VSE CORPORATION General Overview
Our Business
VSE is a leading provider of aftermarket distribution and repair services for
land, sea and air transportation assets for government and commercial markets.
Our core services include maintenance, repair and overhaul ("MRO") services,
parts distribution, supply chain management and logistics, engineering support,
and consulting and training services for global commercial, federal, and
military and defense customers. We also provide information technology and
energy consulting services.
Acquisition and Divestitures
InJanuary 2019 , we acquired1st Choice Aerospace Inc. ("1stChoice Aerospace "), with operations inFlorida andKentucky .1st Choice Aerospace provides component MRO services and products for new generation and legacy commercial aircraft families.1st Choice Aerospace is a subsidiary ofVSE Aviation, Inc. under our Aviation segment. InFebruary 2020 , we sold our subsidiaryPrime Turbines, LLC ("Prime Turbines") and certain related inventory assets for$20.0 million in cash and an$8.3 million note receivable to be paid over a period from 2020 through 2024.VSE's 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 approximately 4% of VSE's revenue for 2019. InJune 2020 , we sold all of 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.VSE's Aviation segment discontinued sales and leasing of engines and supply of used serviceable engine parts.CT Aerospace's revenues totaled less than 2% of VSE's revenue for 2019.
See Note (2) "Acquisition" and Note (3) "Divestitures" to our Consolidated Financial Statements included in Item 1 of this filing for additional information regarding our acquisition and divestitures.
Organization and Segments
Our operations are conducted within three reportable 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 " in our Form 10-K for the year 2019.
Concentration of Revenues
(in thousands)
Source of Revenue Three months ended September 30, Nine months ended September 30,
Customer 2020 % 2019 % 2020 % 2019 %
DoD $ 56,935 34 $ 85,053 43 $ 185,956 36 $ 222,834 40
Other government 59,596 36 50,419 25 169,252 33 158,933 29
Commercial 48,974 30 62,854 32 156,430 31 175,589 31
Total $ 165,505 100 $ 198,326 100 $ 511,638 100 $ 557,356 100
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. Please refer to the discussion under Part II, Item 1A
"Risk Factors" of this Form 10-Q with respect to our discussion of trends or
uncertainties arising from or impacted by the COVID-19 pandemic.
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Demand for Products and Services, Operating Results, and Financial Condition
All of our businesses have remained operational since the onset of the COVID-19 global pandemic through the third quarter of 2020, and we continue to operate with limited disruption. We have experienced varying levels of reduction in demand for our services and products, and have adjusted our cost structure to support the current and near-term forecasted demand environment. Our Aviation segment has seen a reduction in demand for our products and services during the first nine months of 2020 compared to the same period of 2019 and we expect it will continue throughout the remainder of 2020 and into early 2021. This decrease in demand will adversely impact our operating results for 2020. We cannot estimate with certainty the severity of this impact, but we expect it to be consistent with the aviation industry trends. 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 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; 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 meeting our obligations in a timely manner. We currently have sufficient cash flows and unused loan commitments to meet our 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. 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 less than 50%. The potential for additional declines in our earnings may impact our financial covenant ratios in future periods. Accordingly, in the second quarter of 2020, we amended the loan agreement to provide increased financial covenant flexibility through 2021.
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, we do not anticipate any impairments in these two business segments. Our interim impairment analysis 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 is experiencing and will continue to experience lower customer demand for the remainder of 2020 as compared to the same periods of 2019, but we believe market opportunities will increase for us in the long 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, Restructuring Charges" 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 -24- -------------------------------------------------------------------------------- Table of Contents 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. While the COVID-19 pandemic has slowed demand for our products, we do not expect a material adverse impact to the carrying value of our inventory. 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 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.
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 theU.S. Centers for Disease Control and Prevention , and mandated 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. While the overall economic downturn may cause some slowness in every industry, we do not anticipate any parts availability concerns, disruptions in our supply of materials or resources, or an adverse impact on our procurement capabilities or product costs.
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. We do not anticipate our operations being materially impacted by any constraints or other impacts on our human capital resources and productivity.
