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, 2006 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 Select Market
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 require-
ments for the past 90 days. 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. [X]
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 Act). Yes [ ] No [x]
The aggregate market value of outstanding voting stock held by nonaffiliates of
the Registrant as of June 30, 2006, was approximately $42.5 million based on the
last reported sales price of the Registrant's common stock on the Nasdaq
National Market as of that date.
Number of shares of Common Stock outstanding as of March 5, 2007: 2,404,119.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders expected to be held on May 1, 2007, are incorporated by reference
into Part III of this report.
TABLE OF CONTENTS
Page
PART I ----
ITEM 1. Business . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 1A. Risk Factors . . . . . . . . . . . . . . . . . . . . . . 7
ITEM 1B. Unresolved Staff Comments . . . . . . . . . . . . . . . 10
ITEM 2. Properties . . . . . . . . . . . . . . . . . . . . . . . 10
ITEM 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . 10
ITEM 4. Submission of Matters to a Vote of Security Holders . . 10
Executive Officers of the Registrant . . . . . . . . . . 11
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters . . . . . . . . . . . . . . . . . . 12
ITEM 6. Selected Financial Data . . . . . . . . . . . . . . . . 15
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . 16
ITEM 8. Financial Statements and Supplementary Data . . . . . . 33
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure . . . . . . . . . . 55
ITEM 9A. Controls and Procedures . . . . . . . . . . . . . . . . 55
ITEM 9B. Other Information . . . . . . . . . . . . . . . . . . . 55
PART III
ITEM 10. Directors and Executive Officers of the Registrant . . . 55
ITEM 11. Executive Compensation . . . . . . . . . . . . . . . . . 55
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management . . . . . . . . . . . . . . . . . . . . . . . 55
ITEM 13. Certain Relationships and Related Transactions . . . . . 55
ITEM 14. Principal Accountant Fees and Services . . . . . . . . . 56
PART IV
ITEM 15. Exhibits, Financial Statement and Schedules . . . . . . 56
Signatures . . . . . . . . . . . . . . . . . . . . . . . 57
2
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" or the "Registrant") results to differ materially from
those anticipated in the forward looking statements contained in this filing,
see VSE's "Narrative Description of Business" (Items 1, 1A, 2 and 3),
"Management's Discussion and Analysis," and "Notes to Consolidated Financial
Statements." 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 Securities and Exchange
Commission, including the Quarterly Reports on Form 10-Q to be filed by the
Company subsequent to this Annual Report on Form 10-K and any Current Reports
on Form 8-K filed by the Company.
Part I
ITEM 1. Business
(a) General Development
VSE was incorporated in Delaware in 1959. VSE serves as a centralized
management and consolidating entity for the business operations conducted by the
Company's divisions and wholly owned subsidiary, Energetics Incorporated
("Energetics"). 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").
VSE previously conducted business operations in other subsidiaries and
divisions during the past three year period that have been dissolved or became
inactive prior to December 31, 2006. These include Human Resource Systems, Inc.
("HRSI"), dissolved in 2004; Telecommunications Technologies Division ("TTD"),
discontinued operations in 2004 and Information Assurance Division ("IAD",
formerly Value Systems Services Division or "VSS"), inactive as of May 2005.
The term "VSE" or "Company" means VSE and its subsidiaries and divisions unless
the context indicates operations of the parent company only.
The Company's business operations consist primarily of diversified
engineering, logistics, management, and technical services performed on a
contract basis. Substantially all of the Company's contracts are with agencies
of the United States Government (the "government") and other government prime
contractors. The Company's customers also include non-government organizations
and commercial entities.
VSE seeks to provide its customers with competitive, cost-effective
solutions to specific problems. These problems generally require a detailed
technical knowledge of materials, processes, functional characteristics,
information systems, technology and products, and an in-depth understanding of
the basic requirements for effective systems and equipment.
(b) Financial Information
Financial information for the three years ended December 31, 2006,
appears in the "Consolidated Statements of Operations" contained in this Form
10-K.
3
VSE operations are conducted within three reporting segments, the
Federal Group, the International Group, and the Energy and Environmental Group.
The Federal Group, consisting of CED, ELD, MSD, and SED, generated
approximately 52% of VSE's revenues in 2006. The International Group,
consisting of BAV, FMD, and VCG, generated approximately 44% of VSE's revenues
in 2006. The Energy and Environmental Group, consisting of Energetics,
generated approximately 4% of VSE's revenues in 2006. Additional financial
information for VSE's operating segments appears in "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
In 2004, all business operations associated with the Company's TTD
division ceased and financial results of TTD are presented as discontinued
operations.
(c) Description of Business
Services and Products
VSE engineering, logistics, management, and technical services include a
broad array of capabilities and resources used in program planning; systems
integration support; engineering and technical support for ground weapons;
material procurement support; configuration management; computer-aided
drafting and design; design and engineering, including prototype development;
ship reactivation, transfer support and follow-on technical support; logistics
management; training, consulting and implementation support; quality training
services for product, process, and management optimization; technology
insertion; service life extension; environmental management and support;
technology research, development and demonstration programs involving energy
conservation and efficiency; advanced technology transfers; technology
roadmaps; and feasibility, assessment and development programs.
Typical projects include sustaining engineering support for military
vehicles and combat trailers; military equipment refurbishment and
modification; military vehicle ballistic protection systems; ship maintenance,
repair, overhaul planning and follow-on technical support; logistics
management support; machinery condition analysis; specification preparation
for ship alterations and repairs; ship force crew training; life cycle support
for ships; ship communication systems; energy conservation and advanced
technology demonstration projects; technical data package preparation;
multimedia, computer LAN, and telecommunications systems; cross-platform
technical data, product data and technical manual development and support.
Contracts
Depending on solicitation requirements and other factors, VSE offers its
professional and technical services and products through various competitive
contract arrangements and business units which are responsive to customer
requirements and which may also provide an opportunity for diversification.
Such arrangements may include prime contracts, subcontracts, cooperative
arrangements, joint ventures, dedicated ventures, GSA schedules, dedicated
cost centers (divisions) and subsidiaries. Some of the contracts permit the
contracting agency to issue delivery orders or task orders in an expeditious
manner to satisfy relatively short-term requirements for engineering and
technical services. The services ordered pursuant to such arrangements are
normally performed and completed within one year.
Substantially all of the Company's revenues are derived from contract
services performed for the government. The U.S. Navy and U.S. Army are VSE's
largest customers. Other significant customers include the Army Reserve and
the Department of Energy. The Company's customers also include various other
government agencies, non-government organizations, and commercial entities.
4
VSE Revenues by Customer
(dollars in thousands)
2006 2005 2004
Customer Revenues % Revenues % Revenues %
------- -------- - -------- - -------- -
U.S. Army/Army Reserve $174,473 48.0 $ 56,019 20.0 $ 27,384 12.7
U.S. Navy . . . . . . 164,788 45.3 196,363 70.1 157,433 72.9
Department of Energy . 9,420 2.6 9,734 3.5 10,578 4.9
U.S. Air Force . . . . 4,579 1.3 5,431 1.9 3,628 1.7
U. S. Treasury . . . . 2,392 0.7 1,121 0.4 1,153 0.5
U.S. Coast Guard . . . 895 0.2 5,008 1.8 8,498 3.9
All other government . 4,788 1.3 4,674 1.7 5,382 2.5
Commercial and other . 2,399 0.6 1,789 0.6 1,955 0.9
-------- ----- -------- ----- -------- -----
Total $363,734 100.0 $280,139 100.0 $216,011 100.0
======== ===== ======== ===== ======== =====
The government's procurement practices in recent years have tended
toward the bundling of various work efforts under large comprehensive
management contracts ("omnibus"). As a result, the growth opportunities
available to the Company have occurred in large, unpredictable increments. The
Company has pursued these larger efforts by assembling teams of subcontractors
to offer the range of technical competencies required by these omnibus
contracts. Typically the use of subcontractors and large material purchases on
government contracts does not allow for profit margins that are as high as on
work performed by Company personnel. Accordingly, the use of such teaming
arrangements may lower the Company's overall profit margins in some years.
Although the government's practice of using omnibus contracts is expected to
continue, there are indications that the Company will have opportunities to
compete for smaller contracts requiring specific areas of expertise in the
future. VSE is positioned to pursue these opportunities while continuing to
use subcontractor teams to compete for the omnibus contracts. Due to
competitive pressures, the Company has also elected to pursue all of its
contract work through operating divisions and subsidiaries to focus on
particular lines of work or specific customer requirements.
As a result of the bundling trend described above, the Company has some
divisions for which revenues are derived predominantly from one major contract
effort. Substantially all of BAV's work is performed on a program for the U.S.
Navy that accounted for approximately 29%, 43%, and 52% of consolidated
revenues in 2006, 2005, and 2004, respectively. This program has been
performed under two contracts. The original ten-year contract was awarded in
1995 with a total contract ceiling of over $1 billion and was extended to
continue work on a major delivery order effort through most of 2006. A follow-
on five-year contract with a total ceiling of approximately $544 million was
awarded in 2005.
The Company's contracts with the government are typically cost plus fee,
time and materials, or fixed-price contracts. Revenues 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 are earned. Profits on cost-type contracts are equal to the fees that are
earned.
The BAV Division contracts have terms that specify award fee payments
that are determined by performance and level of contract activity. Award fees
under the BAV contracts 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 multiplied by the contract defined
billing rates, plus the cost of materials used in performance on the contract.
5
Profits or losses 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 some fixed-price contracts
revenues are recorded as costs are incurred, using the percentage-of-completion
method of accounting. 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.
Backlog
Funded backlog for government contracts represents a measure of the
Company's potential future revenues and is defined 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. VSE's funded backlog as of December 31, 2006, increased to
approximately $299 million, the highest backlog in the Company's history.
Funded backlog as of December 31, 2005 and 2004 was approximately $276 million
and $168 million, respectively. The increases in funded backlog during these
years are due to increases in funding on the Company's existing programs and
the funding received on new programs in 2006 and 2005. Changes in funded
backlog on contracts are sometimes unpredictable due to uncertainties
associated with changing program requirements and the ultimate availability of
funds. The majority of the Company's funded backlog is expected to be completed
within one year.
In addition to the funded backlog levels, VSE has significant total
contract ceiling amounts available for use by the Company on large multiple
award, indefinite delivery, indefinite quantity contracts with the U.S. Army
and U.S. Navy. While these contracts increase the opportunities available to
VSE to pursue future work, the amount of future work is not determinable until
delivery orders are placed on the contracts. Additionally, these delivery
orders must be funded by the procuring agencies before the Company can perform
work and begin earning revenues from them. The Company has one task order on a
U. S. Army contract that has a base year and a one year option period, which
has been exercised, to be performed in 2006 and 2007 with a combined value of
approximately $351 million. The task order is incrementally funded and the
funded amount is included in the December 31, 2006 funded backlog amount
above.
Marketing
VSE marketing activities are conducted by its professional staff of
engineers, analysts, program managers, contract administrators and other
personnel, with these activities centrally coordinated through the Company's
Business Development staff. Information concerning new programs and
requirements becomes available in the course of contract performance, through
formal and informal briefings, from participation in professional
organizations, and from literature published by the government, trade
associations, professional organizations and commercial entities.
Personnel
VSE services are provided by a staff of professional and technical
personnel having high levels of education, experience, training and skills. As
of February 2007, VSE had 857 employees. Principal categories of VSE technical
personnel include (a) engineers and technicians in mechanical, electronic,
chemical, industrial, energy and environmental services, (b) information
technology professionals in computer systems, applications and products,
configuration, change and data management disciplines, (c) technical editors
and writers, (d) multimedia and computer design engineers, (e) graphic
designers and technicians, and (f) logisticians. The expertise required by VSE
customers also frequently includes knowledge of government administrative
6
procedures. Many VSE employees have had experience as government employees or
have served in the U.S. armed forces.
Competition
The professional and technical services industry in which VSE is engaged
is very competitive. There are numerous other organizations, including large,
diversified firms with greater financial resources and larger technical
staffs, which are capable of providing essentially the same services as those
offered by VSE. Such companies may be publicly owned or privately held or may
be divisions of much larger organizations, including large manufacturing
corporations.
