VSE
Annual Report 2017

Plain-text annual report

This document is printed using soy-based inks using FSC and Green Seal™ certified paper that contains recycled post-consumer fiber. Revenues were up 10% to $760.1 million in 2017 compared to $691.8 million in 2016. The increase was primarily due to increased revenue from our Department of Defense markets served by our Federal Services Group. Operating income was up 5.4% to $54.3 million in 2017 compared to $51.5 million in 2016. The change in operating income was primarily attributable to the increase in our revenues from our Federal Services Group. Net income was up 45.9% to $39.1 million for 2017, or $3.60 per diluted share, compared to $26.8 million, or $2.47 per diluted share for 2016. Our increase in net income for the year benefitted from enactment of the Tax Cuts and Jobs Act, which reduced our deferred tax liabilities and our provision for income taxes by approximately $10.6 million for 2017. Bookings in our Federal Services Group totaled $430 million for 2017 compared to revenue of $411 million for the same period. Funded contract backlog as of December 31, 2017 was $324 million, compared to $403 million as of September 30, 2017 and $322 million as of December 31, 2016. Operational and Contract Highlights in 2017 " Revenues from our Federal Services Group increased by 16% for 2017 as compared to 2016. This increase resulted primarily from a full year of revenue from our equipment refurbishment services at Red River Army Depot, and increased revenue from our Foreign Military Sales (FMS) support contract with the Naval Sea Systems Command (NAVSEA). " Our Supply Chain Management Group sales to the Department of Defense and commercial customers increased approximately $9.6 million, or 40% in 2017. " Our Aviation Group has opened an office in Singapore to provide distribution and supply chain services in support of various strategic partners, which expands our 2017 Highlights geographic footprint and extends new and existing product lines to new clients and geographic markets. " 2017 contract awards: ▪ We were awarded several delivery orders in 2017 to provide support under our FMS contract with NAVSEA International Fleet Support Program Office. The periods of performance for these delivery orders range between nine and 20 months, and the delivery orders have a combined funded value of approximately $207.5 million. ▪ In May we were awarded a task order under the United States Air Force Contract Field Teams (CFT) Indefinite Delivery/Indefinite Quantity (IDIQ) contract, supporting the 18th Equipment Maintenance Squadron at Kadena Air Base in Japan. This task order consists of a one year base period of performance with two one-year option periods and a total potential value of $22.3 million. ▪ In July we were awarded a Cost-Plus Fixed-Fee (CPFF) Task Order under our Rapid Response Third Generation (R2- 3G) prime contract to continue providing support services to the U.S. Army Reserve Command (USARC) for its Equipment, Engineering, Maintenance and Logistics Readiness Program. The R2-3G Task Order has a one-year base period of performance and two one-year option periods, with a total potential value of $17.8 million. ▪ Our subsidiary, VSE Aviation, Inc., was selected to support the United States Department of State (DoS), Bureau of International Narcotics and Law Enforcement Affairs, Office of Aviation for the repair, overhaul and modification of T53-L-703 engines. The single award IDIQ contract has a five year period of performance and supports a fleet of 85 UH-1H “Huey” Helicopters. The maximum ceiling for the contract is $16.6 million. 1 INTEGRITY • AGILITY • VALUE " Our Quality Management System (QMS) was recommended for approval by Lloyd’s Register Quality Assurance (LRQA) to the new International Organization for Standardization (ISO) 9001:2015 certification for Quality Management Systems. Stockholder Inquiries VSE is a publicly owned company and its shares are traded on the NASDAQ Global Select Market under the symbol VSEC. Inquiries about stock ownership, dividends, and stockholder changes of address may be directed to our Transfer Agent: Continental Stock Transfer & Trust, 17 Battery Place, 8th Floor, New York, NY 10004, or to VSE at 6348 Walker Lane, Alexandria, VA 22310, Attention: Corporate Secretary, Telephone (703) 329-4770. Further information about VSE and its subsidiaries is available at www.vsecorp.com. Corporate Profile We are a diversified services and supply chain management company that assists our clients in sustaining, extending the service life, and improving the performance of their transportation, equipment, and other assets and systems. Our offerings include: " Supply Chain Management and Aviation Services ▪ We provide vehicle parts and mission critical supply chain support for government and commercial customers. We specialize in sourcing, acquisition, scheduling, shipping, logistics, data management, and other services to assist our clients with supply chain management efforts. ▪ We specialize in maintenance, repair and overhaul (MRO) services and parts supply for corporate and regional jet aircraft engines and engine accessories. " Federal Services ▪ We are one of the nation’s leading providers of maintenance, reset, overhaul and modernization support, ensuring land, sea and air systems are capable of performing their operational missions throughout their lifecycle. ▪ We provide professional competencies in strategic planning, clean energy solutions, policy analysis, performance metrics, project management, enterprise architecture, data mining, public protection/security, and technical and software engineering. 2 2017 VSE Annual Report and Form 10-KFinancial Highlights 3 INTEGRITY • AGILITY • VALUE4 2017 VSE Annual Report and Form 10-KMessage to Stockholders Overview Our 2017 financial performance was driven by increases in work for our Federal Government clients. Our Federal Services Group revenues benefited from foreign military sales work performed for two ship transfers to Taiwan early in the year and a full year of work on an equipment sustainment and logistics support contract at Red River Army Depot. Our Federal Government work is an integral part of our success and we will continue to pursue opportunities to provide our traditional services to these clients while also seeking to extend newer competencies offered by our other groups to this market. Vehicle parts supply and inventory management support for the USPS delivery vehicle fleet has provided steady revenues for our Supply Chain Management Group, while sales to DoD and commercial clients continue to increase. Our growing commercial client base now includes companies in food distribution, oil field services, waste management, commercial long haul shipping, bus transportation and other clients that have vehicle fleets required to meet mission critical delivery schedules. We are also capturing new customers and increasing revenue using e-commerce solutions. Our Aviation Group revenues were steady but flat in 2017, reflecting market trends. We began extending our gas turbine maintenance, repair, and overhaul competency to international maritime applications in 2017 and we are pursuing additional opportunities for this competency.  We are expanding our aviation aftermarket distribution work to include Asia by opening a new office in Singapore and signing a distribution agreement with a key original equipment manufacturer serving that region. These ongoing initiatives extend both current and new product lines to emerging markets. Tax Cuts and Jobs Act The federal tax legislation enacted in December 2017 resulted in a one-time reduction in our deferred tax liabilities that lowered our provision for income taxes and increased our net income for 2017. Going forward, our federal corporate income tax rate will decline from 35% to 21%, which will benefit our cash flows. Board Membership We are pleased to welcome Admiral Mark Ferguson to our Board of Directors. Adm. Ferguson brings 38 years of experience in the U.S. Navy and in senior positions in the U.S. military, including serving as the Vice Chief of Naval Operations from 2011 to 2014. Adm. Ferguson provides expertise in cyber defense, congressional and regulatory affairs, strategic planning and operations management. Looking Ahead While our Federal Government work has provided us with significant uplift and our Supply Chain Management Group revenues have increased over the past few years, we anticipate that initiatives launched to enhance our Aviation Group revenues will contribute to growth in the coming years. Our strategic plans are formed with long-term growth in mind, and we focus on initiatives that return value to our stockholders. Maurice A. Gauthier CEO/President/COO March 2018 Clifford M. Kendall Chairman of the Board March 2018 5 INTEGRITY • AGILITY • VALUEBoard of Directors Clifford M. Kendall Chairman of the Board VSE Corporation Maurice A. “Mo” Gauthier CEO/President/COO VSE Corporation Ralph E. Eberhart General, USAF (Ret.) President, Armed Forces Benefit Association Chairman and Director of Triumph Group, Inc. Mark E. Ferguson III Admiral, USN (Ret.) Vice Chief of Naval Operations, U.S. Navy Former Commander, U.S. Joint Forces Command Calvin S. Koonce, Ph.D. President and Director of Montgomery Investment Management, Inc. and Sole Member of Koonce Securities, LLC James F. Lafond, CPA Retired Executive; formerly Washington Area Managing Partner, PricewaterhouseCoopers LLP John E. “Jack” Potter President/CEO, Metropolitan Washington Airports Authority, Former Postmaster General and CEO of the USPS Jack C. Stultz, Jr. Lieutenant General, USAR (Ret.) Operations Manager, Procter & Gamble Company (Ret.) Bonnie K. Wachtel Vice President and General Counsel, Wachtel & Co., Inc. VSE Board of Directors (left to right): Adm. Mark Ferguson, Gen. Jack Stultz, Calvin Koonce, Bonnie Wachtel, Mo Gauthier (CEO), Cliff Kendall (Chairman), Jim Lafond, Gen. Ralph Eberhart, Jack Potter. 6 2017 VSE Annual Report and Form 10-KAbout VSE VSE Corporation was established in 1959 with a mission to provide engineering and technical support services to reduce the cost and improve the reliability of DoD systems and equipment. Originally incorporated as Value Engineering Company, VSE has evolved to serve our customers’ asset, systems improvement, service life extension, and sustainment needs. VSE conducts business operations through the parent company and its wholly owned subsidiaries, including Wheeler Bros., Inc. (which includes Ultra Seating), VSE Aviation, Inc. (which includes Prime Turbines, CT Aerospace, Kansas Aviation, Air Parts & Supply Co., and VSE Aviation Singapore), Akimeka LLC and Energetics Incorporated. Today, VSE is a broadly diversified company focused on creating, sustaining, and improving the systems, equipment, and processes of our federal and commercial customers through core competencies in fleet sustainment, supply chain management, maintenance, repair and overhaul (MRO), legacy systems sustainment, obsolescence management, prototyping, reverse engineering, technology insertion, foreign military sales, management consulting, information technology and process improvement.    VSE’s strength lies in the talented professionals who support our customers in maintaining and modernizing products, equipment, and systems. Our nationwide network of local offices provides access to a spectrum of corporate resources and services in diversified engineering, logistics, management, and information technology disciplines. We combine their individual skills, experience, and motivation with corporate resources, technology, teamwork, and the management principles of integrity, honesty, and self-governance to deliver high quality, cost-effective solutions to a global customer base. VSE is a publicly traded (NASDAQ:VSEC) supply chain management and professional services company, and maintains an ISO 9001:2015-registered Quality Management System. VSE’s subsidiary, Wheeler Bros., Inc. has received seven U.S. Postal Service Supplier Performance Awards. VSE has been ranked among the top 100 defense contractors, top 10 foreign military sales contractors, and top 50 Navy contractors in the nation. NASDAQ: VSEC ISO 9001:2015 Corporate Supporter: Yellow Ribbon Fund 7 INTEGRITY • AGILITY • VALUELocations VSE Corporation Headquarters 6348 Walker Lane Alexandria, VA 22310 (703) 960-4600 or Toll-free: (800) 455-4873 Texarkana, Arkansas Durham, North Carolina Mesa, Arizona Fort Bragg, North Carolina Barstow, California Whitesboro, New York Chula Vista, California Butler, Pennsylvania Fort Hunter Liggett, California N. Charleston, South Carolina Subsidiary Headquarters Washington, D.C. MacDill AFB, Florida El Paso, Texas Fort Bliss, Texas Wheeler Bros., Inc. Somerset, Pennsylvania Energetics Incorporated Columbia, Maryland Akimeka, LLC Maitland, Florida VSE Aviation, Inc. Carrollton, Texas Miami, Florida Fort Sam Houston, Texas College Park, Georgia Gatesville, Texas Fort Benning, Georgia Grand Prairie, Texas Kihei, Hawaii San Antonio, Texas Independence, Kansas Texarkana, Texas Baltimore, Maryland Chesapeake, Virginia Other United States Locations Bethesda, Maryland Falls Church, Virginia Fort Chaffee, Arkansas Little Rock, Arkansas Fort Detrick, Maryland Ladysmith, Virginia Indian Head, Maryland Rosslyn, Virginia North Little Rock, Arkansas Sterling Heights, Michigan VSE’s management team celebrates 35 years as a NASDAQ listed company by ringing the trade day closing bell on October 23, 2017. 8 2017 VSE Annual Report and Form 10-KUNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2017 Commission File Number: 0 3676 VSE CORPORATION (Exact Name of Registrant as Specified in its Charter) DELAWARE (State or Other Jurisdiction of Incorporation or Organization) 54-0649263 (I.R.S. Employer Identification No.) 6348 Walker Lane Alexandria, Virginia (Address of Principal Executive Offices) 22310 (Zip Code) www.vsecorp.com (Webpage) Registrant's Telephone Number, Including Area Code: (703) 960-4600 Securities registered pursuant to Section 12(b) of the Act: Title of each class Common Stock, par value $.05 per share Name of each exchange on which registered The NASDAQ Global Select Market Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [x] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [x] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [x] Non-accelerated filer [ ] Smaller reporting company [ ] If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transaction period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Yes [ ] No [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [x] The aggregate approximately Market as of that date. value market $384 million of based outstanding last the on voting reported stock sales held price by of the non-affiliates registrant's of the common Registrant stock as The on June 30, of NASDAQ 2017, was Select Global Number of shares of Common Stock outstanding as of February 27, 2018: 10,849,947. DOCUMENTS INCORPORATED BY REFERENCE Portions are of incorporated Registrant's herein definitive by reference proxy into statement Part III for of this the Annual report. Meeting of Stockholders expected to be held on April 30, 2018, -2- TABLE OF CONTENTS Business Risk Factors Unresolved Staff Comments Properties Legal Proceedings Mine Safety Disclosures Executive Officers of Registrant Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures About Market Risks Financial Statements and Supplementary Data Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Controls and Procedures Other Information Directors, Executive Officers and Corporate Governance Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Certain Relationships and Related Transactions, and Director Independence Principal Accountant Fees and Services PART I ITEM 1 ITEM 1A ITEM 1B ITEM 2 ITEM 3 ITEM 4 ITEM 4(a) PART II ITEM 5 ITEM 6 ITEM 7 ITEM 7A ITEM 8 ITEM 9 ITEM 9A ITEM 9B PART III ITEM 10 ITEM 11 ITEM 12 ITEM 13 ITEM 14 PART IV ITEM 15 Exhibits and Financial Statement Schedules Signatures Exhibits Page 5 8 10 11 11 12 12 14 17 18 29 30 53 53 56 56 56 56 56 56 56 57 58 -3- Forward Looking Statements This constitute harbor actual forward Item and to place Company or occur from files Company Annual Report "forward on Form looking provided protection VSE Corporation looking 7 undue statements "Management's on reliance arise no date undertakes the after time to time to subsequent with this "Company," in this and filing, Analysis "us," see of ("Form 10-K statements" by ("VSE," applicable the contained Discussion these obligation hereof. the Form forward to Readers Securities 10-K 10-K") contains under federal securities laws. statements laws. that, All discussions "we") or VSE's securities For "our," below Financial Condition reflect the extent statements to such identifying to differ results Description "Narrative of Results and management's statements factors looking risk the including 8-K Form Quarterly the by filed are are they not intended important from Business" some materially of Operations." analysis only reflect to in described Reports Company. other on recitations be to factors those (Items fact, historical of safe the to subject cause that could the in anticipated 1A, 3), and 2 not cautioned Readers The the of hereof. as that circumstances or events Company the the by documents Form 1, are date 10-Q filed looking publicly should and and any which forward statements, these revise also carefully Exchange Current review Commission, Reports on -4- PART I ITEM 1. Business (a) General Background chain management diversified a improving for services including are We life, and distribution "government"), civilian supply agencies, chain and management and aviation, fleet, vehicle environmental service and (the federal include for and services; services and the legacy the performance systems United commercial supply of and States and solutions, clients; health parts vehicle IT care other and IT other their equipment transportation and Department customers. and equipment supply and solutions; company equipment, and ("DoD"), customers assists that and other technical the are maintenance, professional Defense of largest Our distribution, in clients systems. and to the States and United Postal the our assets services United DoD the repair, and overhaul and sustaining, We USPS. provide extending the logistics Government ("USPS"), operations services energy States Service Our (“MRO”) engineering; maintenance refurbishment; logistics; and consulting and services. VSE our our The as entity for perform Group. only VSE was operating incorporated groups, services. term the "VSE" parent VSE’s or company. Delaware which groups in each of operating "Company" in 1959 consists include VSE and of our and means parent the one or Supply its more Chain subsidiaries serves company wholly owned Management and divisions a centralized or as subsidiaries Group, Aviation the managing and unincorporated Group, and indicates context consolidating that divisions Services of operations Federal unless (b) Financial Information Our Management, of our financial and Results operations which in are generated and our Operations” 2017; for information revenues of conducted within approximately Federal (3) three 28.2% Services, reportable Item in and segments 8 "Financial appears reportable revenues of our generated which 7 Item in and Statements segments in approximately aligned (2) 2017; with Aviation, our operating groups: which of and this 54.1% Discussion of Data” our generated revenues of 10-K. Analysis Form (1) Supply approximately in 2017. Financial Chain 17.7% Additional Condition "Management’s Supplementary (c) Description of Business Products and Services We a apply equipment core solutions, through IT broad and offerings health of array processes. in care and capabilities creating on focus We management, chain supply services. consulting and IT, resources value to by MRO, systems, assets provide support our sustaining equipment clients’ life the transportation improving and refurbishment, assets, the logistics vehicle performance and fleets, of engineering. aircraft, client also We our Typical supply support offerings and include distribution; military management support cycle supply MRO vehicles; support; for for logistics ships; life modernization electric grid continuity, assurance/business Item 7 regarding control. See information “Management’s business. and more power our and and chain of aircraft military machinery ship inventory engines equipment condition communication projects; risk security management engine refurbishment analysis; systems; technology management, and services; components; and specification energy road-mapping; network of and Analysis Discussion parts fleet engineering support; training; crew supply, and information command for below vehicle aircraft fleet engine ship modification; conservation, preparation for energy enterprise IT services; Financial Condition sustainment programs; and follow-on supply and alterations; parts MRO ship efficiency, sustainable ship’s vehicle distribution; technical force energy development, and medical Operations” architecture logistics; of Results medical and Revenues and Contracts Our products our arrangements. revenues and professional derived and from the technical delivery services are of products and through various from ordering contract services and performed negotiated for and our clients. competitive We offer contract agreements Our commercial Supply Chain We Management recognize Group revenue revenues from the result of sale from vehicle the sale parts of when vehicle the to parts customer the takes USPS and ownership other of government parts. the clients. and -5- Our commercial upon the Aviation Group revenues result aircraft shipment owners, or delivery other of aviation products MRO to from the providers, sale of and based aircraft aviation when on parts original or title customers and performance of MRO equipment loss of risk manufacturers. the transfers to for recognize services We customer. private and revenues Federal contracts Our fixed-price work or from are contracts on basis the performance performed depending performed, recorded Group Services with our allowable labor revenues the government. subcontractors, are costs worked losses hours or billing the and service units Profits defined the over unit work the as by performed as recorded allowable of the on the and the on typically a on contract. contract of nature ratably price result Revenues and from incurred and multiplied and these on rates time for contract period. are delivered. based per from from primarily result costs fees by the material of are cost work materials earned. contract contracts plus fixed performed used in Revenues defined result cost fee, on these performing time and rates, plus own time fee, by our Revenues contracts award contracts work. the materials the cost between plus of the fixed-price and on are materials, employees, cost type recorded used in services vary is are items work materials cost of contracts as difference