VSE CORP

(1)Nature of Operations and Basis of Presentation

Nature of Operations

VSE Corporation (collectively, with its consolidated subsidiaries), "VSE," the "Company," "us," "we," or "our" is a leading provider of aftermarket parts distribution and maintenance, repair and overhaul ("MRO") services for air and land transportation assets for commercial and government markets. We operate intwo reportable segments aligned with our operating segments: Aviation and Fleet.

Basis of Presentation

Our accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles ("U.S. GAAP") for interim financial information and in accordance with the instructions to SEC Form 10-Q and Article 10 of SEC Regulation S-X. Therefore, such financial statements do not include all the information and footnotes required by U.S. GAAP for complete financial statements and should be read in conjunction with the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2023 ("2023 Form 10-K"). In our opinion, all adjustments, including normal recurring items, considered necessary for a fair presentation of results for the interim periods have been included in the accompanying unaudited consolidated financial statements. Operating results for the three and six months ended June 30, 2024, are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2024.

In February 2024, we entered intotwo separate agreements to sell substantially all of the Federal and Defense segment assets. See Note (3) "Discontinued Operations" for further information. The consolidated financial statements reflect the Federal and Defense segment's results of operations as discontinued operations for all periods presented, and the related assets and liabilities as held-for-sale as of December 31, 2023.

Certain reclassifications have been made to the prior period financial information to reflect discontinued operations classification. Unless otherwise noted, amounts and disclosures throughout these Notes to Consolidated Financial Statements relate solely to continuing operations and exclude all discontinued operations.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates affecting the financial statements include fair value measurements, inventory provisions, collectability of receivables, valuation allowances on deferred tax assets, fair value of goodwill and other intangible assets and contingencies.

Underwritten Public Offering

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

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(2)Acquisitions

Turbine Controls, LLC

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

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

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

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

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

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

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

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

Precision Fuel Components, LLC

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

During the six months ended June 30, 2023, we incurred $0.2 million of acquisition-related expenses related to the acquisition of Precision Fuel, which are included in selling, general and administrative expenses.

Desser Aerospace

On July 3, 2023, we completed the acquisition of Desser Holding Company LLC ("Desser Aerospace"), a global aftermarket solutions provider of specialty distribution and MRO services. We purchased Desser Aerospace for a cash consideration of$133.7 million, which included$9.5 million as an estimated net working capital adjustment (subject to post-closing adjustments). Concurrent with the closing of the transaction, we immediately sold, in a separate transaction, Desser Aerospace’s propriety solutions businesses to Loar Group Inc. (“Loar”) for a cash consideration of$31.8 million, which included $1.8 million as an estimated net working capital adjustment (the “Loar Sale”).

During the six months ended June 30, 2024, we adjusted the purchase price allocation as a result of certain measurement period adjustments to acquired assets and liabilities assumed due to updated valuation reports received from our external valuation specialist, revisions to internal estimates, and new information obtained about facts and circumstances that existed as of the acquisition date. The measurement period adjustments included: a decrease in deferred tax liabilities of$1.6 millionand an increase in inventories of$0.1 million These adjustments resulted in a decrease to goodwill of$1.7 million.

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

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

We incurred$0.6 million and$1.7 million of acquisition-related expenses related to the Desser Aerospace acquisition during the three and six ended June 30, 2023, respectively, which are included in selling, general and administrative expenses.

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

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

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Honeywell Fuel Control Systems

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

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

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

The pro-forma impact of the acquisition is not material to the Company’s results of operations.

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(3)Discontinued Operations

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

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

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

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The assets and liabilities reported as held-for-sale consist of the following (in thousands):

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

The FDS sale resulted in the divestiture of certain government contracts requiring novation. Until the novation process is finalized, we continue to receive cash collections related to these contracts, which are due to the purchaser. As of June 30, 2024, we have recorded a $7.0 million liability for these collections within accrued expenses and other current liabilities on our consolidated balance sheets.

Selected financial information related to cash flows from discontinued operations is as follows (in thousands):

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(4)Revenue

Disaggregation of Revenues

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

A summary of revenues by customer for each of our operating segments for the three and six months ended June 30, 2024 and 2023 is as follows (in thousands):

A summary of revenues by type for each of our operating segments for the three and six months ended June 30, 2024 and 2023 is as follows (in thousands):

Contract Balances

Contract balances were as follows (in thousands):

For the six months ended June 30, 2024 and 2023, we recognized revenue that was previously included in the beginning balance of contract liabilities of $1.7 million and $0.8 million, respectively.

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(5)Debt

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

Borrowings under our term loan and revolving facility mature in October 2026. As of June 30, 2024, the interest rate on our outstanding term loan borrowings and weighted average interest rate on our aggregate outstanding revolving facility was 8.18% and 8.20%, respectively. We had letters of credit outstanding of $0.8 million as of June 30, 2024 and December 31, 2023.

Future required term loan and revolving facility payments as of June 30, 2024 are as follows (in thousands):

We were in compliance with required ratios and other terms and conditions under our credit agreement as of June 30, 2024.

(6)Derivative Instruments and Hedging Activities

Our derivative instruments designated as cash flow hedges as of June 30, 2024 were as follows (in thousands):

We are party to fixed interest rate swap instruments that are designated and accounted for as cash flow hedges to manage risks associated with interest rate fluctuations on a portion of our floating rate debt. For the three and six months ended June 30, 2024, we reclassified $1.2 million and $2.3 million, respectively, from accumulated other comprehensive income to interest expense, net. We estimate that we will reclassify $3.5 million of unrealized gains from accumulated other comprehensive income into earnings in the twelve months following June 30, 2024.