Government agencies have emphasized awarding contracts of the types
performed by VSE on a competitive basis as opposed to a sole source or other
non-competitive basis. Most of the significant contracts currently performed
by VSE were either initially awarded on a competitive basis or have been
renewed at least once on a competitive basis. Government agencies also order
work through contracts awarded by the General Services Administration ("GSA").
GSA provides a schedule of services at fixed prices which may be ordered
outside of the solicitation process. The Company has four GSA schedule
contracts for different classes of services, but there is no assurance
regarding the level of work which may be obtained by VSE under these contract
arrangements. Government budgets, and in particular the budgets of certain
government agencies, can also affect competition in VSE's business. A
reallocation of government spending priorities or a general decline in
government budgets can result in lower levels of potential business for VSE
and its competitors, thereby intensifying competition for the remaining
business.
It is not possible to predict the extent and range of competition that
VSE will encounter as a result of changing economic or competitive conditions,
customer requirements, or technological developments. VSE believes the
principal competitive factors for the professional and technical services
business in which it is engaged are technical and financial qualifications,
quality and innovation of services and products, past performance, and low
price.
The government acquisition policies and procedures often emphasize
factors that can present challenges to VSE's efforts to win new business, and
may make it difficult for VSE to qualify as a potential bidder. For example,
past performance may be used to exclude entrance into new government markets,
and multiple-award schedules may result in unequal contract awards between
successful contractors.
Available Information
Copies of VSE's Annual Report on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and amendments to those reports are filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended, and are available free of charge through VSE's website
www.vsecorp.com as soon as reasonably practicable after the reports are
electronically filed with the Securities and Exchange Commission ("SEC").
ITEM 1A. Risk Factors
VSE's future results may differ materially from past results and from
those projected in the forward-looking statements contained in this Form 10-K
due to various uncertainties and risks, including but not limited to those set
forth below, one-time events and other important factors disclosed previously
and from time to time in other filings with the SEC.
7
Federal procurement directives could result in a loss of work on current
programs to set-asides and omnibus contracts.
VSE's business with the government is subject to the risk that one or
more of the Company's potential contracts or contract extensions may be
awarded by the contracting agency to a small or disadvantaged or minority-
owned business pursuant to set-aside programs administered by the Small
Business Administration, or may be bundled into omnibus contracts for very
large businesses. These risks can potentially have an adverse effect on VSE's
revenue growth and profit margins.
Funding uncertainties for federal programs could adversely affect the
Company's ability to continue work on its government contracts.
Government contract business is subject to funding delays, terminations,
reductions, extensions, and moratoriums caused by political and administrative
disagreements within the government. To date, the effect of such negotiations
and disagreements on the Company has not been material, but no assurances can
be given about such risks with respect to future years.
Global economic conditions and political factors could adversely affect
revenues on current programs.
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 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. Work associated
with the transfer of four ships to Taiwan under the BAV Ship Transfer Program
during 2004, 2005 and 2006 also comprised a large percentage of total sales.
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.
VSE is exposed to contractual and financial liabilities if its subcontractors
do not perform satisfactorily.
A large percentage of VSE's contract work is performed by
subcontractors, which raises certain government compliance, performance and
financial risks to VSE. While subcontractor terms generally specify the terms
and performance for which the subcontractor is liable to VSE, if any
unsatisfactory performance occurs on the part of subcontractors, the Company
still must bear the cost to ensure satisfactory performance on its prime
contracts.
As a U.S. Government contractor, VSE is subject to a number of procurement
rules and regulations that could expose the Company to potential liabilities
or loss of work.
VSE must comply with and is affected by laws and regulations relating to
the award, administration and performance of U.S. Government contracts.
Government contract laws and regulations affect how the Company does business
with its customers and, in some instances, impose added costs on the business.
A violation of specific laws and regulations could result in the imposition of
fines and penalties or the termination of contracts or debarment from bidding
on contracts.
8
In some instances, these laws and regulations impose terms or rights
that are more favorable to the government than those typically available to
commercial parties in negotiated transactions. For example, the U.S.
Government may terminate any government contract or subcontract at their
convenience, as well as for default based on performance. Upon termination for
convenience of a fixed-price type contract, the Company would normally be
entitled to receive the purchase price for delivered items, reimbursement for
allowable costs for work-in-process and an allowance for profit on the
contract or adjustment for loss if completion of performance would have
resulted in a loss. Upon termination for convenience of a cost-type contract,
the Company would normally be entitled to reimbursement of allowable costs
plus a portion of the fee. Such allowable costs would include the cost to
terminate agreements with suppliers and subcontractors. The amount of the fee
recovered, if any, is related to the portion of the work accomplished prior to
termination and is determined by negotiation.
A termination for default could expose the Company to liability and have
a material adverse effect on its ability to compete for future contracts and
orders. In addition, the U.S. Government could terminate a prime contract
under which the Company is a subcontractor, irrespective of the quality of
services provided by VSE as a subcontractor.
VSE's business could be adversely affected by a negative audit by the U.S.
Government.
U.S. Government agencies, including the Defense Contract Audit Agency
and the Department of Labor, routinely audit and investigate government
contractors. These agencies review a contractor's performance under its
contracts, cost structure and compliance with applicable laws, regulations and
standards. The U.S. Government also may review the adequacy of, and a
contractor's compliance with, its internal control systems and policies,
including the contractor's purchasing, property, estimating, compensation and
management information systems. Any costs found to be improperly allocated to
a specific contract will not be reimbursed, while such costs already
reimbursed must be refunded. If an audit uncovers improper or illegal
activities, the Company may be subject to civil and criminal penalties and
administrative sanctions, including termination of contracts, forfeiture of
profits, suspension of payments, fines and suspension or prohibition from
doing business with the U.S. Government. In addition, the Company could suffer
serious harm to its reputation if allegations of impropriety were made.
VSE's earnings and margins may vary based on the mix of contracts and
programs.
The Company's business includes both cost-type and fixed-price
contracts. Cost-type contracts generally have lower profit margins than fixed-
price contracts. Typically the use of subcontractors and large material
purchases on government contracts does not allow for profit margins that are
as high as on work performed by Company personnel. Accordingly, the use of
such teaming arrangements may lower the Company's overall profit margins in
some years. Although the government's practice of using omnibus contracts is
expected to continue, there are indications that the Company will have
opportunities to compete for smaller contracts requiring specific areas of
expertise in the future.
VSE uses estimates in accounting for its programs. Changes in estimates could
affect future financial results.
The Company uses 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 and accruals for loss
contracts, contract disallowance and self insured health claims, and estimated
cost to complete on certain fixed-price contracts.
9
New accounting standards could result in changes to VSE's methods of
quantifying and recording accounting transactions, and could affect financial
results and financial position.
Changes to Generally Accepted Accounting Principles in the United States
(GAAP) arise from new and revised standards, interpretations and other
guidance issued by the Financial Accounting Standards Board, the SEC, and
others. The effects of such changes may include prescribing an accounting
method where none had been previously specified, prescribing a single
acceptable method of accounting from among several acceptable methods that
currently exist, or revoking the acceptability of a current method and
replacing it with an entirely different method, among others. Such changes
could result in unanticipated effects on results of operations, financial
position and other financial measures.
ITEM 1B. Unresolved Staff Comments
None
ITEM 2. Properties
VSE's principal executive and administrative offices are located in a
five-story building in Alexandria, Virginia, leased by VSE through April 30,
2013. This building contains approximately 127,000 square feet of engineering,
shop, and administrative space. VSE also provides services and products from
approximately 22 other U.S. leased facilities located near customer sites to
facilitate communications and enhance project performance. These facilities
are generally occupied under short-term leases and currently include an
aggregate of approximately 627,000 square feet of office and warehouse space.
VSE employees often provide services at customer facilities, limiting VSE's
requirement for additional space. BAV provides services from several locations
outside of the United States, generally at foreign shipyards.
VSE owns and operates two facilities in Ladysmith, Virginia. One of
these properties consists of approximately 45 acres of land and multiple
storage and vehicle maintenance buildings totaling approximately 17,000 square
feet of space. The other property, purchased in October 2006 for approximately
$1.5 million, consists of 30 acres of land and buildings totaling
approximately 13,500 square feet of space. These properties are used by VSE to
test military equipment for which VSE provides system technical support or
other engineering services; to provide storage, maintenance and refurbishment
services for military equipment; and to supplement Alexandria, Virginia,
office and shop facilities.
ITEM 3. Legal Proceedings
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.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of stockholders, through the
solicitation of proxies or otherwise, during the three-month period ended
December 31, 2006.
10
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information concerning the executive
officers of the Registrant as of March 5, 2007. Each person named has served
as an executive officer of VSE, or has served in a similar executive capacity
in VSE, for more than the past five years, except for Mr. Reed.
Mr. Reed joined VSE in 2005 as Chief Operating Officer of VSE's wholly
owned subsidiary Energetics, and effective April 1, 2005, he was appointed
Energetics' President. Mr. Reed was a founder of Energetics in 1979 and served
as an officer of Energetics from 1979 to 2001. He provided senior-level
consulting services to government and private clients as a sole proprietor
during the period 2001 through 2004. He is a Registered Professional Engineer
in Maryland.
The executive officers are appointed annually to serve until the first
meeting of VSE's Board of Directors (the "Board") following the next annual
meeting of stockholders and until their successors are elected and have
qualified, or until death, resignation or removal, whichever is sooner.
Name Age Position with Registrant
---- --- ------------------------
Thomas G. Dacus . . . . . . . . 61 Executive Vice President and President,
Federal Group
Donald M. Ervine . . . . . . . 70 Chairman and Chief Executive Officer,
President and Chief Operating Officer
Michael E. Hamerly . . . . . . 61 Executive Vice President,
International Group
James E. Reed . . . . . . . . . 58 President, Energetics Incorporated and
Energy and Environment Group
James M. Knowlton . . . . . . . 64 Executive Vice President and
President, International Group
Thomas R. Loftus . . . . . . . 51 Executive Vice President and Chief
Financial Officer
Craig S. Weber . . . . . . . . 62 Executive Vice President, Chief
Administrative Officer, and Secretary
11
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder
Matters
(a) Market Information
The Company's common stock (par value $.05 per share) is traded in the
Nasdaq Global Select Market, trading symbol, "VSEC," Newspaper listing, "VSE."
The following table sets forth the range of high and low sales price
(based on information reported by the Nasdaq National Market System) and cash
dividend per share information for VSE common stock for each quarter and
annually during the last two years.
Quarter Ended High Low Dividends
------------- ---- --- ---------
2005:
March 31 . . . . . . . $27.49 $21.09 $.05
June 30 . . . . . . . 38.85 23.82 .06
September 30 . . . . . 40.50 30.00 .00
December 31 . . . . . 42.25 31.56 .12
For the Year $42.25 $21.09 $.23
2006:
March 31 . . . . . . . $51.95 $38.15 $.06
June 30 . . . . . . . 41.49 19.98 .07
September 30 . . . . . 34.00 29.54 .07
December 31 . . . . . 37.50 28.66 .07
For the Year $51.95 $19.98 $.27
(b) Holders
There were approximately 1,475 stockholders of VSE common stock as of
February 1, 2007, consisting of approximately 260 stockholders of record plus
the number of beneficial owner proxy sets provided in connection with VSE's
Annual Meeting of Stockholders held on May 2, 2006, to (a) brokers, banks, and
nominees and (b) participants in the VSE Corporation Employee ESOP/401(k)
Plan.
(c) Dividends
In 2005 cash dividends were declared quarterly at the annual rate of
$0.20 per share through March 8, 2005, and at the annual rate of $.24 per
share commencing May 3, 2005.
In 2006 cash dividends were declared quarterly at the annual rate of
$.24 per share through March 31, 2006, and at the annual rate of $.28 per
share commencing June 6, 2006.
Pursuant to VSE's bank loan agreement (see Note 8 of "Notes to
Consolidated Financial Statements"), the payment of cash dividends by VSE is
subject to annual rate restrictions. VSE has paid cash dividends each year
since 1973.