methods on contracts fixed-price contracts service that require are delivery recorded of specific for billing from the recognition services. Revenue on Revenues on fixed-price terms. Revenues The commercial USPS, U.S. entities. and Navy, and U.S. Army are our largest customers. Our customers also include various other government Customer U.S. Postal Service 2017 % 2016 % 2015 % $ 180,205 23.7 $ 181,215 26.2 $ 184,876 Revenues by Customer (dollars in thousands) Years ended December 31, U.S. Navy U.S. Army U.S. Air Force Total - DoD Commercial Aviation Other Commercial Total - Commercial 206,644 188,462 7,123 402,229 126,960 12,498 139,458 27.2 24.8 0.9 52.9 16.7 1.7 18.4 190,155 139,764 3,482 333,401 131,067 10,721 141,788 27.5 20.2 0.5 48.2 19.0 1.5 20.5 98,887 80,086 3,558 182,531 119,729 4,653 124,382 Other Civilian Agencies 38,221 5.0 35,386 5.1 42,193 34.6 18.5 15.0 0.7 34.2 22.4 0.9 23.3 7.9 Total Backlog $ 760,113 100.0 $ 691,790 100.0 $ 533,982 100.0 Funded backlog represents a measure of potential future revenues from work performed by our Federal Services Group on government contracts. Funded backlog is defined by us as the total value of contracts that has been appropriated and funded by the procuring agencies, less the amount of revenues that have already been recognized on such contracts. Our reported backlog is comprised of funding received by us in incremental amounts for work that is generally expected to be completed within six to 12 months following the award of the funding. Our funded backlog for our Federal Services Group as of December 31, 2017, was approximately $324 million and as of December 31, 2016 and 2015 it was approximately $322 million and $238 million, respectively. Changes in funded backlog on contracts are sometimes unpredictable due to uncertainties associated with changing government program priorities and availability of funds, which is heavily dependent upon the congressional authorization and appropriation process. Delays in this process may temporarily diminish the availability of funds for ongoing and planned work. In addition to funded backlog levels, we have contract ceiling amounts available for use on multiple award, indefinite delivery, indefinite quantity contracts with DoD and federal civilian agencies. While these contracts increase the opportunities available for us to pursue future work, the actual amount of future work is indeterminate until task orders are placed on the contracts. Frequently, these task orders are competitively awarded. Additionally, these task orders must be funded by the procuring agencies before we can perform work and begin generating revenues. -6- Marketing Our professional programs, and calls in our new sales participation trade are conducted marketing activities sales of staff requirements client professional representatives, and servicing, opportunities through organizations, at the managers, become by level group operating other and available key contract personnel. through business our New attendance partners, performance, marketing customer at through and with of from and contacts trade business and shows development information and informal published staff and concerning through from government, events, briefings, by formal and literature industry in organizations negotiation the and course commercial entities. associations, professional Personnel Our employees our clients. December 31, logisticians, (c) environmental configuration, government of Some have 2016. have a levels high Principal and warehouse services, change and regulations and data and education. of variety of employee sales (e) management procedures. personnel, information experience, specialized December 31, of include (a) engineers As categories (d) technology The training, 2017, mechanics and and we and technicians in required professionals expertise disciplines. that skills had 2,306 vehicle, in computer our by the provide employees, and aircraft, expertise a decrease equipment mechanical, electronic, systems, applications customers frequently to 2,523 service required of from as technicians, (b) and energy products, knowledge industrial, and includes We Forces. These Approximately actively efforts 30% seek include our of initiatives an and emphasis employees have participate hiring previously on outreach in military programs veterans, to which in assist we the individuals believe U.S. Armed who enhances have the Forces. served quality in of the our Armed U.S. workforce. served as members Competition The supply contracted environments. federally operating chain, professional logistics, and and MRO technical services services offered offered by by our Supply Federal Chain Services Management Group are our and Aviation conducted in very groups and the competitive The competitors that compete for our customer base. vehicle parts aftermarket and aviation parts and servicing markets are fragmented, with many large and small firms with greater contracting us. by sole Large the source diversified services same or other awarded level government work of we services federal offered noncompetitive competitive a on may we work of can agencies, also small for business will offer providing to a either regarding certain reallocation or initially the cause the basis. basis agencies Government the Most of been have or of some under competition programs competition. these in that affect set-aside increased obtain significant renewed contracts. business. in our results financial emphasize contracts least at staffs are basis competitive larger on technical a resources awarding under on and contracts which a once Government A lower reallocation levels currently basis. in we competitive and budgets, government of business potential capable as services perform is There no the particular of opposed were assurance of budgets priorities or serve we spending the markets of in competition of The requirements customer been extent or knowledge, heavily more technological technical in weighted we that developments financial and years. recent as encounter a unpredictable. will is qualifications, past result We changing of believe the performance, principal government or competitive budgetary competitive factors stress, conditions, our for price, and customer are has business which economic Available Information of 8-K Copies and pursuant available filed our amendments Section to free of with Form (“SEC”) are also electronically the publicly to 13(a) charge available those or through SEC. reports 15(d) Annual are of our the website Reports with filed Securities on or 10-K, Form otherwise Exchange www.vsecorp.com Quarterly furnished of soon to 1934, as Act as on Securities Reports the as reasonably amended. Form 10-Q, Current and Such Exchange and reports practicable after the Reports on Commission amendments are reports -7- ITEM 1A. Risk Factors future Our in this important Form factors may results 10-K due disclosed contained other differ to various previously materially from uncertainties and from past and time results risks, time to and from including our in those those projected set filed in forth with risks reports the below, the other SEC. forward-looking non-recurring statements and events Uncertain our affect in result budgets government ability loss to of continue on work and work current shifting under our programs our government priorities could delay contract awards and funding government small to contracts. business set-asides Additionally, and large federal procurement award contracts. multiple and directives adversely could Our government in-sourcing, procurement environment have continue experienced existing business extensions, is delays work to funding delays, moratoriums and awards subject is and unpredictable contract in to and contracts associated could and expiring with adversely funding work. extensions replace or pursuant contracts contract to for set-aside very large on (including terminations the our affect contracts our our Additionally, be may diverted administered programs These the at budgeting government’s to perform ability in recent government the by the by can risks businesses. government's and work that business convenience), The process. contracting existing new and affected adversely risk the to subject or small a to Administration, or effect adverse under have is agency Business have an contracting Small potentially years our of potential minority-owned into growth multiple profit large and business award margins. reductions, federal contracts. ability our that or one disadvantaged be may our on We to more or bundled revenue Increased contracting market award competition criteria could resulting from adversely affect decreases our in ability government sustain to our revenue for levels. spending contract services and government Pressure on government that affect contractors we contracts experience increase work delay This continue can which lowest emphasizes budgets a in that or price, adversely may loss of competition currently the government for our performed contract is reverse technically to to has expiring work of the tended work offerings service under by us Additionally, awards. bids, acceptable flow have perform. to awards, further which that contract criteria federal redirect adversely contractors, their affected particularly efforts ability marketing our Unsuccessful has competition new toward to win bidders programs. types the new work frequently contract used government frequently our in the government intensifies contracts. Competitor work of that or successor protest award markets. Certain to revenue programs growth comprise and a sustainability material portion profit revenue. our of margins. Our work on large government programs presents a risk and The eventual large expiration profits. fixed of Such corporate our and revenues of the inventory reduce portion a larger managed USPS material constitute a if disruptions requirements enough of types to parts customer associated material purchased cause portion program our of operational these with in changes USPS the by revenue costs (“MIP”) revenues. decisions, key our in government losses previously our and could programs also allocated foreign concentration This government recent In revenue years have programs. overall recent levels program the or of our on expiring or erode to military loss profits the sales our contractual, years, and caused revenue other or revenue levels affect changes our in of profit our have on that disruption revenues of programs remaining or programs U.S. the with subjects to us prevent issues FMS for discontinued Navy of risk delay or Program a single would contract contract to work. Program”) adverse fulfillment fluctuated in may absorb Our each revenue work of widely and volume (“FMS material the have variations our margins. Similarly, profit margins. the in roll the out fleet USPS The of new a could initiated a has the fleet and have potentially fleet retirement a replacement the of affect significant program current on for vehicles future generation next and their revenues decision and the on profits. our of a delivery how vehicle of many fleet. The vehicles timing will of both remain such Global economic conditions and political factors could adversely affect our revenues. Revenues these our in by from our countries employees domestic Significant fluctuating in on it have of continuation a will conditions performed country. resulting effect the the upon level our ongoing government to and political FMS our on political and of services FMS programs risks Program unrest in performed for posed to are, client by which by certain a countries our Regime revenues. Program is work ongoing performed foreign extent, can dependent to subject in conflicts on ability predict countries foreign and our to when can countries potential placement maintain these in employees are terrorist of consistent conditions government economic Services client a in levels, staffing occur or will restrictions activity. result our cannot constrain We in these employees. changes work. -8- Economic could commodities conditions potentially in have both an United the adverse States on effect and the foreign demand countries, some for and of global prices our services, and including availability our of aviation oil and other services. Due to the nature of our work we could potentially be exposed to legal actions arising from our operations. Our repairing and and engines materials. performance events could below.) includes and work military engine accessories many manual non-military tasks, vehicles including and aviation challenges or losses employee and for pose general certain incidents, financial warehousing, equipment, and jet that aircraft. could Some cause misconduct affect adversely and shipping and maintaining work our of exposed to be result in financial us that our of packing overhauling efforts to legal truck parts U.S. involve and or Item Navy the other death 3. injury (See inventory, ships. handling liabilities to third "Legal maintaining also repair We hazardous of from arising parties. Such Proceedings” damages, condition. These services work to us issues, cause may related suffer Technology security and cyber attack risks could potentially impact our financial results. We face the threat organized clients' our cyber-attacks proprietary to and or our other classified information. computer security systems problems of unauthorized system and access, disruptions, computer hackers, computer viruses, malicious including possible unauthorized access to our code, and Some Administration there a is damages maintenance with conflict programs. security third to and the of and management work breach contract our military of related medical sensitive to services parties training international includes health and data our in security to support data records. custody and international be could breach such support we clients and us we to directly exposes which costs This or for incur clients motivated to technology to certain provide services information we services, prevent and conduct future through a incidents. DoD. cyber-attack associated and could We Foreign to with technology possibly also Security Social If risks. security held be for liable refurbishment, provide that these with information interests nations access on Costs effect associated on our with preventing expenditures, an such adverse remediating or or earnings, effect. capital have could potentially adverse event information management competitive position. However, security the breaches of occurrence have a not future a had security material breach Acquisitions, which have been a part of our business strategy in recent years, present certain risks. The ineffective an acquisition integration could acquisition of of an adversely a business acquisition, affect that our subsequently inability does service performance. financial not debt to our expected meet associated operating and with an acquisition, financial the or performance to failure timely targets, the complete nature The of management. our operations and work performed by our employees present certain challenges related to work force Our skills, of skill technical diversity staff and compliance. compliance, or attract can result regulatory contract sets. Our local an and We current laws adequately work, and retain in noncompliance. lost financial performance is heavily operating types, also performance, nature face work, challenges of on dependent cost locations, with pricing, work associated abilities the management, legal and our quality countries of safety, and of exposes projected customs, skilled in work workforce workforce, margins, foreign issues, lack of losses reduced profit extended knowledge cost supply or overruns, from administrative and operating our and regulatory workforce, to political critical in performance us chain, training and administrative staff compliance our and export threats. challenges safety, with zone inadequate workplace to respect with efforts. wide A administrative relations labor ethics to levels and staffing accidents, and Failure of work, associated war unrest and functions, or deficiencies, complexities quality challenges business Our significant could financial be liability on us. adversely affected by incidents that could cause an interruption in our operations or impose a Disruption third and our of parties condition. or operations in working fire, flood, A procurement a due high-risk to or internal locations, or contractual earthquake, or external or other natural system operations, employees or performance generating system or disasters service other or at disaster failures, crises physical natural interrupt accidents or adversely that revenues incidents our affect support key from involving financial revenue operations. could facilities the our delay could potentially -9- We are subject to numerous government rules and regulations that could expose us to potential liabilities or work loss. We government or contracts must contracts. debarment are and with violation A from of working laws or affected or by laws regulations on and could government regulations relating the in result contracts. the to imposition bidding comply award, fines of administration penalties and and the or performance termination of of In to favorable government some the may instances, government terminate these than government those government any typically contract regulations laws available or and to subcontract commercial at its impose in parties convenience, terms negotiated as well as or are that transactions. for significantly For performance example, default. rights more the contract termination and A contracts In services future work. of addition, the provided for orders. default A government as by could termination could us a subcontractor. expose for terminate us default a to could prime liability also contract and impact have our under material a past which effect adverse performance are on ability subcontractor, and we ability to our new to irrespective obtain a compete or of for additional quality the our financial Additionally, and other contract If risks. our problems, that work any of ability is our to requirements or compliance by our performed subcontractors our fail obligations subcontractors timely a to as prime is meet subject their contractor fulfill to government compliance, performance regulatory or have contractual may be obligations jeopardized. The agencies in established the FAA adopted and in aviation industry other the by countries. FAA equivalent future or the agencies could that the engines highly is Aviation equivalent of have certain an regulated and agencies other adverse the by engine in certain to us. countries on effect Federal U.S. components Aviation we that We countries. Administration must sell meet operate also and New services. such other perform ("FAA") certain and similar airworthiness that are regulations regulatory standards by be licensed may repair more facilities stringent Our business could be adversely affected by government audits or investigations. Government agencies, including the Defense agencies and review standards. contractors. laws, control These regulations systems Any must applicable its internal information already penalties government with with, management costs such any criminal and fines investigate compliance compliance and and civil payments, to our with reputation Foreign and if Corrupt systems. reimbursed and suspension allegations and costs be administrative debarment or impropriety of and Act Practices the Export from were policies, found refunded. sanctions, doing made. Control Audit contractor’s government Contract a The the including improperly be to audit an If including business with the of compliance. Performance Act Agency and the performance also contractor’s Department its under adequacy allocated may review purchasing, to a improper of government. international specific illegal or contracts, In work addition, can the property, and audit routinely of Labor, and structure cost contracts, a contractor’s of, and compensation estimating, reimbursed not will be to subject may we be suspension profits, of harm suffer serious associated to contract activities, of could us forfeiture we expose risks uncovers termination Investments in facilities could cause losses if certain work is disrupted or discontinued. We service have offerings. made A below intended and operating facilities investments or slowing could levels in disruption cause us and of these business to suffer financial to programs, losses. lease commitments support work specific requirements, business or programs, service work offerings requirements, in results that Environmental and pollution risks could potentially impact our financial results. our contract vehicles, work aircraft Some of refurbish with protection repair, and associated the to position. future compliance the of we However, or environmental with environment cannot pollution predict event. of includes the engines, and State and a had not likelihood use equipment. local material such of chemical This provisions adverse a and solvents exposes us regulating on effect adverse material Federal, have the the to the our certain environmental discharge capital of expenditures, hazardous and or materials materials pollution that to risks. otherwise maintain, Costs relate competitive a or occurrence of earnings, the effect should we experience handling of ITEM 1B. Unresolved Staff Comments None. -10- ITEM 2. Properties Our executive 95,000 and square administrative feet office of headquarters by leased space are us located through in a April five-story 2027. building in Alexandria, Virginia, with approximately We Chain own facilities Management of feet square Supply 271,000 located Group. in an These industrial properties and park in consist warehouse Somerset, of space. office, engineering, Pennsylvania 30 acres that of we land use and to conduct buildings the totaling operations our approximately of approximately We of Florida. in space own two approximately own We Independence, properties one and we that acre of operate use land a Kansas conduct to and a property that located is building consisting of operations our approximately with with building a of municipal leased Group. square Aviation 14,000 approximately land. airport the on consisting Miami, in office and feet We of 30,500 own and warehouse square operate and of feet property a office space warehouse and We own storage multiple and land 30 consists of acres of Texarkana, properties 114,000 We feet. maintenance. in square two operate vehicle and land and Arkansas use these facilities in Ladysmith, maintenance buildings buildings consisting totaling an of primarily properties aggregate to Virginia. totaling approximately of provide of these One approximately square 13,500 16 consists properties 56,000 of feet of land services square space. and for of feet We of also buildings military acres refurbishment approximately approximately space. The and own totaling equipment, 44 other acres of property operate two approximately and storage and also We sites to facilities services the of provide facilitate with at United services communications a total customer States, products and approximately limiting foreign at of facilities, generally from enhance 319,000 our shipyards program square requirement facilities customer 19 such provide outside generally short-term under occupied As of shop, December and 31, 2017, warehouse also We provide leases we space. located primarily leased Our services near approximately often locations employees from performance. of feet office, additional for space. or U.S. military installations. ITEM 3. Legal Proceedings Hawaii Litigation of 2012, In other individuals vendor of insurance financial estates the and entities in April retained we or carriers, condition, individuals 2011 was VSE by settled cash a for caused to this flows. five deceased individuals and their unspecified by dispose matter damages, of fireworks all negligence of with plaintiffs filed relatives the that the other explosives in resulting complaints explosion of defendants. by seized material no alleging and other 2017, in state a fireworks five The federal the adverse VSE and in in diesel court and deceased Hawaii fuel plaintiffs against that killed government. on our effect were Together of results and VSE the five employees our with operations, Aviation Litigation In by LLC, named that on VSE's Plaintiffs together predicted lawsuit Arrieta et al plaintiffs defendants. 