capital gains tax treatment, state income taxes, certain federal and state tax credits and other items caused differences between our statutoryU.S. Federal income tax rate and our effective tax rate. The lower effective tax rate for the third quarter of 2021 primarily resulted from: 1) goodwill impairment loss recognized in 2020 that was not deductible for tax purposes, 2) larger estimated FDII deduction in 2021 compared to 2020.
Nine Months Ended
Revenues Our revenues increased$29.0 million or 5.7% for the first nine months of 2021 compared to the same period for the prior year. The increase in revenues resulted from an increase in our Aviation segment of$38.5 million , an increase in our Federal and Defense segment of$5.6 million , and was partially offset by a decrease in our Fleet segment of$15.1 million . See "Segment Operating Results" for a breakdown of our results of operations by segment.
Costs and Operating Expenses
Our costs and operating expenses increased$61.1 million or 13.0% for the first nine months of 2021 compared to the same period for the prior year. 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 a breakdown of our results of operations by segment. The increase includes the effects of COVID-19 on the valuation of inventory reserve which increased costs and operating expenses by$24.4 million in the second quarter of 2021. The inventory reserve increase was primarily due excess quantities of inventory at levels higher than our updated forecasts of future demand. Costs and operating expenses for 2020 included an expense reduction of$3.1 million for an adjustment to our earn-out obligation and included an expense of approximately$700 thousand for severance pay related to a reduction in our workforce associated with the COVID-19 pandemic induced reduction in demand. -31-
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Loss on Sale of a Business Entity and Certain Assets
In 2020, the business recorded a loss on the sale of a business entity and certain assets of$8.2 million and was comprised of (1) the difference between the carrying value on our books for ourPrime Turbines, LLC business and the sale price upon divestiture, plus the difference between the carrying value on our books of inventory sold that is used to support the operations of our divestedPrime Turbines, LLC business and the sale price of the inventory upon divestiture, and (2) the difference between the carrying value on our books of ourCT Aerospace subsidiary's inventory and the sale price of the inventory upon sale in the second quarter of 2020.
Gain on Sale of Property
In 2020, the business recorded a gain on sale of property of
In 2020, the business recorded a goodwill and intangible asset impairment of$33.7 million and was comprised of a charge to write down the carrying value of our Aviation businesses due to an anticipated decline in demand for these services caused by the global aviation industry downturn associated with the COVID-19 pandemic and a charge to write down the carrying value ofCT Aerospace related intangible assets that were determined to have no residual value or ongoing future cash flows due to the sale of all the subsidiary's inventory.
Operating Income
Our operating income increased$8.8 million or 437% for the first nine months of 2021 compared to the same period for the prior year. Operating income increased$15.8 million for our Aviation segment, decreased$5.4 million for our Fleet segment, and decreased$1.0 million for our Federal and Defense segment. See "Segment Operating Results" for a breakdown of our results of operations by segment.
Interest Expense
Interest expense decreased
Provision for Income Taxes
Our effective tax rate was 23.4% for the first nine months of 2021 and (38.4)%
for the same period of 2020. 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 ("FDII") deduction,
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 higher effective tax rate for
the first nine months of 2021 primarily resulted from 1) a significantly higher
tax loss than book loss in connection with our sale of Prime Turbines stock and
a full valuation allowance established in 2020 to offset the capital loss due to
a lack of anticipated capital gain income in the carryforward period, 2)
goodwill impairment loss recognized in 2020 that was not deductible for tax
purposes, and 3) book loss in 2020 compared to book income in the same period in
2021.
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Table of Contents Segment Operating Results Aviation Segment Results
The results of operations for our Aviation segment are (in thousands):
Three months Nine months Change
ended September 30, ended September 30, Three Nine
2021 2020 2021 2020 Months Months
Revenues $ 73,124 $ 36,218
69,405 34,632 183,895 120,359 34,773 63,536
Loss on sale of a business
entity and certain assets - - - (8,214) - 8,214
Gain on sale of property - - - 1,108 - (1,108)
Goodwill and intangible
impairment - - - (33,734) - 33,734
Operating income (loss) $ 3,719 $ 1,586
5.1 % 4.4 % (11.4) % (27.4) %
Revenues for our Aviation segment increased $36.9 million or 102% for the third
quarter of 2021 compared to the third quarter of 2020. The revenue growth is
primarily attributable to revenue contributions from recently initiated
distribution contract wins, contributions from the acquisition of Global Parts,
and improved demand in end markets.