12
(d) Equity Compensation Plan Information
Compensation Plans
The Company has four compensation plans approved by VSE's stockholders
under which the Company's equity securities are authorized for issuance to
employees and directors: The VSE Corporation 2004 Stock Option Plan, the
predecessor 1998 Stock Option Plan, the VSE Corporation 2004 Non-employee
Directors Stock Plan and the VSE Corporation 2006 Restricted Stock Plan.
On December 30, 2005, the Board directed VSE to discontinue, until and
unless the Board determined otherwise, awarding options, both discretionary
and nondiscretionary, to purchase VSE common stock, par value $.05 per share
("VSE Stock"), under VSE's 2004 Stock Option Plan (the "2004 Plan"). The
options outstanding under the 2004 Plan and predecessor 1998 Stock Option Plan
were not affected by this Board action.
The following table provides information about the Company's equity
compensation plans as of December 31, 2006:
Number of Shares
Remaining
Available for
Number of Weighted Future Issuance
Shares to be Average Under Equity
Issued upon Exercise Compensation Plans
Exercise of Price of (excluding shares
Outstanding Outstanding reflected in
Options (1) Options column (a))(2)
Plan Category (a) (b) (c)
------------- ------------ ----------- ------------------
Equity compensation
plans approved by
stockholders . . . . . 166,625 $17.22 454,930
Equity compensation
plan not approved
by stockholders . . . . - - -
Total 166,625 $17.22 454,930
(1) Excludes 238,867 shares of issued and outstanding VSE Stock held by the
VSE Corporation Employee ESOP/401(k) Plan; these shares may be transferred to
Plan participants on retirement, termination of VSE employment, or pursuant to
ESOP diversification.
(2) At December 31, 2006, 287,500, 44,230, and 123,200 shares of VSE Stock
were available under the 2004 Stock Option Plan and predecessor 1998 Stock
Option Plan, the 2004 Non-employee Directors Stock Plan and the 2006
Restricted Stock Plan, respectively.
13
Performance Graph
Set forth below is a line graph comparing the cumulative total return of
VSE Stock with (a) a performance index for the broad market in which VSE Stock
is traded and (b) a published industry index. VSE Stock is traded on the
NASDAQ Global Select Market, and VSE's industry group is engineering and
technical services (formerly SIC Code 8711). Accordingly, the performance
graph compares the cumulative total return for VSE Stock with (a) an index for
the NASDAQ Market (U.S. companies) ("NASDAQ Index") and (b) a published
industry index for SIC Code 8711 ("Industry Index").
[insert graph]
* Total return assumes reinvestment of dividends and assumes $100 invested
on December 31, 2001, in VSE Stock, the NASDAQ Index, and the Industry
Index.
Performance Graph Table
2001 2002 2003 2004 2005 2006
---- ---- ---- ---- ---- ----
VSE Stock 100 149 186 356 600 487
NASDAQ Index 100 72 107 117 120 137
Industry Index 100 79 119 135 200 246
14
ITEM 6. Selected Financial Data
(In thousands, except per share data)
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Revenues, principally from contracts . . . . $363,734 $280,139 $216,011 $133,059 $128,417
======== ======== ======== ======== ========
Income from continuing operations . . . . . $ 7,789 $ 6,169 $ 3,445 $ 2,090 $ 1,585
(Loss) income from discontinued operations . - - (1) (79) (933)
-------- -------- -------- -------- --------
Net income . . . . . . . . . . . . . . $ 7,789 $ 6,169 $ 3,444 $ 2,011 $ 652
======== ======== ======== ======== ========
Basic earnings per common share:
Income from continuing operations . . . . $ 3.29 $ 2.66 $ 1.54 $ .96 $ .73
Loss (income) from discontinued operations - - - (.04) (.43)
-------- -------- -------- -------- --------
Net income . . . . . . . . . . . . . . $ 3.29 $ 2.66 $ 1.54 $ .92 $ .30
======== ======== ======== ======== ========
Diluted earnings per common share:
Income from continuing operations . . . . $ 3.21 $ 2.58 $ 1.49 $ .94 $ .72
Loss (income) from discontinued operations - - - (.04) (.42)
-------- -------- -------- -------- --------
Net income . . . . . . . . . . . . . . $ 3.21 $ 2.58 $ 1.49 $ .90 $ .30
======== ======== ======== ======== ========
Working Capital . . . . . . . . . . . . . . $ 25,646 $ 22,028 $ 15,748 $ 13,394 $ 10,762
======== ======== ======== ======== ========
Total assets . . . . . . . . . . . . . . . . $ 98,535 $ 73,866 $ 60,352 $ 30,776 $ 32,075
======== ======== ======== ======== ========
Stockholders' equity . . . . . . . . . . . . $ 38,236 $ 30,151 $ 23,043 $ 19,058 $ 17,043
======== ======== ======== ======== ========
Cash dividends per common share . . . . . . $ .27 $ .23 $ .19 $ .16 $ .16
======== ======== ======== ======== ========
This consolidated summary of selected financial data should be read in
conjunction with Management's Discussion and Analysis of the 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 in this Form 10-K. The historical results set forth in this Item 6 are not
necessarily indicative of the results of operations to be expected in the
future.
15
ITEM 7. 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 Energetics. 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 during the past three fiscal years that have been dissolved or
became inactive prior to December 31, 2006. These include Human Resource
Systems, Inc. ("HRSI"), dissolved in 2004; Telecommunications Technologies
Division ("TTD"), discontinued operations in 2004 and Information Assurance
Division ("IAD", formerly Value Systems Services Division or "VSS"), inactive
as of May 2005.
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 Revenues by Customer
(dollars in thousands)
2006 2005 2004
Source of Revenue Revenues % Revenues % Revenues %
----------------- -------- - -------- - -------- -
Army/Army Reserve $174,473 48.0 $ 56,019 20.0 $ 27,384 12.7
Navy 164,788 45.3 196,363 70.1 157,433 72.9
Other 24,473 6.7 27,757 9.9 31,194 14.4
-------- ----- -------- ----- -------- -----
Total Revenues $363,734 100.0 $280,139 100.0 $216,011 100.0
======== ===== ======== ===== ======== =====
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 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
16
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.
ELD provides full lifecycle 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
lifecycle 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.
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 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 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.
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 lifecycle 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.
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
17
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 our clients in both the public
and private sectors.
BAV Ship Transfer Program
VSE's BAV Division provides the U.S. Navy with engineering, technical
and logistical support services associated with the sale, lease, or transfer of
Navy ships to foreign governments. This program has been the Company's single
largest revenue producer in recent years. 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
29% and 43% of consolidated revenues in 2006 and 2005, 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 under
this program was a major contributor to the Company's revenues in 2004, 2005,
and 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 second 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 work
associated with the transfer of four ships to Taiwan under delivery orders
issued on the original contract was substantially completed in September 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. In 2004, 2005 and
2006, each of the three month periods ended March 31, June 30 and December 31
includes BAV award fee income. The three month periods ended September 30,
2004, 2005 and 2006 do not include BAV award fee income.
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
18
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 $17 million as of
December 31, 2006. Contract value on the TBPS contracts is fully funded at the
time of award or modification. Currently, contractual coverage for work on the
TBPS program runs through May 2007 and the Company expects to complete work in
2007.
The TBPS Program contributed significantly to VSE revenues in 2005 and
2006. The work performed on this program also significantly increases the
amount of fixed price contract work performed by the Company. In general, the
Company's fixed price contract work has higher risk and profit margins than
work on other contract types. Accordingly, the TBPS program has presented, and
is expected to continue to present during 2007, VSE's business with both
increased profit margins and risk of loss.
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 based on the
contract value and a significant level of contract funding and funded backlog,
is expected to contribute significantly to VSE's revenues in 2007, however,
profit margins on subcontract work are lower than on work performed by Company
personnel.
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 management ("omnibus") 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 businesses 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
government compliance, performance and financial risks to VSE in that
19
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 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 offered 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. Work associated
with the transfer of four ships to Taiwan under the BAV Ship Transfer Program
during 2004, 2005, and 2006 also comprised a large percentage of total sales.
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)
2006 2005 2004
Source of Revenue Revenues % Revenues % Revenues %
----------------- -------- - -------- - -------- -
BAV Egypt $ 51,446 14.1 $ 52,926 18.9 $ 50,250 23.3
BAV Taiwan 45,729 12.6 63,058 22.5 56,038 25.9
BAV Other 9,649 2.7 5,024 1.8 6,675 3.1
-------- ----- -------- ----- -------- -----
Total BAV 106,824 29.4 121,008 43.2 112,963 52.3
TBPS Program 29,770 8.2 29,533 10.5 134 0.1
CED Army Equipment
Support 106,209 29.2 - - - -
VSE Other 120,931 33.2 129,598 46.3 102,914 47.6
-------- ----- -------- ----- -------- -----
Total Revenues $363,734 100.0 $280,139 100.0 $216,011 100.0
======== ===== ======== ===== ======== =====
Management Outlook
------------------
Growth Continued in 2006
The growth trend in revenues and profits in 2004 and 2005 continued in
2006. Major contributors to 2006 results were the Taiwan Ship Transfer work
performed by BAV, performance on the TBPS Program, work performed on the CED
Army Equipment Support Program, growth in ELD's Equipment Refurbishment
Services provided to the U. S. Army Reserve, and additional work provided by
20
Significant IDIQ Contracts. See "Results of Operations" below for a more
detailed discussion of 2006 results.
More Growth in 2007
Subject to the risk elements discussed above, VSE believes it has the
potential to continue to increase revenues and profits in 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. The contract task orders for this program are incrementally
funded, with funded backlog of approximately $140 million as of December 31,
2006. The task order in place for 2007 is valued at approximately $212 million.
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. 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 and provide potential revenue over the life of the contract
of approximately $113 million, depending on service requirements.
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 2004, 2005, and 2006. 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. 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 $51 million as of December 31, 2006.
TBPS Program
Contractual coverage for work on the TBPS program runs through May 2007
and the Company expects to complete work in 2007. The scheduled expiration of
this program raises a challenge to the Company with respect to replacing the
revenues and profits that it has provided over the prior two years. Revenues
from this program were approximately $30 million in both 2006 and 2005. Funded
backlog remaining on the program was approximately $17 million as of December
31, 2006.
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. The Company expects further increases in 2007 and future
years.
21
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-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 has
generated revenues for all of VSE of approximately $143 million, $37 million
and $27 million during 2006, 2005 and 2004, respectively, including revenues
of approximately $106 million on the CED Army Equipment Support Program in
2006. CED was awarded a new task order under this contract in December 2006
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 December 31, 2006, 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 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.
Increases in Bookings and 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 2006, 2005, and 2004 is as follows.
(in $ millions)
2006 2005 2004
---- ---- ----
Bookings . . . . . . . . . . . . . . . . 388 390 303
Funded Backlog . . . . . . . . . . . . . 299 276 168
Revenues . . . . . . . . . . . . . . . . 364 280 216
Longer Term
The growth in VSE revenue and profits during 2004, 2005, and 2006
presents the Company with both challenges and opportunities for future years.
The biggest challenge VSE expects to face in future years is sustaining its
recent level of growth. Certain work efforts that have supported VSE's growth
22
during the past three years are due to expire. VSE has received significant
contributions to its revenue growth 1) in these three years from the Taiwan
Ship Transfer work, which ended in September 2006; 2) in 2005 and 2006 from
the TBPS Program work, which is scheduled to expire in 2007; and, 3) in 2006
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 Rapid
Response support contract award 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 Company currently
has proposals under evaluation and in preparation, and is tracking multiple
bidding opportunities for new contract work. Additionally, 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
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. Pro forma disclosure is no
longer an alternative. 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 ($157 thousand after tax) in 2006. 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 than as an
operating cash flow as required under current literature. The amount of
financing cash flows from benefits of tax deductions in excess of recognized
compensation cost for 2006 was $312 thousand. The amount of operating cash
flows recognized for such excess tax deductions was approximately $761
thousand and $433 thousand for 2005 and 2004, respectively.