In the second quarter of 2020, we implemented a cost reduction plan which
included a reduction in workforce and reduced approximately
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
The COVID-19 pandemic caused a reduction in global demand for air travel and
decreased revenue passenger miles, which had an adverse impact on demand for our
Aviation products and services beginning with the second quarter of 2020. Due to
the uncertainty in the travel industry associated with the COVID-19 pandemic, we
expect decreased demand to continue for the remainder of 2020 and into early
2021. Revenue in our non-divested Aviation businesses for the third quarter of
2020 decreased approximately 26% from the third quarter of 2019. Despite the
year over year decline, we believe that the second quarter of 2020 represented
the bottom of the revenue decline, as revenue in our non-divested Aviation
businesses for the third quarter of 2020 increased approximately 16% over the
second quarter of 2020. It is difficult to predict how the pandemic will impact
2021 and future years.
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 of 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/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 pursue 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 more than doubled during the third quarter of 2020 compared to the same period in 2019, driven by a four-fold increase in e-commerce fulfillment revenues. We believe the COVID-19 pandemic is likely 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 appears to be progressing steadily.
Federal and Defense Segment
We entered 2020 with a focus on growing this segment of our business and redefining VSE in the federal marketplace. We are investing in business development, growing our capability and product offerings, and broadening our range of new business targets to build our contract backlog and expand our markets and offerings. The anticipated revenue decline experienced by this segment in the third quarter and first nine months of 2020 is primarily attributable to the expiration of a largeU.S. Army contract inJanuary 2020 . We expect that our refocused business development efforts in 2020 will produce revenue growth in subsequent years. We expect the COVID-19 pandemic 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
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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 2020, Federal and Defense segment bookings
increased 3% year-over-year to $195 million , while total funded backlog declined
30% year-over-year to $177 million . The decline in funded backlog was primarily
attributable to the completion of certain DoD contracts in 2020. 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, 2020 and 2019, and funded contract backlog
as of September 30, 2020 and 2019 is as follows (in millions):
2020 2019
Bookings $ 195 $ 190
Revenues $ 197 $ 233
Funded Contract Backlog $ 177 $ 252 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.
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.
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Our Aviation segment revenues result from the sale of aircraft parts and
performance of MRO services for private and commercial aircraft owners, other
aviation MRO providers, and aviation original equipment manufacturers. 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.
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 2017 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.
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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 first quarter of 2020, despite the excess fair value identified in our 2019 impairment assessment, market conditions as a result of the COVID-19 pandemic resulted in a significant decline in our market capitalization as well as an overall stock market decline amid market volatility, triggering the need for an interim goodwill impairment test. We performed an interim impairment analysis as ofMarch 31, 2020 , utilizing a qualitative approach for our reporting units. Under this approach, we reviewed our previous forecasts and assumptions based on our current projections that are subject to various risks and uncertainties, which included the duration and extent of the impact to our business from the COVID-19 pandemic. We concluded it was more likely than not that the fair value exceeded the carrying value of our reporting units with the exception of ourVSE Aviation reporting unit, which required a quantitative impairment test. Under the income approach, the fair value of ourVSE Aviation reporting unit was determined based on the present value of estimated future cash flows, discounted at an appropriate risk-free rate. We used our updated forecasts which considered recent events to estimate future cash flows. Our forecasts assumed containment of the COVID-19 pandemic to be achieved by mid-2020 with a gradual increase in travel demand beginning mid-to-late 2020 and into 2021, with substantial recovery thereafter. Based on our assessment, it was determined that the fair value of theVSE Aviation reporting unit approximated its carrying value and no impairment charge was required. Given the continued presence and impact of the COVID-19 pandemic on the global economy, we performed an interim impairment analysis in the second quarter of 2020 utilizing a quantitative assessment approach for all reporting units. Based on our quantitative impairment assessment as ofJune 1, 2020 , we determined that the fair value of our reporting units, with the exception of ourVSE Aviation reporting unit, exceeded their carrying value and no impairment charge