Costs and operating expenses increased a $34.8 million or 100% for the third
quarter of 2021 compared to the third quarter of 2020 due to improved demand for
our products and services. Costs and operating expenses for this segment
included expenses for amortization of intangible assets associated with
acquisitions, allocated corporate costs, and a reduction in expense for
valuation adjustments to accrued earn-out obligations associated with
acquisitions. Expense for amortization of intangible assets was $2.4 million for
the third quarter of 2021 and $2.1 million for the third quarter of 2020.
Allocated corporate costs were $2.3 million for the third quarter of 2021 and
$1.1 million for the third quarter of 2020. There was no expense for earn-out
valuation adjustments for the third quarter of 2021 compared to a reduction in
expense for earn-out valuation adjustments of $1.7 million for the third quarter
of 2020.
Operating income increased
Revenues for our Aviation segment increased$38.5 million or 30% for the first nine months of 2021 compared to the first nine months of 2020. The revenue growth is primarily attributable to contributions from recently initiated distribution contract wins, contributions from the acquisition of Global Parts, and improved demand in end markets. The increases in revenue were partially offset by the divestiture of Prime Turbines in February of 2020 and the sale of all ofCT Aerospace inventory inJune 2020 . We did not have revenue for these two divested businesses for the first nine months of 2021 compared to combined revenues for these divested businesses of$8.9 million for the first nine months of 2020. Costs and operating expenses increased$63.5 million or 53% for the first nine months of 2021 compared to the first nine months of 2020 due to improved demand for our products and services and a$23.7 million additional inventory valuation reserve recognized in the second quarter of 2021. Costs and operating expenses for this segment included expenses for amortization of intangible assets associated with acquisitions, allocated corporate costs, and a reduction in expense for valuation adjustments to accrued earn-out obligations associated with acquisitions. Expense for amortization of intangible assets was$6.5 million for the first nine months of 2021 compared to$6.7 million for the first nine months of 2020. Allocated corporate costs were$6.0 million for the first nine months of 2021, compared to$4.1 million for the first nine months of 2020. There was no expense for earn-out valuation adjustments for the first nine months of 2021 compared to a reduction in expense for earn-out valuation adjustments of$3.1 million for the first nine months of 2020. Loss on sale of a business entity and certain assets of$8.2 million for the first nine months of 2020 is comprised of the difference between the carrying value on our books for our Prime Turbines business and certain associated assets and the sale price upon divestiture in the first quarter of 2020, plus the difference between the carrying value on our books ofCT Aerospace inventory and the sale price of the inventory upon sale in the second quarter of 2020. -33- -------------------------------------------------------------------------------- Table of Contents Gain on sale of property for the first nine months of 2020 is comprised of$1.1 million associated with the sale of aMiami, Florida real estate holding. Operating loss decreased$15.8 million or 46% for the first nine months of 2021 compared to the first nine months of 2020. Components of the change in operating loss included 1) an additional inventory reserve valuation of$23.7 million in the second quarter of 2021, 2) the elimination of profits from our divested businesses in 2020 of$1.3 million for the first nine months of 2020, 3) a$1.1 million gain on the sale of a real estate property in 2020, 4) a loss on the divestiture of Prime Turbines and associated assets and the sale ofCT Aerospace inventory in 2020 of$8.2 million , and 5) a$33.7 million goodwill and intangible asset impairment charge in 2020.
Fleet Segment Results
The results of operations for our Fleet segment are (in thousands):
Three months Nine months Change
ended September 30, ended September 30, Three Nine
2021 2020 2021 2020 Months Months
Revenues $ 60,268 $ 63,719
54,881 57,130 157,944 167,636 (2,249) (9,692)
Operating income $ 5,387 $ 6,589 $ 15,128 $ 20,509 $ (1,202) $ (5,381)
Profit percentage 8.9 % 10.3 % 8.7 % 10.9 %
Revenues for our Fleet segment decreased $3.5 million or 5% for the third
quarter of 2021 compared to the third quarter of 2020. Revenues from commercial
customers increased $8.2 million or 66%, driven by growth in our e-commerce
fulfillment business. Revenues from sales to DoD customers decreased $4.5
million or 62%, and revenues from sales to other government customers decreased
$7.1 million or 16% primarily due to a non-recurring $7.1 million order for
COVID-19 related supplies in the third quarter of 2020.