On December 30, 2005, the Board directed VSE to discontinue awarding
options, both discretionary and nondiscretionary, to purchase VSE Stock under
VSE's 2004 Stock Option Plan (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
On July 13, 2006, the Financial Accounting Standards Board issued
Interpretation No. (FIN) 48, "Accounting for Uncertainty in Income Taxes,"
which is effective January 1, 2007. The purpose of FIN 48 is to clarify and
set forth consistent rules for accounting for uncertain tax positions in
accordance with SFAS 109, "Accounting for Income Taxes." The cumulative effect
of applying the provisions of this interpretation are required to be reported
23
separately as an adjustment to the opening balance of retained earnings in the
year of adoption. The Company has begun to review and evaluate FIN 48 and the
impact of its adoption is not expected to be material.
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 the 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 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 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. 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.
Certain direct and incremental contract costs have been deferred and
reported as a current asset prior to the recognition of revenue. These costs
are realizable beginning in August 2006 through January 2007. The amount of
remaining costs classified as a current asset as of December 31, 2006 is
approximately $164 thousand.
24
Revenues by contract type for the three years ended December 31, 2006
were as follows (in thousands):
2006 2005 2004
Contract Type Revenues % Revenues % Revenues %
------------- -------- - -------- - -------- -
Cost-type . . . . . $147,733 40.6 $177,567 63.4 $148,043 68.5
Time and materials. 172,766 47.5 60,618 21.6 31,928 14.8
Fixed-price . . . . 43,235 11.9 41,954 15.0 36,040 16.7
-------- ----- -------- ----- -------- -----
$363,734 100.0 $280,139 100.0 $216,011 100.0
======== ===== ======== ===== ======== =====
The large increase in time and materials revenues from 2005 to 2006
shown in the table above is primarily attributable to approximately $106
million in 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. Revenues recognized in
2006 include approximately $369 thousand for which the Company had not
received formalized funding as of December 31, 2006. The Company received
funding modifications for approximately $174 thousand of this amount as of
February 2007, leaving approximately $195 thousand of 2006 revenues classified
as risk funding. VSE believes that it will receive funding for this remaining
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.
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 December 31, 2006, the Company had
approximately $1.1 million of unamortized 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.
25
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 in the future, VSE
may be required to record valuation allowances against its deferred tax
assets, resulting in additional income tax expense.
Results of Operations
---------------------
Revenues
The following table shows the revenues from operations of VSE, its
subsidiaries and divisions, and such revenues as a percent of total revenues:
Revenues from Operations
(dollars in thousands)
2006 2005 2004
Company or Business Unit Revenues % Revenues % Revenues %
------------------------ -------- - -------- - -------- -
VSE (parent company). . . . . $ 57 0.0 $ 34 0.0 $ 12 0.0
CED . . . . . . . . . . . . . 128,658 35.4 28,564 10.2 24,615 11.4
BAV . . . . . . . . . . . . . 106,824 29.4 121,008 43.2 112,963 52.3
FMD . . . . . . . . . . . . . 50,480 13.9 59,800 21.3 41,711 19.3
SED . . . . . . . . . . . . . 42,016 11.5 49,001 17.5 12,762 5.9
ELD . . . . . . . . . . . . . 16,771 4.6 - - - -
Energetics . . . . . . . . . 14,269 3.9 12,694 4.5 11,693 5.4
MSD . . . . . . . . . . . . . 3,511 1.0 4,063 1.5 3,300 1.5
VCG . . . . . . . . . . . . . 1,148 0.3 4,975 1.8 7,314 3.4
Business Units Inactive
as of December 31, 2006 . . - - - - 1,641 0.8
-------- ----- -------- ----- -------- -----
$363,734 100.0 $280,139 100.0 $216,011 100.0
======== ===== ======== ===== ======== =====
Revenues increased by approximately 30% per year for the years ended
December 31, 2006 and 2005, as compared to the respective prior years. A
substantial portion of the increase in revenues for 2006 was attributable to
revenues associated with the CED Army Equipment Support Program work, which
started in January 2006. Increased revenues from ELD equipment refurbishment
services (revenues from these services were included in SED's results in 2005
and 2004) and SED and Energetics contract services also contributed to the
Company's increases in revenues. The increases in revenues were partially
offset by decreases in the level of work performed under the BAV Ship Transfer
Program, on FMD's Navy contracts, and on VCG's contract with the U.S. Coast
Guard.
The primary reasons for the increases in revenues in 2005 were 1) work
attributable to the TBPS program; 2) increased levels of work performed by FMD
on its U.S. Navy contracts; 3) an increase in work performed under the BAV
Ship Transfer Program, including revenues associated with the Taiwan ship
transfer; 4) an increase in work performed on the CED Rapid Response contract;
and 5) increased levels of military equipment refurbishment services performed
for the U.S. Army Reserve.
Income from Continuing Operations Before Income Taxes
The following table shows consolidated revenues and income from
operations before income taxes, other items of income and expense, and such
amounts as a percent of revenues.
26
Income from Continuing Operations Before Income Taxes
(dollars in thousands)
Description 2006 % 2005 % 2004 %
----------- ---- - ---- - ---- -
Revenues . . . . . . . . . $363,734 100.0 $280,139 100.0 $216,011 100.0
Costs and expenses . . . . 350,978 96.5 269,780 96.3 209,841 97.1
Gross profit . . . . . . . 12,756 3.5 10,359 3.7 6,170 2.9
Selling, general and
administrative expenses. 694 0.2 580 0.2 636 0.3
Interest(income)expense . (427) (0.1) (210) (0.1) (102) 0.0
-------- ----- -------- ----- -------- -----
Income from continuing
operations before
income taxes . . . . . . $ 12,489 3.4 $ 9,989 3.6 $ 5,636 2.6
======== ===== ======== ===== ======== =====
VSE's gross profits as a percentage of revenues on continuing operations
decreased slightly in 2006 as compared to 2005 and increased in 2005 as
compared to 2004. Company-wide revenue increases tend to increase the gross
profit percentages realized on the Company's fixed price and time and
materials contracts due to the ability to spread corporate costs over a larger
revenue base. The ability to spread corporate costs over a larger revenue base
and an increase in the amount of work performed on fixed price and time and
materials contracts, which have more favorable profit margins than work
performed on cost type contracts, had a positive impact on gross profit
dollars in both 2006 and 2005. Conversely, the Company realized a substantial
increase in low margin revenues on the CED Army Equipment Support Program in
2006, resulting from the large amount of subcontractor pass-through work
performed on this program, which caused a slight decrease in the Company's
gross profits as a percentage of revenues. The effect of the increased
revenues from the CED Army Equipment Support Program in 2006 was to increase
gross profit dollars while at the same time slightly decrease gross profits as
a percentage of revenues.
Programs that contributed to gross profit increases, in part due to the
improved gross margins resulting from higher revenue levels, included the TBPS
Program and services provide by FMD and Energetics. Additionally, BAV Ship
Transfer Program services experienced improved profitability in 2006, and CED
operational losses were reduced in 2006 and 2005 as compared to 2004. Other
factors that affect the Company's gross margins include the timing of contract
award fees, effective project and cost management, and competitive factors.
Selling, general and administrative expenses consist primarily of costs
and expenses that are not chargeable or reimbursable on the Company's
operating unit contracts. As a percentage of revenues, these expenses varied
little in 2006 and 2005 as compared to the respective prior years.
VSE did not have significant borrowing requirements or interest expense
in 2006, 2005, and 2004. The Company's interest income increased in 2006 as
compared to 2005 and increased in 2005 as compared to 2004 as profits from
operations and resulting cash surpluses were invested.
Segment Operating Results
Federal Group
-------------
The following table shows consolidated revenues, costs and expenses, and
gross profit from operations for the Federal Group (in thousands).
Description 2006 2005 2004
----------- ---- ---- ----
Revenues . . . . . . . . . . . . $190,956 $ 81,628 $ 42,318
Costs and expenses . . . . . . . 185,076 76,193 40,386
-------- -------- --------
Gross profit . . . . . . . . . . $ 5,880 $ 5,435 $ 1,932
======== ======== ========
Gross profit percent . . . . . . 3.1% 6.7% 4.6%
Revenues in the Federal Group increased by approximately 134% and 93%
for the years ended December 31, 2006 and 2005, as compared to the respective
27
prior years. A substantial portion of the increase in revenues for 2006 was
attributable to revenues associated with the CED Army Equipment Support
Program work, which started in January 2006. Increased revenues from ELD's
equipment refurbishment services and SED contract services also contributed to
the increases in 2006 revenues. The increase in revenues in 2005 was primarily
attributable to the TBPS program, for which production started in January
2005. Growth in ELD's equipment refurbishment services also contributed to the
Federal Group's revenue increase in 2005.
Gross profit in the Federal Group increased by approximately 8% and 181%
for the years ended December 31, 2006 and 2005, as compared to the respective
prior years. While the CED Army Equipment Support Program work accounted for
the majority of the Federal Group's revenue increase in 2006, substantially
all of the work on this program is performed by a subcontractor and these
costs are passed on to the government essentially at cost. Accordingly, the
increase in gross profit for 2006 was very modest in relation to the revenue
increase, and gross profit as a percentage of revenues declined from 6.7% to
3.1%. Production efficiency improvements on the TBPS Program contributed to an
increase in gross profit dollars in 2006. The increase in gross profit in 2005
was primarily due to having the TBPS Program work in 2005 as compared to 2004
when production work on this program had not yet begun. Increased military
equipment refurbishment services performed for the U. S. Army Reserve
(performed by SED in 2005 and 2004) and the reduction of operational losses
associated with CED also contributed to increased gross profit in 2005.
International Group
-------------------
The following table shows consolidated revenues, costs and expenses, and
gross profit from operations for the International Group(in thousands).
Description 2006 2005 2004
----------- ---- ---- ----
Revenues . . . . . . . . . . . . $158,452 $185,784 $161,988
Costs and expenses . . . . . . . 153,132 182,131 159,176
-------- -------- --------
Gross profit . . . . . . . . . . $ 5,320 $ 3,653 $ 2,812
======== ======== ========
Gross profit percent . . . . . . 3.4% 2.0% 1.7%
Revenues in the International Group decreased by approximately 15% and
increased by approximately 15% for the years ended December 31, 2006 and 2005,
as compared to the respective prior years. The decrease in revenues in 2006
was primarily due to the completion of BAV's work associated with the transfer
of U. S. Navy ships to Taiwan and to a reduction in the amount of
subcontractor pass-through ordered through FMD's Navy contracts. A reduction
in the amount of services ordered on VCG's contract with the U. S. Coast Guard
also contributed to the decrease in revenues in 2006. The increase in revenues
in 2005 was primarily due to increased levels of work performed by FMD on its
U. S. Navy contracts and an increase in work performed under the BAV Ship
Transfer Program, including revenues associated with the Taiwan ship transfer.
Gross profit in the International Group increased by approximately 46%
and 30% for the years ended December 31, 2006 and 2005, as compared to the
respective prior years. The increases in gross profit in these years was
primarily due to the transition from the old BAV contract to the new contract
and to an increase in labor driven revenues on FMD's Navy contracts.
Energy and Environmental Group
The following table shows consolidated revenues, costs and expenses, and
gross profit from operations for the Energy and Environmental Group (in
thousands).
Description 2006 2005 2004
----------- ---- ---- ----
Revenues . . . . . . . . . . . . $ 14,268 $ 12,694 $ 11,693
Costs and expenses . . . . . . . 12,665 11,331 10,218
-------- -------- --------
Gross profit . . . . . . . . . . $ 1,603 $ 1,363 $ 1,475
======== ======== ========
Gross profit percent . . . . . . 11.2% 10.7% 12.6%
28
Revenues in the Energy and Environmental Group increased by
approximately 12% and 9% for the years ended December 31, 2006 and 2005, as
compared to the respective prior years. The increases in revenues for both
years was due primarily to increases in the energy and environmental
consulting services performed as a result of increased emphasis on marketing
efforts.
Gross profit in the Energy and Environmental Group increased by
approximately 18% and decreased by approximately 8% for the years ended
December 31, 2006 and 2005, as compared to the respective prior years. The
increase in gross profit in 2006 was primarily due to the growth in revenues.