2016, November Arrieta, Edgar three and defendants April subsidiaries a and other are 2016, lawsuit, four other unrelated Pratt a were & plane 1, Whitney crashed in relief negligent monetary are with with having seeking its certainty material a insurance carrier, and the adverse will amount effect was et al, Kansas filed, Prime Turbines VSE the vs. against LLC subsidiaries, was lawsuit Since Cessna Corporation, Canada three in of death the service maintenance, the from million five Aircraft plaintiffs and defendants. proceedings. the reasonably cannot be financial operation, of resulting providing $1.0 over aggressively loss, of our on if results Texas Court District Independence, joined of L.L.C. the have Inc. Woodward six other engine for legal to airplane scheduled the of plaintiffs and in filed Aviation other Company and serious inspection of The trial the While estimated, or condition, injuries the is results we cash of believe flows that is any, of defend the remote. The Dallas in and Prime lawsuit. County, Turbines other The allege plaintiffs that crash. VSE be this cannot of the 2018. and plaintiffs prior to November proceedings likelihood addition In legal adverse cannot the to proceedings, effect be our on predicted above-referenced us against results with and of certainty, against operations, the Aviation amount we Litigation, In our parties. position, any, if have may opinion, or cash cannot certain the flows. be loss, of financial other claims resolution However, reasonably the in of these because estimated. normal other the course claims results of will of business, have not including material a proceedings any legal -11- time-to-time, for contractual other from conducted Further, applicable or imposed being years often take of outcome any position, financial upon to such or us, complete government flows. cash whether investigate and reasons, could or and government agencies regulatory requirements. in could result or suspension to lead no in adverse result many investigations and administrative, debarment action will Government civil operations us, of our investigations liabilities, criminal or government future from We us. against believe, material a have not disputes being are whether including contracting. upon based effect adverse conducted in accordance relating to repayments, government or fines Government current our on information, results with contracts penalties investigations that the operations, of ITEM 4. Mine Safety Disclosures Not applicable. ITEM 4(a). Executive Officers of Registrant officers Our family meeting elected executive relationships VSE's of have and among Board of qualified, listed any of Directors until or below, our (the death, well as executive "Board") resignation as officers. following or information The the removal, are is no first are executive annual next whichever their officers meeting is age are of sooner. concerning and positions appointed stockholders VSE. held annually and with to until serve their There until the successors Name Joseph R. Brown Maurice A. Gauthier Paul W. Goffredi Thomas M. Kiernan Thomas R. Loftus Chad Wheeler Age 61 70 60 50 62 43 with Registrant Position President, Federal Services Group Director, Chief Executive Officer, President and Chief Operating Officer President, VSE's subsidiary VSE Aviation, Inc. Vice President, General Counsel and Secretary Executive Vice President and Chief Financial Officer President, VSE's subsidiary Wheeler Bros., Inc. Mr. Brown was appointed the President of the Federal Services Group in May 2015. Mr. Brown brings over 20 years of experience as a program and business unit manager at VSE. Mr. Brown leads a team whose primary focus is refurbishment services to extend and enhance the life of existing vehicles and equipment, fleet-wide ship and aircraft support, aircraft sustainment and maintenance, foreign military sales and other technical, management, engineering, logistics, maintenance, configuration management, prototyping, technology, and field support services to the U.S. Navy and Marine Corps, U.S. Army and Army Reserve, U.S. Air Force, and other U.S. and foreign military customers. Prior to joining VSE in 1996, Mr. Brown served 20 years active duty in the U.S. Navy. He earned a Bachelor of Business Administration from University of Maryland University College and an Associate of Science in Mechanical Engineering from the University of Tennessee at Knoxville. Mr. Gauthier has served as VSE's Chief Executive Officer, President and Chief Operating Officer since April 2008, and has served as a Board member since February 2009. Mr. Goffredi has served as President and Chief Operating Officer of our subsidiary VSE Aviation, Inc. since January 2015, when VSE Aviation, Inc. acquired Prime Turbines LLC (including both U.S. and Germany-based operations), CT Aerospace LLC, Kansas Aviation of Independence, L.L.C. and Air Parts & Supply Co. (collectively, "the Aviation Acquisition"). His focus and background includes business development, strategic OEM and major customer relations, supply chain management, engine and material acquisition, and operational excellence and improvement. Prior to joining VSE, Mr. Goffredi served for three years as Chief Operating Officer for Killick Aerospace, and 13 years with BBA Aviation as Program Director for all Honeywell Engine Programs. Mr. Goffredi received a degree in Business Administration from Mesa State College (Colorado) and holds an MBA in Marketing and Finance from The University of St. Thomas (Texas). Mr. Kiernan has served as VSE's Vice President, General Counsel and Secretary since November 2008. Mr. Loftus has served as VSE's Chief Financial Officer and Executive Vice President since March 2002. Mr. Loftus has served in various roles of increasing responsibility at VSE since 1978, and served as VSE's Comptroller, Senior Vice President and Corporate Tax Director from March 1999 to February 2002. Mr. Wheeler has served as President and Chief Operating Officer of Wheeler Bros., Inc. ("WBI") since July 2013. Since 1991, Mr. Wheeler has served in various roles at WBI, including Senior Vice President of Operations, Senior Vice President of Sales and Marketing, and Marketing and Sales Manager. While serving as Marketing and Sales Manager, Mr. Wheeler coordinated -12- implementation country. of Wheeler Mr. WBI's Managed graduated Inventory cum Program laude from which is Indiana summa used the at University USPS' of Vehicle Pennsylvania Maintenance 1998 in with Facilities degree a throughout in the Marketing. -13- PART II ITEM 5. Market for Securities Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity (a) Market Information VSE common stock, par value $0.05 per share, is traded on The NASDAQ Global Select Market, trading symbol, "VSEC," Newspaper listing, "VSE." In Stock May Split The amounts Stock the have Split. our 2016, a had record adjusted been Board date to approved July of retroactive give a 20, two-for-one and 2016 effect stock the to split distribution increased stock effected in the occurred of number on shares form stock a of August 3, of common 2016. dividend All stock ("Stock share per and outstanding Split"). share to due The Select years. following Market) Sales table and prices cash and the forth dividend cash per dividend sets of share per and high information low for information sales our have (based price common been on stock adjusted information each for the for quarter Stock reported and Split. share range Global two last by The annually NASDAQ the during Quarter Ended High Low Dividends $ For the Year $ $ For the Year $ 35.60 35.98 38.23 42.69 42.69 42.18 45.93 58.70 59.90 59.90 $ $ $ $ 26.38 30.86 29.94 26.16 26.16 34.98 38.90 41.95 45.12 34.98 $ $ $ $ 0.055 0.060 0.060 0.060 0.235 0.060 0.070 0.070 0.070 0.270 2016: March 31 June 30 September 30 December 31 2017: March 31 June 30 September 30 December 31 (b) Holders As of February 1, 2018, VSE common stock, par value $0.05 per share, was held by approximately 241 stockholders of record. The number of stockholders of record is not representative of the number of beneficial holders because many of VSE's shares are held by depositories, brokers or nominees. (c) Dividends Pursuant to our bank loan agreement (see Note 7, Debt, of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K), the payment of cash dividends is subject to annual rate restrictions. We have paid cash dividends each year since 1973 and have increased our dividend each year since 2004. (d) Certain Sales and Repurchases of VSE Common Stock During the fiscal year covered by this Form 10-K, VSE did not sell any of its equity securities that were not registered under the Securities Act of 1933, as amended. During the fourth quarter of the fiscal year covered by this Form 10-K, no purchases of equity securities of VSE were made by or on behalf of VSE or any "affiliated purchaser" (as defined in Exchange Act Rule 10b-18 (a)(3)) other than 12,473 shares of our restricted common stock that were voluntarily forfeited to VSE by participants in its 2006 Restricted Stock Plan to cover their personal tax liability for restricted stock awards. -14- (e) Equity Compensation Plan Information We have two compensation plans approved by our stockholders under which our equity securities are authorized for issuance to employees and directors: (i) the VSE Corporation 2004 Non-Employee Directors Stock Plan and (ii) the VSE Corporation 2006 Restricted Stock Plan. As of December 31, 2017, 132,357 shares of VSE common stock were available for future issuance under the VSE Corporation 2004 Non-Employee Directors Stock Plan and 436,532 shares of VSE common stock were available for future issuance under the VSE Corporation 2006 Restricted Stock Plan. -15- Performance Graph below Set broad VSE forth market common (formerly (a) an SIC index with line is (The stock a NASDAQ traded is Code 8711). for The the for index. services stock graph comparing the cumulative Market) on Global The Select NASDAQ the Select on Accordingly, Global Select Global performance Market (U.S. graph NASDAQ total which return VSE Market, of VSE common our and compares companies) common is stock industry stock traded group with and is total Index") (a) a (b) a performance published and VSE peer index industry technical common group. engineering for our return (b) and cumulative the ("NASDAQ *$100 invested on 12/31/12 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Performance Graph Table VSE NASDAQ Composite Peer Group 2012 100 100 100 2013 197.84 141.63 152.19 -16- 2014 273.38 162.09 158.10 2015 259.75 173.33 173.87 2016 326.82 187.19 190.30 2017 410.02 242.29 211.15 ITEM 6. Selected Financial Data (in thousands, except per share data) Revenues Income from continuing operations Loss from discontinued operations Net income Basic earnings per share: Income from continuing operations Loss from discontinued operations Net income Diluted earnings per share: Income from continuing operations Loss from discontinued operations Net income Cash dividends per common share Working capital Total assets Long-term debt Long-term lease obligations Stockholders' equity 2017 760,113 39,096 — 39,096 3.61 — 3.61 3.60 — 3.60 0.270 2017 134,563 629,013 165,614 20,581 293,095 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ Years ended December 31, 2015 2014 2016 691,790 26,793 — 26,793 2.48 — 2.48 2.47 — 2.47 0.235 $ $ $ $ $ $ $ $ 533,982 24,918 — 24,918 2.32 — 2.32 2.31 — 2.31 0.215 $ $ $ $ $ $ $ $ 424,071 20,489 (1,124) 19,365 1.91 (0.10) 1.81 1.91 (0.10) 1.81 0.195 As of December 31, 2015 2014 2016 110,021 661,839 193,621 21,959 255,194 $ $ $ $ $ 100,780 617,354 215,243 23,251 229,309 $ $ $ $ $ 33,037 353,430 23,483 24,584 205,489 2013 471,638 23,990 (1,138) 22,852 2.25 (0.11) 2.14 2.25 (0.11) 2.14 0.175 2013 46,828 380,077 64,221 25,721 186,803 $ $ $ $ $ $ $ $ $ $ $ $ $ This consolidated summary of selected financial data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of this Form 10-K and with the Consolidated Financial Statements and related Notes included in Item 8 of this Form 10-K. The historical results set forth in this Item 6 are not necessarily indicative of VSE's future results of operations. -17- ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Executive Overview Customers and Services We are and life, distribution "government"), civilian supply diversified a improving for services including to agencies, chain aviation, and management and IT other and services; by customer. fleet, vehicle environmental revenues for management services and performance the systems legacy the United commercial solutions, clients; chain supply of and States and parts vehicle IT their equipment transportation and of Department other customers. and equipment and supply and solutions; health care service and (the federal include for and above company equipment, and ("DoD"), our assets services that assists other and technical United the the customers are repair, maintenance, clients and to States DoD in systems. the Postal the and overhaul United and professional Defense Our distribution, largest and maintenance and consulting services. See refurbishment; 1 Item “Business logistics; - Revenues sustaining, We Service USPS. States provide extending the logistics Government and operations services energy Contracts” ("USPS") Our (“MRO”) engineering; and Organization and Segments Our Management; Consulting operations 2) Group Aviation; our with are conducted within three 3) and Federal Federal Services. Services Group. reportable Beginning in segments we 2017, aligned have with our combined management IT, former our groups: Energy 1) and Supply Chain Management Supply transportation, of Operations fleets, truck and for source this support chain Chain shipping, group this DoD group the for Management data logistics, conducted are fleet with USPS is the vehicle USPS Group Our - management, wholly our by and management Managed Inventory fleet. other Supply and owned sustainment Chain services subsidiary Management assist to Wheeler and that solutions, ("MIP") Group our Bros., managed supplies provides with which inventory vehicle clients Inc., Program sourcing, supply acquisition, chain management USPS, supports services. and the The mission parts primary critical scheduling, efforts. commercial revenue supply Aviation aviation for general to a providers, diversified cargo Our - Group aircraft jet client of base transporters, and Aviation engines corporate and agricultural private clients. Group and engine provides parts accessories. aircraft supply This owners, and group distribution, offers supply of aviation a range airlines, regional chain solutions, complimentary and services MRO and aviation services supplies MRO manufacturers, and customers. Federal to and extend maintenance, technology, other (“FMS”) Services Benning Army programs Reserve for Program Program Logistics U.S. Services the enhance and other Group of life technical, - Our existing Federal vehicles Services and Group equipment, support field Significant work services surface for (“RRAD Support ships ERS”) Services refurbishment commands. Army vehicle engineering, Navy management, U.S. the for this leased to efforts sold, providing Program program group or on-site supporting and and include to logistics base granted various refurbishment services, support, aircraft management, sales aircraft configuration and in River Marine provides logistics, fleet-wide military foreign and ship maintenance, U.S. Army Corps, to the assistance countries, foreign for support operations and U.S. our River logistics Red and equipment Navy Red Army at U.S. Foreign Reserve, its Depot Texarkana, Army executing Army at Benning, Depot Fort Force, sustainment Air Military services and prototyping, and Sales Related Equipment Fort our Texas, and U.S. our sustainment refurbishment, maintenance Georgia, and vehicle Our with focus a Departments and system; Federal on of other medical Energy; Services and the government Group health Social also related Security and energy provides fields for Administration; commercial and various the clients. agencies environmental and DoD National consulting civilian of federal Institutes services agencies, solutions and IT including in and United military services States health the the Health; customers -18- Concentration of Revenues Source of Revenues USPS FMS Program Other Total Revenues Management Outlook (in thousands) Years ended December 31, 2017 180,205 185,556 394,352 760,113 $ $ % 2016 181,215 169,754 340,821 691,790 24 24 52 100 $ $ % 2015 184,876 76,476 272,630 533,982 26 25 49 100 $ $ % 35 14 51 100 We saw revenue growth in 2017 of 10% over 2016 revenues, which was up 30% over 2015 revenues. The improvement in our revenues were again led by our Federal Services Group for which revenues increased by 16%. Increased revenues from our Supply Chain Management Group also contributed to our revenue growth in 2017. We are pursuing initiatives in each of our groups to sustain our growth. Our 2017 Federal Services Group revenues increase resulted primarily from a full year of performance on our RRAD ERS Program as compared to a partial year of performance in its 2016 start-up year. Various smaller programs also contributed to revenue increases in this group. Our FMS Program remains the largest contributor to our Federal Services Group revenues and FMS Program revenues increased 9% over 2016. Our Federal Services Group revenues were supported by contract funding awards exceeding $400 million and funded contract backlog exceeding $300 million for the second consecutive year. However, funding activity has been clouded by federal government budget uncertainties in the fourth quarter of 2017 and early 2018. We are well positioned in our pursuit of opportunities to expand our services supporting our traditional government clients, and to capture new work for which our Federal Services Group can team with our Aviation Group to provide enhanced competencies to a wider range of government and international clients. Additionally, we have developed strong international business relationships through our decades of work with foreign client countries. We are extending these relationships to market our services to several international clients. Our vehicle parts supply and inventory management support for the USPS delivery vehicle fleet continues to provide steady revenues while increases in parts sales and supply chain and inventory management support services to our DoD and commercial clients have provided revenue growth in our Supply Chain Management Group. Sales from the Supply Chain Management Group to DoD increased 51% and revenue from commercial customers increased 25% in 2017 from the prior year. Our investment in resources and management efforts to diversify and expand our operational capacity, market channels, and client base has resulted in the capture and on-boarding of new commercial customers in 2017. Our commercial client base now includes companies in food distribution, oil field services, waste management, linen and uniform, commercial long haul shipping, bus transportation, and other clients that have vehicle fleets required to meet mission critical delivery or service schedules. We are also capturing new customers and increasing revenue using e-commerce solutions. We are in the beginning stages in our relationship with many of these new clients, and we look forward to further developing these relationships and adding new clients to grow our revenues from commercial markets. We continue to closely monitor the USPS delivery vehicle procurement efforts and are positioning ourselves to support both newly procured vehicles as they are placed in service and aging vehicles that remain in service. While it will likely be several years before the planned custom next-generation delivery vehicle is placed in service in significant numbers, the USPS has begun some shorter term annual vehicle acquisitions through the procurement of commercial of-the-shelf ("COTS") mass-market vehicles and the retirement of some of its aging COTS vehicles. While we cannot predict with certainty the impact of the USPS delivery vehicle procurement and retirement transition cycle on our future revenues, we believe that our years of service and knowledge of this client’s needs strategically position us to continue to serve as a key vehicle fleet sustainment partner. We will remain agile and support this client during its complex vehicle transition initiatives. We look forward to achieving results from our revenue enhancement initiatives in our Aviation Group in 2018. In conjunction with our Federal Services Group, we began extending our gas turbine MRO competency to maritime applications in 2017 and we are pursuing additional opportunities for this competency. We have also opened a Singapore office and signed an agreement with a key original equipment manufacturer that provides us the opportunity to expand our geographic distribution footprint and extend both current and new product lines to new markets. Revenues and operating income for our Aviation Group may experience fluctuations due to market demand and the mix of products sold. -19- 115-97, No. Public a resulted in our increased the lowering Law one-time net U.S. reduction income by corporate enacted our upon deferred in approximately rate income tax $10.6 from and the Tax passage tax of liabilities for 21% that 2017. Cuts lowered This effective million to 35% our a was January Jobs Act provision non-cash 2018. 