SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended March 31, 2007 Commission File Number: 0-3676
VSE CORPORATION
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 54-0649263
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2550 Huntington Avenue
Alexandria, Virginia 22303-1499 www.vsecorp.com
(Address of Principal Executive Offices) (Zip Code) (Webpage)
Registrant's Telephone Number, Including Area Code: (703) 960-4600
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- -------------------
Common Stock, par value $.05 per share NASDAQ Global Market
Securities registered pursuant to Section 12(g) of the Act: None
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 require-
ments for the past 90 days. Yes [x] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [x]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
Number of shares of Common Stock outstanding as of April 30, 2007: 2,431,363.
VSE Corporation and Subsidiaries
--------------------------------------------------------------------------------
Forward Looking Statements
This filing contains statements which, to the extent they are not recitations of
historical fact, constitute "forward looking statements" under federal
securities laws. All such statements are intended to be subject to the safe
harbor protection provided by applicable securities laws. For discussions
identifying some important factors that could cause actual VSE Corporation
("VSE" or the "Company") results to differ materially from those anticipated in
the forward looking statements contained in this filing, see VSE's discussions
captioned "Business," "Risk Factors," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Notes to Consolidated
Financial Statements" contained in VSE's Annual Report on Form 10-K for the
fiscal year ended December 31, 2006 filed with the Securities and Exchange
Commission (the "SEC") on March 5, 2007.
Readers are cautioned not to place undue reliance on these forward looking
statements, which reflect management's analysis only as of the date hereof. The
Company undertakes no obligation to publicly revise these forward looking
statements to reflect events or circumstances that arise after the date hereof.
Readers should carefully review the risk factors described in other documents
the Company files from time to time with the SEC, including this and other
Quarterly Reports on Form 10-Q to be filed by the Company subsequent to its
Annual Report on Form 10-K and any Current Reports on Form 8-K filed by the
Company.
-2-
PART I. Financial Information
Item 1. Financial Statements
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Balance Sheets
--------------------------------------------------------------------------------
(in thousands except share and per share amounts)
March 31, December 31,
2007 2006
---- ----
(Unaudited)
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . $ 9,394 $ 8,745
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . 83,214 66,730
Contract inventories . . . . . . . . . . . . . . 2,324 4,459
Deferred tax assets . . . . . . . . . . . . . . 1,356 1,196
Other current assets . . . . . . . . . . . . . . 3,388 2,472
-------- --------
Total current assets . . . . . . . . . . . . . 99,676 83,602
Property and equipment, net . . . . . . . . . . . 8,922 8,409
Deferred tax assets . . . . . . . . . . . . . . . 1,308 1,133
Goodwill . . . . . . . . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . 5,139 4,337
-------- --------
Total assets . . . . . . . . . . . . . . . . . $116,099 $ 98,535
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . $ 59,041 $ 44,302
Accrued expenses . . . . . . . . . . . . . . . 11,842 13,486
Dividends payable . . . . . . . . . . . . . . . 170 168
-------- --------
Total current liabilities . . . . . . . . . . 71,053 57,956
Deferred compensation . . . . . . . . . . . . . . 2,997 2,183
Other liabilities . . . . . . . . . . . . . . . . 309 160
-------- --------
Total liabilities . . . . . . . . . . . . . . 74,359 60,299
-------- --------
Commitments and contingencies
Stockholders' equity:
Common stock, par value $.05 per share,
Authorized 15,000,000 shares; issued and
outstanding 2,431,363 in 2007 and 2,394,081
shares in 2006 . . . . . . . . . . . . . . . . 122 120
Paid-in capital . . . . . . . . . . . . . . . . 8,227 7,283
Retained earnings . . . . . . . . . . . . . . . 33,391 30,833
-------- --------
Total stockholders' equity . . . . . . . . . . 41,740 38,236
-------- --------
Total liabilities and stockholders' equity . . $116,099 $ 98,535
======== ========
The accompanying notes are an integral part of these balance sheets.
-3-
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Income (Unaudited)
--------------------------------------------------------------------------------
(in thousands except share and per share amounts)
For the three months
ended March 31,
2007 2006
---- ----
Revenues, principally from contracts . . . . . . . . $ 120,689 $ 63,300
Costs and expenses of contracts . . . . . . . . . . 116,248 60,912
--------- ---------
Gross profit . . . . . . . . . . . . . . . . . . . . 4,441 2,388
Selling, general and administrative expenses . . . . 151 123
Interest income, net . . . . . . . . . . . . . . . . (116) (137)
--------- ---------
Income before income taxes . . . . . . . . . . . . . 4,406 2,402
Provision for income taxes . . . . . . . . . . . . . 1,677 917
--------- ---------
Net income . . . . . . . . . . . . . . . . . . . . . $ 2,729 $ 1,485
========= =========
Basic earnings per share:
Net income . . . . . . . . . . . . . . . . . . . . . $ 1.14 $ 0.63
========= =========
Basic weighted average shares outstanding 2,403,712 2,361,261
========= =========
Diluted earnings per share:
Net income . . . . . . . . . . . . . . . . . . . . . $ 1.12 $ 0.61
========= =========
Diluted weighted average shares outstanding 2,444,767 2,433,317
========= =========
Dividends declared per share $ 0.07 $ 0.06
========= =========
The accompanying notes are an integral part of these financial statements.
-4-
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Stockholders' Equity (Unaudited)
-----------------------------------------------------------------------------------------
(in thousands except per share data)
Total
Common Stock Paid-In Retained Stockholders'
Shares Amount Surplus Earnings Investment
------ ------ ------- -------- ----------
Balance at
December 31, 2006 2,394 $ 120 $ 7,283 $ 30,833 $ 38,236
Net income for the period . . . . - - - 2,729 2,729
Stock-based compensation . . . . 2 - 126 - 126
Exercised stock options . . . . . 35 2 433 - 435
Excess tax benefits from
Share-based payment
arrangements. . . . . . . . . . - - 385 - 385
Dividends declared ($.07) . . . . - - - (171) (171)
----- ----- ------- -------- --------
Balance at
March 31, 2007 2,431 $ 122 $ 8,227 $ 33,391 $ 41,740
===== ===== ======= ======== ========
The accompanying notes are an integral part of these financial statements.
-5-
VSE Corporation and Subsidiaries
Consolidated Financial Statements (Unaudited)
Consolidated Statements of Cash Flows
--------------------------------------------------------------------------------
(in thousands)
For the three months
ended March 31
2007 2006
---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . $ 2,729 $ 1,485
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . 601 391
Loss on sale of property and equipment . . . . . . . - 1
Deferred taxes . . . . . . . . . . . . . . . . . . . (335) (308)
Stock-based compensation . . . . . . . . . . . . . . 126 63
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable, net. . . . . . . . . . . . . . . (16,484) (72)
Contract inventories . . . . . . . . . . . . . . . . 2,135 (384)
Other current assets and noncurrent assets . . . . . (1,743) (1,896)
Increase (decrease) in:
Accounts payable and deferred compensation . . . . . 15,553 128
Accrued expenses . . . . . . . . . . . . . . . . . . (1,644) (3,249)
Other liabilities . . . . . . . . . . . . . . . . . . 149 40
------- -------
Net cash provided by (used in) operating activities 1,087 (3,801)
------- -------
Cash flows from investing activities:
Purchases of property and equipment . . . . . . . . . . (1,089) (914)
------- -------
Net cash used in investing activities (1,089) (914)
------- -------
Cash flows from financing activities:
Dividends paid . . . . . . . . . . . . . . . . . . . . . (169) (141)
Excess tax benefits from share-based
payment arrangements . . . . . . . . . . . . . . . . . 385 37
Proceeds from the exercise of options of common stock . 435 74
------- -------
Net provided by (used in)in financing activities 651 (30)
------- -------
Net increase (decrease) in cash and cash equivalents . . . 649 (4,745)
Cash and cash equivalents at beginning of period . . . . 8,745 12,717
------- -------
Cash and cash equivalents at end of period . . . . . . . $ 9,394 $ 7,972
======= =======
The accompanying notes are an integral part of these financial statements.