The decrease in gross profit in 2005 was primarily due to an increase in lower
margin subcontract pass-through work in place of labor driven revenues.
Discontinued Operations
In July 2004, all business operations associated with the Company's TTD
division ceased. Accordingly, prior period consolidated financial statements
have been restated to reflect the financial results of TTD as discontinued
operations. The revenues, costs and expenses of TTD have been excluded from
the respective captions in the Consolidated Statement of Operations. The loss
from discontinued operations associated with TTD, net of tax, in the years
ended December 31, 2006, 2005, and 2004 was approximately $0, $0 thousand and,
$1 thousand, respectively.
Financial Condition
VSE's financial condition remained strong during 2006. The Company's
largest assets are its accounts receivable and cash and cash equivalents. The
largest liabilities are its accounts payable and accrued expenses. Accounts
receivable increased approximately $23 million, cash and cash equivalents
decreased approximately $4 million, accounts payable increased approximately
$15 million, and accrued expenses increased by approximately $1 million during
2006. These increases and changes to other asset and liability accounts were
due primarily to the increase in the level of business activity, contract
delivery schedules, subcontractor and vendor payments required to perform this
work, and the timing of associated billings to customers and collections.
The increase in total stockholders' equity in 2006 resulted from
earnings and dividend activity and from the exercise of stock options. In June
2006, the Board authorized the Company to repurchase up to 50,000 shares of
VSE Stock from time to time on the open market, subject to corporate
objectives. As of December 31, 2006, the Company had not purchased any of
these shares.
Liquidity and Capital Resources
Cash Flows
The Company's cash and cash equivalents decreased by approximately $4.0
million during 2006. Approximately $1.6 million in net cash was provided by
operating activities, approximately $5.6 million was used in investing
activities, and approximately $15 thousand was provided by financing
activities. The difference between cash provided by operating activities of
approximately $1.6 million in 2006 as compared to cash provided by operating
activities of approximately $15.6 million in 2005 is primarily due to
differences in the levels of accounts receivable, contract inventories,
accounts payable and accrued expenses associated with contract requirements
and the associated billing and collections cycle, and to the Company's
increase in profits. Investing activities consisted of the purchase of
property and equipment. Financing activities consisted of $630 thousand
provided by stock purchase transactions by directors and officers associated
with the exercise of stock options and directors' fees, and $615 thousand used
to pay dividends.
29
The Company's cash and cash equivalents increased by approximately $12.6
million during 2005. Approximately $15.6 million in net cash was provided by
operating activities, approximately $1.6 million was used in investing
activities, and approximately $1.4 million was used in financing activities.
The difference between cash provided by operating activities of approximately
$15.6 million in 2005 as compared to cash used in operating activities of
approximately $8.8 million in 2004 is primarily due to differences in the
levels of accounts receivable, contract inventories, and accounts payable
associated with contract requirements and the associated billing and
collections cycle, and to the Company's increase in profits. Investing
activities consisted of the purchase of property and equipment. Financing
activities consisted of $1.6 million used to repay bank loans, $715 thousand
provided by the issuance of common stock to directors and officers associated
with the exercise of stock options and directors' fees, and $510 thousand used
to pay dividends.
The Company's cash and cash equivalents decreased by approximately $9.7
million during 2004. Approximately $8.8 million in net cash was used in
operating activities, investing activities used approximately $2.6 million,
and financing activities provided approximately $1.7 million. Investing
activities consisted of the purchase of property and equipment. Financing
activities consisted of $1.6 million provided by bank loan proceeds, $518
thousand provided by the issuance of common stock to directors and officers
associated with the exercise of stock options and directors' fees, and $401
thousand used to pay dividends.
Quarterly cash dividends were paid at the rate of $.06 per share during
each of the three months ended March 31 and June 30, 2006, and at the rate of
$.07 per share during the three month periods ended September 30 and December
31, 2006. Pursuant to its bank loan agreement (see Note 8 of "Notes to
Consolidated Financial Statements"), 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.
30
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 acquisition,
expansion, improvement, and maintenance of its operational and administrative
facilities. The growth in the level of equipment refurbishment services
provided by ELD has 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 Note 8 of "Notes to Consolidated Financial Statements"). The
bank financing complements the 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 of December 31, 2006. 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
The following table shows the consolidated contractual obligations for
VSE as of December 31, 2006 (in thousands):
Payments Due by Period
----------------------
Less than 1-3 4-5 After 5
Contractual Obligations Total 1 year years years years
----------------------- ----- ------ ----- ----- -----
Operating leases, net of
non-cancelable sublease
income . . . . . . . . $23,835 $4,212 $7,826 $5,485 $6,312
Purchase obligations . . 1,142 1,142 - - -
------- ------ ------ ------ ------
Total $24,977 $5,354 $7,826 $5,485 $6,312
======= ====== ====== ====== ======
Operating lease commitments are primarily for VSE's principal executive
and administrative offices and leased facilities for office, shop, and
warehouse space located near customer sites or to serve customer needs. The
Company also has some equipment and software leases that are included in these
amounts.
Purchase obligations consist primarily of contractual commitments
associated with construction, improvements and maintenance on VSE facilities,
and for the acquisition of office, shop, and computer equipment. The table
excludes contractual commitments for materials or subcontractor work purchased
to perform U.S. Government contracts. Such commitments for materials and
subcontractors are reimbursable when used on the contracts, and generally are
also reimbursable if a contract is "terminated for convenience" by the U.S.
Government pursuant to federal contracting regulations.
31
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 of computer systems
equipment, furniture and fixtures, leasehold improvements, buildings, land and
land improvements. The overall impact of inflation on replacement costs of
such property and equipment is not expected to be significant.
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, or enter into other loan arrangements, 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 very limited. Accordingly, the Company does not
believe that it is exposed to any material foreign currency risk.
32
ITEM 8. Financial Statements and Supplementary Data
Index To Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm . . . . 34
Consolidated Balance Sheets as of December 31, 2006 and 2005 . . 35
Consolidated Statements of Operations for the years ended
December 31, 2006, 2005, and 2004 . . . . . . . . . . . . 36
Consolidated Statements of Stockholders' Equity
for the years ended December 31, 2006, 2005, and 2004 . . 37
Consolidated Statements of Cash Flows for the years ended
December 31, 2006, 2005, and 2004 . . . . . . . . . . . . 38
Notes to Consolidated Financial Statements . . . . . . . . . . . 39
33
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of VSE Corporation:
We have audited the accompanying consolidated balance sheets of VSE
Corporation and subsidiaries as of December 31, 2006 and 2005, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 2006. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged
to perform an audit of the Company's internal control over financial
reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of VSE Corporation
and subsidiaries at December 31, 2006 and 2005, and the consolidated results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2006, in conformity with U.S. generally accepted
accounting principles.
As disclosed in Note 1 in the notes to consolidated financial statements, the
Company adopted Statement of Financial Accounting Standards Board No. 123(R),
effective January 1, 2006.
/s/ Ernst & Young LLP
McLean, Virginia
February 21, 2007
34
VSE Corporation and Subsidiaries
Consolidated Balance Sheets
--------------------------------------------------------------------------------
(in thousands, except per share amounts)
As of December 31,
2006 2005
---- ----
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . $ 8,745 $12,717
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . . . . . 66,730 43,926
Contract inventories . . . . . . . . . . . . . . . . . . 4,459 4,273
Deferred tax assets . . . . . . . . . . . . . . . . . . 1,196 1,033
Other current assets . . . . . . . . . . . . . . . . . . 2,472 2,205
------- -------
Total current assets . . . . . . . . . . . . . . . . 83,602 64,154
Property and equipment, net . . . . . . . . . . . . . . . 8,409 4,583
Deferred tax assets . . . . . . . . . . . . . . . . . . . 1,133 682
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . . . . . 4,337 3,393
------- -------
Total assets . . . . . . . . . . . . . . . . . . . . $98,535 $73,866
======= =======
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . $44,302 $29,752
Accrued expenses . . . . . . . . . . . . . . . . . . . . 13,486 12,233
Dividends payable . . . . . . . . . . . . . . . . . . . 168 141
------- -------
Total current liabilities . . . . . . . . . . . . . 57,956 42,126
Deferred compensation . . . . . . . . . . . . . . . . . . 2,183 1,589
Other liabilities . . . . . . . . . . . . . . . . . . . . 160 -
------- -------
Total liabilities . . . . . . . . . . . . . . . . . 60,299 43,715
------- -------
Commitments and contingencies
Stockholders' equity:
Common stock, par value $.05 per share, authorized
15,000,000 shares; issued and outstanding 2,394,081
in 2006 and 2,359,611 in 2005 . . . . . . . . . . . . 120 118
Paid-in surplus . . . . . . . . . . . . . . . . . . . . 7,283 6,348
Deferred stock-based compensation . . . . . . . . . . . - (1)
Retained earnings . . . . . . . . . . . . . . . . . . . 30,833 23,686
------- -------
Total stockholders' equity . . . . . . . . . . . . . 38,236 30,151
------- -------
Total liabilities and stockholders' equity . . . . . $98,535 $73,866
======= =======
The accompanying notes are an integral part of these balance sheets.
35
VSE Corporation and Subsidiaries
Consolidated Statements of Operations
--------------------------------------------------------------------------------
(in thousands, except share and per share amounts)
For the years ended December 31,
2006 2005 2004
---- ---- ----
Revenues, principally from contracts . . . . $ 363,734 $ 280,139 $ 216,011
Costs and expenses of contracts . . . . . . 350,978 269,780 209,841
--------- --------- ---------
Gross profit . . . . . . . . . . . . . . . . 12,756 10,359 6,170
Selling, general and administrative expenses 694 580 636
Interest (income) expense, net . . . . . . . (427) (210) (102)
--------- --------- ---------
Income before income taxes . . . . . . . . . 12,489 9,989 5,636
Provision for income taxes . . . . . . . . . 4,700 3,820 2,191
--------- --------- ---------
Income from continuing operations . . . . . 7,789 6,169 3,445
Discontinued operations:
Loss from operations before income taxes . - - (2)
Benefit for income taxes . . . . . . . . . - - (1)
--------- --------- ---------
Loss from discontinued operations . . . . - - (1)
--------- --------- ---------
Net income . . . . . . . . . . . . . . . . . $ 7,789 $ 6,169 $ 3,444
========= ========= =========
Basic earnings per share:
Income from continuing operations $ 3.29 $ 2.66 $ 1.54
Loss from discontinued operations 0.00 0.00 0.00
--------- --------- ---------
Net income . . . . . . . . . . . . . . . . . $ 3.29 $ 2.66 $ 1.54
========= ========= =========
Basic weighted average shares outstanding 2,368,725 2,322,736 2,231,848
========= ========= =========
Diluted earnings per share:
Income from continuing operations $ 3.21 $ 2.58 $ 1.49
Loss from discontinued operations 0.00 0.00 0.00
--------- --------- ---------
Net income . . . . . . . . . . . . . . . . . $ 3.21 $ 2.58 $ 1.49
========= ========= =========
Diluted weighted average shares
outstanding . . . . . . . . . . . . . . . . 2,424,442 2,392,027 2,309,932
========= ========= =========
The accompanying notes are an integral part of these statements.