was required. The estimated fair value of ourVSE Aviation reporting unit was determined to be below its carrying value. The internal forecasts used to estimate future cash flows in the quantitative analysis for ourVSE Aviation reporting unit projected lower forecasted revenues and operating results than those used in the first quarter interim analysis. The decline in revenue projections was due to lower demand for the reporting unit's products and services, which was impacted by reduced global air travel and decreased passenger miles caused by the COVID-19 pandemic. The lower projections also considered updated assumptions regarding the uncertainty surrounding the timing and speed at which recovery from the COVID-19 pandemic could occur. The updated forecasts assumed suppressed demand to continue to remain in place throughout 2020 and into 2021, with a slower and more gradual recovery thereafter. These lower expected operating results and cash flows from the reductions in revenue, resulted in a substantial decline in the fair value of theVSE Aviation reporting unit. As a result, we recognized an impairment charge in the second quarter of 2020 of$30.9 million which is the amount by which the carrying amount exceeded the reporting unit's fair value. We performed a quarterly assessment to identify potential indicators of impairment for each of our reporting units during the third quarter of 2020. In performing this assessment, we reviewed key assumptions and information, including updated macroeconomic indicators that impact the markets we serve, financial forecast information for each reporting unit, and recent performance of the Company's share price. Based on our assessment performed, we did not identify any impairment indicators for any reporting units during the third quarter of 2020 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 as they relate to goodwill impairment. -29- -------------------------------------------------------------------------------- Table of Contents OurVSE Aviation reporting unit had approximately$144 million of remaining goodwill as ofSeptember 30, 2020 . The remaining goodwill balance of this reporting unit continues to be at risk for future impairment due to the uncertainty surrounding the macroeconomic factors impacting this reporting unit. A sustained downturn, significantly extended recovery, or a change in long-term operating growth for this reporting unit could increase the likelihood of an additional impairment. We also review the recoverability of our long-lived assets with finite lives when an indicator of impairment exists. For the same reasons discussed above, during the second quarter of 2020 we assessed the recoverability of the long-lived assets with finite lives. Based on our analysis of estimated undiscounted future cash flows expected to result from the use of these long-lived assets with finite lives, we determined that their carrying values were recoverable. During the third quarter of 2020, 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 2020 that may indicate that the carrying amount of long-lived assets may not be recoverable. As ofSeptember 30, 2020 , we had no intangible assets with indefinite lives and we had an aggregate of approximately$238 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
(12) 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 2020 to the third
quarter of 2019, and the first nine months of 2020 to the first nine months of
2019.
Three months Nine months Change
ended September 30, ended September 30, Three Nine
2020 2019 2020 2019 Months Months
Revenues $ 165,505 $ 198,326
151,320 181,111 468,789 511,912 (29,791) (43,123)
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 14,185 17,215 2,009 45,444 (3,030) (43,435)
Interest expense, net 3,530 3,706 10,088 10,262 (176) (174)
Income (loss) before income
taxes 10,655 13,509 (8,079) 35,182 (2,854) (43,261)
Provision for income taxes 2,547 2,982 3,105 8,154 (435) (5,049)
Net income (loss) $ 8,108 $ 10,527 $ (11,184) $ 27,028 $ (2,419) $ (38,212)
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Quarter Ended
Revenues
Our revenues decreased approximately$32.8 million or 16.5% for the third quarter of 2020 compared to the same period for the prior year. The change in revenues resulted from a decrease in our Aviation segment of approximately$23.0 million , an increase in our Fleet segment of approximately$8.4 million , and a decrease in our Federal and Defense segment of approximately$18.2 million . See "Segment Operating Results" for a breakdown of our results of operations by segment.
Costs and Operating Expenses
Our costs and operating expenses decreased approximately$29.8 million or 16.4% for the third quarter of 2020 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. Costs and operating expenses for 2020 included an expense reduction of approximately$1.7 million for an adjustment to our earn-out obligation. Costs and operating expenses for 2019 included an expense of approximately$0.5 million for acquisition related and executive transition costs.
Operating Income
Our operating income decreased approximately$3.0 million or 17.6% for the third quarter of 2020 compared to the same period for the prior year. Operating income decreased approximately$5.0 million for our Aviation segment, decreased approximately$1.3 million for our Fleet segment, and increased approximately$2.2 million for our Federal and Defense segment. Operating income for 2020 increased approximately$1.7 million for an adjustment to our earn-out obligation. Operating income for 2019 decreased approximately$518 thousand for acquisition related and executive transition costs.