-6-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three months ended March 31, 2007 are not necessarily indicative
of the results that may be expected for the year ending December 31, 2007. For
further information refer to the consolidated financial statements and footnotes
thereto included in the VSE Corporation Annual Report on Form 10-K for the year
ended December 31, 2006.
Management of VSE's business operations is conducted under three reportable
operating segments, the Federal Group, the International Group, and the Energy
and Environmental Group.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Significant
estimates affecting the financial statements include the allowance for doubtful
accounts, accruals for loss contracts, contract disallowance reserves, self
insured health claims and estimated cost to complete on firm fixed-price
contracts.
Recent Accounting Pronouncements
In February 2007, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities - Including an amendment of FASB Statement No. 115." SFAS No. 159
permits entities to choose to measure eligible items at fair value at specified
election dates and report unrealized gains and losses on items for which the
fair value option has been elected in earnings at each subsequent reporting
date. SFAS No. 159 is effective for fiscal years beginning after November 15,
2007. Management is currently evaluating the effect that adoption of this
statement will have on the company's consolidated financial position and results
of operations when it becomes effective in 2008.
Contract Inventories
The components of contract inventories as of March 31, 2007 and December 31,
2006 were as follows (in thousands):
2007 2006
---- ----
Work in process . . . . . . . . . . . . . . . . . . . . $ 2,324 $ 4,459
------- -------
Total contract inventories $ 2,324 $ 4,459
======= =======
Contract inventories consist of materials purchased, and other expenditures for
use in a contract to modify and apply a protective system, the Tanker Ballistic
Protection System ("TBPS") to military vehicles for the U.S. Army.
-7-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Although these costs are classified as inventories for accounting purposes, they
are similar in nature to materials and direct supplies purchased for use in
performance on the Company's other contracts in that they are solely and
directly attributable to the contract and will be billed to the customer within
a relatively short time. These materials and direct supplies will not be
restocked to maintain any permanent inventory levels. Contract inventories are
relieved when units are delivered and revenue is recognized.
Work in process inventories consist of amounts for materials, supplies and other
expenditures for which work has been performed but for which the end unit has
not yet been completed and accepted. Work in process inventories at March 31,
2007 and December 31, 2006 included applicable indirect cost burdens, including
general and administrative costs totaling approximately $317 thousand and $608
thousand, respectively. Indirect cost burdens, including general and
administrative costs charged to cost of sales from inventories for the periods
ended March 31, 2007 and December 31, 2006 totaled $946 thousand and $3.9
million, respectively.
Debt
VSE has a loan agreement with a bank under which credit is made available to the
Company in the form of revolving loan amounts or letters of credit. The amount
of credit available to the Company is $15 million, subject to certain
conditions, including a borrowing formula based on billed receivables. The
expiration date of the loan agreement is May 31, 2008. From time to time the
bank and the Company may negotiate an amendment to the loan to increase or
decrease the amount of available credit or to change the expiration date to a
later date.
The loan agreement contains terms whereby the Company may borrow against the
revolving loan and has the option at any time and from time to time to prepay
such borrowings in whole or in part without premium or penalty. There are
collateral requirements by which Company assets secure amounts outstanding,
restrictive covenants that include minimum tangible net worth and profitability
requirements, a limit on annual dividends, and other affirmative and negative
covenants. As of March 31, 2007 the Company has not been notified by the bank,
nor is the Company aware of any default under the loan agreement.
The Company pays a fixed annual commitment fee of $20 thousand, interest on any
revolving loan borrowings at a prime-based rate or an optional LIBOR-based rate,
and fees on any letters of credit that are issued. As of March 31, 2007 and
December 31, 2006, there were no revolving loan amounts outstanding and no
letters of credit. There was no interest expense incurred during the three
months ended March 31, 2007 and 2006.
Stock-based Compensation
2006 Restricted Stock Plan
On May 2, 2006, the Company's stockholders approved the VSE Corporation 2006
Restricted Stock Plan (the "2006 Plan"). Under the 2006 Plan, not more than a
total of 125,000 shares of VSE Common Stock, par value $.05 per share ("shares"
or "VSE Stock") may be issued. The shares issued under the 2006 Plan may, at the
Company's option, be either shares held in treasury or shares originally issued.
On January 2, 2007 and June 27, 2006, the Company granted 2,400 shares and 1,800
shares, respectively, of restricted VSE Stock to the Company's outside Directors
under the 2006 Plan. The fair market value on the grant date was $33.67 and
$31.50 per share, respectively. The shares issued vested immediately and cannot
be sold, transferred, pledged or assigned before the second anniversary of the
grant date.
-8-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company notified certain employees of their participation in the 2006
VSE Corporation Restricted Stock Plan for calendar year 2007 on January 3, 2007.
Accordingly, such employees are eligible to receive an award based on VSE's
financial performance for 2007. The earned amount will be expensed ratably over
the vesting period of approximately three years, including the service period of
one year which begins on January 1, 2007. As a result, the Company has
recognized approximately $53 thousand in related expense during the first
quarter of 2007.
Stock Option Plans
2004 Stock Option Plan
As of March 31, 2007, options issued under the 2004 Plan for up to 64,500 shares
remain outstanding. Each option granted under the 2004 Plan was issued at the
fair market value of VSE shares on the date of grant. Each option vests 25% on
date of award and 25% on each anniversary date thereafter, becoming 100% vested
as of the third anniversary date of award. The 2004 Plan will terminate on the
earliest of May 1, 2014, or the date on which all options issued under the 2004
Plan have been exercised, expire, or have been terminated.
1998 Stock Option Plan
As of March 31, 2007, options issued under the 1998 Plan for up to 67,243 shares
remain outstanding. The 1998 Plan will terminate on the earliest of May 6, 2008,
or the date on which all options issued under the 1998 Plan have been exercised,
expire, or have been terminated.
Accounting for Stock-based Compensation
Prior to January 1, 2006, the Company had followed the provisions of SFAS 123,
"Accounting for Stock-Based Compensation," as amended by SFAS 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure." Accordingly, the
Company accounted for stock-based compensation under Accounting Principles Board
(APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations, using the intrinsic value method. Effective January 1, 2006,
the Company adopted the fair value recognition provisions of SFAS 123(R), using
the modified-prospective-transition method. Under that transition method,
compensation cost recognized for the three months ended March 31, 2007 and 2006
includes compensation cost for all share-based payments granted prior to,
but not yet vested as of January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of Statement 123. Results
for prior periods have not been restated.
As a result of adopting SFAS 123(R) on January 1, 2006, the Company's net income
for the three month ended March 31, 2007 and 2006 was approximately $28 thousand
lower or approximately $.01 per share basic and diluted and $39 thousand lower
or approximately $.02 per share basic and diluted, respectively, than if it had
continued to account for share-based compensation under Opinion 25. The total
compensation cost not yet recognized in the Company's income before income taxes
as of March 31, 2007 is approximately $136 thousand, to be recognized over
approximately nine months.
Prior to the adoption of SFAS 123(R), the Company presented all tax benefits of
deductions resulting from the exercise of stock options as operating cash flows
in the Statement of Cash Flows. SFAS 123(R) requires the cash flows
-9-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
resulting from the tax benefits resulting from tax deductions in excess of the
compensation cost recognized for those options (excess tax benefits) to be
classified as financing cash flows. Approximately $385 thousand and $37 thousand
in excess tax benefits classified as cash provided by financing activities
for the three months ended March 31, 2007 and 2006, respectively, would have
been classified as cash provided by operating activities if the Company had not
adopted SFAS 123(R).