36
VSE Corporation and Subsidiaries
Consolidated Statements of Stockholders' Equity
-----------------------------------------------------------------------------------------------
(in thousands except per share data)
Deferred Total
Common Stock Paid-In Stock-based Retained Stockholders'
Shares Amount Surplus Compensation Earnings Investment
------ ------ ------- ------------ -------- ----------
Balance at
December 31, 2003 2,214 $ 110 $ 3,928 $ (17) $ 15,037 $19,058
Net income for the year . . - - - - 3,444 3,444
Exercised stock options . . 62 4 505 - - 509
Tax benefit of options
exercised . . . . . . . - - 433 - - 433
Deferred stock-based
compensation . . . . . . - - 4 (4) - -
Amortization of deferred
stock-based compensation. - - - 17 - 17
Issuance of stock . . . . . 1 - 9 - - 9
Dividends declared ($.19) . - - - - (427) (427)
----- ----- ------- ----- -------- -------
Balance at
December 31, 2004 2,277 114 4,879 (4) 18,054 23,043
Net income for the year . . - - - - 6,169 6,169
Exercised stock options . . 79 4 587 - - 591
Tax benefit of options
exercised . . . . . . . - - 761 - - 761
Deferred stock-based
compensation . . . . . . - - (3) - - (3)
Amortization of deferred
stock-based compensation. - - - 3 - 3
Issuance of stock . . . . . 4 - 124 - - 124
Dividends declared ($.23) . - - - - (537) (537)
----- ----- ------- ----- -------- -------
Balance at
December 31, 2005 2,360 118 6,348 (1) 23,686 30,151
Net income for the year . . - - - - 7,789 7,789
Stock-based compensation . 2 - 308 - - 308
Exercised stock options . . 31 2 255 - - 257
Excess tax benefits from
Share-based payment
arrangements. . . . . . . - - 312 - - 312
Deferred stock-based
compensation . . . . . . - - - 1 - 1
Issuance of stock . . . . . 1 - 60 - - 60
Dividends declared ($.27) . - - - - (642) (642)
----- ----- ------- ----- -------- -------
Balance at
December 31, 2006 2,394 $ 120 $ 7,283 $ - $ 30,833 $38,236
===== ===== ======= ===== ======== =======
The accompanying notes are an integral part of these statements.
37
VSE Corporation and Subsidiaries
Consolidated Statements of Cash Flows
------------------------------------------------------------------------------------------------
(in thousands)
For the years ended December 31,
2006 2005 2004
---- ---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,789 $ 6,169 $ 3,444
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . . . 1,882 1,417 1,304
Loss on sale of property and equipment . . . . . . . . . . 9 1 -
Deferred taxes . . . . . . . . . . . . . . . . . . . . . . (614) (326) (273)
Stock-based compensation . . . . . . . . . . . . . . . . . 308 - -
Tax benefit of options exercised . . . . . . . . . . . . . - 761 433
Amortization of deferred stock-based compensation . . . . . - - 17
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable, net . . . . . . . . . . . . . . . . . (22,804) (3,652) (18,439)
Contract inventories . . . . . . . . . . . . . . . . . . . (186) 4,231 (8,504)
Other current assets and noncurrent assets . . . . . . . . (1,310) (932) (801)
Increase (decrease) in:
Accounts payable and deferred compensation. . . . . . . . . 15,144 3,646 12,655
Accrued expenses . . . . . . . . . . . . . . . . . . . . . 1,308 4,256 1,332
Other liabilities . . . . . . . . . . . . . . . . . . . . . 105 55 -
------- ------- -------
Net cash provided by (used in) operating activities 1,631 15,626 (8,832)
------- ------- -------
Cash flows from investing activities:
Purchase of property and equipment. . . . . . . . . . . . . . . (5,618) (1,666) (2,576)
------- ------- -------
Net cash used in investing activities (5,618) (1,666) (2,576)
------- ------- -------
Cash flows from financing activities:
Net proceeds from (repayment of) bank loans . . . . . . . . . . - (1,578) 1,578
Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . (615) (510) (401)
Excess tax benefits from share-based payment arrangements . . . 312 - -
Proceeds from the exercise of options of common stock . . . . . 258 591 508
Proceeds from issuance of common stock . . . . . . . . . . . . 60 124 10
------- ------- -------
Net cash provided by (used in) financing activities 15 (1,373) 1,695
------- ------- -------
Net (decrease) increase in cash and cash equivalents . . . . . . (3,972) 12,587 (9,713)
Cash and cash equivalents at beginning of year . . . . . . . . 12,717 130 9,843
------- ------- -------
Cash and cash equivalents at end of year . . . . . . . . . . . $ 8,745 $12,717 $ 130
======= ======= =======
Supplemental cash flow disclosures (in thousands):
2006 2005 2004
Cash paid during the year for:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ 2 $ -
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,472 $ 3,153 $ 2,292
The accompanying notes are an integral part of these statements.
38
VSE Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
(a) Principles of Consolidation
The consolidated financial statements consist of the operations of the
parent company, operations of the Company's unincorporated divisions and
wholly owned subsidiary. Energetics Incorporated ("Energetics") is currently
VSE's only active subsidiary. Active divisions include BAV Division ("BAV"),
Coast Guard Division ("VCG"), Communications and Engineering Division ("CED"),
Fleet Maintenance Division ("FMD"), Management Sciences Division ("MSD"),
Systems Engineering Division ("SED"), and Engineering and Logistics Division
("ELD") beginning in 2006.
VSE previously conducted business operations in other subsidiaries and
divisions during the past three year period that have been dissolved or became
inactive prior to December 31, 2005. These include Human Resource Systems, Inc.
("HRSI"), dissolved in 2004, Telecommunications Technologies Division ("TTD"),
discontinued operations in 2004 and Information Assurance Division ("IAD",
formerly Value Systems Services Division or "VSS"), inactive as of May 2005.
The term "VSE" or "Company" means VSE and its subsidiaries and divisions
unless the context indicates operations of the parent company only. Intercompany
sales are principally at cost. All intercompany transactions have been
eliminated in consolidation. Certain prior year balances have been reclassified
for comparative purposes.
The Company's business operations consist primarily of diversified
engineering, logistics, management, and technical services performed on a
contract basis. Substantially all of the Company's contracts are with agencies
of the United States Government (the "government") and other federal
government prime contractors. The Company's customers also include non-
government organizations and commercial entities.
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. See Note 15 of the Company's consolidated
financial statements for further discussion.
(b) 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 and accruals for loss contracts, contract disallowance
and self insured health claims, and estimated cost to complete on certain
fixed-price contracts.
(c) 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 ("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 June 27, 2006, the
Company granted 1,800 shares of restricted VSE Stock to the Company's outside
Directors under the 2006 Plan. The fair market value on the grant date was
39
$31.50 per share. The shares issued vested immediately and cannot be sold,
transferred, pledged or assigned before the second anniversary of the grant
date.
Stock Option Plans
On December 30, 2005, VSE's board of directors (the "Board")
discontinued, until and unless the Board determined otherwise, awarding
options, both discretionary and nondiscretionary, to purchase VSE Stock under
VSE's 2004 Stock Option Plan (the "2004 Plan"). The options outstanding under
the 2004 Plan and predecessor 1998 Stock Option Plan (the "1998 Plan") were not
affected by this Board action.
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 as of December 31,
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 year ended December 31, 2006, was approximately $157
thousand lower or approximately $.07 per share basic and $.06 per share
diluted 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 December 31, 2006 is approximately $181
thousand, to be recognized in 2007.
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 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. The Statement of Cash
Flows has approximately $312 thousand in excess tax benefits classified as
cash provided by financing activities for the year ended December 31, 2006.
The amount of operating cash flows recognized for such excess tax deductions
for the years ended December 31, 2005 and 2004 was approximately $761 thousand
and $433 thousand, respectively.
The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions of
SFAS 123 to all stock-based employee compensation (in thousands, except per
share amounts):
40
Year Ended December 31
2005 2004
---- ----
Net income, as reported . . . . . . . . $6,169 $3,444
Add: Total stock-based employee
compensation expense as reported
under intrinsic value method
(APB No. 25) for all awards, net
of related tax effects . . . . . . . . - 9
Deduct: Total stock-based
compensation expense
determined under fair value based
method (SFAS No. 123) for all
awards, net of related tax effects . . (294) (126)
------ ------
Pro forma net income . . . . . . . . . $5,875 $3,327
====== ======
Earnings per share:
Basic - as reported . . . . . . . . . $2.66 $1.54
Diluted - as reported . . . . . . . . $2.58 $1.49
Basic - pro forma . . . . . . . . . . $2.53 $1.49
Diluted - pro forma . . . . . . . . . $2.46 $1.44
The fair value of the options is estimated on the date of grant using
the Black-Scholes option pricing model. The following assumptions were used
in the pricing calculations for 2005, and 2004:
2005 2004
---- ----
Risk free interest rate . . . . . . . . 3.28% 2.47%
Dividend yield . . . . . . . . . . . . 0.79% 1.30%
Expected life . . . . . . . . . . . . . 3 years 3 years
Expected volatility . . . . . . . . . . 60.50% 48.30%
(d) 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.
Years Ended December 31,
2006 2005 2004
---- ---- ----
Basic weighted average
common shares outstanding . . 2,368,725 2,322,736 2,231,848
Dilutive effect of options . . 55,717 69,291 78,084
--------- --------- ---------
Diluted weighted average
common shares outstanding . . 2,424,442 2,392,027 2,309,932
========= ========= =========
(e) Cash and Cash Equivalents
Cash and cash equivalents reported by the Company consist of cash
balances in the Company's bank accounts and short term temporary invested
41
balances netted by checks issued on the Company's bank accounts that have not
yet been presented to the bank for collection. The Company considers 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 value on our consolidated balance sheet approximates fair value.
(f) Contract Inventories
Contract inventories consist of materials purchased and other
expenditures arising from and solely and directly attributable to contract
requirements. The cost of such contract inventories is expected to be billed
to the customer within a relatively short time. These materials and direct
supplies are purchased to satisfy contract requirements and are not restocked
to maintain any permanent contract inventory levels.
Work in process contract 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
contract inventory is stated at cost plus applicable indirect cost burdens,
including general and administrative costs. Pursuant to contract provisions,
agencies of the U.S. Government and certain other customers have title to or a
security interest in inventories related to such contracts as a result of
advances, performance based payments and progress payments. Such advances and
payments are reflected as an offset against the related inventory balances.
(g) Property and Equipment
Property and equipment are stated at cost. Depreciation of computer
systems equipment is provided principally by the double-declining method over
periods of two to four years. Depreciation of furniture and fixtures is
provided principally by the straight-line method over approximately nine
years. Depreciation of other equipment is provided principally by the double-
declining method over periods of three to ten years. Depreciation of buildings
and land improvements is provided principally by the straight-line method over
periods of approximately twenty to thirty 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.
(h) Concentration of Credit Risk/Fair Value of Financial Instruments
Financial instruments that potentially subject the Company to
concentration of credit risk consist primarily of cash, cash equivalents and
trade accounts receivable. The Company believes that concentrations of credit
risk with respect to trade accounts receivable are limited as they are
primarily government receivables. The Company believes that the fair market
value of all financial instruments, including assets of the deferred
compensation plan and debt, approximate book value.
Contracts with the U.S. Government either as a prime or subcontractor,
primarily with the U.S. Department of Defense, accounted for approximately 99%
of revenues for each of the years ending December 31, 2006, 2005, and 2004.
The BAV contract accounted for approximately 29%, 43% and 52% of consolidated
revenues during 2006, 2005 and 2004, respectively. The CED Army Equipment
Support Programs started in 2006 and accounted for approximately 29% of
consolidated revenues during 2006.
(i) Contract Revenues
Substantially all of the Company's revenues result from contract
services performed for the U.S. Government or for contractors engaged in work
for the government under a variety of contracts. Revenue is considered earned
when persuasive evidence of an arrangement exists, services have been
rendered, the price is fixed and determinable and collectibility is reasonably
assured.
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
42
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 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. 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.
Revenue related to work performed on contracts at risk, which is work
performed at the customer's request prior to the government formalizing
funding, is not recognized as income until it can be reliably estimated and
its realization is probable. The Company provides for anticipated losses on
contracts, based on total contract revenue compared to total contract costs,
by a charge to income during the period in which losses are first identified.
Contract costs include direct and indirect costs, including general and
administrative costs, which are considered costs and expenses of contracts.
Certain direct and incremental contract costs have been deferred and
reported as a current asset prior to the recognition of revenue. Such costs
are amortized over the life of the contract.
A substantial portion of contract and administrative costs is subject to
audit by the Defense Contract Audit Agency. The Company's indirect cost rates
have been audited and approved for 2003 and prior years and partially audited
for 2004 with no material adjustments to the Company's results of operations
or financial position. While the Company maintains reserves to cover the risk
of potential future audit adjustments based primarily on the results of prior
audits, there can be no assurances that the audits of the indirect cost rates
for 2006, 2005 and 2004 will not result in material adjustments to the
Company's results of operations or financial position.