1, Act") (the for event "Tax income for 2017 on taxes a as December and result 2017, 22, correspondingly Act Tax the of Entering on effect adverse 2018, our we results have of settled the operations, Hawaii financial Litigation, condition, as discussed cash or in flows. Item 3. "Legal Proceedings" above, with no material We amended reduced our our we strengthens bank loan our bank balance debt during agreement 2017 to enhances by extend our approximately maturity the and liquidity, $43 date on positions million our us bank to sheet, and our leverage debt better and support increase our declined. ratio the current has borrowing business January commitments. strategic and In 2018 This efforts. Bookings and Funded Backlog government Revenues and potential contract for bookings future backlog (“bookings”), indicator have of funded generally revenue. that While expires contract occur work when bookings or performed contract and de-obligated funded is by funding Federal our documentation backlog Services is generally and Group received. result does upon contract completion contract Funded in not revenue, generate depend contract on contract we funding backlog an is occasionally may revenue. 2016 and summary of our bookings and revenues for our Federal Services Group for the years ended A 2015, and funded contract backlog for this group as of December 31, 2017, December 31, 2017, 2016 and 2015 is as follows (in millions): 2017 2016 2015 $ $ $ 430 411 324 $ $ $ 458 353 322 $ $ $ 281 217 238 Bookings Revenues Funded Backlog 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 1 of the Notes to our Consolidated Financial Statements in this Form 10-K. Critical Accounting Policies Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and assumptions. We believe the following 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. Revenue Recognition Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee is fixed or determinable, and collection is probable. Substantially all of our Supply Chain Management Group revenues result from the sale of vehicle parts to clients. We recognize revenue from the sale of vehicle parts when the customer takes ownership of the parts. Sales returns and allowances are not significant. Our Aviation Group revenues are recognized upon the shipment or delivery of products to customers based on when title or risk of loss transfers to the customer. Sales returns and allowances are not significant. Substantially all of our Federal Services Group work is performed for our customers on a contract basis. 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. -20- Revenues is contract and is and the Program by the year of fee performance fee award and in the award notifications. that 2017 when contract are contract. recorded This cost-type on contracts fee plus a cost award activity. contract of level subsequent issued the to recognized years prior or became fees as contract are fees Award which in period award fee determinable. has made the revenue We that the allowable terms during is income award are specify through year Award performed. the period revenue incurred award a fee we and fees payments earned. that are modification occur contractual from 2017 fee contract evaluations received in income FMS determined authorizing times per notification award three in fee work and recognized fixed costs three Our and are we Revenue Revenues on recognition on fixed-price fixed-price methods service that contracts on contracts fixed-price are delivery require terms. Revenues contracts recorded of specific will as items vary is are work depending performed, recorded on the typically on a based the of ratably per and work the units over as the service are contract period. delivered. unit nature price Revenues for defined on contract performance performed by used of the in services and time billing the and contracts materials plus direct the Generally, defined rates, contract. the contract profits billing are costs recorded and on indirect and these on rates time for A years summary ended of revenues 31 December for the for is our presented operating below groups, (in including thousands). of burdens basis the cost materials contract allowable with from associated result labor materials the hours and difference worked subcontract the between multiplied work cost contracts services. a summary by contract type for our Federal Services Group, Contract Type Cost-type Fixed-price Time and materials Total Federal Services revenues Supply Chain Management and Aviation revenues 2017 Revenues $ 230,981 90,064 89,717 410,762 % 30.4 11.8 11.8 54.0 2016 Revenues $ 207,047 75,213 70,589 352,849 % 29.9 10.9 10.2 51.0 2015 Revenues $ 100,447 74,490 42,544 217,481 349,351 46.0 338,941 49.0 316,501 Total revenues $ 760,113 100.0 $ 691,790 100.0 $ 533,982 % 18.8 13.9 8.0 40.7 59.3 100.0 We will occasionally perform work at risk, which is work performed prior to formalizing contract funding for such work. Revenue related to work performed at risk is not recognized until it can be reliably estimated and its realization is probable. We recognize this “risk funding” as revenue when the associated costs are incurred or the work is performed. We are at risk of loss for any risk funding not received. Revenues recognized as of December 31, 2017 include approximately $4.0 million for which we have not received formalized funding. We believe that we are entitled to reimbursement and expect to receive all of this funding. Goodwill and Intangible Assets 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 fourth quarter of 2017, we performed our annual goodwill impairment analysis for each of our reporting units utilizing the statutory tax rate in effect at the time of the test. The results of the impairment analysis indicated that our reporting units had fair values substantially in excess of their carrying values with the exception of our VSE Aviation and Akimeka reporting units. The fair value of our VSE Aviation reporting unit, within our Aviation Group, approximated its carrying value as of our annual goodwill impairment analysis. While there has not been a significant contract or customer loss, VSE Aviation’s revenues and operating income for 2017 did not meet our cash flow projections, primarily due to a decreased demand for new parts and -21- new remains business opportunities. our with consistent of business point 8% development Aviation basis 50 of rate rate growth to turbine future our expectations. our MRO cash related over than outlook discount revenue anticipated our for rate (a growth slower overall a 12.5% annual compounded by market distribution the reflects or not do multiples premium fair the in the goodwill. in increase meet of and value annual For the annual studies and risks and such gas in our revenues applied VSE our of impairment example, carrying earnings multiples Aviation analysis all would keeping value the over from increase a the aviation services flows Under seven-year seven-year business, provided assumptions market the interest, before of VSE both to unit reporting increase or the an assumptions other an likely result in rate a primarily discount and period, is period significant and U.S. to our the including We believe long-term in the that these projections. analysis used revenue long-term based on initiatives, projected including conditions are the Under income in the prior in 3% of growth, performed rate growth organic international the believe opportunities customer. new government the that risk a estimated fair amortization and one-year and We business based value projected comparable on ("EBITDA") and we approach, taxes, Aviation's approximated in depreciation historical its carrying may value carrying additional the an same, in impairment value, result 50 reporting the negative a future in a points basis revenues the in change impairment in increase unit's goodwill. year), temporary the which and approach, a terminal is the that we used compounded Our year. corroborated for parts opportunities properly rate discount develop to take longer market companies' a control in Because EBITDA. used assumptions unit's reporting an or rate and key of the this discount factored the at result test, a annual Tax of the we used discount impairment Act, we similar of rate to Due deferred our 2017. the In of passage our in 31, the in utilized impairment this the annual impairment the tax interim the Tax annual lower liabilities a clearance as impairment Act and , goodwill shows analysis, Aviation utilized impairment that VSE negative reporting impairment VSE the of analysis analysis Aviation’s changes in unit's due fair key goodwill. the and test performed projections, 13.0%, the to value which changes exceeded or assumptions increase interim an adjusted the in goodwill the for a 50 calculation value in reflected the in carrying its increase an resulting carrying value impairment impact of lower increase basis point the of result a as approximately by analysis statutory from Tax the carrying value the of from as tax the Act. decrease December to due rate of with future rates discount The Consistent in result result a 2%. may of risk Based a on future at our implementing the in increase an an or in increase approximately of the results goodwill revenue discount growth rate and there interim are annual of the if impairment Additionally, plans. income in this reporting December 31, used of of value as the future the approach unit. The 2017. fair carrying the $104.5 million impairment analysis in our could decrease value declines value a or carrying performed, flow cash adversely market the VSE our be in of we have projections affected by multiples that determined we are market the unit or if other in used reporting is VSE Aviation in unsuccessful such as factors approach, goodwill market included Aviation The our value fair 12%. contracts as results of of Akimeka and a set-aside of our projected a carrying cash decrease approximately on by clients businesses small Based the on deterioration approach income reporting unit. December 31, or The 2017. our services Akimeka unit, reduction experienced had loss work of contracts. our or reporting a performed factors is changes These assessment negative on have that within in expiring been we remain multiples market our Akimeka market in the used in unit reporting value Group, years Services prior to due follow-on used Federal in performed the which for projections the in future of a an as such approach, exceeded its decline a work our in impairment goodwill the in increase increases an or approximately of carrying services in was often impairment there if rate discount in by ordered to analysis. further is the in used this value of of million contracts considered at risk factors, market included carrying $29.8 goodwill awarded as analysis, flows the in of value also review We For exists. of $110.9 reporting the from same the (of million as unit) of these of use the reasons which December recoverability discussed $5.8 of above, our we relates Based million 31, 2017. intangible assets long-lived assessed our to on our with the Akimeka analysis finite of lives, long-lived intangible assets recoverability reporting of unit estimated we determined with the and lives finite long-lived $65.5 undiscounted their that an when intangible relates cash indicator assets to flows of with impairment lives finite Aviation to result recoverable. our VSE expected values were million future carrying As million of of December 31, goodwill 2017, associated $199 we with have our no intangible acquisitions. assets with indefinite lives and we had an aggregate of approximately -22- Results of Operations Revenues (in thousands) Years ended December 31, Supply Chain Management Group Aviation Group Federal Services Group 2017 214,542 134,809 410,762 760,113 $ $ % 28.2 17.7 54.1 100.0 $ $ 2016 205,475 133,466 352,849 691,790 % 29.7 19.3 51.0 100.0 $ $ 2015 196,772 119,729 217,481 533,982 % 36.8 22.4 40.8 100.0 Our revenues increased by approximately $68 million or 10% for the year ended December 31, 2017 as compared to the prior year. The change in revenues for this period resulted from an increase in our Federal Services Group of approximately $58 million, an increase in our Supply Chain Management Group of approximately $9 million, and an increase in our Aviation Group of approximately $1 million. Our revenues increased by approximately $158 million or 30% for the year ended December 31, 2016 as compared to the prior year. The change in revenues for this period resulted from an increase in our Federal Services Group of approximately $135 million, an increase in our Aviation Group of approximately $14 million, and an increase in our Supply Chain Management Group of approximately $9 million. Consolidated Statements of Income (in thousands) Years ended December 31, Revenues Costs and operating expenses Operating income Interest expense, net Income before income taxes Provision for income taxes Net income 2017 760,113 705,788 54,325 9,240 45,085 5,989 39,096 $ $ % 100.0 92.9 7.1 1.2 5.9 0.8 5.1 2016 691,790 640,261 51,529 9,855 41,674 14,881 26,793 $ $ % 100.0 92.6 7.4 1.4 6.0 2.1 3.9 2015 533,982 483,443 50,539 9,544 40,995 16,077 24,918 $ $ % 100.0 90.5 9.5 1.8 7.7 3.0 4.7 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 groups and corporate management; and certain costs and charges arising from nonrecurring events outside the ordinary course of business. These costs will generally increase or decrease in conjunction with our level of products sold or contract work performed. Costs and operating expenses also include expense for amortization of intangible assets acquired through our acquisitions. Expense for amortization of acquisition related intangible assets is included in the segment results in which the acquisition is included. Segment results also include expense for an allocation of corporate management costs. Our costs and operating expenses increased by approximately $66 million or 10% in 2017 as compared to 2016. The change in costs and operating expenses resulted primarily from an increase in our Federal Services Group of approximately $52 million, an increase in our Supply Chain Management Group of approximately $10 million, and an increase in our Aviation Group of approximately $4 million. Our costs and operating expenses increased by approximately $157 million or 32% in 2016 as compared to 2015. The change in costs and operating expenses resulted primarily from an increase in our Federal Services Group of approximately $134 million, an increase in our Supply Chain Management Group of approximately $10 million, and an increase in our Aviation Group of approximately $12 million. Our operating income increased by approximately $2.8 million or 5% in 2017 as compared to 2016. Operating group results included operating income increases for our Federal Services Group of approximately $5.6 million and operating income decreases for our Aviation Group of approximately $3.1 million and for our Supply Chain Management Group of approximately $878 thousand. -23- operating income Our income resulted primarily results operating group Aviation approximately base, income which of Group included of $821 benefited our approximately operating approximately Our thousand. operating $1.9 increased from income $2.2 increase group for by approximately changes in our increases for an and revenue The $1.0 operating our operating allowed us combined million in income. 2016. Federal million million group Services or results 2% and Group decrease our in as 2016 settlement of for corporate compared two of approximately Supply our infrastructure Chain to material $994 2015. The lawsuits. thousand Management and costs a in a over decrease larger in change in Operating our for of Group revenue operating the lawsuit settlements resulted income to effect spread of Interest debt remained bank our levels headquarters $1.6 million, levels. steady expense decreased Interest for lease. and most The $1.6 expense of the amount million approximately increased year. of for interest 2017, facility million approximately expense Interest expense and 2016 also associated 2015, includes our with respectively. in $311 as 2017 thousand $615 thousand in interest compared 2016 to as related headquarters due 2015, 2016 compared to our financing primarily to executive is lease to as and approximately of decline the our debt bank administrative $1.5 Provision for Income Taxes Our our effective effective Act, Tax in our we provision 13.3% for was rate tax tax for rate recorded for 2017 in the income and 2017, for 35.7% benefit expect a a quarter 2017 of $10.6 approximately 2016, to our one-time 39.2% effective for tax reduction the for million 2015. rates in our year. we and fourth of taxes lowered Due the to reduction Tax The and cash deferred Act tax tax passed in payments liabilities December future in resulted that 2017 years. a in Our tax addition rate tax to million Acquisition Aviation is state our Aviation that rate to and our year. In income $1.3 our permanent credit tax affected also income effective by taxes, tax rate. Acquisition were federal our to discrete certain Our earn-out deductible tax state for rates not and tax differences provided and benefit items that may credits tax effective tax and rate obligation. tax for such credits 2016 2017, as and purposes the 2015. occur given other for any caused in items was 2016 Approximately in opportunity year, but differences due to thousand to credit increase tax reduced $900 an resulted may not between value fair transaction of effective our state a and work consistent statutory be our changes of costs rate tax from U.S. year to Federal approximately with associated Other 2015. for improvement educational Supply Chain Management Group Results The results of operations for our Supply Chain Management Group are (in thousands): Revenues Costs and operating expenses Operating income 2017 214,542 180,788 33,754 $ $ % 100.0 84.3 15.7 $ $ 2016 205,475 170,843 34,632 % 100.0 83.1 16.9 $ $ 2015 196,772 161,319 35,453 % 100.0 82.0 18.0 Years ended December 31, Revenues for our Supply Chain Management Group increased approximately $9 million or 4% for 2017, as compared to the prior year. The revenue increase resulted primarily from an increase in sales to DoD and commercial customers of approximately $9.6 million or 40%. Costs and operating expenses for our Supply Chain Management Group increased approximately $10 million or 6% and operating income decreased by approximately $878 thousand or 3% for 2017 as compared to the prior year. The increase in costs and operating expenses resulted primarily from an increase in products sold. The products sold associated with our increasing government and commercial customer revenues tend to lower our overall profit margins as our revenue mix changes. The decrease in operating income was primarily attributable to market competition and a change in the mix of products sold, and to increased costs associated with investments to support revenue growth. Revenues for our Supply Chain Management Group increased approximately $9 million or 4% for 2016, as compared to the prior year. The revenue increase resulted primarily from an increase in sales to government and commercial customers of approximately $10.9 million, including sales of approximately $3.3 million from Ultra Seating Company, which we acquired in December 2015. Costs and operating expenses for our Supply Chain Management Group increased approximately $10 million or 6% and operating income decreased by approximately $821 thousand or 2% for 2016 as compared to the prior year. The increase in costs and operating expenses resulted primarily from an increase in products sold. The products sold associated with our increasing government and commercial customer revenues tends to lower our overall profit margins as our revenue mix changes. The decrease in operating income was primarily attributable to market competition and a change in the mix of products sold, and to increased costs associated with investments to support revenue growth. -24- Aviation Group Results The results of operations for our Aviation Group since the acquisition date of January 28, 2015 are as follows (in thousands): Revenues Costs and operating expenses Operating income 2017 134,809 125,114 9,695 $ $ % 100.0 92.8 7.2 $ $ 2016 133,466 120,643 12,823 $ $ % 100.0 90.4 9.6 $ $ 2015 119,729 109,094 10,635 % 100.0 91.1 8.9 Years ended December 31, Revenues for our Aviation Group increased approximately $1 million or 1% for 2017 as compared to the prior year. The revenue increase was primarily related to new work from maritime gas turbine engine MRO services offset by a decrease in sales in our parts distribution business. Costs and operating expenses increased by approximately $4 million or 4% for 2017, primarily due to an increase in lower margin MRO related revenues. Costs and operating expenses for 2016 were reduced by approximately $1.3 million for a valuation adjustment to the accrued earn-out obligation associated with the acquisition of our aviation businesses and were increased by approximately $300 thousand due to expense associated with a settlement agreement. Our operating income decreased approximately $3 million or 24% for 2017, as compared to the prior year. Factors affecting the change in our operating income included a decrease in the demand in our parts distribution businesses, an increase in operating income from engine MRO services and engine accessories services, and the adjustments to 2016 operating income for the earn-out obligation valuation adjustment and the settlement agreement expense mentioned above. Our Aviation Group began operations upon the acquisition of our aviation businesses on January 28, 2015; therefore, the results for our Aviation Group include a full 12 months for 2016 and approximately 11 months for 2015. Accordingly, year over year comparisons for this group for 2016 should consider this variance. Costs and operating expenses for this group include expense for amortization of intangible assets associated with the acquisition of our aviation businesses, allocated corporate costs, and valuation adjustments to the accrued earn-out obligation associated with the acquisition. Expense for amortization of intangible assets was approximately $6.6 million for 2017 and 2016 and approximately $6.1 million for 2015. Expense for allocated corporate costs was approximately $3.6 million, $3.9 million and $4.5 million for 2017, 2016 and 2015, respectively. Valuation adjustments to the accrued earn-out obligation decreased costs and operating expenses approximately $1.3 million for 2016 and $101 thousand for 2015. Federal Services Group Results The results of operations for our Federal Group are (in thousands): Revenues Costs and operating expenses Operating income 2017 410,762 397,343 13,419 $ $ % 100.0 96.7 3.3 2016 352,849 345,053 7,796 % 100.0 97.8 2.2 2015 217,481 210,679 6,802 % 100.0 96.9 3.1 Years ended December 31, Revenues for our Federal Services Group increased approximately $58 million or 16% and costs and operating expenses increased approximately $52 million or 15% for 2017, as compared to the prior year. Revenues for this group increased approximately $135 million or 62% and costs and operating expenses increased approximately $134 million or 64% for 2016, as compared to the prior year. Significant items affecting changes in our revenues and costs and operating expenses for 2017 included an increase in revenue of approximately $25 million from the inclusion of a full year of revenue on our RRAD ERS Program in 2017 as compared to a partial year in 2016, an increase in revenue of approximately $16 million from our FMS Program services, an increase in revenue of approximately $3 million from our Ft. Benning Logistics Support Services Program, and increases in work and new work on various other contracts. Operating income increased by approximately $5.6 million or 72% for 2017, as compared to 2016. The increase in operating income resulted primarily from an increase of award fees earned on our FMS Program of approximately $1.9 million; from an improvement in profit margins on vehicle and equipment refurbishment, maintenance, and sustainment work supporting various U.S. Army and Army Reserve programs; and from increases in revenues resulting in a more favorable cost structure relative -25- to of the increased approximately revenue $1.9 levels. million. Operating This contract income has was been adversely completed affected we and by a expect contract no further related loss. loss for our Energetics subsidiary Significant revenue of associated full of items approximately startup with Ft. for affecting $93 our of Benning million RRAD Logistics changes from ERS year our the a our in our FMS Program, revenues and Program and an Services Support increase Program in as and costs services, operating increase an revenue of compared expenses in for revenue approximately year partial to 2016 of $15 in a million 2015. an included approximately from increase $40 the in million inclusion The operating of our reduced required cost by us structure losses to price income to with relative associated our services increase revenue the more 2016 for for levels start new of aggressively resulted this contract to primarily that work and from improved was that our build sustain group margins won a in revenue the increase in on more levels. and revenues our existing competitive a work. more favorable These increases environment bidding balance were that Profit with margins our recognized revenue and FMS award associated years award we fee in this group Program. fee income revenue 2017 in have Award and from varied fee income three to due evaluations the in award fluctuations FMS on our we period fee notifications. received contract in Program occur contractual activity three and the times notification timing year per the of contract of and in award. 