Costs and operating expenses decreased $2.2 million or 4%, primarily due to
decreased revenues. Costs and operating expenses for this segment include
expense for amortization of intangible assets associated with acquisitions and
allocated corporate costs. Expense for amortization of intangible assets was
$1.8 million for the third quarter of 2021 and $1.8 million for the third
quarter of 2020. Expense for allocated corporate costs was $2.1 million for the
third quarter of 2021 and $1.9 million for the third quarter of 2020.
Operating income decreased
Revenues for our Fleet segment decreased$15.1 million or 8% for the first nine months of 2021 compared to the first nine months of 2020. Revenues from commercial customers increased$22.9 million or 76.9%, driven by growth in our e-commerce fulfillment business. Revenues from sales toDoD customers decreased$6.4 million or 37.9%, and revenues from sales to other government customers decreased$31.6 million or 22.3% primarily due to a non-recurring$26.6 million order for COVID-19 related supplies during the first nine months of 2020. Costs and operating expenses decreased$9.7 million or 6%, primarily due to decreased revenues. Costs and operating expenses for this segment include expense for amortization of intangible assets associated with acquisitions and allocated corporate costs. Expense for amortization of intangible assets was$5.3 million for the first nine months of 2021 and$5.7 million for the first nine months of 2020. Expense for allocated corporate costs was$6.6 million for the first nine months of 2021 and$6.0 million for the first nine months of 2020. Operating income decreased$5.4 million or 26% for the first nine months of 2021, primarily due to a change in the mix of products sold, including increased commercial customer revenues, an increase in allocated corporate costs, and a$0.7 million inventory valuation reserve recognized in the second quarter of 2021. -34-
-------------------------------------------------------------------------------- Table of Contents Federal and Defense Segment Results
The results of operations for our Federal and Defense segment are (in thousands):
Three months Nine months Change
ended September 30, ended September 30, Three Nine
2021 2020 2021 2020 Months Months
Revenues $ 67,190 $ 65,568
61,804 58,822 185,183 178,533 2,982 6,650
Operating income $ 5,386 $ 6,746 $ 17,410 $ 18,441 $ (1,360) $ (1,031)
Profit percentage 8.0 % 10.3 % 8.6 % 9.4 %
Revenues for our Federal and Defense segment increased $1.6 million or 2% and
costs and operating expenses increased $3.0 million or 5% for the third quarter
of 2021 compared to the third quarter of 2020 primarily due to new revenues from
the U.S. Air Force work performed by our HSS acquisition partially offset by
declines in our U.S. Army work due to program completions.
Operating income decreased
Revenues for our Federal and Defense segment increased$5.6 million or 3% and costs and operating expenses increased$6.7 million or 4% for the first nine months of 2021 compared to the first nine months of 2020 primarily due to revenue performance on ourU.S. Department of Justice program and new revenues from theU.S. Air Force work performed by our HSS acquisition, partially offset by declines in ourU.S. Army work due to program completions and a decline in ourU.S. Navy work. Operating income decreased$1.0 million or 6% for the first nine months of 2021 primarily due to a favorable mix of fixed priced awards during the first nine months of 2020. Financial Condition There has been no material adverse change in our financial condition in the third quarter of 2021. Our bank debt increased approximately$43.1 million for the first nine months of 2021 and we had$117 million of unused bank loan commitments as ofSeptember 30, 2021 . InFebruary 2021 , we completed an underwritten public offering of common stock, generating gross proceeds of approximately$56 million and net proceeds of approximately$52 million through the issuance of 1,599,097 shares of common stock. Changes to other asset and liability accounts were primarily due to our earnings; our level of business activity; the timing and level of inventory purchases to support new distribution programs, contract delivery schedules, and subcontractor and vendor payments required to perform our contract work; the timing of government contract funding awarded; collections from our customers; and our acquisition of Global Parts.