The Company establishes allowances for collection of doubtful accounts.
The Company assesses the adequacy of these reserves by considering general
factors, such as the length of time individual receivables are past due and
historical collection experience. The Company believes that the established
valuation allowances are adequate.
(j) Deferred Compensation Plans
Deferred compensation plan expense for the years ended December 31,
2006, 2005, and 2004 was $769 thousand, $421 thousand, and $240 thousand,
respectively.
Included in other assets are assets of the deferred compensation plans
which include debt and equity securities recorded at fair value. The fair
value of the deferred compensation plan assets was approximately $2.2 million
and $1.6 million as of December 31, 2006, and 2005, respectively. Because plan
43
participants are at risk for market value changes in these assets, the
liability to plan participants fluctuates with the asset values.
(k) Impairment of Long-Lived Assets
Long-lived assets include property and equipment to be held and used.
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount should be addressed pursuant
to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," ("SFAS No. 144"). The criteria for determining impairment for such
long-lived assets to be held and used are determined by comparing the carrying
value of these long-lived assets to management's best estimate of future
undiscounted cash flows expected to result from the use of the assets. The
Company believes that no impairment existed under SFAS No. 144 as of
December 31, 2006.
(l) Income Taxes
Income taxes are accounted for under the asset and liability method in
accordance with FASB Statement No. 109, "Accounting for Income Taxes." 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 bases. 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 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 in the future, VSE
may be required to record valuation allowances against its deferred tax
assets, resulting in additional income tax expense. Management believes that
the deferred tax assets will be realized through future taxable income and,
therefore, no valuation allowance is required.
On July 13, 2006, the Financial Accounting Standards Board issued
Interpretation No. (FIN) 48, "Accounting for Uncertainty in Income Taxes,"
which is effective January 1, 2007. The purpose of FIN 48 is to clarify and
set forth consistent rules for accounting for uncertain tax positions in
accordance with SFAS 109, "Accounting for Income Taxes." The cumulative effect
of applying the provisions of this interpretation is required to be reported
separately as an adjustment to the opening balance of retained earnings in the
year of adoption. The Company has begun to review and evaluate FIN 48 and the
impact of its adoption is not expected to be material.
(m) Discontinued Operations
In July 2004, all business operations associated with the Company's TTD
division ceased. Accordingly, prior period consolidated financial statements
have been restated to reflect the financial results of TTD as discontinued
operations. The revenues, costs and expenses of TTD have been excluded from
the respective captions in the Consolidated Statement of Operations. The
revenue from discontinued operations associated with TTD in the year ended
December 31, 2004 was approximately $9 thousand. The loss from discontinued
operations associated with TTD, net of tax, in the year ended December 31,
2004 was approximately $1 thousand. Approximately $6 thousand net current
liabilities comprised primarily of payables, related to TTD, were included in
the December 31, 2005 balance sheet. There were no balances from discontinued
operations included in the December 31, 2006 consolidated balance sheet.
44
(n) Goodwill
SFAS No. 142 does not permit amortization of goodwill, but requires a
review for impairment at least annually, or more frequently if an asset might
be impaired, using a fair-value based approach. See Note 7 of the Company's
consolidated financial statements for further discussion.
(2) Accounts Receivable
The components of accounts receivable as of December 31, 2006 and 2005,
were as follows (in thousands):
2006 2005
---- ----
Billed . . . . . . . . . . . . . . . . . . . . $16,424 $14,218
Unbilled:
Government retainage . . . . . . . . . . . . 28 65
Subcontract retainage . . . . . . . . . . . . 4,000 4,160
Other (principally December work billed in
January) . . . . . . . . . . . . . . . . 46,292 25,539
Less-Allowance for doubtful accounts . . . . . (14) (56)
------- -------
Total accounts receivable, net $66,730 $43,926
======= =======
Unbilled subcontract retainage includes amounts withheld from payments
to subcontractors.
The "Unbilled: Other" includes certain costs for work performed at risk
but which the Company believes will be funded by the government. Amounts not
presently funded included in "Unbilled: Other" were $369 thousand and $21
thousand as of December 31, 2006, and 2005, respectively.
The Company generally expects to collect all accounts receivable other
than retainages within one year.
The following table summarizes activity in the allowance for doubtful
accounts (in thousands):
Additions
Balance at Charged to Balance at
Beginning Costs and End of
Allowance for Doubtful Accounts of Period Deductions(1) Expenses Period
------------------------------- ---------- ------------- ---------- ----------
For the year ended
December 31, 2006 . . . . . . . . $56 $42 $ - $14
For the year ended
December 31, 2005 . . . . . . . . $52 $22 $26 $56
For the year ended
December 31, 2004 . . . . . . . . $77 $35 $10 $52
(1) Write-offs and settlements
45
(3) Other Current Assets
Other current assets consisted of the following as of December 31, 2006
and 2005 (in thousands):
2006 2005
---- ----
Prepaid rent . . . . . . . . . . . . . . . . . . . . $ 639 $ 345
Subcontract receivables . . . . . . . . . . . . . . 223 -
Prepaid materials . . . . . . . . . . . . . . . . . 167 392
Deferred contract costs . . . . . . . . . . . . . . 164 106
Travel advances . . . . . . . . . . . . . . . . . . 133 299
Prepaid software license . . . . . . . . . . . . . . 124 164
Acquired software . . . . . . . . . . . . . . . . . 114 -
Federal and state tax receivable . . . . . . . . . . - 171
Other . . . . . . . . . . . . . . . . . . . . . . . 908 728
------ ------
Total other current assets $2,472 $2,205
====== ======
(4) Contract Inventories
The components of contract inventories as of December 31, 2006 and 2005
were as follows (in thousands):
2006 2005
---- ----
Work in process . . . . . . . . . . . . . . . . . . $4,459 $9,965
Less: Progress payments and customer
advances received . . . . . . . . . . . . . . . . - (5,692)
------ ------
Total contract inventories $4,459 $4,273
====== ======
Inventories at December 31, 2006 and 2005 consisted 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. This contract was awarded to VSE in
November 2004.
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
December 31, 2006 and 2005 included applicable indirect cost burdens,
including general and administrative costs totaling approximately $608
thousand and $1.3 million thousand, respectively. Indirect cost burdens,
including general and administrative costs charged to cost of sales from
inventories for the years ended December 31, 2006 and 2005 totaled $3.9
million and $3.4 million, respectively.
(5) Other Assets
Other assets consisted of the following as of December 31, 2006 and 2005
(in thousands):
2006 2005
---- ----
Cash surrender value of life insurance . . . . . . $ 1,516 $ 1,432
Deferred compensation. . . . . . . . . . . . . . . 2,183 1,589
Other assets . . . . . . . . . . . . . . . . . . . 638 372
------- -------
Total other assets $ 4,337 $ 3,393
======= =======
46
(6) Property and Equipment
Property and equipment (recorded at cost) consisted of the following as
of December 31, 2006 and 2005(in thousands):
2006 2005
---- ----
Computer systems equipment . . . . . . . . . . . . . $ 6,064 $ 4,591
Furniture, fixtures, equipment and other . . . . . . 4,945 3,168
Leasehold improvements . . . . . . . . . . . . . . . 3,256 2,799
Buildings and building improvements. . . . . . . . . 2,327 1,259
Land and land improvements . . . . . . . . . . . . . 1,175 385
------- -------
17,767 12,202
Less accumulated depreciation and amortization . . . (9,358) (7,619)
------- -------
Total property and equipment $ 8,409 $ 4,583
======= =======
Depreciation and amortization expense for property and equipment was
approximately $1.8 million for 2006, $1.4 million for 2005 and $1.3 million
for 2004.
(7) Goodwill and Intangible Assets
As part of the August 29, 1995, acquisition of Energetics, the Company
recorded approximately $1.7 million of goodwill. Between 1995 and 2001, VSE
amortized the goodwill by the straight-line method using a fifteen year life.
In accordance with SFAS No. 142, VSE stopped amortizing the goodwill in
January 2002, but continues to review it at least annually, or more
frequently, if this asset might be impaired, to determine if impairment has
occurred. Approximately $1.1 million of unamortized goodwill remains on the
books as of December 31, 2006.
(8) 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 December 31, 2006 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 December
31, 2006, there were no revolving loan amounts outstanding and no letters of
credit. As of December 31, 2005, there were no revolving loan amounts
outstanding and one letter of credit for approximately $192 thousand. Interest
expense incurred for revolving loan amounts borrowed was $0 for 2006 and 2005
and approximately $1 thousand for 2004.
47
(9) Accrued Expenses
The components of accrued expenses as of December 31, 2006 and 2005,
were as follows (in thousands):
2006 2005
---- ----
Accrued bonus . . . . . . . . . . . . . . . . . . $ 4,386 $ 4,040
Accrued vacation . . . . . . . . . . . . . . . . 2,234 1,951
Accrued salaries . . . . . . . . . . . . . . . . 2,040 1,745
Billed amounts in excess of revenue recognition . 1,570 1,618
Accrued deferred compensation . . . . . . . . . . 768 419
Accrued insurance . . . . . . . . . . . . . . . . 488 593
Accrued pension and 401(k) contributions . . . . 453 446
Estimated contract disallowances . . . . . . . . 397 499
Accrued federal and state taxes . . . . . . . . . 378 -
Estimated future losses on contracts . . . . . . - 320
Other accrued expenses . . . . . . . . . . . . . 772 602
------- -------
Total accrued expenses $13,486 $12,233
======= =======
(10) ESOP/401(k) Plan and Profit Sharing Plan
VSE has an ESOP/401(k) plan that allows employees meeting certain age
and service requirements to contribute a portion of their salary to certain
investment trusts. Under the terms of the plan, employer 401(k) contributions
are made on behalf of the eligible employee participants based on the
employees' 401(k) payroll deferrals. The employer contribution is equal to 50%
of the employee deferral on the first 6% of the employee pay deferred. The
Company expense associated with this plan for 2006, 2005, and 2004 was $584
thousand, $578 thousand, and $415 thousand, respectively.
Prior to April 1, 1999, the Company made contributions under this plan
into an ESOP trust which purchased VSE stock on behalf of employees who met
certain age and service requirements and were employed at the end of the plan
year. Subsequent to April 1, 1999, the ESOP contributions were discontinued
and replaced by employer 401(k) contributions. The ESOP/401(k) plan held
238,867 shares and 262,913 shares of VSE stock as of December 31, 2006 and
2005, respectively. Such shares receive dividend payments and are included in
the weighted average shares for earnings per share calculations.
Energetics maintains a profit sharing plan for employees. All employees
who have completed two years of service are members of the profit sharing
plan. At its discretion, Energetics may make contributions to the plan. The
plan expense for 2006, 2005, and 2004 was $412 thousand, $420 thousand, and
$443 thousand, respectively.
(11) Stock Option Plans
On December 30, 2005, the board of directors of VSE Corporation (the
"Board") directed VSE to discontinue, until and unless the Board determined
otherwise, awarding options, both discretionary and nondiscretionary, to
purchase VSE common stock ("VSE Stock") under VSE's 2004 Stock Option Plan
approved by VSE' stockholders on May 3, 2005 (the "2004 Plan"). The options
outstanding under the 2004 Plan, as of December 30, 2006, were not affected by
this Board action. In addition, the options to purchase shares of VSE Stock
under VSE's 1998 Stock Option Plan (the "1998 Plan") were 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.
48
(a) 2004 Stock Option Plan
As of December 31, 2006, options issued under the 2004 Plan for up to
66,750 shares of VSE Common Stock, par value $.05 per share ("shares" or "VSE
Stock") 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.
(b) 1998 Stock Option Plan
As of December 31, 2006, options issued under the 1998 Plan for up to
99,875 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.