Set forth below is a summary of the Company's stock option activity for the
three months ended March 31, 2007 and 2006:
Weighted Weighted
Average Average
Exercise Exercise
2007 Price 2006 Price
---- ----- ---- -----
Number of shares under
stock options:
Outstanding at beginning of period 166,625 $17.22 197,563 $15.83
Exercised (34,882) 12.46 (4,500) 16.36
------- ------ ------- ------
Outstanding at end of period 131,743 $18.49 193,063 $15.82
======= ====== ======= ======
Exercisable at end of period 114,243 $17.46 141,938 $13.85
======= ====== ======= ======
Weighted average remaining
contractual life 1 Year 2 Years
The aggregate intrinsic values of outstanding, exercisable and exercised stock
options as of March 31, 2007 and 2006 are as follows (in thousands):
2007 2006
---- ----
Outstanding stock options $2,987 $4,958
Exercisable stock options $2,707 $3,924
Exercised stock options $1,020 $ 115
As of March 31, 2007, there was approximately $136 thousand of unrecognized
compensation cost related to nonvested stock options which the Company expects
to recognize during 2007.
Earnings Per Share
Basic earnings per share have been computed by dividing net income by the
weighted average number of shares of common stock outstanding during each
period. Shares issued during the period and shares reacquired during the period
are weighted for the portion of the period that they were outstanding.
Diluted earnings per share have been computed in a manner consistent with that
of basic earnings per share while giving effect to all potentially dilutive
common shares that were outstanding during each period. Potentially dilutive
common shares include incremental common shares issuable upon exercise of stock
options.
Three Months Ended March 31,
2007 2006
---- ----
Basic weighted average
common shares outstanding 2,403,712 2,361,261
Diluted effect of options 41,055 72,056
--------- ---------
Diluted weighted average
common shares outstanding 2,444,767 2,433,317
========= =========
-10-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Uncertainty in Income Taxes
The Company adopted the provisions of FIN 48, "Accounting for Uncertainty in
Income Taxes - an interpretation of FASB Statement No. 109," (FIN 48), on
January 1, 2007. As a result of the implementation of FIN 48, the Company made
a comprehensive review of its portfolio of uncertain tax positions in accordance
with recognition standards established by FIN 48. In this regard, an uncertain
tax position represents the Company's expected treatment of a tax position taken
in a filed tax return, or planned to be taken in a future tax return, that has
not been reflected in measuring income tax expense for financial reporting
purposes. As a result of this review, the Company concluded that at this time
there are no uncertain tax positions. As a result of applying the provisions of
FIN 48, there was no cumulative effect on retained earnings.
As of March 31, 2007, the Company has accrued approximately $75 thousand related
to expected interest payments to the Internal Revenue Service ("IRS") for an
open tax issue. This issue is a temporary difference that should not materially
impact future tax liabilities.
The Company files income tax returns in the U.S. federal jurisdiction, and in
various states.
Litigation
VSE and its subsidiaries have, in the normal course of business, certain claims
against them and against other parties. In the opinion of management, the
resolution of these claims will not have a material adverse effect on the
Company's results of operations or financial position. However, the results of
any legal proceedings cannot be predicted with certainty.
Segment Information
Management of VSE's business operations is conducted under three reportable
operating segments, the Federal Group, the International Group, and the Energy
and Environmental Group.
Federal Group - VSE's Federal Group provides engineering, technical, management,
integrated logistics support, and information technology services to all U.S.
military services and other government agencies. It consists of four divisions:
CED, ELD, MSD and SED.
International Group - VSE's International Group provides engineering,
industrial, logistics, and foreign military sales services to the U.S. military
and other government agencies. It consists of three divisions: BAV, VCG and FMD.
Energy and Environmental Group - VSE's Energy and Environmental Group provides
high-level consulting services in the field of energy and environmental
management. The Energy and Environmental Group includes VSE's wholly owned
subsidiary, Energetics, Inc.
-11-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
These segments operate under separate management teams and discrete financial
information is produced for each segment. The Company evaluates segment
performance based on consolidated revenues and profits or losses from operations
before income taxes. The Company's segment information for the three months
ended March 31, 2007 and 2006 is as follows (in thousands):
2007 2006
---- ----
Revenues from continuing operations:
Federal Group $ 70,503 $20,205
International Group 46,904 39,849
Energy and Environmental Group 3,246 3,224
Corporate 36 22
-------- -------
Total revenues $120,689 $63,300
======== =======
Income from continuing operations before
income taxes:
Federal Group $ 2,726 $ 706
International Group 1,487 1,322
Energy and Environmental Group 313 376
Corporate/unallocated expenses (120) (2)
-------- -------
Income from continuing operations
before income taxes $ 4,406 $ 2,402
======== =======
Customer Information
The Company is engaged principally in providing engineering, design, logistics,
management and technical services to the U.S. Government (the "government"),
other government prime contractors, and commercial entities. The largest
customer for the Company's services is the U.S. Department of Defense
("Defense"), including agencies of the U.S. Navy, Army, and Air Force. The
Company's revenue by Customer is as follows (in thousands):
2007 2006
Source of Revenue Revenues % Revenues %
----------------- -------- - -------- -
Army/Army Reserve $ 65,884 54.6 $ 11,323 17.9
Navy 40,421 33.5 45,040 71.2
Other 14,384 11.9 6,937 10.9
-------- ----- -------- -----
Total Revenues $120,689 100.0 $ 63,300 100.0
======== ===== ======== =====
VSE does 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 VSE and its customers.
-12-
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Executive Overview
VSE Organization
VSE's business operations consist primarily of services performed by the
Company's unincorporated divisions and wholly owned subsidiary. The Company uses
multiple operating entities to bid on and perform contract work. The use of an
operating structure with multiple entities gives the Company certain competitive
advantages and the flexibility to pursue a diverse business base. The term "VSE"
or "Company" refers to VSE and its divisions and subsidiaries unless the context
indicates operations of the parent company only.
Unincorporated divisions include BAV Division ("BAV"), Communications and
Engineering Division ("CED"), Coast Guard Division ("VCG"), Engineering and
Logistics Division ("ELD") beginning in 2006, Fleet Maintenance Division
("FMD"), Management Sciences Division ("MSD"), and Systems Engineering Division
("SED"). Energetics Incorporated ("Energetics") is currently VSE's only active
subsidiary.
VSE previously conducted business operations in other subsidiaries and divisions
that had no operating activity in 2006 and 2007.
VSE Customers and Services
The Company is engaged principally in providing engineering, design, logistics,
management and technical services to the U.S. Government (the "government"),
other government prime contractors, and commercial entities. The largest
customer for the Company's services is the U.S. Department of Defense
("Defense"), including agencies of the U.S. Navy, Army, and Air Force.
VSE Operating Segments
Management of VSE's business operations is conducted under three reportable
operating segments, the Federal Group, the International Group, and the Energy
and Environmental Group.
Federal Group - VSE's Federal Group provides engineering, technical, management,
integrated logistics support, and information technology services to all U.S.
military services and other government agencies. It consists of four divisions
- CED, ELD, MSD, and SED.
CED is dedicated to supporting the Army's Communications and Electronics Command
(CECOM) in the management and execution of the Rapid Response (R2) Program,
which supports clients across DoD and the Federal Government. CED manages
execution of tasks involving research and development, technology insertion,
systems integration and engineering, hardware/software fabrication and
installation, testing and evaluation, studies and analysis, technical data
management, logistics support, training, and acquisition support.
CED Army Equipment Support Program - In December 2005, VSE's CED Division was
awarded a task order on its Rapid Response support contract to provide
maintenance and logistics services in support of U.S. Army equipment in Iraq and
Afghanistan. Services provided under this program include deployed sustainment
management, deployed logistics and repairs management, unique system training
and curriculum support, resource management, and acquisition and administrative
support. Work on this program began in 2006.