Liquidity and Capital Resources
Cash Flows
Cash and cash equivalents increased
Cash used in operating activities was$30.5 million in the first nine months of 2021 compared to cash provided by operating activities of$35.2 million in the same period of the prior year. The change was comprised of a reduction of$13.0 million in net loss, a decrease of$14.2 million in other non-cash operating activities and a decrease of$64.5 million due to changes in the levels of operating assets and liabilities. Inventories and accounts receivable represent a significant amount of our assets, and accounts payable represent a significant amount of our operating liabilities. The net cash used in operating activities during the first nine months of 2021 of$66.5 million for inventories was primarily due to an increased investment in new inventory to support recent distribution program wins and program launches within our Aviation segment and$13.8 million for receivables and unbilled receivables was primarily due to the timing of collections and customer billings. This use of net cash was partially offset by a$18.0 million increase in accounts payable and deferred compensation primarily resulting from timing of payments. Our levels of accounts receivable and accounts payable may fluctuate depending on the timing of material and inventory purchases, services ordered, product sales, government funding delays, the timing of billings received from subcontractors and materials vendors, and the timing of payments received -35- -------------------------------------------------------------------------------- Table of Contents for services. Such timing differences have the potential to cause significant increases and decreases in our inventory, accounts receivable, and accounts payable in short time periods, and accordingly, can cause increases or decreases in our cash provided by operations. We have recently experienced and expect to continue to experience delays in some of our Aviation segment receivables as a result of the COVID-19 pandemic. Cash used in investing activities was$59.8 million in the first nine months of 2021 compared to cash provided by investing activities of$20.6 million in the same period of the prior year. In 2021,$53.2 million was used for the acquisitions of HSS and Global Parts. In 2020,$22.8 million was provided by proceeds from the divestiture of our Prime Turbines business andCT Aerospace inventory and the sale of aMiami, Florida real estate holding and other property and equipment. Other cash used in investing activities consisted primarily of purchases of property and equipment. Other cash provided by investing activities consisted primarily of proceeds from payments on notes receivable in connection with the divestiture of Prime Turbines and sale ofCT Aerospace inventory. Cash provided by financing activities was$90.4 million in the first nine months of 2021 compared to cash used in financing activities of$56.1 million in the same period of 2020. In 2021, we received$52.0 million in proceeds from the public underwritten offering of our common stock inFebruary 2021 , which is net of underwriters' discounts and issuance costs. In 2020,$31.7 million was used for the payment of an earn-out obligation in connection with the acquisition of our1st Choice Aerospace subsidiary in 2019. Other financing activities consisted primarily of borrowing and repayment of debt and payment of dividends. We paid cash dividends totaling$3.3 million or$0.27 per share in the first nine months of 2021. 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. 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 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. Government funding delays can cause delays in our ability to invoice for revenues earned, presenting a potential negative impact on our days sales outstanding. We also purchase property and equipment; invest in expansion, improvement, and maintenance of our operational and administrative facilities; and invest in the acquisition of other companies. We have considered the effects of the COVID-19 pandemic on our liquidity and capital resources, and we currently do not expect a material adverse impact on our ability to meet future liquidity needs. See "COVID-19 Discussion-Capital , Financial Resources, Credit Losses, and Liquidity" and Item 1A, "Risk Factors" of our 2020 Form 10-K for additional details regarding risks related to the impact of COVID-19 on our liquidity and capital resources. In addition, as discussed in greater detail below, under the terms of our existing loan agreement, we are required to maintain certain financial covenants. The COVID-19 pandemic has disrupted the demand for our Aviation segment products and services and further disruption is possible. Based on our current estimates of future earnings and cash flows, we believe we have sufficient cash and available borrowings for the next twelve months.