Interest Expense
Interest expense decreased approximately$176 thousand for the third quarter of 2020 compared to the same period for the prior year due to a decrease in our average interest rates and amounts borrowed.
Provision for Income Taxes
Our effective tax rate was 23.9% for the third quarter of 2020 and 22.1% for the same period of 2019. Our tax rate is affected by discrete items that may occur in any given year but may not be consistent from year to year. Capital gains tax treatment, state income taxes, certain tax credits and other items caused differences between our statutoryU.S. Federal income tax rate and our effective tax rate. Other permanent differences and federal and state tax credits such as foreign derived intangible income ("FDII") deduction, the work opportunity tax credit, and educational improvement tax credits provide benefit to our tax rates.
Nine Months Ended
Revenues Our revenues decreased approximately$45.7 million or 8.2% for the first nine months of 2020 compared to the same period for the prior year. The change in revenues resulted from a decrease in our Aviation segment of approximately$37.0 million , an increase in our Fleet segment of approximately$27.3 million , and a decrease in our Federal and Defense segment of approximately$36.0 million . See "Segment Operating Results" for a breakdown of our results of operations by segment.
Costs and Operating Expenses
Our costs and operating expenses decreased approximately$43.1 million or 8.4% for the first nine months of 2020 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. Costs and operating expenses for 2020 included an expense reduction of approximately$3.1 million for an adjustment to our earn-out obligation. Costs and operating expenses for 2020 included an expense of approximately$700 thousand for severance pay related to a reduction in workforce associated with the COVID-19 pandemic induced reduction in demand. Costs and expenses for 2019 included expenses of approximately$2.3 million for acquisition related and executive transition costs. -31-
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Loss on Sale of a Business Entity and Certain Assets
Loss on sale of a business entity and certain assets of$8.2 million 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 of ourCT Aerospace inventory and the sale price of the inventory upon sale in the second quarter of 2020.
Gain on Sale of Property
Gain on sale of property is comprised of
Goodwill and intangible asset impairment of$33.7 million is comprised of a charge to write down the carrying value of our Aviation businesses in the second quarter of 2020 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 in the second quarter of 2020 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 decreased approximately$43.4 million or 95.6% for the first nine months of 2020 compared to the same period for the prior year. Operating income decreased approximately$49.5 million for our Aviation segment, decreased approximately$1.9 million for our Fleet segment, and increased approximately$5.5 million for our Federal and Defense segment. The decrease in the operating income for our Aviation segment was primarily due to a$33.7 million goodwill and intangible asset impairment charge and a$8.2 million loss on the divestiture of Prime Turbines and the sale ofCT Aerospace inventory. These decreases were partially offset by a$1.1 million gain on the sale of certain real estate holdings. Operating income for the first nine months of 2020 increased approximately$3.1 million for an adjustment to our earn-out obligation and decreased approximately$700 thousand for severance pay related to a reduction in workforce associated with the COVID-19 pandemic induced reduction in demand. Operating income for the first nine months of 2019 decreased approximately$2.3 million for acquisition related and executive transition costs.
Interest Expense
Interest expense decreased approximately$174 thousand for the first nine months of 2020 compared to the same period for the prior year, due to a decrease in our average interest rates and amounts borrowed.
Provision for Income Taxes
Our effective tax rate was (38.4)% for the first nine months of 2020 and 23.2% for the first nine months of 2019. The difference in the effective tax rate for the first nine months of 2020 compared to the same period of the prior year primarily results from: (1) approximately$16.4 million of our goodwill impairment loss that is non-deductible for income tax purposes, and (2) a full valuation allowance established to offset the capital loss benefit in connection with our divestiture of Prime Turbines due to a lack of anticipated capital gain income in the carryforward period. -32- --------------------------------------------------------------------------------
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
2020 2019 2020 2019 Months Months
Revenues $ 36,218 $ 59,186
34,632 52,618 120,359 148,733 (17,986) (28,374)
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) $ 1,586 $ 6,568
4.4 % 11.1 % (27.4) % 9.1 %
Revenues for our Aviation segment decreased approximately $23.0 million or 38.8%
for the third quarter and approximately $37.0 million or 22.6% for the first
nine months of 2020 compared to the same periods of the prior year. The revenue
declines are primarily attributable to the impact of the COVID-19 pandemic on
the broader aviation markets that has lowered demand from our Aviation customers
and the divestiture of Prime Turbines in February 2020 and the sale of all of CT
Aerospace inventory in June 2020 . We did not have revenue for these two divested
businesses for the third quarter of 2020 compared to combined revenues for these
businesses of approximately $10.3 million for the third quarter of 2019.