Substantially all of the services on this task order are provided by CED's
subcontractor. CED provides certain program management services. The contract
task order has a base year valued at approximately $139 million and an
additional one-year option period valued at approximately $212 million. This
program contributed significantly to VSE's revenues in 2006 and the first
quarter of 2007, and based on the contract value and a significant level of
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contract funding and funded backlog, is expected to contribute significantly to
VSE's revenues in the remaining three quarters of 2007; however, profit margins
on subcontract work such as this are lower than on work performed by Company
personnel.
ELD provides full life cycle engineering, logistics, maintenance, and
refurbishment services to extend and enhance the life of existing equipment. ELD
principally supports the U.S. Army, Army Reserve, and Army National Guard with
core competencies in combat and combat service support system conversions,
technical research, sustainment and re-engineering, system integration, and
configuration management.
MSD provides nationally and internationally recognized experts in product and
process improvement, supporting a variety of government and commercial clients.
MSD provides training, consulting, and implementation support in the areas of:
Enterprise Excellence, Lean Six Sigma, process and product optimization,
project management, leadership quality engineering, Integrated Product and
Process Development (IPPD), and reliability engineering. MSD's services range
from individual improvement projects to global organizational change programs.
SED provides comprehensive systems and software engineering, logistics, and
prototyping services to DoD. SED principally supports U.S. Army, Air Force, and
Marine Corps combat and combat support systems. SED's core competencies include:
systems technical support, configuration management, and life cycle support for
wheeled and tracked vehicles and ground support equipment; obsolescence
management, service life extension, and technology insertion programs; and
technical documentation and data packages.
TBPS Program - VSE's SED Division performs work on a program to provide a
protection system, the Tanker Ballistic Protection System ("TBPS"), for vehicles
deployed by the U.S. Army in Iraq. Under this program, SED applies a
polyurethane based ballistic coating system and necessary Add-on Armor Panels
for Army Fuel Dispensing Tankers as protection from hostile fire. Delivery of
completed vehicle protection systems began in January 2005.
SED has performed on the TBPS program under multiple firm fixed price per unit
contracts. Subsequent to program implementation, VSE has received modifications
to consolidate contracting activity into fewer contracts and to adjust the
number of tankers based on Army tanker availability and needs, and the
possibility remains that there may be future contract modifications as the
Army's needs change. The total contract ceiling value on the TBPS Program
contracts is approximately $76 million, and the remaining available contract
ceiling on the TBPS Program contracts is approximately $8.6 million as of
March 31, 2007. Contract value on the TBPS contracts is fully funded at the time
of award or modification. Contractual coverage for work on the TBPS program runs
through June 2007 and the Company expects to complete work that is currently
under contract in 2007.
The TBPS Program contributed significantly to VSE revenues in 2006 and the first
quarter of 2007 and is expected to continue to provide significant revenues in
2007. The work performed on this program also significantly increases the amount
of fixed price contract work performed by the Company. In general, fixed price
contract work carries a higher level of risk and has higher profit margins than
work on other contract types. Accordingly, the TBPS program has presented, and
is expected to continue to present, VSE's business with the potential for both
increased profit margins and increased risks of incurring a loss.
International Group - VSE's International Group provides engineering,
industrial, logistics, and foreign military sales services to the U.S. military
and other government agencies. It consists of three divisions - BAV, FMD, and
VCG.
BAV provides assistance to the U.S. Navy in executing its Foreign Military Sales
(FMS) Program for surface ships sold, leased or granted to foreign countries by
providing program management, engineering, technical support, and logistics
-14-
services for ship reactivations and transfers, as well as follow-on support.
BAV's expertise includes: ship reactivation/transfer, overhaul and maintenance,
follow-on technical support, FMS integrated logistics support, engineering and
industrial services, training, and spare and repair parts support.
BAV Ship Transfer Program - BAV provides its ship transfer services to the Navy
under large omnibus contracts. During its life, this program has been a
significant revenue producer for the Company. Revenues generated by this program
have typically accounted for a significant percentage of VSE's consolidated
revenues, and revenues generated by this program accounted for approximately 22%
and 44% of consolidated revenues during the three-month periods ended March 31,
2007 and 2006, respectively. The level of revenues and associated profits
resulting from fee income generated by this program varies depending on a number
of factors, including the timing of ship transfers and associated support
services ordered by foreign governments and economic conditions of potential
customers worldwide. The Company has experienced significant quarterly and
annual revenue fluctuations and anticipates that future quarterly and annual
revenues will be subject to variation due to changes in the level of activity
associated with the Navy's ship transfer program. The transfer of four U.S. Navy
ships to Taiwan conducted under this program was a major contributor to the
Company's revenues in 2006.
The original contract associated with this program was a ten-year cost-plus
award fee contract awarded in 1995 with a total ceiling value of more than
$1 billion. BAV was awarded a second contract in April 2005 to continue work on
this program. The new contract is a five-year cost-plus award fee contract with
a total ceiling value of approximately $544 million. The Navy began issuing
orders on the new contract in the second quarter of 2005 and ceased issuing
orders for new work on the original contract at that time. BAV continued work
associated with the transfer of four ships to Taiwan under delivery orders
issued on the original contract until the work was substantially completed in
2006.
Contract terms under both the original and new contracts specify base fee
payments and award fee payments to BAV. Base fee payments are determined by
level of contract activity and base fee income is recognized each month. Award
fee payments are determined by performance and level of contract activity. A
contract modification authorizing the award fee payment is issued subsequent to
the period in which the work is performed. The Company does not recognize award
fee income until the fees are fixed and determinable, generally upon contract
notification confirming the award fee. Award fees are made three times during
the year. Accordingly, the Company typically has three quarterly reporting
periods per year that include the recognition of BAV award fee income and one
quarterly reporting period that does not include BAV award fee income. Due to
such timing, and to fluctuations in the level of revenues, profits as a
percentage of revenues will fluctuate from period to period. The Company
recognized BAV award fee income in the three-month period ended March 31, 2007.
In 2006, the Company recognized BAV award fee income in each of the three-month
periods ended December 31, June 30, and March 31, and did not recognize any BAV
award fee income in the three-month period ended September 30.
FMD provides global field engineering, logistics, maintenance, and information
technology services to the U.S. Navy and Air Force, including fleet-wide ship
and aircraft support programs. FMD's expertise includes ship repair and
modernization, ship systems installations, ordnance engineering and logistics,
facility operations, war reserve materials management, aircraft sustainment and
maintenance automation, and IT systems integration. FMD also provides
management, maintenance, storage, and disposal support for the U.S. Department
of Treasury's seized and forfeited general property program.
VCG provides the U.S. Coast Guard with FMS support and life cycle support for
vessels transferred to foreign governments. VCG's core competencies include
pre-transfer joint vessel inspections, reactivations, crew training, transit
assistance, heavy-lift contracting, logistics support, technical support, and
overseas husbandry.
-15-
Energy and Environmental Group - VSE's Energy and Environmental Group provides
high-level consulting services in the field of energy and environmental
management. The Energy and Environmental Group includes VSE's wholly owned
subsidiary, Energetics, Inc.
Energetics, Inc. is a full-service energy and environmental consulting company
providing technical and management support in all aspects of technology
research, development, and demonstration. The company's expertise lies in state-
of-the-art and advanced technology assessment, technical and economic
feasibility analysis, technology transfer, R&D program planning, engineering
studies, market assessment, strategic resource management, regulatory analysis,
environmental compliance, and risk management. Founded in 1979 and acquired by
VSE in 1995, Energetics has enjoyed steady growth as a result of its dedication
to providing superior products and services to clients in both the public and
private sectors.
Government Procurement Policies and Practices
VSE's business is subject to the risks arising from economic conditions and
political factors that may impact the budgets and program funding of customers
served through VSE's contracts. VSE's revenues have historically been subject to
annual fluctuations resulting from changes in the level of Defense spending.