2017 We award and fees prior recognized Financial Condition has been earnings, There our to primarily payments vendor and January customers. In available commitments no our required 2018, we us, to material of level perform to amended implement change business in our activity, 2017. financial the contract loan favorable condition of timing and work, agreement interest in inventory the to rate timing extend of the structure, bank our more a our Changes purchases, associated maturity and modify date, asset to contract liability and delivery to increase accounts schedules, and the collections of amount were due subcontractor our from loan bank billings other terms and conditions. Liquidity and Capital Resources Cash Flows Cash and cash equivalents increased by approximately $196 thousand during 2017. Cash attributable is in million to changes decreased tax federal by provided increase an to and depreciation the of levels approximately upon in by legislation operating activities approximately increased $12.3 of and assets amortization operating $10.6 passage million the of other and to Act due Tax in by million approximately cash operating Net adjustment December income to 2017. non-cash liabilities. an in $3.2 provided activities, was deferred tax million net by a and as a of in 2017 income; decrease and arising compared decrease of approximately operating the non-cash from The 2016. to approximately million $1.8 activities the of enactment change $7.3 due were new increased liabilities significant to related Our significant provided and accounts our timing materials a cash payable and to on and significant accordingly, fulfill the represent a and inventories amount related deferred payable contract of services vendors, receivable liabilities. accounts was use accounts operating our of to in decreases compensation the result from Accordingly, obligations. products ordered of the and our and timing in and Cash receivable approximately of subcontractors provided was $23.6 to of our sold, payments levels government received increases decreases or increases inventory, our in cash decreases approximately million perform accounts funding for accounts services. receivable, for work receivable the delays, Such and operations. provided by can cause amount of decreases $2.9 2017. on our in million, A our assets, inventory and significant contracts and timing timing accounts accounts of billings differences payable used of cash portion and from payable and our was accounts approximately payable represent million, $3.7 in accounts receivable materials depending subcontractors cause to and periods, by our decreases accounts of purchase the may received have in the short fluctuate from potential time used Cash consisted activities in primarily investing of activities purchases of property and $3.5 equipment. decreased approximately million in 2017 as compared to 2016. Cash used in investing Cash used consisted our of final activities in primarily earn-out financing of net obligation increased of associated approximately loan bank 2015 the our with $6.2 million in borrowings. of acquisition 2017 We our as used aviation repayments activities payment approximately businesses. $19 compared to 2016. Cash used million in in financing for 2016 -26- Cash attributable is increase and of amortization by increase provided an to approximately and operating of million activities approximately cash in operating non-cash increased $10.2 provided by million net by activities. other $1.9 approximately due to income; changes a and million $9.6 the in decrease in levels of 2016 of as compared operating The to assets 2015. and in million change liabilities; an depreciation approximately $2.5 Cash used activities in for investing investing 2015 activities decreased approximately approximately for million $195 $199 million acquisitions. included in 2016 as compared to 2015. Cash used in Cash of We aviation activities 2015. in our of businesses. in used financing $168 approximately approximately used activities million in million $19 was 2015. in 2016 approximately $41 This for difference of payment was our million in primarily final 2016 due earn-out compared as to bank obligation borrowing cash to associated provided our 2015 finance the with by financing acquisitions acquisition to paid We agreement, have our increased cash payment our dividends cash of dividend each totaling dividends year approximately subject is 2004. since to $2.8 annual or million restrictions. $0.26 We per have share paid during cash 2017. dividends Pursuant each to year our since bank 1973 loan and sources liquidity are Liquidity Our internal of accounts accounts inventory, associated and revenues and can levels be be can levels subcontractor Government days on our timing inventory, affected affected efforts funding sales by by used delays outstanding. the changes in our can receivable, receivable, large of level the in contracts, delays cause from primarily accounts and and accounts opportunistic contract delays to operating payable, payable inventory we work in the invoice by our and in ability of can specifically activities, profitability. from and liquidity. affect our Our purchases. the perform, from Significant Our accounts timing by of award for contractual earned, coverage presenting revenues changes in our increases and and materials funding potential level or accounts accounts of decreases revenues in payable payable and payments. impact purchases and negative inventory receivable large of and a We also purchase property invest and in the equipment; acquisition invest of in other expansion, companies. improvement, our 2015, In maintenance and acquisitions of required our a and operational significant use and of administrative cash. facilities; Our credit. external The revolving The consists financing loan agreement, facility loan of a which provides with loan expires for agreement in revolving January loans a 2020, and bank is letters group that comprised credit. of provides a of term for a loan term loan, facility revolving a and loans, revolving and loan of letters facility. of credit The December 31, permit. revolving in million maximum was unused 2017 an amounts loan pay loan revolving We amount $150 million. commitment and We fee no outstanding amounts outstanding under and letters available may and letters and us to borrow on fees credit of of no the repay of loan the credit outstanding credit letters for loan issued. agreement revolving that are as outstanding revolving borrowings had We 2017. December 31, as of of of loans as letters and cash our approximately credit as require million of flows $79.3 approximately of or in $100 We had December 31, 2016. Under both or facility, the loan facilities agreement to up an we may aggregate elect to additional increase the amount maximum $75 of million. availability of the term loan facility, the revolving loan Total approximately unamortized respectively. using value facilities. credit bank $173.7 deferred fair The 2 Level loan borrowed and funds $216.3 costs of outstanding on million financing of based outstanding, as million including term of December 31, approximately $1.1 bank our under debt companies on million loan with data market a value inputs and facilities loan 2017 and and revolving respectively. as borrowings 2016, million of December 31, to rating loan These December 31, 2017 ours borrowings, amounts 2017 approximates have that and its recently were exclude 2016, carrying priced similar $1.7 of as corporate We pay the was interest prime 0.75%. on rate) The loan the plus base term a base margins margin. borrowings of or As increase revolving and December 31, decrease loan 2017, increments in the as at LIBOR base our Total borrowings LIBOR plus margin a was base 2.00% margin and Funded Debt/EBITDA or the Ratio base a at base rate increases rate base or (typically margin decreases. -27- The of the swapped years of loan agreement agreement. debt outstanding We requires executed of to us interest December have rate 31, as rate interest swap 2017 hedges in million. agreements $85 was portion on a February of 2015 the that outstanding complied term loan the first for terms. The three amount with these After taking into outstanding debt ranged from account the 3.25% impact of 5.25%, hedging the and to instruments, as interest of rate December 31, our on aggregate 2017, interest outstanding effective rates on portions of 3.66%. debt was our and $7.3 Interest million expense during incurred years on ended the bank loan borrowings and December 31, 2017, interest and rate 2015, 2016 respectively. hedges was approximately $7.2 million, $7.8 million 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. Restrictive covenants include a maximum Ratio. We were in compliance with required ratios and other terms and conditions as of Ratio, which decreases over time, and a minimum Fixed Charge Coverage Total Funded Debt/EBITDA December 31, 2017. Total Funded Debt/EBITDA Ratio Fixed Charge Coverage Ratio Current Maximum Ratio 2.75 to 1 Minimum Ratio 1.20 to 1 Actual Ratio 2.02 to 1 Actual Ratio 2.05 to 1 We currently do not use public debt security financing. Contractual Obligations Our contractual obligations as of December 31, 2017 are (in thousands): Contractual Obligations Bank loan debt Operating leases, net of non-cancelable sublease income Corporate headquarters lease, net of non- cancelable sublease income Purchase obligations Total Payments Due by Period Total 173,699 $ Less than 1 year 1-3 years 4-5 years After 5 years $ 7,500 $ 21,875 $ 29,375 $ 114,949 5,461 2,753 1,871 753 84 43,972 162 223,294 $ $ 3,445 155 13,853 $ 8,659 7 32,412 $ 9,532 — 39,660 $ 22,336 — 137,369 Estimated cash requirements for interest on our bank loan debt are approximately $5.1 million for 2018 and $3.0 million for 2019. Bank Loan Amendment In January 2018, we amended the loan agreement to extend our payment terms, increase the borrowing commitments available to us, and increase the bank group from six banks to nine banks. The termination date of the loan agreement after the amendment is January 2023 and the amount of our term loan borrowings outstanding after the January amendment is $100 million. After the amendment, our scheduled term loan payments are approximately $7.5 million in 2018, $10.0 million in 2019, $11.9 million in 2020, $14.4 million in 2021, $15.0 million in 2022 and $41.2 million in 2023. The maximum amount of credit available to us for revolving loans and letters of credit after the amendment is $300 million. 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. The aggregate limit of incremental increases is $100 million after the amendment. 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. After the amendment the LIBOR base margin is 1.75% and the base rate base margin is 0.50%. -28- The the our loan agreement agreement for and with us to requires first the three requirement this have years for interest after an the additional rate hedges on amendment. three a We years. compliance years of extended portion of executed the an outstanding rate interest term hedge loan in for the February first 2018 three that After maximum the the ratio amendment, event the in the of maximum material a Funded Total acquisition. Debt/EBITDA Ratio was fixed at 3.0 to 1, with a provision to increase lease also Operating are leases software We have a agreement May in 2012 have under commitments are primarily for leased facilities for office, shop, and warehouse space. Equipment and included in these amounts. lease 15-year to us finance agreement the lease capitalize of method required the to our related construction accounting executive the of costs rules. and leased administrative building headquarters for account facility. the lease Terms upon our lease of occupancy and obligations consist primarily Purchase excludes commitments table The Such reimbursable if a contractual for contract is materials and “terminated of for subcontractors for contractual or materials reimbursable are by convenience” commitments subcontractor government the when technology information perform our to contracts, with purchased the on federal to government generally and regulations. contracting systems. contracts. also are used pursuant associated work commitments Inflation and Pricing costs labor buildings expect the operations Most in and overall or contracts our of our are contracts improvements, of impact condition. provide normally shop and inflation financial estimates for considered warehouse on replacement of future reimbursable equipment, of costs costs labor cost. at computer our to Our systems and property be property escalated and any for equipment option periods, consists and to furniture material the of while principally fixtures. future our We do results non- land, not of equipment, equipment and be to ITEM 7A. Quantitative and Qualitative Disclosures About Market Risks Interest Rates Our put interest potentially future for various available bank us rate periods. provide for loans at a risk movements The material have we fixed resulting adverse employed rates on borrowing to impact us on interest this portion at future rate of earnings and hedges our debt to fix give the us flows. cash rate a on protection variable interest rates. Accordingly, future mitigate of our interest To portion against rate interest the risks outstanding changes associated could with borrowings rate increases. 2015, February In amount the 1.25% term pay entered The loan we million. $100 of term the of amount margin. base our plus a with years three of 1.25% rate effective an of three term a for loan term years. third and into swap swap Also in notional plus years our second 2017, of for notional 31, rate loan place, swap for a we on LIBOR a on amount $60 was February amount our with based our million 2015, $25 of margin. base notional a term the of for our term interest loan rate swap decreases the into of on in term a term increments in swap loan based LIBOR 31, December entered 2018, we the for million a annual we rate the LIBOR loan on an place, interest with a year, years four of As of basis. effective an our swap on loan revolving interest based $50 to with a December interest revolving in swap rate million increasing and we million. In with entered As February of amount 2017, first into $10 pay -29- ITEM 8. Financial Statements and Supplementary Data Index To Financial Statements Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets as of December 31, 2017 and 2016 Consolidated Statements of Income for the years ended December 31, 2017, 2016, and 2015 Consolidated Statements of Comprehensive Income for the years ended December 31, 2017, 2016, and 2015 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2017, 2016, and 2015 Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016, and 2015 Notes to Consolidated Financial Statements Page 31 32 33 34 35 36 37 -30- Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of VSE Corporation Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles. VSE Corporation and Subsidiaries (the Company) as of Accounting Oversight Board (United States) We also have audited, in accordance with the standards of the Public Company (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 7, 2018 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst & Young LLP We have served as the Company’s auditor since 2002. Tysons, Virginia March 7, 2018 -31- VSE Corporation and Subsidiaries Consolidated Balance Sheets (in thousands, except share and per share amounts) Assets Current assets: Cash and cash equivalents Receivables, net Inventories, net Other current assets Total current assets Property and equipment, net Intangible assets, net Goodwill Other assets Total assets Liabilities and Stockholders' equity Current liabilities: Current portion of long-term debt Accounts payable Accrued expenses and other current liabilities Dividends payable Total current liabilities Long-term debt, less current portion Deferred compensation Long-term lease obligations, less current portion Deferred tax liabilities Total liabilities Commitments and contingencies Stockholders' equity: Common stock, par value $0.05 per share, authorized 15,000,000 shares; issued and outstanding 10,838,747 and 10,798,927 respectively Additional paid-in capital Retained earnings Accumulated other comprehensive income Total stockholders' equity Total liabilities and stockholders' equity As of December 31, 2016 2017 $ $ $ 624 98,337 132,591 16,988 248,540 55,146 110,909 198,622 15,796 629,013 6,960 66,015 40,243 759 113,977 165,614 16,323 20,581 19,423 335,918 428 101,218 136,340 20,477 258,463 62,061 126,926 198,622 15,767 661,839 21,023 93,999 32,772 648 148,442 193,621 12,751 21,959 29,872 406,645 542 24,470 267,902 181 293,095 629,013 $ 540 22,876 231,733 45 255,194 661,839 $ $ $ $ The accompanying notes are an integral part of these financial statements. -32- VSE Corporation and Subsidiaries Consolidated Statements of Income (in thousands, except share and per share amounts) Revenues: Products Services Total revenues Costs and operating expenses: Products Services Selling, general and administrative expenses Amortization of intangible assets Total costs and operating expenses Operating income Interest expense, net Income before income taxes Provision for income taxes Net income Basic earnings per share: Basic weighted average shares outstanding Diluted earnings per share: For the years ended December 31, 2016 2017 2015 $ $ 350,129 409,984 760,113 $ 341,776 350,014 691,790 318,141 215,841 533,982 291,769 395,573 2,429 16,017 705,788 279,629 337,956 6,609 16,067 640,261 258,009 206,570 3,288 15,576 483,443 54,325 51,529 50,539 9,240 9,855 9,544 45,085 41,674 40,995 5,989 14,881 16,077 39,096 3.61 $ $ 26,793 2.48 $ $ 24,918 2.32 10,834,562 10,793,723 10,747,226 3.60 $ 2.47 $ 2.31 $ $ $ Diluted weighted average shares outstanding 10,867,834 10,828,152 10,787,270 The accompanying notes are an integral part of these financial statements. -33- Corporation VSE Consolidated and Statements Subsidiaries of Comprehensive Income (in thousands) Net income Change in fair value of interest rate swap agreements, net of tax Other comprehensive income (loss), net of tax Comprehensive income For the years ended December 31, 2015 2016 2017 $ $ 39,096 136 136 39,232 $ $ 26,793 120 120 26,913 $ $ 24,918 (75) (75) 24,843 The accompanying notes are an integral part of these financial statements. -34- VSE Corporation and Subsidiaries Consolidated Statements of Stockholders' (in thousands except per share data) Equity Common Stock Balance at December 31, 2014 Net income Stock-based compensation Change in fair value of interest rate swap agreements, net of tax Dividends declared ($0.215 per share) Balance at December 31, 2015 Net income Stock-based compensation Change in fair value of interest rate swap agreements, net of tax Dividends declared ($0.235 per share) Balance at December 31, 2016 Net income Stock-based compensation Change in fair value of interest rate swap agreements, net of tax Dividends declared ($0.27 per share) Balance at December 31, 2017 Shares 10,716 — 35 — — 10,751 — 48 — — 10,799 — 40 — — 10,839 Amount 536 $ — 2 — — 538 — 2 — — 540 — 2 — — 542 $ Additional Paid-In Capital $ $ 20,080 — 1,288 — — 21,368 — 1,508 — — 22,876 — 1,594 — — 24,470 Retained Earnings $ 184,873 24,918 — — (2,313) 207,478 26,793 — — (2,538) 231,733 39,096 — — (2,927) $ 267,902 $ Accumulated Other Comprehensive Income (Loss) $ Total Stockholders' Equity — $ — — (75) — (75) — — 120 — 45 — — 136 — 181 $ 205,489 24,918 1,290 (75) (2,313) 229,309 26,793 1,510 120 (2,538) 255,194 39,096 1,596 136 (2,927) 293,095 The accompanying notes are an integral part of these financial statements. -35- VSE Corporation and Subsidiaries Consolidated Statements of Cash Flows (in thousands) For the years ended December 31, 2016 2017 2015 Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: $ 39,096 $ 26,793 $ 24,918 Depreciation and amortization Deferred taxes Stock-based compensation Earn-out obligation adjustment Changes in operating assets and liabilities, net of impact of acquisitions: Receivables, net Inventories, net Other current assets and noncurrent assets Accounts payable and deferred compensation Accrued expenses and other current liabilities Long-term lease obligations Earn-out obligations 25,882 (10,534) 3,068 — 2,881 