Revenues for the divested businesses were approximately $8.9 million for the
first nine months of 2020 compared to approximately $28.8 million for the same
period of 2019. Revenues for our Aviation segment non-divested businesses
decreased approximately $12.7 million or 26.0% for the third quarter and
approximately $17.1 million or 12.7% for the first nine months of 2020 compared
to the same periods of the prior year.
Costs and operating expenses decreased approximately $18.0 million or 34.2% for
the third quarter and approximately $28.4 million or 19.1% for the first nine
months of 2020 due to the decreased demand for our products and services, to
cost reduction actions implemented in response to the reduction in demand, and
to the elimination of costs and expenses associated with our divested
businesses.
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 of CT Aerospace inventory and
the sale price of the inventory upon sale in the second quarter of 2020.
Gain on sale of property for the first nine months of 2020 is comprised of
approximately
The goodwill and intangible asset impairment of$33.7 million for the first nine months of 2020 is comprised of a charge to write down the goodwill 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 decreased approximately$5.0 million or 75.9% for the third quarter of 2020 compared to the same period for the prior year. Components of the decrease included the elimination of profits from our divested businesses of approximately$1.0 million and a decline in profits for our continuing businesses due to a decrease in demand for products and services associated with the COVID-19 pandemic. Operating income decreased approximately$49.5 million or 334.0% for the first nine months of 2020 compared to the same period for the prior year. The primary components of the decrease were a$33.7 million goodwill and intangible asset impairment charge, a$8.2 million loss on the divestiture of Prime Turbines and sale ofCT Aerospace inventory, and a decline in profits for our continuing businesses due to a decrease in demand for our products and services associated with the COVID-19 pandemic. Partially offsetting the decrease was a$1.1 million gain on the sale of certain real estate holdings. -33- -------------------------------------------------------------------------------- Table of Contents 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 approximately$2.1 million for the third quarter and approximately$6.7 million for the first nine months of 2020 compared to approximately$2.7 million for the third quarter and approximately$8.0 million for the first nine months of 2019. Allocated corporate costs were approximately$1.1 million for the third quarter and approximately$4.1 million for the first nine months 2020, compared to approximately$1.6 million for the third quarter and approximately$4.8 million for the first nine months of 2019. Reductions in expense for earn-out valuation adjustments were$1.7 million for the third quarter and$3.1 million for the first nine months of 2020. There were no earn-out valuation adjustments in the corresponding periods of 2019.
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
2020 2019 2020 2019 Months Months
Revenues $ 63,719 $ 55,369
57,130 47,526 167,636 138,490 9,604 29,146
Operating income $ 6,589 $ 7,843 $ 20,509 $ 22,388 $ (1,254) $ (1,879)
Profit percentage 10.3 % 14.2 % 10.9 % 13.9 %
Revenues for our Fleet segment increased approximately $8.4 million or 15.1% for
the third quarter of 2020 compared to the third quarter of 2019. Revenues from
commercial customers increased approximately $6.5 million or 107.3%, driven by
growth in our e-commerce fulfillment business. Revenues from sales to DoD
customers increased approximately $340 thousand or 4.9%, and revenues from sales
to other government customers increased approximately $1.6 million or 3.7%.
Sales to other government customers included revenue of approximately $7.1
million for completion of a non-recurring $26.6 million order for COVID-19
related supplies.