Future budgetary and funding decisions by government lawmakers or Defense
restructuring efforts could affect the types and level of services provided by
VSE to its government customers and could potentially have a material adverse
impact on the Company's results of operations or financial condition.
The revenues of the Company depend on its ability to win new contracts and on
the amount of work ordered by the government under the Company's existing
contracts. The Company's ability to win new contracts is affected by government
acquisition policies and procedures, including government procurement practices
that in some years have tended toward bundling work efforts under large
comprehensive ("omnibus") management contracts. This emphasis on large contracts
presents challenges to winning new contract work, including making it more
difficult for the Company to qualify as a bidder, increasing the level of
competition due to the award of fewer contracts, and forcing the Company into
competition with larger organizations that have greater financial resources and
larger technical staffs. Competing for these contracts requires the Company to
use teams of subcontractors to be able to offer the range of technical
competencies needed to do the work. While the use of subcontractors on a large
scale basis allows the Company to compete for this work, profit margins on
subcontract work are lower than on work performed by Company personnel, thereby
reducing the Company's overall profit margins.
The use of subcontractors on government contracts also raises certain
performance and financial risks to VSE because government prime contractors are
responsible for performing to the requirements of the contract and ensuring
compliance with U.S. Government regulations relative to the performance by
subcontractors.
Other government procurement practices that can affect the Company's revenues
are 1) the length of contracts issued, which may vary depending on changes in
contracting regulations and other factors; 2) the use of past performance
criteria that may preclude entrance into new government markets; and
3) government social programs that limit contract work to small, woman, or
minority owned businesses. Additional risk factors that could potentially
affect the Company's results of operations are the government's right to
terminate contracts for convenience, the government's right to not exercise all
of the option periods on a contract, and funding delays caused by government
political or administrative actions.
Global Economic Conditions and Political Factors
VSE's business is subject to the risks arising from global economic conditions
and political factors associated with current and potential customers served
through VSE's contracts with the U.S. Government. An economic slowdown in
-16-
countries served under the BAV Ship Transfer Program could potentially affect
sales. Failure by the government of a potential foreign customer to approve and
fund acquisition of U.S. Navy ships serviced under this program could affect
sales. In any one year, a significant amount of the Company's revenues may
result from sales on the BAV Ship Transfer Program to a single foreign
government. BAV sales to Egypt have historically comprised a large percentage
of the Company's total sales in any one year.
The current international situation posed by potential terrorist activity and
the continuing conflict in the Middle East could potentially increase the
political risks for revenues from the BAV Ship Transfer, TBPS, and CED Army
Equipment Support Programs. International tensions can also affect work by FMD
on U.S. Navy ships when they are deployed outside of U.S. Navy facilities and
are unavailable for maintenance work during this time period. Adverse results
arising from these global economic and political risks could potentially have a
material adverse impact on the Company's results of operations.
Concentration of Revenues From Continuing Operations
(in thousands)
For the three months ended March 31,
------------------------------------
2007 2006
Source of Revenue Revenues % Revenues %
----------------- -------- - -------- -
BAV Egypt $ 13,724 11 $ 12,054 19
BAV India 9,354 8 - -
BAV Taiwan 1,998 2 13,588 22
BAV Other 958 1 2,001 3
-------- --- -------- ---
Total BAV 26,034 22 27,643 44
TBPS Program 8,166 6 4,133 7
CED Army Equipment Support 41,983 35 5,233 8
VSE Other 44,506 37 26,291 41
-------- --- -------- ---
Total Revenues $120,689 100 $ 63,300 100
======== === ======== ===
Management Outlook
The Company's growth in revenues and profits continued in the first quarter of
2007. Subject to the risk elements discussed above, VSE believes it has the
potential to continue to increase revenues and profits through the remainder of
2007. Discussion of some of the events and circumstances that will impact the
Company's growth follows below.
CED Army Equipment Support Program. CED began work on this program in 2006 and
revenues from this program in 2006 were approximately $106 million. Work on the
program is expected to increase in 2007. Revenues for the three months ended
March 31, 2007 were approximately $42 million. The contract task orders for this
program are incrementally funded, with funded backlog of approximately
$169 million as of March 31, 2007. While profit margins on this program are
expected to be low, the Company expects to benefit from the increased revenue
base that this program provides.
Treasury Seized Property Management Contract Award. In August 2006, VSE was
awarded a contract to support the U.S Department of the Treasury seized and
forfeited general property program. This is a single award, cost-plus-incentive-
fee contract that includes a base period of performance, four option periods,
and award term provisions. Phase in work on the contract began in 2006 to
transition the program from a predecessor contractor. Revenues for the three
months ended March 31, 2007 were approximately $8.5 million. This program is
expected to be a significant contributor to VSE's revenues and profits in 2007
and future years. If all option and award term periods are exercised, contract
performance is expected to continue through September 30, 2014.
-17-
BAV Ship Transfer Program. Work on the transfer of four U.S. Navy ships to
Taiwan under this program was substantially completed in September 2006, marking
the end of a major contributor to the Company's revenues in recent years.
Despite the absence of this work going forward, BAV has some solid prospects for
follow on work in Taiwan and additional work in other countries, including the
work currently performed for India. The Company expects the BAV Ship Transfer
Program to continue to be a major provider of revenues in 2007 and future years.
Funded backlog on the BAV Ship Transfer Program was approximately $76 million as
of March 31, 2007.
TBPS Program. Contractual coverage for work on the TBPS program runs through
June 2007 and the Company expects to complete work that is currently under
contract in 2007. is the Army has identified potential additional work to
continue the TBPS program beyond June of 2007. Revenues from this program were
approximately $30 million in both 2006 and 2005, and the potential additional
contract work would sustain this program at approximately the same level. Funded
backlog remaining on the program was approximately $8.6 million as of March 31,
2007.
ELD Equipment Refurbishment Services. VSE has provided the U. S. Army Reserve
with military vehicle and equipment refurbishment services for several years.
Beginning in 2006, VSE formed ELD to continue the performance of these services.
ELD has expanded its workforce, facilities, capacity to perform work,
contractual coverage and funding since its inception, resulting in increases
in revenues from these services in 2006 and the first quarter of 2007. The
Company expects further increases in the remainder of 2007 and future years.
Other Significant Contracts. VSE has three multiyear, multiple award, indefinite
delivery, indefinite quantity contracts that have large nominal ceiling amounts
with no funding committed at the time of award. VSE is one of several awardees
on each contract. While future VSE revenue from these contracts cannot be
predicted with certainty, the award of these contracts provides the Company with
the opportunity to compete for work that could contribute to future revenue
growth, including new work in 2007. These three contracts are described below.
VSE's CED Division has a multiyear Rapid Response support contract awarded by
the U.S. Army Communications and Electronics Command (CECOM) in January 2003.
The contract enhances the Company's revenue producing capabilities by allowing
it to provide services through any of VSE's operating entities or through third
party subcontractors for various end user government customers. If all options
are exercised, this contract has a potential total nominal ceiling of
approximately $2.9 billion over an eight-year period. While it is unlikely that
the full ceiling amount will be realized, this contract generated revenues for
all of VSE of approximately $143 million during 2006, including revenues of
approximately $106 million on the CED Army Equipment Support Program. CED was
awarded a new task order under this contract in December 2006 for work that will
be subcontracted that represents potential revenues to the Company of about
$164.8 million over a 16-month period if all options are exercised. VSE
continues to pursue new orders on this contract that present potential revenue
opportunities for the future.
VSE's FMD Division has a contract with the U.S. Navy, SeaPort Enhanced, awarded
in April 2004, which includes a five-year base period and two five-year option
periods. This contract is a procurement vehicle for the Navy to use for ordering
services from a wide range of contractors to support all phases of naval ship
and shipboard weapons systems acquisition and life-cycle support. While this
award does not guarantee any revenues for VSE, the Company is one of several
contractors eligible to bid for services during the life of the contract. As of
March 31, 2007, FMD has been awarded approximately $20.8 million in contract
task orders under this contract.