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(7)Earnings Per Share

Basic earnings per share ("EPS") is computed by dividing net income by the weighted average number of shares of common stock outstanding during each period. Shares issued during the period are weighted for the portion of the period that they were outstanding. Our calculation of diluted earnings per common share includes the dilutive effects for the assumed vesting of outstanding stock-based awards. The antidilutive common stock equivalents excluded from the diluted per share calculation are not material.

The weighted-average number of shares outstanding used to compute basic and diluted EPS were as follows:

(8)Commitments and Contingencies

Contingencies

We may have certain claims in the normal course of business, including legal proceedings, against us and against other parties. In our opinion, the resolution of these claims will not have a material adverse effect on our results of operations, financial condition, or cash flows.

Further, from time-to-time, government agencies audit or investigate whether our operations are being conducted in accordance with applicable contractual and regulatory requirements. Government audits or investigations of us, whether relating to government contracts or conducted for other reasons, could result in administrative, civil or criminal liabilities, including repayments, fines or penalties being imposed upon us, or could lead to suspension or debarment from future government contracting. Government investigations often take years to complete and many result in no adverse action against us. We believe, based upon current information, that the outcome of any such government disputes, audits and investigations will not have a material adverse effect on our results of operations, financial condition, or cash flows.

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(9)Business Segments

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

Aviation

Our Aviation segment provides aftermarket MRO and distribution services to commercial, business and general aviation, cargo, military and defense, and rotorcraft customers globally. Core services include parts distribution, MRO services including engine components and accessories, fuel controls, avionics, pneumatics, hydraulics, wheel and brake, and rotable exchange and supply chain services.

Fleet

Our Fleet segment provides parts, inventory management, e-commerce fulfillment, logistics, supply chain support and other services to support the commercial aftermarket medium- and heavy-duty truck market, and the United States Postal Service ("USPS"). Core services include vehicle parts distribution, sourcing, IT solutions, customized fleet logistics, warehousing, kitting, just-in-time supply chain management, alternative product sourcing, and engineering and technical support.

We evaluate segment performance based on consolidated revenues and operating income. Net sales of our business segments exclude inter-segment sales as these activities are eliminated in consolidation. Corporate expenses are primarily selling, general and administrative expenses not allocated to segments. Our segment information is as follows (in thousands):

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(10)Goodwill and Intangible Assets

Goodwill

Changes in the carrying amount of goodwill by segment for the six months ended June 30, 2024 were as follows (in thousands):

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

Intangible Assets

Intangible assets consisted of the following (in thousands):

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

As of June 30, 2024, the estimated future annual amortization expense related to intangible assets is as follows (in thousands):

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(11)Fair Value Measurements

The following table summarizes the financial assets and liabilities measured at fair value on a recurring basis and the level they fall within the fair value hierarchy (in thousands):

The carrying amounts of cash and cash equivalents, receivables, accounts payable and amounts included in other current assets and accrued expenses and other current liabilities that meet the definition of a financial instrument approximate fair value due to their relatively short maturity. The carrying value of our outstanding debt obligations approximates its fair value. The fair value of long-term debt is calculated using Level 2 inputs based on interest rates available for debt with terms and maturities similar to our existing debt arrangements.

(12)Income Taxes

Income tax expense during interim periods is based on our estimated annual effective income tax rate plus any discrete items that are recorded in the period in which they occur. Our tax rate is affected by discrete items that may occur in any given year but may not be consistent from year to year.

Our effective tax rate for continuing operations was 24.8% and 17.4% for the three and six months ended June 30, 2024 respectively, and 24.0% and 24.3% for the three and six months ended June 30, 2023 respectively. The effective tax rate was higher for the three months ended June 30, 2024 compared to the same period of the prior year primarily due to lower book income and higher disallowed executive compensation in 2024. The effective tax rate was lower for the six months ended June 30, 2024 compared to the same period of the prior year primarily due to lower book income in 2024 and higher excess stock compensation deduction recognized for tax purposes in connection with current year stock vesting.

(13)Lease Abandonment and Other Restructuring Costs

In connection with the FDS sale as described in Note (3) "Discontinued Operations", we implemented changes during the second quarter of 2024 that resulted in one-time charges primarily related to the lease abandonment of our headquarters office space and certain other corporate restructuring actions.

On June 28, 2024, we ceased use of our 95,000 sq. ft. leased office space in Alexandria, VA. We relocated our VA based corporate staff to a 4,000 sq. ft. office space in Vienna, VA under a new short-term lease. During the three and six months ended June 30, 2024, we recognized one-time lease abandonment costs of $12.9 million, which comprised of a reduction in our operating lease right-of-use assets of $6.7 million, exit costs of $3.7 million, and a non-cash write-off of certain property and equipment of $2.5 million. These one-time costs are included within lease abandonment costs on our consolidated statements of (loss) income. As of June 30, 2024, we had a lease abandonment liability of $13.9 million, which will be reduced as lease payments are made through the end of the April 2027 lease term.

During the three and six months ended June 30, 2024, we incurred $3.8 million of corporate restructuring expenses, which are included in selling, general and administrative expenses, primarily related to the cancellation of contracts and leasing agreements associated with the FDS Sale. As of June 30, 2024, approximately $1.1 million of these costs are included within accrued expenses and other current liabilities on our consolidated balance sheets. Our corporate restructuring activities related to the FDS Sale are substantially complete, and we do not expect to incur additional material costs associated with these activities.

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