Costs and operating expenses increased approximately $9.6 million or 20.2%,
primarily due to increased revenues. Operating income decreased by approximately
$1.3 million or 16.0% for the third quarter of 2020, primarily due to a change
in the mix of products sold, including increased commercial customer 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 approximately $1.8 million for
the third quarter of 2020 and approximately $2.0 million for the third quarter
of 2019. Expense for allocated corporate costs was approximately $1.9 million
for the third quarter of 2020 and approximately $1.5 million for the third
quarter of 2019. The lower profit percentage for the third quarter of 2020 was
primarily due to lower profit margins on revenues from the non-recurring order
for COVID-19 related supplies and an increase in allocated corporate costs.
Revenues for our Fleet segment increased approximately $27.3 million or 16.9%
for the first nine months of 2020 compared to the same period of the prior year.
Revenues from commercial customers increased approximately $14.7 million or
97.7%, driven by growth in our e-commerce fulfillment business. Revenues from
sales to DoD customers decreased approximately $1.3 million or 7.1%, and
revenues from sales to other government customers increased approximately $13.8
million or 10.8%. Sales to other government customers included revenue of
approximately $26.6 million for fulfillment of a non-recurring order for
COVID-19 related supplies.
Costs and operating expenses increased approximately $29.1 million or 21.0%
primarily due to the $26.6 million of revenues for the completion of a
non-recurring order for COVID-19 related supplies. Operating income decreased by
approximately $1.9 million or 8.4% for the first nine months of 2020 primarily
due to a change in the mix products sold, including increased commercial
customer revenues. Expense for amortization of intangible assets was
approximately $5.7 million for the first nine months of 2020 and approximately
$5.9 million for the first nine months of 2019. Expense for allocated corporate
costs was approximately $6.0 million for the first nine months of 2020 and
approximately $4.7 million for the first nine months of 2019. The lower profit
percentage for the first nine months of 2020 was primarily due to lower profit
margins on revenues from the non-recurring order for COVID-19 related supplies
and an increase in allocated corporate costs.
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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
2020 2019 2020 2019 Months Months
Revenues $ 65,568 $ 83,771
58,822 79,247 178,533 219,957 (20,425) (41,424)
Operating income $ 6,746 $ 4,524 $ 18,441 $ 12,968 $ 2,222 $ 5,473
Profit percentage 10.3 % 5.4 % 9.4 % 5.6 %
Revenues for our Federal and Defense segment decreased $18.2 million or 21.7%
and costs and operating expenses decreased $20.4 million or 25.8% for the third
quarter of 2020 compared to the third quarter of 2019 primarily due to the
expiration of a large U.S. Army contract in January 2020 and decreased revenues
from some of our other U.S. Army programs. Other changes affecting our revenues
and costs and operating expenses included decreased revenues from a U.S. Navy
program and increased revenues from other government work.
Operating income increased approximately $2.2 million or 49.1% for the third
quarter of 2020 compared to the third quarter of 2019. Revenue declines occurred
in our lower margin work, resulting in minimal loss of operating income, and we
have increased operating income through margin improvements primarily due to
work performed under fixed price contracts.
Revenues for our Federal and Defense segment decreased $36.0 million or 15.4%
and costs and operating expenses decreased $41.4 million or 18.8% for the first
nine months of 2020 compared to the same period of the prior year primarily due
to the expiration of a large U.S. Army contract in January 2020 and decreased
revenues from some of our other U.S. Army programs. Other changes affecting our
revenues and costs and operating expenses included an increase in revenues from
a U.S. Navy program and changes in revenues from other work.
Operating income increased approximately
Financial Condition
There has been no material adverse change in our financial condition in the first nine months of 2020. Our bank debt decreased approximately$20.1 million and our earn-out obligation decreased approximately$34.8 million . We had$190 million of unused bank loan commitments as ofSeptember 30, 2020 . InJune 2020 , we amended our loan agreement with our banks to provide increased financial covenant flexibility due to market volatility resulting from the COVID-19 pandemic. Changes to other asset and liability accounts were primarily due to our earnings; our level of business activity; the timing of inventory purchases, 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; the sale of a real estate holding inMiami, Florida ; and the divestiture of our Prime Turbines business and sale ofCT Aerospace inventory.