ELD has a contract, the Field and Installation Readiness Support Team ("FIRST")
Contract, awarded in November 2006, with the U.S. Army to provide a broad range
of logistics and engineering and technical services to Army activities in the
continental United States and overseas locations. The contract has a five-year
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base period and three five-year option periods. VSE is one of several awardees
eligible to share in the potential total contract ceiling amount, which is
expected to be several billion dollars. The award of this contract provides VSE
with the opportunity to compete for work which may contribute to future revenue
growth.
Funded Backlog
Revenues in government contracting businesses are dependent upon contract
funding ("Bookings") and funded contract backlog is an indicator of potential
future revenues. A summary of VSE's bookings, funded contract backlog, and
revenues for as of March 31, 2007 is as follows.
(in millions)
-------------
Bookings for the three months ended March 31, 2007 $205
Funded backlog as of March 31, 2007 $384
Revenues for the three months ended March 31, 2007 $121
Longer Term
The growth in VSE revenue and profits during 2006 and the first quarter of 2007,
and the expected continuation of this growth in the remainder of 2007 will
present the Company with both challenges and opportunities for future years.
Certain work efforts that have supported VSE's growth in recent years have
expired or are due to expire. VSE has received significant contributions to its
revenue growth 1) from the Taiwan Ship Transfer work, which was substantially
completed in September 2006; 2) from the TBPS Program work, for which current
contractual coverage is scheduled to expire in 2007; and, 3) from the CED Army
Equipment Support Program, which is scheduled to expire in December 2007. The
expiration of these programs at various dates in 2006 and 2007 will reduce VSE
annual revenues if the expiring work is not replaced by new or follow-on work.
The Company believes it is well prepared to meet the challenge of replacing the
expiring work. Progress has already been made toward this end with the start up
of the Treasury Seized Property Management program awarded in August 2006, the
FIRST contract awarded in November 2006, the new task order awarded under the
Rapid Response support contract in December 2006, and continued increases in
ELD's equipment refurbishment services.
Opportunities associated with VSE's recent growth include a more competitive
price structure with which to bid on future work, a wider range of employee
skill sets, and a broader name recognition and past performance record for use
in expanding the Company's customer base. The larger revenue level and capital
base built up in recent years improves the Company's ability to pursue larger
programs and potential acquisition opportunities.
Recent Accounting Pronouncements
Accounting for Employee Stock Options
In December 2004, the Financial Accounting Standards Board issued SFAS 123(R),
"Share-Based Payment," which is a revision to SFAS 123. SFAS 123(R) supersedes
APB Opinion No. 25 and amends SFAS 95, "Statement of Cash Flows." Generally, the
approach in SFAS 123(R) is similar to the approach described in SFAS 123.
However, SFAS 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the income statement based
on their fair values. The Company adopted SFAS 123(R), using the modified
prospective method, on January 1, 2006.
The impact of adopting SFAS 123(R) decreased income before income taxes by
approximately $252 thousand in 2006. The amount of stock-based compensation
expense for the three months ended March 31, 2007 was approximately
$45 thousand. SFAS 123(R) also requires the benefits of tax deductions in excess
of recognized compensation cost to be reported as a financing cash flow, rather
-19-
than as an operating cash flow as required under the old method. The amount of
financing cash flows from benefits of tax deductions in excess of recognized
compensation cost for the three months ended March 31, 2007 and 2006 was
approximately $385 thousand and $37 thousand, respectively.
On December 30, 2005, VSE's board of directors (the "Board") directed VSE to
discontinue awarding options, both discretionary and nondiscretionary, to
purchase VSE common stock ("VSE Stock") under VSE's 2004 Stock Option Plan
approved by VSE's stockholders on May 3, 2005 (the "2004 Plan"). The options
outstanding under the 2004 Plan as of December 30, 2005, and the options to
purchase VSE Stock under VSE's 1998 Stock Option Plan (the "1998 Plan") are not
affected by this Board action. The primary reason for the Board's suspension of
option awards under the 2004 Plan was the potential impact on VSE's results of
operations from the application of SFAS 123 (R) to share-based payments to
employees, including stock option awards.
Accounting for Uncertainty in Income Taxes
The Company adopted the provisions of FIN 48, "Accounting for Uncertainty in
Income Taxes - an interpretation of FASB Statement No. 109," (FIN 48), on
January 1, 2007. As a result of the implementation of FIN 48, the Company made
a comprehensive review of its portfolio of uncertain tax positions in accordance
with recognition standards established by FIN 48. In this regard, an uncertain
tax position represents the Company's expected treatment of a tax position taken
in a filed tax return, or planned to be taken in a future tax return, that has
not been reflected in measuring income tax expense for financial reporting
purposes. As a result of this review, the Company concluded that at this time
there are no uncertain tax positions. As a result of applying the provisions of
FIN 48, there was no cumulative effect on retained earnings.
As of March 31, 2007, the Company has accrued approximately $75 thousand related
to expected interest payments to the Internal Revenue Service ("IRS") for an
open tax issue. This issue is a temporary difference that should not materially
impact future tax liabilities.
The Company files income tax returns in the U.S. federal jurisdiction, and in
various states.
Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities - Including an amendment of FASB Statement No. 115." SFAS No. 159
permits entities to choose to measure eligible items at fair value at specified
election dates and report unrealized gains and losses on items for which the
fair value option has been elected in earnings at each subsequent reporting
date. SFAS No. 159 is effective for fiscal years beginning after November 15,
2007. Management is currently evaluating the effect that adoption of this
statement will have on the company's consolidated financial position and results
of operations when it becomes effective in 2008.
Critical Accounting Policies
VSE's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require VSE
to make estimates and assumptions. The Company believes the following critical
accounting polices affect our more significant judgments, estimates and
assumptions used in the preparation of its consolidated financial statements.
Revenue Recognition
Substantially all of the Company's services are performed for its customers on a
contract basis. The three primary types of contracts used are cost-type
contracts, time and materials contracts, and fixed-price contracts. Revenues
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result from work performed on these contracts by the Company's employees and
from pass-through of costs for material and work performed by subcontractors.
Revenues on cost-type contracts are recorded as contract allowable costs are
incurred and fees earned. Profits on cost-type contracts are equal to the fees
that are earned. The BAV contract terms specify award fee payments that are
determined by performance and level of contract activity. Award fees are made
three times during the year and a contract modification authorizing the award
fee payment is issued subsequent to the period in which the work is performed.
The Company does not recognize award fee income until the fees are fixed and
determinable, generally upon contract notification confirming the award fee. 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.
Revenues for time and materials contracts are recorded on the basis of contract
allowable labor hours worked times the contract defined billing rates, plus the
cost of materials used in performance on the contract. Profits on time and
material contracts result from the difference between the cost of services
performed and the contract defined billing rates for these services.
Revenue recognition methods on fixed-price contracts will vary depending on the
nature of the work and the contract terms. On certain fixed-price contracts
revenues are recorded as costs are incurred, using the percentage-of-completion
method of accounting, since these contracts require design, engineering, and
manufacturing performed to the customer's specifications. Revenues on fixed-
price service contracts are recorded as work is performed. Revenues on fixed-
price contracts that require delivery of specific items may be recorded based on
a price per unit as units are delivered. Profits on fixed-price contracts result
from the difference between the incurred costs and the revenue earned.
Revenues by contract type for the three months ended March 31, 2007 and 2006
were as follows (in thousands):
2007 2006
Contract Type Revenues % Revenues %
------------- -------- - -------- -
Cost-type $ 39,341 33 $38,308 61
Time and materials 70,620 58 18,583 29
Fixed-price 10,728 9 6,409 10
-------- --- ------- ---
$120,689 100 $63,300 100
======== === ======= ===
A large amount of the time and materials revenues shown in the table above is
attributable to revenues from the CED Army Equipment Support contract that
started in 2006. Substantially all of the revenues on this contract result from
the pass through of subcontractor support services that have a very low profit
margin for VSE.