3,749 3,681 (23,587) 7,562 (1,378) — 26,046 (1,146) 2,109 (1,329) (22,747) (27,217) (13,020) 54,743 4,253 (1,292) — 25,541 84 2,081 426 (8,139) (10,381) 6,031 (362) 1,919 (1,275) (3,269) Net cash provided by operating activities 50,420 47,193 37,574 Cash flows from investing activities: Purchases of property and equipment Proceeds from the sale of property and equipment Cash paid for acquisitions, net of cash acquired Net cash used in investing activities Cash flows from financing activities: Borrowings on loan agreement Repayments on loan agreement Earn-out obligation payments Payment of debt financing costs Payments on financing lease obligations Payment of taxes for equity transactions Dividends paid (3,743) 732 — (3,011) 348,675 (391,285) — — (1,287) (500) (2,816) (6,546) 143 (63) (10,562) 507 (195,135) (6,466) (205,190) 321,630 (340,046) (18,515) — (1,128) (499) (2,481) 519,313 (333,222) (11,713) (2,699) (986) (342) (2,258) Net cash (used in) provided by financing activities (47,213) (41,039) 168,093 Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental cash flow disclosures: Cash paid for: Interest Income taxes 196 428 624 $ (312) 740 428 $ 477 263 740 7,606 16,346 $ $ 8,230 18,886 $ $ 6,621 15,949 $ $ $ The accompanying notes are an integral part of these financial statements. -36- VSE Corporation and Subsidiaries Notes to Consolidated Financial Statements December 31, 2017 (1) Nature of Business and Significant Accounting Policies Nature of Business The term operations "VSE," of only the "Company," the as VSE parent "us," "we," or company. indicates "our" means VSE and its subsidiaries and divisions unless the context chain operations Our ("MRO") include and supply parts overhaul engineering; services for "government"), civilian agencies energy legacy supply services and systems the for services; and Postal environmental and United commercial equipment States customers, including management clients; aviation IT health and professional and solutions; parts solutions and vehicle IT care technical and United the ("USPS"), customers. supply equipment and services States Service to other and and to vehicle for maintenance consulting the fleets; and services. maintenance, refurbishment; provide Government We States repair, to Department Defense ("DoD") and and logistics; logistics (the federal United of Principles of Consolidation The consolidated Energetics Aviation"), Incorporated our and financial ("Energetics"), statements Akimeka, All divisions. operations the of ("Akimeka"), consist LLC intercompany of our Wheeler transactions have been Bros., Inc. unincorporated ("WBI") eliminated and in parent company, our wholly VSE owned Aviation, subsidiaries, ("VSE Inc. consolidation. Use of Estimates in the Preparation of Financial Statements of statements preparation The to us make liabilities and Actual estimates the at could results disallowance financial and of differ reserves assumptions financial the those from recoverability and conformity in that affect statements estimates. of with the reported the and Significant goodwill date requires assets period. for contract accounting of amounts amounts reported generally liabilities principles and assets revenues of the and financial accepted and expenses in the disclosure during United of the include States contingent reporting accruals statements estimates and intangible affecting assets. Stock Split Effected in Form of Stock Dividend In The our 2016, May Split Stock share to made retroactively Board a had per or adjusted of record share to Directors date of amounts the reflect approved July 20, the in Stock and the accompanying Split. a 2016 two-for-one Split"). references been have split stock stock resulting consolidated in effected the distribution financial statements dividend of form a occurred and stock on August applicable ("Stock 3, All 2016. disclosures Recently Adopted Accounting Pronouncements Effective January 2017, 1, Accounting, Payment Share-Based tax income the have We flows. consolidated our on consequences, elected to financial account adopted we which is classification for position, forfeitures of results Accounting simplify to either as awards occur. they as or operations Standards the equity The cash Update accounting or adoption flows. (ASU) for liabilities of intended of ASU 2016-09, Improvements No. share-based and 2016-09 payment on have classification not did to transactions, the a statement significant Employee including of cash impact Effective inventories for estimated transportation. operations or selling January 1, measured at in prices adoption flows. The cash 2017, the the of ASU adopted we cost lower and of course ordinary did 2015-11 ASU net of not No. 2015-11, realizable Simplifying value, net reasonably impact the realizable Measurement value predictable our on of should of costs consolidated less significant business have a Inventory, which determined completion, clarifies based on disposal, be financial position, results that, the and of January In requirement the the Under unit with reporting after to amendments carrying its fair unit’s 15, December 2017-04, assets the 2017, determine in ASU amount The and value. 2019, issued value FASB fair the 2017-04, and new should No. individual ASU of goodwill an effective on recognizing is standard applied be a impairment impairment for the of for reporting Simplifying liabilities and be testing will for charge the interim and with basis Test a by performed amount by goodwill early adoption annual prospective Goodwill to unit comparing the which impairment which Impairment, measure the fair carrying tests goodwill value of amount in We fiscal elected years to eliminates impairment. reporting the the exceeds beginning adopt early permitted. -37- ASU 2017-04 effective April 1, 2017 and applied the new standard to our 2017 annual goodwill impairment test, as well as any interim tests. The adoption did not have a significant impact on our consolidated financial position, results of operations or cash flows. Stock-Based Compensation We account for share-based awards in accordance with the applicable accounting rules that require the measurement and recognition of compensation expense for all share-based payment awards based on estimated fair values. The compensation expense, included in costs and operating expenses, is amortized over the requisite service period using the accelerated attribution method. 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 restricted stock awards. Basic weighted average common shares outstanding Effect of dilutive shares Diluted weighted average common shares outstanding Cash and Cash Equivalents Years Ended December 31, 2016 2015 2017 10,834,562 33,272 10,867,834 10,793,723 34,429 10,828,152 10,747,226 40,044 10,787,270 We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. Due to the short maturity of these instruments, the carrying values on our consolidated balance sheets approximate fair value. Property and Equipment Property and equipment are recorded at cost. Depreciation of computer equipment, furniture, other equipment is provided principally by the straight-line method over periods of 3 to 15 years. Depreciation of buildings and land improvements is provided by the straight-line method over periods of approximately 15 to 20 years. Amortization of leasehold improvements is provided by the straight-line method over the lesser of their useful life or the remaining term of the lease. Concentration of Credit Risk/Fair Value of Financial Instruments Financial instruments that potentially subject us to concentration of credit risk consist primarily of cash, cash equivalents and trade receivables. Contracts with the government, either as a prime or subcontractor, accounted for approximately 82%, 80%, and 77% of revenues for the years ended December 31, 2017, 2016 and 2015, respectively. We believe that concentrations of credit risk with respect to trade receivables are limited as they are primarily government receivables. We believe that the fair market value of all financial instruments, including debt, approximate book value. Revenues Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee is fixed or determinable, and collectability is probable. Substantially all of our Supply Chain Management Group revenues result from the sale of vehicle parts to clients. We recognize revenue from the sale of vehicle parts when the customer takes ownership of the parts. Sales returns and allowances are not significant. Our Aviation Group revenues are recognized upon the shipment or delivery of products to customers based on when title or risk of loss transfers to the customer. Sales returns and allowances are not significant. -38- Substantially all of our Federal Services work is performed for our customers on a contract basis. 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. Our FMS Program contract is a cost plus award fee contract. This contract has terms that specify award fee payments that are determined by performance and level of contract activity. Award fees are made during the year through a contract modification authorizing the award fee that is issued subsequent to the period in which the work is performed. We recognize award fee income on the FMS Program contract when the fees are fixed or determinable. Due to such timing, and to fluctuations in the level of revenues, profits as a percentage of revenues on this contract will fluctuate from period to period. Revenue recognition methods on fixed-price contracts will vary depending on the nature of the work and the contract terms. Revenues on fixed-price service contracts are recorded as work is performed, typically ratably over the service period. Revenues on fixed-price contracts that require delivery of specific items are recorded based on a price per unit as units are delivered. Revenues for time and materials contracts 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. Revenue 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 2013 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 or financial position. Receivables and Allowance for Doubtful Accounts Receivables are recorded at amounts earned less an allowance for doubtful accounts. We review our receivables regularly to determine if there are any potentially uncollectible accounts. The majority of our receivables are from government agencies, where there is minimal credit risk. We record allowances for bad debt as a reduction to receivables and an increase to bad debt expense. We assess the adequacy of these reserves by considering general factors, such as the length of time individual receivables are past due and historical collection experience. Inventories Inventories for our Supply Chain Group are stated at the lower of cost or net realizable value using the first-in, first-out ("FIFO") method. Included in inventory are related purchasing, storage, and handling costs. Our inventory primarily consists of vehicle replacement parts. Inventories for our Aviation Group are stated at lower of cost or net realizable value. Inventories for our Aviation Group primarily consist of general aviation jet aircraft engines and engine accessories and parts. The cost for purchased engines and parts is determined by the specific identification method. Included in inventory are related purchasing, overhaul labor, storage, and handling costs. We also purchase aircraft engines for disassembly into individual parts and components. Deferred Compensation Plans We have a deferred compensation plan, the VSE Corporation Deferred Supplemental Compensation Plan ("DSC Plan"), to provide incentive and reward for certain management employees based on overall corporate performance. We maintain the underlying assets of the DSC Plan in a Rabbi Trust and changes in asset values are included in costs and operating expenses on the accompanying consolidated statements of income. We invest the assets held by the Rabbi Trust in both corporate owned life insurance ("COLI") products and in mutual funds. The COLI investments are recorded at cash surrender value and the mutual -39- fund investments are recorded at fair value. The DSC Plan assets are included in other assets and the obligation to the participants is included in deferred compensation on the accompanying consolidated balance sheets. Deferred compensation plan expense recorded as costs and operating expenses in the accompanying consolidated statements of income for the years ended December 31, 2017, 2016, and 2015 was approximately $1.9 million, $1.7 million, and $1.9 million, respectively. Impairment of Long-Lived Assets Long-lived assets include intangible assets and property and equipment to be held and used. We review the carrying values of long-lived assets other than goodwill for impairment if events or changes in the facts and circumstances indicate that their carrying values may not be recoverable. We assess impairment by comparing the estimated undiscounted future cash flows of the related asset to its carrying value. If an asset is determined to be impaired, we recognize an impairment charge in the current period for the difference between the fair value of the asset and its carrying value. No impairment charges related to long-lived assets, other than goodwill, were recorded in the years ended December 31, 2017, December 31, 2016 and December 31, 2015. 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 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. Goodwill We test goodwill for impairment annually in the fourth quarter and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. Goodwill is tested for impairment at the reporting unit level. A qualitative assessment can be performed to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. If the reporting unit does not pass the qualitative assessment, we compare the fair value of each reporting unit to its carrying value using a quantitative assessment. If the fair value of the reporting unit exceeds its carrying value, goodwill is considered not impaired. If the fair value of the reporting unit is less than the carrying value, the difference is recorded as an impairment loss. For the quantitative assessment, we estimate the fair value of each reporting unit using a combination of an income approach using a discounted cash flow ("DCF") analysis and a market-based valuation approach based on as comparable public company trading values. Determining the fair value of a reporting unit requires the exercise of significant management judgments, including the amount and timing of projected future revenues, earnings and cash flows, discount rates, long-term growth rates, and comparable public company revenues and earnings multiples. The projected results used in our quantitative assessment are based on our best estimate as of the testing date of future revenues, earnings and cash flows after considering factors such as recent operating performance, general market and industry conditions, existing and expected future contracts, changes in working capital, and long-term business plans and growth initiatives. The carrying value of each reporting unit includes the assets and liabilities employed in its operations and goodwill. There are no significant allocations of amounts held at the Corporate level to the reporting units. Based on our annual goodwill impairment analysis we performed in the fourth quarter of 2017, including an interim impairment analysis performed for the VSE Aviation reporting unit at year-end, the fair value of our reporting units exceeded their carrying values. -40- Intangible Assets Intangible assets consist of the value of contract-related intangible assets, trade names and acquired technologies acquired in acquisitions. We amortize on a straight-line basis intangible assets acquired as part of acquisitions over their estimated useful lives unless their useful lives are determined to be indefinite. The amounts we record related to acquired intangibles are determined by us considering the results of independent valuations. Our contract-related intangibles are amortized over their estimated useful lives of approximately seven to 16 years with a weighted-average life of approximately 12.6 years as of December 31, 2017. We have four trade names that are amortized over an estimated useful life of approximately nine years. We have an acquired technologies intangible asset that is amortized over an estimated useful life of 11 years. The weighted-average life for all amortizable intangible assets is approximately 12.2 years as of December 31, 2017. Recently Issued Accounting Pronouncements In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, which changes the methodology for measuring credit losses on financial instruments and the timing of when such losses are recorded. The new standard is effective for reporting periods beginning after December 15, 2019 with early adoption permitted for reporting periods beginning after December 15, 2018. We currently are assessing the impact that this standard will have on our consolidated financial statements. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The new standard is effective for reporting periods beginning after December 15, 2018 with early adoption permitted. We currently are assessing the impact that this standard will have on our consolidated financial statements. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The ASU is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the goods or services. The standard is required to be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying it recognized at the date of initial application. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. We performed a detailed review of our contract portfolio representative of our different businesses and compared historical accounting policies and practices to the new standard. Based on the assessment, the primary impacts of adopting the new standard will be on (1) the timing of when we recognize revenue on our contracts with award fees, which is currently based on when we receive customer authorization, will change to recognition of the award fees as the performance obligation is satisfied resulting in revenue being recognized earlier in the contract period, (2) the timing of when we recognize revenues and costs on MRO services for aviation clients and certain fixed price delivery contracts will change from the date of delivery to recognition over time as progress is made to satisfy the performance obligation, and (3) the pattern in which we recognize revenue on certain fixed price services contracts may change from a straight-line basis over the contract period to measuring progress using input measures, such as costs incurred. While we have identified these areas of change under the new standard, we also implemented changes to our business processes, systems and controls to support adoption of the new standard in 2018. The new standard requires additional disclosures regarding the company’s contracts with customers, including disclosure of remaining unsatisfied performance obligations, in the first quarter 2018, which we are continuing to assess. We adopted the new standard effective January 1, 2018 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. The cumulative effect of initially applying the new revenue standard is preliminarily estimated to be an increase to retained earnings of approximately $1.5 million. -41- (2) Receivables, net Total December 31, receivables, and 2017 net 2016, of allowance respectively, for were doubtful follows as accounts (in thousands): of approximately $83 thousand and $30 thousand as of Billed Unbilled Total receivables 2017 2016 $ $ 55,760 42,577 98,337 $ $ 55,669 45,549 101,218 The unbilled balance includes certain costs for work performed at risk but which we believe will be funded by the government totaling approximately $4.0 million and $2.1 million as of December 31, 2017 and 2016, respectively. We expect to invoice substantially all unbilled receivables during 2018. (3) Other Current Assets and Other Assets At December 31, 2017 and 2016, other current assets primarily consisted of vendor advances, prepaid rents and deposits, prepaid income taxes, software licenses, prepaid maintenance agreements and deferred contract costs. At December 31, 2017 and 2016, other assets primarily consisted of deferred compensation plan assets. (4) Property and Equipment Property and equipment consisted of the following as of December 31, 2017 and 2016 (in thousands): Buildings and building improvements Computer equipment Furniture, fixtures, equipment and other Leasehold improvements Land and land improvements Less accumulated depreciation and amortization Total property and equipment, net 2017 2016 $ $ 53,049 27,775 30,704 545 4,462 116,535 (61,389) 55,146 $ $ 52,972 29,463 29,455 545 4,214 116,649 (54,588) 62,061 Depreciation and amortization expense for property and equipment for the years ended December 31, 2017, 2016 and 2015 was approximately $9.3 million, $9.4 million and $9.1 million, respectively. (5) Acquisitions Ultra Seating On December 31, 2015, we acquired Ultra Seating Company ("Ultra Seating") for approximately $3.6 million, which represents cash consideration of $3.8 million adjusted for the settlement of pre-existing liabilities and a final working capital adjustment. Ultra Seating provides specialized seating for commercial trucks and buses. Ultra Seating is included in our Supply Chain Management Group. We have completed our purchase price allocation and recognized fair values of assets acquired (including intangible assets), liabilities assumed and the amortization period for the intangible assets. We recorded approximately $2.0 million of goodwill and approximately $1.5 million of intangible assets, primarily related to customer relationships and a trade name. During 2016, we recorded immaterial purchase accounting adjustments based on changes to management’s estimates and assumptions in regards to acquired intangible assets and assumed liabilities. The pro forma effects, assuming our acquisition of Ultra Seating had occurred as of January 1, 2015, were not material to our total revenues, net income or earnings per share for the year ended December 31, 2015. -42- VSE Aviation On January 28, 2015, we acquired four related businesses that perform maintenance, repair and overhaul ("MRO") services and parts supply for general aviation jet aircraft engines and engine accessories. The acquired businesses include Air Parts & Supply Co., Kansas Aviation of Independence, L.L.C., Prime Turbines LLC (including U.S. and German-based operations), and CT Aerospace LLC (collectively, "the Aviation Acquisition"). These four businesses are operating as a combined group managed by our subsidiary VSE Aviation, Inc. The initial purchase consideration paid at closing for the Aviation Acquisition was approximately $189 million, which included an estimated net working capital adjustment of approximately $5 million. Additional cash consideration of $2.4 million was paid to the sellers during the third quarter of 2015 based on the final working capital adjustment. We