Our external financing consists of a loan agreement with a bank group that
expires in
The term loan requires quarterly installment payments. Our required term loan payments afterSeptember 30, 2021 are approximately$3.8 million in 2021,$15.0 million in 2022,$15.0 million in 2023, and$30.2 million in 2024. The amount of term loan borrowings outstanding as ofSeptember 30, 2021 was$63.9 million . The maximum amount of credit available to us under our loan agreement for revolving loans and letters of credit as ofSeptember 30, 2021 was$350 million . We pay an unused commitment fee and fees on letters of credit that are issued. We had approximately$232.7 million in revolving loan amounts outstanding and$803 thousand of letters of credit outstanding as ofSeptember 30, 2021 . -36- -------------------------------------------------------------------------------- Table of Contents 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 incremental increases is$100 million . We pay interest on the term loan borrowings and revolving loan borrowings at LIBOR plus a base margin or at a base rate (typically the prime rate) plus a base margin. The applicable LIBOR rate has a floor of 0.50%. As ofSeptember 30, 2021 , the LIBOR base margin was 2.25% and the base rate base margin was 1.75%. The base margins increase or decrease in steps as our Total Funded Debt to EBITDA Ratio increases or decreases. We use interest rate hedges on a portion of our debt. As ofSeptember 30, 2021 , interest rates on portions of our outstanding debt ranged from 3.50% to 6.18%, and the effective interest rate on our aggregate outstanding debt was 3.90%. The loan agreement contains collateral requirements to secure our loan agreement obligations, restrictive covenants, a limit on annual dividends, and other affirmative and negative covenants, conditions and limitations. The restrictive covenants require that we maintain a Fixed Charge Coverage Ratio of not less than 1.20 to 1.00 and a maximum Total Funded Debt to EBITDA Ratio that varies over future periods as indicated in the table below. We were in compliance with required ratios and other terms and conditions as ofSeptember 30, 2021 . We continue to monitor the impacts of COVID-19 on our results of operations and liquidity relative to compliance with financial covenants; at this time, we expect that we will remain in compliance with such covenants over the next twelve months. Testing Period Maximum Total Funded Debt
to EBITDA
Ratio
From July 23, 2021 through and including 4.50 to 1.00
December 31, 2021
From January 1, 2022 through and including June 4.25 to 1.00
30, 2022
From July 1, 2022 through and including 4.00 to 1.00
September 30, 2022
From October 1, 2022 through and including 3.75 to 1.00
December 31, 2022
From January 1, 2023 through and including March 3.50 to 1.00
31, 2023
From April 1, 2023 and thereafter 3.25 to 1.00
We currently do not use public debt security financing.
Inflation and Pricing
In our Federal and Defense segment, most of our contracts provide for estimates of future labor costs to be escalated for any option periods, while the non-labor costs in our contracts are normally considered reimbursable at cost. Our property and equipment consist principally of land, buildings and improvements, shop and warehouse equipment, computer systems equipment, and furniture and fixtures. We do not expect the overall impact of inflation on replacement costs of our property and equipment to be material to our future results of operations or financial condition.
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 Rates
Our bank loan agreement provides available borrowing to us at variable 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. InFebruary 2019 , we entered into a LIBOR-based interest rate swap on our revolving loan for a term of three years with a notional amount of$75 million . This swap amount decreases in increments on an annual basis to$45 million for the second year -37-
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and to
InMarch 2020 , we entered into a LIBOR-based interest rate swap on our revolving loan for a term of two years with a notional amount of$50 million . We pay an effective interest rate of 0.73% plus our base margin on the debt matched to this swap. LIBOR is used as a reference rate for borrowings under our loan agreement and related interest rate swap agreements. LIBOR is expected to be phased out in the future, and the option to select some LIBOR tenors may no longer be available under our loan agreement afterDecember 31, 2021 . Other LIBOR tenors, including those that we most commonly use, may no longer be available under our loan agreement afterJune 30, 2023 . In connection with our loan amendment inJuly 2021 , language was added to the agreement to provide procedures for determining a replacement or alternative rate in the event that LIBOR becomes unavailable. At this time, there is no definitive information regarding the future transition of LIBOR to a replacement rate; however, we continue to monitor the developments with respect to the potential discontinuance of LIBOR and intend to work with our bank group to minimize the impact of such discontinuance on our financial condition and results of operations. The consequences of the discontinuance of LIBOR cannot be entirely predicted but could result in an increase in our variable rate debt. -38-
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