The Company will occasionally perform work at risk, which is work that is
performed prior to the government formalizing 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. VSE recognizes this "risk funding" as
revenue when the associated costs are incurred or the work is performed. VSE is
at risk of loss for any risk funding not received. The Company provides for
anticipated losses on contracts by a charge to income during the period in which
losses are first identified. As of March 31, 2007, VSE has recognized
approximately $376 thousand in risk funding. VSE believes that it will receive
funding for all or substantially all of this risk funding revenue.
Long-Lived Assets
In assessing the recoverability of long-lived assets, including goodwill and
other intangibles, VSE must make assumptions regarding estimated future cash
flows and other factors to determine the fair value of the respective assets. If
these estimates or their related assumptions change in the future, VSE may be
required to record impairment charges for these assets not previously recorded.
-21-
Goodwill
Goodwill and intangible assets with indefinite lives are subject to a review for
impairment at least annually. The Company performs its annual impairment test on
September 30. As of March 31, 2007, the Company had approximately $1.1 million
of goodwill associated with its acquisition of Energetics in 1995. The Company
has not recognized any reduction to the goodwill due to the impairment rules. If
at some time in the future it is determined that impairment has occurred, such
impairment could potentially have a material adverse impact on the Company's
results of operations or financial condition.
Contingencies
From time to time VSE is subject to proceedings, lawsuits, and other claims
related to environmental, labor, and other matters. VSE is required to assess
the likelihood of any adverse judgments or outcomes to these contingencies as
well as potential ranges of probable losses and establish reserves accordingly.
The amount of reserves required may change in future periods due to new
developments in each matter or changes in approach to a matter such as a change
in settlement strategy.
Income Taxes
The carrying value of VSE net deferred tax assets is based on assumptions
regarding VSE's ability to generate sufficient future taxable income to utilize
these deferred tax assets. If the estimates and related assumptions regarding
VSE's future taxable income change, VSE may be required to record valuation
allowances against its deferred tax assets, resulting in additional income tax
expense.
Results of Operations
The following table sets forth certain items for VSE, including consolidated
revenues, pre-tax income and net income from continuing operations, and the
changes in these items for the three-month periods ended March 31, 2007 and
2006 (in thousands):
2007
Compared
2007 2006 to 2006
---- ---- -------
Revenues $120,689 $63,300 $ 57,389
======== ======= ========
Income before income taxes $ 4,406 $ 2,402 $ 2,004
Provision for income taxes 1,677 917 760
-------- ------- --------
Net income $ 2,729 $ 1,485 $ 1,244
======== ======= ========
Revenues increased by approximately 91% for the three-month period ended
March 31, 2007, as compared to the same period of 2006. The primary reasons for
the increase in revenues were 1) revenues associated with the CED Army Equipment
Support program work; 2) revenues from the start of FMD's Treasury Seized
Property Management Program; 3) increased production on the TBPS program; and
4) an increase in the level of ELD equipment refurbishment services.
Income before income taxes increased by approximately 83% for the three-month
period ended March 31, 2007, as compared to the same period of 2006. The
increase was primarily due to profits associated with the TBPS program, the
increase in revenues on the CED Army Equipment Support program, the Treasury
Seized Property Management program, and ELD's equipment refurbishment services.
-22-
Federal Group Results
The following table shows consolidated revenues, costs and expenses, and gross
profit from operations, and the changes in these items for the Federal Group for
the three-month periods ended March 31, 2007 and 2006 (in thousands).
2007
Compared
Description 2007 2006 to 2006
----------- ---- ---- -------
Revenues $70,503 $20,205 $50,298
Costs and expenses 67,276 18,997 48,279
------- ------- -------
Gross profit $ 3,227 $ 1,208 $ 2,019
======= ======= =======
Gross profit percent 4.6% 6.0%
Revenues for the Federal Group increased by approximately 249% for the three-
month period ended March 31, 2007, as compared to the same period for the prior
year. A substantial portion of the increase in revenues for 2007 was
attributable to revenues associated with the CED Army Equipment Support Program
work. Other reasons for the increases in 2007 revenues included: 1) work on
additional CED task orders; 2) increases in SED contract services, including
increased levels of production on the TBPS program; and 3) increased revenues
from ELD's equipment refurbishment services.
Gross profit for the Federal Group increased by approximately 167% for the
three-month period ended March 31, 2007, as compared to the same period for the
prior year. The increase in gross profit was primarily due to the increase in
production and efficiency improvements on the TBPS Program and the increase in
revenues on the CED Army Equipment Support Program work. Increased military
equipment refurbishment services performed by ELD for the U. S. Army Reserve
also contributed to increased gross profit in 2007. Substantially all of the
work on The CED Army Equipment Support Program work is performed by a
subcontractor and these costs are passed on to the government essentially at
cost. Accordingly, the Federal Group gross profit percent declined from 6.0%
to 4.6% for the three month period ended March 31, 2007 as compared to the same
period of 2006.
International Group Results
The following table shows consolidated revenues, costs and expenses, and gross
profit from operations, and the changes in these items for the International
Group for the three-month periods ended March 31, 2007 and 2006 (in thousands).
2007
Compared
Description 2007 2006 to 2006
----------- ---- ---- -------
Revenues $46,904 $39,849 $ 7,055
Costs and expenses 45,168 38,444 6,724
------- ------- -------
Gross profit $ 1,736 $ 1,405 $ 331
======= ======= =======
Gross profit percent 3.7% 3.5%
Revenues for the International Group increased by approximately 18% for the
three month period ended March 31, 2007, as compared to the same period for the
prior year. The International Group revenues benefited from revenues provided by
the start of FMD's Treasury Seized Property Management Program. These additional
revenues were offset somewhat by the decrease in revenues of BAV in 2007 due to
the substantial completion of work associated with the transfer of U.S. Navy
ships to Taiwan.
Gross profit for the International Group increased by approximately 24% for the
three month period ended March 31, 2007, as compared to the same period for the
prior year. The increase was primarily due to profits from FMD's Treasury Seized
Property Management Program and to an increase in labor driven revenues on FMD's
Navy contracts, which have higher profit margins than subcontractor pass-through
revenues.
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Energy and Environmental Group Results
The following table shows consolidated revenues, costs and expenses, and gross
profit from operations, and the changes in these items for the Energy and
Environmental Group for the three-month periods ended March 31, 2007 and 2006
(in thousands).
2007
Compared
Description 2007 2006 to 2006
----------- ---- ---- -------
Revenues $ 3,246 $ 3,224 $ 22
Costs and expenses 2,975 2,842 133
------- ------- -----
Gross profit $ 271 $ 382 $(111)
======= ======= =====
Gross profit percent 8.3% 11.8%
Revenues in the Energy and Environmental Group were substantially unchanged for
the three month period ended March 31, 2007, as compared to the same period for
the prior year.
Gross profit in the Energy and Environmental Group declined by approximately 29%
for the three month period ended March 31, 2007, as compared to the same period
for the prior year. The decrease in gross profit in 2007 was primarily due to an
increase in indirect cost rates and to funding issues on two contracts during
this period.
Financial Condition
VSE's financial condition did not change materially during the three months
ended March 31, 2007. The Company's largest assets are its accounts receivable.
The largest liabilities are its accounts payable and accrued expenses. Accounts
receivable increased by approximately $16 million and accounts payable and
accrued expenses increased by approximately $13 million during the three months
ended March 31, 2007, primarily as a result of the Company's increased revenue
during this period. The change in total stockholders' investment in this period
resulted from earnings and dividend activity and from the exercise of stock
options.