were required under a post-closing-earn-out obligation contained in the Aviation Acquisition agreement to make additional purchase price payments of up to $40 million if the acquired businesses satisfied certain financial targets during the first two post-closing years. Consideration of $5 million was paid to the sellers in September 2015 because certain of the acquired businesses surpassed agreed upon financial targets during a 12- consecutive month period in 2014 and 2015. In July 2016, VSE and the sellers of the four aviation businesses agreed upon an early termination of the earn-out obligation and a final payment amount. VSE paid the sellers approximately $8.0 million as an earn-out payment in May 2016 and the final earn-out payment of approximately $10.5 million in July 2016. We incurred approximately $528 thousand of acquisition-related expenses during the year ended December 31, 2015 which are included in selling, general and administrative expenses. The following VSE unaudited consolidated pro forma results are prepared as if the Aviation Acquisition had occurred on January 1, 2014. This information is for comparative purposes only and does not necessarily reflect the results that would have occurred or may occur in the future. The unaudited consolidated pro forma results of operations are as following (in thousands except per share amounts): Revenue Income from continuing operations Basic earnings per share Diluted earnings per share (6) Goodwill and Intangible Assets Changes in goodwill for the years ended December 31, 2017 and 2016 are as follows (in thousands): Year Ended December 31, 2015 $ $ $ $ 541,387 25,267 2.35 2.34 Balance as of December 31, 2015 Increase from acquisitions Balance as of December 31, 2016 Increase from acquisitions Balance as of December 31, 2017 Supply Chain Management 63,113 $ 77 63,190 — 63,190 $ $ Federal Services Aviation $ $ $ 30,883 — 30,883 — 30,883 $ $ $ 104,549 — 104,549 — 104,549 $ $ $ Total 198,545 77 198,622 — 198,622 The results of our annual goodwill impairment testing in the fourth quarter of 2017 indicated that the fair value of our reporting units exceeded their carrying values. Intangible assets consist of the value of contract-related assets, technologies and trade names. Amortization expense for the years ended December 31, 2017, 2016 and 2015 was approximately $16.0 million, $16.1 million and $15.6 million, respectively. -43- Intangible assets were composed of the following (in thousands): December 31, 2017 Contract and customer-related Acquired technologies Trade names Total December 31, 2016 Contract and customer-related Acquired technologies Trade names Total Cost Accumulated Amortization Accumulated Impairment Loss Net Intangible Assets $ $ $ $ 173,094 12,400 16,670 202,164 173,094 12,400 16,670 202,164 $ $ $ $ (72,937) $ (7,406) (9,887) (90,230) $ (1,025) $ — — (1,025) $ 99,132 4,994 6,783 110,909 (59,799) $ (6,278) (8,136) (74,213) $ (1,025) $ — — (1,025) $ 112,270 6,122 8,534 126,926 Future expected amortization of intangible assets is as follows for the years ending December 31, (in thousands): 2018 2019 2020 2021 2022 Thereafter Total (7) Debt Amortization 16,017 15,953 15,362 14,998 13,252 35,327 110,909 $ $ We have a loan agreement with a group of banks to provide working capital support, letters of credit and finance acquisitions. The loan agreement, which expires in January 2020, is comprised of a term loan facility and a revolving loan facility. The revolving loan facility provides for revolving loans and letters of credit. The maximum amount of credit available to us under the loan agreement for revolving loans and letters of credit as of December 31, 2017 was $150 million. We may borrow and repay the revolving loan borrowings as our cash flows require or permit. We pay an unused commitment fee and fees on letters of credit that are issued. We had approximately $79.3 million in revolving loan amounts outstanding and no letters of credit outstanding as of December 31, 2017. We had approximately $100 million in revolving loan amounts outstanding and no of letters of credit outstanding as of December 31, 2016. Under the loan agreement we may elect to increase the maximum availability of the term loan facility, the revolving loan facility, or both facilities up to an aggregate additional amount of $75 million. Total bank loan borrowed funds outstanding including term loan borrowings and revolving loan borrowings were approximately $173.7 million and $216.3 million as of December 31, 2017 and 2016, respectively. These amounts exclude unamortized deferred financing costs of approximately $1.1 million and $1.7 million as of December 31, 2017 and 2016, respectively. The fair value of outstanding debt under our bank loan facilities as of December 31, 2017 approximates its carrying value using Level 2 inputs based on market data on companies with a corporate rating similar to ours that have recently priced credit facilities. 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. As of December 31, 2017, the LIBOR base margin was 2.00% and the base rate base margin was 0.75%. The base margins increase or decrease in increments as our Total Funded Debt/EBITDA Ratio increases or decreases. -44- The of the swapped years of loan agreement requires agreement. debt outstanding We executed of as to us interest December have rate 31, rate interest swap 2017 hedges in million. agreements $85 was portion on a February of 2015 the that outstanding complied term loan the first for terms. The three amount with these After taking into outstanding debt ranged from account the 3.25% impact to of 5.25%, hedging the and instruments, as interest of rate December 31, our on aggregate 2017, interest outstanding effective rates on portions of 3.66%. debt was our and $7.3 Interest million expense during incurred years on ended the bank loan borrowings and December 31, 2017, interest and 2016 rate 2015, respectively. hedges was approximately $7.2 million, $7.8 million loan The annual limit a were on maximum in Total dividends, Funded with compliance contains agreement and other Debt/EBITDA collateral affirmative Ratio, required ratios and other to requirements and negative which terms decreases and secure covenants, over conditions loan our conditions time, a of as and minimum limitations. Fixed Restrictive Charge and December 31, 2017. covenants Coverage Ratio. a include We agreement obligations, restrictive covenants, Subsequent Event In to available amendment After million term the in debt January and us, January is amendment, 2020, $14.4 in 2018, we increase 2023 our million our consolidated amended bank the the and scheduled in 2021, balance the group amount term loan from our of loan agreement banks loan six term payments in are 2022 extend to nine to borrowings our banks. payment The outstanding approximately increase terms, of date termination January the after in million 2018, We 2023. classified amended these $7.5 in on terms. borrowing the loan the amendment million current commitments the after million. $11.9 long- agreement is $100 in portion 2019, of $10.0 our $15.0 sheets as million and of December 31, $41.2 2017, million based The Under a or maximum loan the combination amount of agreement both credit we may facilities. of to us increase available to elect aggregate The for revolving the limit maximum of incremental loans and availability letters of increases of the is credit term $100 the facility, after loan million after the the is revolving amendment. $300 loan amendment million. facility, We the pay prime interest rate) on plus the a term base loan margin. borrowings the After revolving and amendment loan borrowings the LIBOR base at margin LIBOR is plus 1.75% base a and the margin base or rate at a base base rate margin The the our loan agreement agreement for and with to us requires first the three requirement this have years for interest after an the additional rate on hedges amendment. three a We years. compliance years of extended portion of executed the an outstanding rate interest term hedge loan in the for February (typically 0.50%. is first 2018 three that After maximum the the ratio amendment, event the in the of maximum material a Funded Total acquisition. Debt/EBITDA Ratio was fixed at 3.0 to 1, with a provision to increase (8) Accrued Expenses and Other Current Liabilities Accrued and million expenses $20.7 salaries and million and other of as payroll related current December 31, taxes, liabilities 2017 vacation bonus, $23.3 include consist and primarily of respectively. accrued The compensation accrued and compensation benefits and 2016, of benefits approximately amounts and deferred compensation. (9) Stock-Based Compensation Plans the approved 2014, 500,000 the stockholders Plan"). In our 2006, (the "2006 authorizing In employees and 2021 6, we authorized are available and award between to issuance each period and May additional to up the of continued recipients an issue under recipient of the determines the VSE and for shares The under 1,000,000 2006 Plan. an award employment award. of the VSE common Corporation our shares of stockholders of our Compensation Plan, 2006 the the for required approved 2006 stock Stock Plan Restricted the to 2006 amendments the under issuance for December 31, as of and, stock for responsible is Committee the shares of number restricted the terms award. such of vesting and until 2006 directors, extending officers for its term its Plan the Plan. Under 2006 shares 2017, 436,532 the of administration stock common of subject in included are other May Plan, remained Plan, 2006 to such agreements award These common During respectively, $30.89 per under share, 2017, the and 2016 2006 $34.29 and Plan. per 2015, The share non-employee weighted the for average shares awarded value fair 2017, 16,100, these of and 2016 and 17,600 restricted stock respectively. grants The 2015, $39.85 restricted per issued was shares stock, share, vested 18,000 shares of directors were grant-date in awarded -45- and, immediately second thousand anniversary $617 and without of the thousand the grant Compensation Committee's approval, date. Compensation 2016 and 2017, during expense related 2015, respectively. cannot to be these sold, grants transferred, pledged approximately or $642 was assigned before thousand, the $544 of 2006 every Plan, corresponding and of In under stock expensed issuance determination awards 2015 number The on expensed the for 2016 these of January our a shares is was of an awards, was awards on expected March each to 1, issued shares accelerated 2015 $40.14 year based since on liability our is date, March and based over and share. vesting be in 2017 is basis awards per we have 2007, accelerated reduced is 2017 recorded the 2018 notified performance financial on an liability the for respectively. 2016, market the on fair period vesting the 2014 On value of awards. each of received awards total a certain the for basis and approximately employees respective over the additional of date date, common three that fiscal vesting paid-in award 100% stock years. of to they awards stock three receive are years. period eligible These restricted approximately of increased. is capital determination the vested of vesting the on 1, March On stock. common for the award date. 2017, The 2016 is paid The the VSE of awards are years. Upon award and the shares. is eligible value of date awards our amount in earned employees grant-date The fair of 23,508 shares The vesting our The (in follows thousands): total stock-based compensation expense related to restricted stock awards for the years ended December 31, are as Employees Non-employee Directors Total 2017 2016 2015 $ $ 2,416 642 3,058 $ $ 1,555 544 2,099 $ $ 1,423 617 2,040 Employees are permitted to use a certain number of shares of restricted stock to cover their personal tax liability for restricted stock awards. We paid approximately $500 thousand, $499 thousand and $342 thousand, to cover this liability in the years ended December 31, 2017, 2016 and 2015, respectively. These payments are classified as financing cash flows on the consolidated statements of cash flows. The total compensation cost related to non-vested awards not yet recognized was approximately $2.3 million with a weighted average amortization period of 1.7 years and $1.1 million with a weighted average amortization period of 1.9 years as of December 31, 2017 and 2016, respectively. Stock-based compensation consisting of restricted stock awards was included in costs and operating expenses and provision for income taxes on the accompanying statements of income for the years ended December 31, 2017, 2016 and 2015 (in thousands): Stock-based compensation included in costs and operating expenses Income tax benefit recognized for stock-based compensation Stock-based compensation expense, net of income tax benefit 2017 2016 2015 $ $ 3,068 (1,180) 1,888 $ $ 2,109 (811) 1,298 $ $ 2,081 (800) 1,281 (10) Income Taxes We are subject to U.S. federal income tax as well as income tax in multiple state and local jurisdictions. We have concluded all U.S. federal income tax matters as well as material state and local tax matters for years through 2013. The Tax Cuts and Jobs Act (the "Tax Act") was signed into law on December 22, 2017. The Tax Act significantly affects the U.S. corporate income tax by, among other things, lowering the statutory corporate tax rate from 35% to 21%, eliminating certain deductions, imposing a mandatory one-time tax on accumulated earnings of foreign subsidiaries, and changing how foreign earnings are subject to U.S. tax. The Tax Act also enhanced and extended through 2026 the option to claim accelerated depreciation deductions on qualified property. We have not completed our determination of the accounting implications of the Tax Act on our tax accruals. However, we have reasonably estimated the effects of the Tax Act and recorded provisional amounts in our financial statements as of December 31, 2017. We recorded a provisional tax benefit for the impact of the Tax Act of approximately $10.6 million. This amount is primarily comprised of the re-measurement of our federal net deferred tax liabilities resulting from the permanent reduction in the U.S. corporate tax rate from 35% to 21%. As we complete our analysis of the Tax Act, collect and prepare necessary data, and interpret any additional guidance issued by the U.S. Treasury Department, the Internal Revenue Service, and other standard-setting bodies, we may make adjustments to the provisional amounts. Those adjustments, if any, are not expected to have a material impact on our consolidated financial statements. -46- We taxes file from consolidated continuing federal operations income for tax the returns years that ended income all include of December 31, our 2017, subsidiaries. and 2016 The 2015 components as of follows are the (in provision for thousands): Current Federal State Deferred Federal State Foreign Provision for income taxes 2017 2016 2015 $ $ 14,149 2,511 16,660 (10,645) 110 (136) (10,671) 5,989 $ $ 13,648 2,379 16,027 (983) (163) — (1,146) 14,881 $ $ 13,641 2,352 15,993 73 11 — 84 16,077 The differences between the amount of tax computed at the federal statutory rate of 35% and the provision for income taxes from continuing operations for the years ended December 31, 2017, 2016 and 2015 are as follows (in thousands): Tax at statutory federal income tax rate Increases (decreases) in tax resulting from: State taxes, net of federal tax benefit Permanent differences, net Impact of Tax Act Other, net Provision for income taxes 2017 2016 2015 $ 15,780 $ 14,586 $ 14,348 1,732 (643) (10,556) (324) 5,989 $ 1,599 (974) — (330) 14,881 $ 1,683 88 — (42) 16,077 $ The tax effect of temporary differences representing deferred tax assets and liabilities as of December 31, 2017 and 2016 are as follows (in thousands): Gross deferred tax assets Deferred compensation and accrued paid leave Accrued expenses Stock-based compensation Reserve for contract disallowances Capitalized inventory State operating loss carryforward Tax credit carryforward Foreign country operating loss carryforward Legal settlements Other Total gross deferred tax assets Gross deferred tax liabilities Interest rate swaps Depreciation Deferred revenues Goodwill and intangible assets Total gross deferred tax liabilities $ 2017 2016 $ 5,594 1,013 772 84 916 263 178 136 — — 8,956 (74) (2,439) (1,875) (23,854) (28,242) 7,602 1,933 803 90 1,104 283 155 — 614 65 12,649 (28) (3,522) (2,291) (36,680) (42,521) Net deferred tax liabilities $ (19,286) $ (29,872) Certain amounts from the prior year have been reclassified to conform to the current year presentation. -47- (11) Commitments and Contingencies (a) Leases and Other Commitments We have terms The upon the agreements thousands): years. based rent (in various the of operating having non-cancelable facilities of cost escalating leases the rent operating leases provide typically and the Lease for for consumer for expense facilities, certain price the years facility terms. minimum index. Rent ended with as software well and as payments recognized is expense 2017, December 31, terms increases a and on 2016 between in lease straight-line as 2015 was and 15 payments basis for follows two equipment, 2017 2016 2015 Operating Lease Expense Sublease Income Net Expense $ $ $ 4,924 5,100 5,824 $ $ $ 1,134 888 506 $ $ $ 3,790 4,212 5,318 Future minimum annual non-cancelable commitments as of December 31, 2017 are as follows (in thousands): 2018 2019 2020 2021 2022 Thereafter Total Operating Leases Lease Commitments 2,753 $ 1,214 657 427 326 84 5,461 $ $ $ Sublease Income Net Commitments 2,753 1,214 657 427 326 84 5,461 — $ — — — — — — $ We signed a lease in 2009 for a building to serve as our headquarters with a rent commencement date of May 1, 2012. Certain terms in the lease agreement resulted in the capitalization of construction costs due to specific accounting rules. We recorded a construction asset and corresponding long-term liability of approximately $27.3 million on May 1, 2012, which represents the construction costs incurred by the landlord as of that date. According to accounting rules, we have forms of continuing involvement that required us to account for this transaction as a financing lease upon commencement of the lease period. The building and building improvements are included on our consolidated balance sheets and are being depreciated over a 15-year period. The accumulated depreciation of the construction asset was $10.9 million and $9.0 million as of December 31, 2017 and 2016, respectively. Payments made under the lease agreement are applied to service the financing obligation and interest expense based on an imputed interest rate amortizing the obligation over the life of the lease agreement. The long-term lease liability of $20.3 million and $21.7 million as of December 31, 2017 and 2016, respectively, is included in long-term lease obligations in our consolidated balance sheets. The current portion of our obligation, which is included in accrued expenses and other current liabilities in our consolidated balance sheets, was $1.4 million and $1.3 million as of December 31, 2017 and 2016, respectively. Future minimum annual non-cancelable commitments under our headquarters lease as of December 31, 2017, which are not included in the table above, are as follows (in thousands): 2018 2019 2020 2021 2022 Thereafter Total Lease Commitments 4,337 $ 4,456 4,579 4,705 4,827 22,336 45,240 $ $ $ Sublease Income 892 376 — — — — 1,268 Net Commitments 3,445 $ 4,080 4,579 4,705 4,827 22,336 43,972 $ -48- (b) Contingencies 2012, the entities in vendor In other individuals a insurance of deceased individuals of five individuals was VSE estates and April retained we condition, 2011 by settled or for caused to this cash unspecified by dispose matter flows. of with negligence carriers, and VSE the five employees with of our operations, financial and their alleging and VSE other and in plaintiffs filed relatives the that the other explosives resulting damages, of fireworks all complaints of state a fireworks five The defendants. by seized federal the material no in explosion 2017, in in court and diesel deceased Hawaii fuel that plaintiffs government. against killed were Together results adverse effect on our Prime Turbines other 2016, Prime Arrieta, lawsuit, four November Edgar and Canada Mexico, In by County, Aviation”) of Whitney in crashed negligent were monetary relief carrier, the adverse a and Turbines Corporation, resulting providing in $1.0 over aggressively of effect will amount any, results LLC Cessna in death maintenance, from the the be operation, million defend cannot of loss, on if our the et Arrieta al plaintiffs vs. against and three (“Prime”) Company Aircraft plaintiffs of three and service defendants. VSE's other and and inspection is trial The results we or proceedings. reasonably the While estimated, financial condition, in al, was Kansas defendants. The Inc. injuries to airplane filed Aviation The Plaintiffs other six engine November prior the of other Texas L.L.C. Court District of Independence, named that defendants April on allege plaintiffs the to VSE 2018. be cannot this that 1, VSE's Plaintiffs with with that and crash. together predicted lawsuit will have are 2016, in Dallas (“Kansas Pratt & a plane subsidiaries seeking are insurance its and certainty material a LLC et subsidiaries, unrelated Woodward serious the of scheduled legal that flows of believe cash for proceedings the is remote. likelihood government addition In legal adverse cannot the may we In and of agencies proceedings, parties. other legal against operations, above-referenced to us against proceedings, results on effect our with predicted be investigate Government or civil from against not debarment action will financial of amount operations us, of liabilities, government We believe, material the certainty, whether our investigations criminal future us. a our position, if loss, being are relating whether including repayments, contracting. based current our on upon effect have certain opinion, the cash or flows. be cannot any, conducted information, of results Government government fines adverse have or to administrative, result in suspension in result no investigations and or adverse including a material proceedings time, regulatory could to lead many disputes requirements. claims resolution in of However, reasonably in accordance contracts penalties investigations that the operations, the these because estimated. with or being often outcome financial course claims results normal other the Further, of will of from applicable contractual business, have not any legal time-to- and reasons, could or and government flows. cash complete other us, conducted imposed years take of any position, for upon to such or (12) Business Segments and Customer Information Segment Information Beginning is now restated combined reflect to in with such we Federal 2017, our change. changed our structure and as a Services Management Group. our of Consequently, business result