Liquidity and Capital Resources
Cash Flows
Cash and cash equivalents decreased approximately
Cash provided by operating activities increased approximately$17.8 million in the first nine months of 2020 compared to the same period in 2019. The change was comprised of a decrease of approximately$38.2 million in cash provided by net income, an increase of approximately$33.8 million in other non-cash operating activities and an increase of approximately$22.2 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. Cash used related to increases in inventory was approximately$27.6 million , cash provided by decreases in receivables and unbilled receivables was approximately$19.2 million , and cash used by decreases in accounts -35- -------------------------------------------------------------------------------- Table of Contents payable and deferred compensation was approximately$3.3 million for the first nine months of 2020. A significant portion of accounts receivable and accounts payable result from the use of subcontractors to perform work on our contracts and from the purchase of materials and inventory to fulfill contract obligations and distribution agreements. Accordingly, 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 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 economic down-turn. Cash provided by investing activities was approximately$20.6 million in the first nine months of 2020 compared to cash used in investing activities of approximately$120.3 million in the same period of the prior year. In 2019 approximately$113 million was used for the acquisition of1st Choice Aerospace and in 2020 approximately$23.6 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. Other cash used in investing activities consisted primarily of purchases of property and equipment. Cash used in financing activities was approximately$56.1 million in the first nine months of 2020 compared to cash provided by financing activities of approximately$103.8 million in the same period of 2019. Financing activities consisted primarily of borrowing and repayment of debt, payment of dividends and payment of earn-out obligation. We paid cash dividends totaling approximately$3.0 million or$0.27 per share in the first nine months of 2020. 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" for additional details regarding the impact of COVID-19 on our liquidity and capital resources. 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. Accordingly, we amended our existing loan agreement with our banks in the second quarter of 2020 to provide increased financial covenant flexibility. Our external financing consists of a loan agreement with a bank group that was amended inJune 2020 and expires inJanuary 2023 . The loan agreement includes a term loan facility and a revolving loan facility. The revolving loan facility provides for revolving loans and letters of credit. The term loan requires quarterly installment payments. Our required term loan payments afterSeptember 30, 2020 are approximately$4.7 million in 2020,$21.6 million in 2021,$22.5 million in 2022, and$43.9 million in 2023. The amount of term loan borrowings outstanding as ofSeptember 30, 2020 was$92.7 million . The maximum amount of credit available to us under our loan agreement for revolving loans and letters of credit as ofSeptember 30, 2020 was$350 million . We pay an unused commitment fee and fees on letters of credit that are issued. We had approximately$160.0 million in revolving loan amounts outstanding and no of letters of credit outstanding as ofSeptember 30, 2020 . -36-
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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 0.75%. As ofSeptember 30, 2020 , the LIBOR base margin was 3.00% and the base rate base margin was 1.75%. The base margins increase or decrease in steps as our Total Funded Debt/EBITDA Ratio increases or decreases. The loan agreement requires us to have interest rate hedges on a portion of the outstanding term loan untilFebruary 6, 2021 . We executed compliant interest rate hedges. As ofSeptember 30, 2020 , interest rates on portions of our outstanding debt ranged from 3.75% to 6.31%, and the effective interest rate on our aggregate outstanding debt was 4.82%. 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, 2020 . 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
First Amendment Effective Date (November 26, 2019 ) 3.50 to 1.00
through and including March 31, 2020
From April 1, 2020 through and including September 30 , 4.00 to 1.00
2020
From October 1, 2020 through and including March 31 , 4.25 to 1.00
2021
From
3.50 to 1.00
31, 2021
From January 1, 2022 and thereafter 3.25 to 1.00
We currently do not use public debt security financing.
Inflation and Pricing
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.
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InFebruary 2018 , we entered into a LIBOR based interest rate swap on our term loan for a term of three years with a notional amount of$10 million for the first year and$50 million for the second and third years. We pay an effective interest rate of 2.54% plus our base margin on the debt matched to this swap. 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 and to$25 million for the third year. We pay an effective interest rate of 2.805% plus our base margin on the debt matched to this swap. 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 by the end of 2021, which is before the maturity of our loan agreement. 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 after 2021 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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