Liquidity and Capital Resources
Cash Flows
Cash and cash equivalents increased by approximately $650 thousand during the
three months ended March 31, 2007. The increase in cash and cash equivalents
during this period resulted from cash provided by operating activities of
approximately $1.1 million, cash used in investing activities of approximately
$1.1 million, and cash provided by financing activities of approximately
$650 thousand. Investing activities consisted of expansion and improvement of
facilities of approximately $505 thousand and purchases of property and
equipment, net of dispositions, of approximately $584 thousand. Financing
activities consisted of dividend payments and proceeds received from the
issuance of common stock associated with stock incentive plans.
Cash and cash equivalents decreased by approximately $4.7 million during the
three months ended March 31, 2006. The decrease in cash and cash equivalents
during this period resulted from cash used in operating activities of
approximately $3.8 million, cash used in investing activities of approximately
$914 thousand, and cash used in financing activities of approximately
$30 thousand. Investing activities consisted of expansion and improvement of
facilities of approximately $165 thousand and purchases of property and
equipment, net of dispositions, of approximately $749 thousand. Financing
activities consisted of dividend payments and proceeds received from the
issuance of common stock associated with stock incentive plans.
The difference between cash provided by operating activities of approximately
$1.1 million in 2007 as compared to cash used in operating activities of
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approximately $3.8 million in 2006 is primarily due to the increase in net
income and to fluctuations in operating assets and liabilities associated with
increased revenues and the timing of accounts receivable collections and
subcontractor and vendor payments.
Quarterly cash dividends were paid at the rate of $.07 per share during the
three months ended March 31, 2007. Pursuant to its bank loan agreement, the
payment of cash dividends by VSE is subject to annual rate restrictions. VSE
has paid cash dividends each year since 1973.
Liquidity
The Company's internal sources of liquidity result primarily from operating
activities, specifically from changes in the level of revenues and associated
accounts receivable and accounts payable from period to period, and from
profitability. Significant increases or decreases in revenue and accounts
receivable and accounts payable can cause significant increases or decreases in
internal liquidity.
Accounts receivable arise primarily from billings made by the Company to the
government or other government prime contractors for services rendered, and
payments received on accounts receivable represent the principal source of cash
for the Company. Accounts receivable levels can be affected significantly by
the timing of large materials purchases and subcontractor efforts used in
performance on the Company's contracts. Accounts receivable levels are also
affected by contract retainages, differences between the provisional billing
rates authorized by the government compared to the costs actually incurred by
the Company, differences between billable amounts authorized by contract terms
compared to costs actually incurred by the Company, and government delays in
processing administrative paperwork for contract funding.
Work on the TBPS program requires the Company to acquire inventories consisting
of materials, supplies, and other expenditures for which end units have not yet
been completed and accepted. Although these costs are classified as inventories
for accounting purposes, they are similar in nature to materials and direct
supplies purchased for use in performance on the Company's other contracts in
that they are solely and directly attributable to the contract and will be
billed to the customer within a relatively short time. All of the inventories
are expected to be liquidated, billed, and collected as vehicle protection
systems are completed and accepted by the government customer. These materials
and direct supplies will not be restocked to maintain any permanent inventory
levels.
Accounts payable arise primarily from purchases of subcontractor services and
materials used by the Company in the performance of its contract work. Payments
made on accounts payable, along with payments made to satisfy employee payroll
and payroll associated expenses, make up the principal cash requirements of the
Company. Accounts payable levels can be affected by changes in the level of
contract work performed by the Company and by the timing of large materials
purchases and subcontractor efforts used in performance on the Company's
contracts.
Other cash requirements include income tax payments, the acquisition of capital
assets for shop, office and computer support, and the payment of cash dividends.
From time to time, the Company also invests in the expansion, improvement, and
maintenance of its operational and administrative facilities. The growth in the
level of equipment refurbishment services provided by ELD required an increased
level of investment in operational facilities in 2006 and the Company could
possibly make additional investment in such facilities 2007 and future years.
VSE's external sources of liquidity consist of a revolving bank loan agreement
that provides loan financing based on the Company's accounts receivable (see
"Notes to Consolidated Financial Statements"). The bank financing complements
the Company's internal sources of liquidity by providing increasing levels of
borrowing capacity as accounts receivable levels increase. The bank loan
agreement provided loan financing up to a maximum commitment of $15 million as
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of March 31, 2007. The amount of this commitment is negotiable between the
Company and the bank. The Company has determined that the current $15 million
commitment amount is adequate to cover known current and future liquidity
requirements.
Performance of work under the Company's larger contracts that require
significant amounts of subcontractor or material purchases have the potential
to cause substantial requirements for working capital; however, management
believes that cash flows from operations and the bank loan commitment are
adequate to meet current operating cash requirements.
Contractual Obligations
In March 2007, the Company signed two five-year facility leases for warehouse
space to begin in March 2007 for an aggregate amount of approximately
$8.4 million. [See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" contained in VSE's Annual Report on Form 10-K for the
fiscal year ended December 31, 2006 for a summary of the Company's other
contractual obligations.]
Inflation and Pricing
Most of the contracts performed by VSE provide for estimates of future labor
costs to be escalated for any option periods provided by the contracts, while
the non-labor costs included in such contracts are normally considered
reimbursable at cost. VSE property and equipment consists principally of
computer systems equipment, furniture and fixtures, and land and improvements.
The overall impact of inflation on replacement costs of such property and
equipment is not expected to be material to VSE's future results of operations
or financial condition.
Disclosures About Market Risk
Interest Rates
VSE's bank loan financing provides available borrowing to the Company at
variable interest rates. The Company has not borrowed significant amounts on the
loan in recent years. Accordingly, the Company does not believe that any
movement in interest rates would have a material impact on future earnings or
cash flows. If VSE were to significantly increase borrowings on the current loan
arrangement, future interest rate changes could potentially have a material
impact.
Foreign Currency
While a significant amount of the Company's business results from the services
provided by BAV related to the transfer of ships to foreign governments, the
BAV contract payments are made by the U.S. Government in U.S. dollars.
Additionally, most funding requirements to support work performed or services
purchased in foreign countries are made in U.S. dollars, and the infrequent
disbursements that are made in foreign currencies are reimbursable to BAV in
post conversion dollars. Foreign currency transactions of other VSE divisions or
subsidiaries are minimal. Accordingly, the Company does not believe that it is
exposed to any material foreign currency risk.
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VSE CORPORATION AND SUBSIDIARIES
Item 3. Quantitative and Qualitative Disclosures About Market Risks
See "Disclosures About Market Risk" in Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Item 4. Controls and Procedures
As of the end of the period covered by this report, based on management's
evaluation, with the participation of VSE's Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the disclosure controls and
procedures (as defined in Rules 13a-15(e) or 15d - 15(e) under the Securities
Exchange Act of 1934, as amended) our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures
are effective in ensuring that information required to be disclosed by us in
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities
and Exchange Commission's rules and regulations.
There was no change in our internal control over financial reporting during our
first quarter of fiscal 2007 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
PART II. Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The Registrant did not purchase any of its equity securities during the period
covered by this report.
Under the Registrant's bank loan agreement dividends may be paid in an annual
aggregate amount of $.60 per share, provided there is no default under the loan
agreement.
Item 6. Exhibits
(a) Exhibits.
Exhibit No.
-----------
31.1 Section 302 CEO Certification
31.2 Section 302 CFO and PAO Certification
32.1 Section 906 CEO Certification
32.2 Section 906 CFO and PAO Certification
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has omitted all other items contained in "Part II. Other Information"
because such other items are not applicable or are not required if the answer is
negative or because the information required to be reported therein has been
previously reported.
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VSE CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VSE CORPORATION
Date: April 30, 2007 /s/ D. M. Ervine
__________________________________
D. M. Ervine
Chairman, President,
Chief Executive Officer and
Chief Operating Officer
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