our former our segment IT, financial Energy operations is conducted under and information three Management 2016 for reportable Consulting and 2015 operating Group been segments: has Supply Inventory Chain Management ("MIP") Program Group and – direct Our Supply to the sales Chain Management States Postal United Group supplies primarily through a Managed Service ("USPS") other customers. vehicle and parts to Aviation aviation Group jet – aircraft Our Aviation and engines Group engine provides MRO accessories. services, parts supply and distribution, and supply chain solutions for general Federal equipment ("DoD") Services Group sustainment other and – Our services, Federal and IT agencies. government Services technical Group and provides consulting engineering, services industrial, primarily to the logistics, United foreign States military Department sales, of legacy Defense These segment sales evaluate intersegment segments operate performance these based activities as under on are separate consolidated in eliminated management revenues consolidation. teams and and financial operating income. information sales Net is of produced our for business each segments segment. We exclude -49- Our segment information is as follows (in thousands): For the years ended December 31, Revenues Supply Chain Management Group Aviation Group Federal Services Group Total revenues Operating income: Supply Chain Management Group Aviation Group Federal Services Group Corporate expenses Operating income Depreciation and amortization expense: Supply Chain Management Group Aviation Group Federal Services Group Total depreciation and amortization Capital expenditures: Supply Chain Management Group Aviation Group Federal Services Group Corporate Total capital expenditures Total assets: Supply Chain Management Group Aviation Group Federal Services Group Corporate Total assets 2017 2016 2015 $ $ $ $ $ $ $ $ 214,542 134,809 410,762 760,113 33,754 9,695 13,419 (2,543) 54,325 6,536 4,835 14,511 25,882 1,376 1,387 177 373 3,313 $ $ $ $ $ $ $ $ $ $ 205,475 133,466 352,849 691,790 34,632 12,823 7,796 (3,722) 51,529 6,445 5,461 14,140 26,046 4,195 1,459 94 1,624 7,372 $ $ $ $ $ $ $ $ 196,772 119,729 217,481 533,982 35,453 10,635 6,802 (2,351) 50,539 7,074 5,865 12,602 25,541 7,544 959 94 1,965 10,562 December 31, 2017 2016 176,860 282,738 102,372 67,043 629,013 $ $ 185,004 291,500 107,549 77,786 661,839 Revenues are net of inter-segment eliminations. Corporate expenses are primarily selling, general and administrative expenses not allocated to segments. Included in our Corporate expenses for 2016 is a charge of approximately $3.3 million for the settlement of the Heritage Litigation offset by a gain of approximately $1.4 million resulting primarily from the Maritime Administration contract close-outs. Corporate assets are primarily cash, property and equipment and investments held in separate trust. -50- Customer Information derived Our of delivery customers years ended products revenues to include December also are our various (in 31, clients. other thousands): from contract USPS, The government services U.S. agencies Army and performed and for DoD Reserve, agencies and or U.S. Army commercial entities. Our federal Navy revenue civilian our are customer by agencies largest is from and customers. for follows as the Our the Customer U.S. Postal Service 2017 180,205 $ % 23.7 $ 2016 181,215 % 26.2 $ 2015 184,876 % Revenues by Customer Years ended December 31, U.S. Navy U.S. Army U.S. Air Force Total - DoD Commercial Aviation Other Commercial Total - Commercial Other Government 206,644 188,462 7,123 402,229 126,960 12,498 139,458 38,221 27.2 24.8 0.9 52.9 16.7 1.7 18.4 5.0 190,155 139,764 3,482 333,401 131,067 10,721 141,788 27.5 20.2 0.5 48.2 19.0 1.5 20.5 98,887 80,086 3,558 182,531 119,729 4,653 124,382 35,386 5.1 42,193 34.6 18.5 15.0 0.7 34.2 22.4 0.9 23.3 7.9 Total $ 760,113 100.0 $ 691,790 100.0 $ 533,982 100.0 We do not measure revenue or profit by product or service lines, either for internal management or external financial reporting purposes, because it would be impractical to do so. Products offered and services performed are determined by contract requirements and the types of products and services provided for one contract bear no relation to similar products and services provided on another contract. Products and services provided vary when new contracts begin or current contracts expire. In many cases, more than one product or service is provided under a contract or contract task order. Accordingly, cost and revenue tracking is designed to best serve contract requirements and segregating costs and revenues by product or service lines in situations for which it is not required would be difficult and costly to both us and our customers. Geographical Information Revenue by geography is based on the billing address of the customer. Our revenue by geographic area is as follows (in thousands): United States Other Countries (1) Total revenue Years ended December 31, 2016 $ 638,726 53,064 $ 691,790 2015 $ 481,466 52,516 $ 533,982 2017 $708,474 51,639 $760,113 (1) No individual country, other than disclosed above, exceeded 10% of our total revenue for any period presented. (13) Capital Stock Common Stock Our common stock has a par value of $0.05 per share. Proceeds from common stock issuances that are greater than $0.05 per share are credited to additional paid in capital. Holders of common stock are entitled to one vote per common share held on all matters voted on by our stockholders. Stockholders of record are entitled to the amount of dividends declared per common share held. (14) 401(k) Plan -51- We defined a maintain of all our plan the years substantially in specified the for ended million covers rates at $4.8 contribution plan under Section employees. Under provisions of documents. Our December 31, the expense 2017, associated and 2016, the 401(k) our with 2015, of 401(k) plan, was plan this respectively. Internal Revenue employees' approximately Code eligible $6.2 as of 1986, contributions $6.3 million, amended, that matched and are million (15) Fair Value Measurements The for hierarchy accounting measuring standard value. fair for The fair value standard measurements applicable is defines whenever fair assets value, and and liabilities establishes are a market-based fair at measured framework value. or The fair value hierarchy established in the standard prioritizes the inputs used in valuation techniques into three levels as follows: Level 1 – Observable inputs – quoted prices in active markets for identical assets and liabilities; Level Observable 2 for – similar inputs instruments, all other quoted significant than the prices inputs quoted for are prices identical or observable in active similar active in for markets instruments markets; identical in inactive and where models quoted from prices valuation assets and markets, liabilities and – amounts includes derived Level 3 unobservable are – and Unobservable us require inputs to develop includes relevant amounts assumptions. derived – from valuation models where one or more significant inputs The December 31, following and 2017 summarizes table December 31, 2016 the financial the level assets they and and fall liabilities the within measured value fair at fair hierarchy value (in a recurring on thousands): basis as of Amounts Recorded at Fair Value Non-COLI assets held in Deferred Supplemental Compensation Plan Interest rate swaps Financial Statement Classification Other assets Other current assets Fair Value Hierarchy Fair Value December 31, 2017 Fair Value December 31, 2016 1 2 $ $ 389 294 $ $ 299 73 Non-COLI assets held in the deferred supplemental compensation plan consist of equity funds with fair value based on observable inputs such as quoted prices for identical assets in active markets and changes in its fair value are recorded as selling, general and administrative expenses. We account for our interest rate swap agreements under the provisions of ASC 815, Derivatives and Hedging, and have determined that our swap agreements qualify as cash flow hedges. Accordingly, the fair value of the swap agreements, which is an asset recorded in other current assets of approximately $294 thousand and approximately $73 thousand at December 31, 2017 and 2016, respectively. The offset, net of an income tax effect of approximately $113 thousand and $28 thousand is included in accumulated other comprehensive income in the accompanying balance sheets as of December 31, 2017 and 2016, respectively. The amounts paid and received on the swap agreements are recorded in interest expense in the period during which the related floating-rate interest is incurred. We determine the fair value of the swap agreements based on a valuation model using market data inputs. -52- (16) Selected Quarterly Data (Unaudited) The following table shows selected quarterly data for 2017 and 2016, in thousands, except earnings per share. Revenues Costs and operating expenses Operating income Net income Basic earnings per share: Net income Basic weighted average shares outstanding Diluted earnings per share: Net income Diluted weighted average shares outstanding Revenues Costs and operating expenses Operating income Net income Basic earnings per share: Net income Basic weighted average shares outstanding Diluted earnings per share: Net income Diluted weighted average shares outstanding 1st 197,294 183,098 14,196 7,293 0.67 10,823 0.67 10,849 1st 143,636 130,895 12,741 6,552 0.61 10,778 0.61 10,806 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2017 Quarters 2nd 3rd 193,860 178,855 15,005 7,807 0.72 10,838 0.72 10,862 $ $ $ $ $ $ 174,164 161,927 12,237 6,639 0.61 10,838 0.61 10,857 2016 Quarters 2nd 3rd 160,473 148,594 11,879 5,969 0.55 10,799 0.55 10,826 $ $ $ $ $ $ 172,780 159,157 13,623 7,088 0.66 10,799 0.65 10,826 $ $ $ $ $ $ $ $ $ $ $ $ 4th 194,795 181,908 12,887 17,357 1.60 10,838 1.59 10,903 4th 214,901 201,615 13,286 7,184 0.67 10,799 0.66 10,853 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. ITEM 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management has evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. -53- Management's Report on Internal Control Over Financial Reporting responsible is Exchange Act Executive Management in Chief reporting financial of Committee Internal in effective was opinion on Accounting defined is term our including over control the by issued framework the under reporting financial firm, an issued has Registered Public establishing for Rules 13a-15(f) and Officer Chief as December 31, of Sponsoring Organizations and Financial 2017 of Integrated – Control of as internal our forth set Firm December 31, control below. over and 15d-15(f). maintaining adequate Officer, based the conducted Under we the on Treadway supervision an framework Commission the Framework, our & Ernst Young reporting. financial control internal the with and assessment Internal in (2013 financial of reporting, our effectiveness over participation of the – Control Based Framework). our that registered in as such management, our internal of Framework Integrated assessment on our over internal accounting Independent public of control Report the management our LLP, opinion This concluded independent appears 2017. Change in Internal Controls During in materially fourth the Rules 13a-15(f) affect quarter and these of 15d-15(f) controls 2017, year the under subsequent there Exchange the to were Act) evaluation no that of changes have these our materially controls. in fiscal defined to likely internal control these over controls, financial or are reporting (as reasonably affected -54- Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of VSE Corporation Opinion on Internal Control over Financial Reporting VSE Corporation and Subsidiaries’ We have audited internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria. VSE Corporation and Subsidiaries (the We also have audited, in accordance with the standards of the Public Company (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, stockholders’ ended December 31, 2017, and the related notes and our report dated March 7, 2018 expressed an unqualified opinion thereon. equity and cash flows for each of the three years in the period Accounting Oversight Board (United States) Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting and its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We are a public accounting firm registered with the PCAOB and are required to be We conducted our audit in accordance with the standards of the PCAOB. audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Those standards require that we plan and perform the Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. reasonable basis for our opinion. We believe that our audit provides a Definition and Limitations of Internal Control over Financial Reporting A company’s internal control over financial reporting includes those policies and procedures A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Also, Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst & Young LLP Tysons, Virginia March 7, 2018 -55- ITEM 9B. Other Information None. PART III as Except in omitted statement to stockholders otherwise reliance be filed scheduled indicated General of the with be to SEC held below, the Instruction later April not on information G(3) than 30, to 120 2018 (the Form days required 10-K after "Proxy 11, 10, Items is 12, incorporated 2017 by and December 31, Statement"). been has proxy VSE's 14 and 13 herein in by respect of Part reference the of III to Annual of our Form 10-K definitive of Meeting ITEM 10. Directors, Executive Officers and Corporate Governance See incorporated 4 Item by under reference the to caption Proxy "Executive Statement. the Officers of Registrant," and the remaining information required by this Item is ITEM 11. Executive Compensation The information required by this Item is incorporated by reference to the Proxy Statement. ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Except for incorporated the by Item is "Equity reference Compensation Proxy the to Plan Statement. Information" disclosed in Item 5(e) above, the information required by this ITEM 13. Certain Relationships and Related Transactions, and Director Independence The information required by this Item is incorporated by reference to the Proxy Statement. ITEM 14. Principal Accountant Fees and Services The information required by this Item is incorporated by reference to the Proxy Statement. ITEM 15. Exhibits and Financial Statement Schedules 1. Financial Statements PART IV The consolidated financial statements are listed under Item 8 of this Form 10-K. 2. Supplemental Financial Statement Schedules schedules have been supplied the financial statements All in omitted or notes because the to they are financial applicable, not statements. not required, or the information has been otherwise 3. Exhibits See "Exhibit Index" hereinafter contained and incorporated by reference. -56- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SIGNATURES Date: March 7, 2018 By: VSE CORPORATION /s/ M. A. Gauthier M. A. Gauthier Chief Executive Officer, President and Chief Operating Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of Registrant and in the capacities and on the dates indicated. Name Title Date /s/ Maurice A. Gauthier Maurice A. Gauthier /s/ Thomas R. Loftus Thomas R. Loftus /s/ Clifford M. Kendall Clifford M. Kendall /s/ Calvin S. Koonce Calvin S. Koonce /s/ James F. Lafond James F. Lafond /s/ Bonnie K. Wachtel Bonnie K. Wachtel /s/ Ralph E. Eberhart Ralph E. Eberhart /s/ Jack C. Stultz Jack C. Stultz /s/ John E. Potter John E. Potter /s/ Mark E. Ferguson III Mark E. Ferguson III Director, Chief Executive Officer, President and Chief Operating Officer Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) March 7, 2018 March 7, 2018 Chairman/Director March 7, 2018 Director Director Director Director Director Director Director -57- March 7, 2018 March 7, 2018 March 7, 2018 March 7, 2018 March 7, 2018 March 7, 2018 March 7, 2018 EXHIBIT INDEX Reference No. Per Item 601 of Regulation S-K Description of Exhibit Exhibit No. In this Form 10-K 3.1 3.2 4.1 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 21.1 23.1 31.1 31.2 32.1 32.2 Certificate of incorporation and by-laws Restated Certificate of Incorporation of VSE Corporation dated as of February 6, 1996 (Exhibit 3.2 to Form 10-K405 dated March 25, 1996) By-Laws of VSE Corporation as amended through December 17, 2008 (Exhibit 3.1 to Form 8-K dated December 17, 2008) Instruments defining the rights of security holders, including indentures Specimen Stock Certificate as of May 19, 1983 (Exhibit 4 to Registration Statement No. 2-83255 dated April 22, 1983 on Form S-2) Material contracts Employment Agreement dated as of July 1, 2004, by and between VSE Corporation and Thomas R. Loftus (Exhibit 10.1 to Form 10-Q dated July 30, 2004) Amended and Restated Employment Agreement dated as of December 6, 2013 by and between VSE Corporation and Maurice A. Gauthier (Exhibit 10.3 to Form 10-Q dated April 29, 2016); and Amendment Agreement dated as of December 14, 2016 by and between VSE Corporation and Maurice A. Gauthier (Exhibit 10.1 to Form 8-K dated December 9, 2016) Severance and Mutual Protection Agreement dated as of November 7, 2008, by and between VSE Corporation and Thomas M. Kiernan (Exhibit 10.3 to Form 10-K dated March 3, 2009) Fourth Amended and Restated Business Loan and Security Agreement dated January 28, 2015 among VSE Corporation and its wholly owned subsidiaries, Citizens Bank of Pennsylvania and a syndicate of eight other banks (Exhibit 10.1 to Form 8-K dated January 8, 2018) Lease Agreement by and between Metropark 7 LLC and VSE Corporation (Exhibit 10.2 to Form 8-K dated November 4, 2009) VSE Corporation Deferred Supplemental Compensation Plan effective January 1, 1994 as amended by the Board through March 9, 2004 (Exhibit 10.2 to Form 10-Q dated April 28, 2004) VSE Corporation 2004 Non-Employee Directors Stock Plan (Appendix B to Registrant's definitive proxy statement for the Annual Meeting of Stockholders held on May 6, 2014) Subsidiaries of the Registrant Consent of Ernst & Young LLP, independent registered public accounting firm Section 302 CEO Certification Section 302 CFO and PAO Certification Section 906 CEO Certification Section 906 CFO and PAO Certification -58- * * * + * + * + * + * * * + * + Exhibit 21 Exhibit 23.1 Exhibit 31.1 Exhibit 31.2 Exhibit 32.1 Exhibit 32.2 99.1 101.INS 101.SCH 101.CAL 101.DEF 101.LAB 101.PRE Audit Committee Charter (as adopted by the Board Of Directors of VSE Corporation on March 9, 2004)(Appendix A to Registrant's definitive proxy statement for the Annual Meeting of Stockholders held on May 3, 2004) XBRL Instance Document XBRL Taxonomy Extension Schema Document XBRL Taxonomy Extension Calculation Linkbase Document XBRL Taxonomy Extension Definition Linkbase Document XBRL Taxonomy Extension Label Linkbase Document XBRL Taxonomy Extension Presentation Linkbase Document * *Document has been filed as indicated and is incorporated by reference herein. +Indicates management contract or compensatory plan or arrangement. -59- Exhibit 21 SUBSIDIARIES OF THE REGISTRANT The following is a listing of the subsidiaries of the Registrant: Jurisdiction Organization Energetics Incorporated Maryland Integrated Concepts and Research Corporation District of Columbia Akimeka, LLC Wheeler Bros., Inc. VSE Aviation, Inc. Air Parts & Supply Co. Kansas Aviation of Independence, L.L.C. Prime Turbines LLC CT Aerospace LLC Ultra Seating Company Hawaii Pennsylvania Delaware Florida Kansas Delaware Texas Texas Consent of Independent Registered Public Accounting Firm Exhibit 23.1 We consent to the incorporation by reference in the following Registration Statements of VSE Corporation and Subsidiaries: • Registration Statement (Form S-8 No. 333-195802) pertaining to the 2004 Non-employee Directors Stock Plan, as amended; • Registration Statement (Form S-8 No. 333-195803) pertaining to the 2006 Restricted Stock Plan, as amended; and • Registration Statement (Form S-8 No. 333-134285) pertaining to the 2006 Restricted Stock Plan, as amended of our reports dated March 7, 2018, with respect to the consolidated financial statements of VSE Corporation and Subsidiaries and the effectiveness of internal control over financial reporting of VSE Corporation and Subsidiaries included in this Annual Report (Form 10-K) for the year ended December 31, 2017. /s/ Ernst & Young LLP Tysons, Virginia March 7, 2018 CERTIFICATION PURSUANT TO RULE 13A-14 OF THE SECURITIES EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 31.1 I, M. A. Gauthier, certify that: 1. I have reviewed this annual report on Form 10-K of VSE Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly 3. present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have: (a) (b) (c) (d) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control 5. over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): (a) (b) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Dated: March 7, 2018 /s/ M. A. Gauthier M. A. Gauthier Chief Executive Officer, President and Chief Operating Officer CERTIFICATION PURSUANT TO RULE 13A-14 OF THE SECURITIES EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 31.2 I, T. R. Loftus, certify that: 1. I have reviewed this annual report on Form 10-K of VSE Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly 3. present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have: (a) (b) (c) (d) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control 5. over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): (a) (b) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: March 7, 2018 /s/ T. R. Loftus T. R. Loftus Executive Vice President and Chief Financial Officer CERTIFICATION PURSUANT TO SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 32.1 Pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as President, Chief Executive Officer and Chief Operating Officer of VSE Corporation (the "Company"), does hereby certify that to the best of the undersigned's knowledge: 1) our Annual Report on Form 10-K for the year ending December 31, 2017 (the "Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) the information contained in our Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 7, 2018 /s/ M. A. Gauthier M. A. Gauthier Chief Executive Officer, President and Chief Operating Officer CERTIFICATION PURSUANT TO SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 32.2 Pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as Executive Vice President and Chief Financial Officer of VSE Corporation (the "Company"), does hereby certify that to the best of the undersigned's knowledge: 1) our Annual Report on Form 10-K for the year ending December 31, 2017 (the "Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) the information contained in our Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 7, 2018 /s/ T. R. Loftus T. R. Loftus Executive Vice President and Chief Financial Officer 

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