Information with respect to stock options is as follows:
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
2006 Price 2005 Price 2004 Price
---- ----- ---- ----- ---- -----
Number of shares under
stock options:
Outstanding at beginning
of year . . . . . . . . 197,563 $15.83 211,625 $ 9.51 212,250 $ 8.07
Granted . . . . . . . . - - 70,000 25.17 65,500 12.82
Exercised . . . . . . . (30,938) 8.31 (79,312) 7.45 (62,125) 8.19
Forfeited . . . . . . . - - (4,750) - - -
Terminations . . . . . . - - - - (4,000) 8.03
------- ------ ------- ------ ------- ------
Outstanding at end
of year 166,625 $17.22 197,563 $15.83 211,625 $ 9.51
======= ====== ======= ====== ======= ======
Exercisable at end
of year 149,125 $16.29 146,438 $13.93 161,938 $ 8.70
======= ====== ======= ====== ======= ======
Weighted average remaining
contractual life 2 years 3 years 2 years
Weighted average fair
value of options granted $ - $4.70 $2.76
===== ===== =====
The total intrinsic value of options exercised during 2006, 2005 and
2004 was approximately $827 thousand, $2.0 million and $317 thousand,
respectively. The aggregate intrinsic value of options outstanding as of
December 31, 2006, 2005 and 2004 was approximately $2.8 million, $5.2 million
and $3.3 million, respectively. At December 31, 2006, there was approximately
$181 thousand of unrecognized compensation cost related to nonvested stock
options which the Company expects to recognize in 2007.
The following table summarizes the range of exercise prices for options
outstanding at December 31, 2006:
Outstanding Options
-------------------
Exercisable Options
Weighted -------------------
Average Weighted Weighted
Contractual Average Average
Number of Life Exercise Number of Exercise
Range of Exercise Prices Shares (in years) Price Shares Price
------------------------ ------ ---------- ----- ------ -----
$10.73 . . . . . . . . . 43,250 1 $10.73 43,250 $10.73
$12.82 . . . . . . . . . 56,625 2 12.82 56,625 12.82
$25.17 . . . . . . . . . 66,750 3 25.17 49,250 25.17
------- - ------ ------- ------
Total 166,625 2 $17.24 149,125 $16.29
======= = ====== ======= ======
49
(12) Restricted Stock Plan
The Company has adopted a restricted stock plan for its directors,
officers and other employees. Under the provisions of the plan, the Company
is authorized to issue 125,000 shares of VSE common stock. The Compensation
Committee is responsible for the administration of the 2006 Plan. The shares
issued under the 2006 Plan may, at the Company's option, be either shares held
in treasury or shares originally issued. The Compensation Committee shall
determine each recipient of an award under the 2006 Plan, the number of
restricted shares of common stock subject to such award and the period of
continued employment required for the vesting of such award. These terms will
be included in an award agreement between the Company and the recipient of the
award. As of December 31, 2006, 123,200 restricted shares were available for
grant under this plan.
On June 27, 2006, the Company granted 1,800 shares of restricted VSE
Stock to the Company's outside Directors under the 2006 Plan. The fair market
value on the grant date was $31.50 per share. The shares issued vested
immediately and cannot be sold, transferred, pledged or assigned before the
second anniversary of the grant date. Compensation expense related to the
restricted stock grants was approximately $57 thousand for the year ended
December 31, 2006.
(13) Income Taxes
The Company files consolidated federal income tax returns with all of
its subsidiaries. The components of the provision for income taxes from
continuing operations for the years ended December 31, 2006, 2005, and 2004
are as follows (in thousands):
2006 2005 2004
---- ---- ----
Current
Federal . . . . . . . . . . . . . . . . . . $4,521 $3,475 $1,989
State . . . . . . . . . . . . . . . . . . . 793 671 475
------ ------ ------
5,314 4,146 2,464
Deferred
Federal . . . . . . . . . . . . . . . . . . (546) (288) (202)
State . . . . . . . . . . . . . . . . . . (68) (38) (71)
------ ------ ------
(614) (326) (273)
------ ------ ------
Provision for income taxes $4,700 $3,820 $2,191
====== ====== ======
The benefit for income taxes from discontinued operations for the years
ended December 31, 2006, 2005 and 2004 are as follows (in thousands):
2006 2005 2004
---- ---- ----
Current . . . . . . . . . . . . . . . . . . . $ - $ - $ (1)
Deferred . . . . . . . . . . . . . . . . . . . - - -
------ ------ ------
Total income tax benefit $ - $ - $ (1)
====== ====== ======
The differences between the amount of tax computed at the federal
statutory rate of 34% and the provision for income taxes for 2006, 2005, and
2004 are as follows (in thousands):
2006 2005 2004
---- ---- ----
Tax at statutory federal income
tax rate at 34% . . . . . . . . . . . . . . $4,246 $3,396 $1,916
Increases (decreases) in tax resulting from:
State taxes, net of federal tax benefit . . 479 417 266
Permanent differences, net . . . . . . . . 15 6 9
Other, net . . . . . . . . . . . . . . . . (40) 1 -
------ ------ ------
Provision for income taxes $4,700 $3,820 $2,191
====== ====== ======
50
The Company's deferred tax assets (liabilities) as of December 31, 2006
and 2005 which represent the tax effects of temporary differences between tax
and financial accounting bases of assets and liabilities and are measured
using presently enacted tax rates, are as follows (in thousands):
2006 2005
---- ----
Current deferred tax assets . . . . . . . . . . $1,357 $1,247
Current deferred tax liabilities . . . . . . . . (161) (214)
------ ------
Net current deferred tax assets 1,196 1,033
------ ------
Noncurrent deferred tax assets . . . . . . . . . 1,974 1,480
Noncurrent deferred tax liabilities . . . . . . . (841) (798)
------ ------
Net noncurrent deferred tax assets 1,133 682
------ ------
Net deferred tax assets $2,329 $1,715
====== ======
The tax effect of temporary differences representing deferred tax assets
and liabilities as of December 31, 2006 and 2005, are as follows (in
thousands):
2006 2005
---- ----
Deferred compensation and accrued paid leave . . $2,008 $1,558
Accrued expenses . . . . . . . . . . . . . . . . 219 101
Accelerated depreciation . . . . . . . . . . . . 164 65
Reserve for contract and other disallowances . . 153 198
Stock option expense . . . . . . . . . . . . . . 96 -
Retainages not taxed until billed . . . . . . . 15 (7)
Reserve for doubtful accounts . . . . . . . . . . 5 16
Reserve for future losses . . . . . . . . . . . . - 126
Deferred revenues . . . . . . . . . . . . . . . . (141) (180)
Intangible assets . . . . . . . . . . . . . . . . (230) (185)
Other . . . . . . . . . . . . . . . . . . . . . . 40 23
------ ------
Net deferred tax assets $2,329 $1,715
====== ======
(14) Commitments and Contingencies
(a) Leases and other commitments
The Company and its subsidiaries have various non-cancelable operating
leases for facilities, equipment, and software with terms between two and ten
years. Rent expense is recognized on a straight-line basis for rent agreements
having escalating rent. Payments on these leases for 2006, 2005, and 2004
were:
(in thousands)
------------------------------------------
Payments Sublease Net
on Leases Income Expense
--------- ------ -------
2006 . . . . . . . . . . . $4,128 $ 930 $3,198
2005 . . . . . . . . . . . 3,733 922 2,811
2004 . . . . . . . . . . . 3,692 566 3,126
Future minimum annual non-cancelable commitments as of December 31, 2006
are as follows:
(in thousands)
------------------------------------------
Payments Sublease Net
on Leases Income Expense
--------- ------ -------
2007 . . . . . . . . . . . $ 5,106 $ 894 $ 4,212
2008 . . . . . . . . . . . 4,642 363 4,279
2009 . . . . . . . . . . . 3,642 95 3,547
2010 . . . . . . . . . . . 3,009 - 3,009
2011 . . . . . . . . . . . 2,476 - 2,476
Thereafter . . . . . . . . 6,312 - 6,312
------- ------ -------
Total $25,187 $1,352 $23,835
======= ====== =======
51
(b) Contingencies
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.
(15) Business Segment and Customer Information
Segment Information
During the fourth quarter of 2006, management changed the method in
which operating segments are aggregated for reporting. All prior periods have
been adjusted to conform to the current reporting structure.
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.
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 accounting policies of each segment are
the same as the policies described in Note 1: Summary of Significant
Accounting Policies. The Company's segment information is as follows (in
thousands):
2006 2005 2004
---- ---- ----
Revenues from continuing operations:
Federal Group $190,956 $ 81,628 $ 42,318
International Group 158,452 185,784 161,988
Energy and Environmental Group 14,269 12,693 11,693
Corporate 57 34 12
-------- -------- --------
Total revenues $363,734 $280,139 $216,011
======== ======== ========
Income from continuing operations before
income taxes:
Federal Group $ 5,432 $ 5,118 $ 1,867
International Group 5,487 3,700 2,730
Energy and Environmental Group 1,795 1,353 1,407
Corporate/unallocated expenses (225) (182) (368)
-------- -------- --------
Income from continuing operations
before income taxes $ 12,489 $ 9,989 $ 5,636
======== ======== ========
52
(15) Business Segment and Customer Information (continued)
2006 2005 2004
---- ---- ----
Interest (income) expense:
Federal Group $ 423 $ 266 $ 29
International Group (258) (30) 30
Energy and Environmental Group (218) (115) (58)
Corporate (374) (330) (103)
-------- -------- --------
Total interest (income) expense $ (427) $ (210) $ (102)
======== ======== ========
Total assets:
Federal Group $ 40,670 $ 15,649 $ 15,279
International Group 33,541 33,373 35,442
Energy and Environmental Group 4,174 3,087 2,491
Corporate 20,150 21,757 7,140
-------- -------- --------
Total assets $ 98,535 $ 73,867 $ 60,352
======== ======== ========
Depreciation and amortization expense:
Federal Group $ 1,044 $ 487 $ 302
International Group 655 764 823
Energy and Environmental Group 183 166 179
-------- -------- --------
Total depreciation and amortization $ 1,882 $ 1,417 $ 1,304
======== ======== ========
Capital expenditures:
Federal Group $ 2,258 $ 773 $ 895
International Group 519 336 291
Energy and Environmental Group 99 72 100
Corporate 2,742 485 1,290
-------- -------- --------
Total capital expenditures $ 5,618 $ 1,666 $ 2,576
======== ======== ========
Revenues are net of inter-segment eliminations. Corporate/unallocated
expenses are primarily selling, general and administrative expenses not
allocated to segments. Corporate assets are primarily cash and fixed assets.
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):
2006 2005 2004
Source of Revenue Revenues % Revenues % Revenues %
----------------- -------- - -------- - -------- -
Army/Army Reserve $174,473 48.0 $ 56,019 20.0 $ 27,384 12.7
Navy 164,788 45.3 196,363 70.1 157,433 72.9
Other 24,473 6.7 27,757 9.9 31,194 14.4
-------- ----- -------- ----- -------- -----
Total Revenues $363,734 100.0 $280,139 100.0 $216,011 100.0
======== ===== ======== ===== ======== =====
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.
53
(16) Selected Quarterly Data (Unaudited)
The following table shows selected quarterly data for 2006 and 2005, in
thousands, except earnings per share:
2006 Quarters
-------------
1st 2nd 3rd 4th
--- --- --- ---
Revenues . . . . . . . . . . . . . . . . $63,300 $94,844 $103,630 $101,960
======= ======= ======== ========
Gross profit . . . . . . . . . . . . . . $ 2,388 $ 3,490 3,173 $ 3,705
======= ======= ======== ========
Income from continuing operations . . . $ 1,485 $ 2,027 $ 1,889 $ 2,388
Loss from discontinued operations . . . - - - -
------- ------- -------- --------
Net income . . . . . . . . . . . . . . . $ 1,485 $ 2,027 $ 1,889 $ 2,388
======= ======= ======== ========
Basic earnings per share:
Income from continuing operations . . . $ .63 $ .86 $ .80 $ 1.01
Loss from discontinued operations . . . - - - -
------- ------- -------- --------
Net income per share . . . . . . . . . . $ .63 $ .86 $ .80 $ 1.01
======= ======= ======== ========
Weighted average shares outstanding . . 2,361 2,367 2,371 2,376
======= ======= ======== ========
Diluted earnings per share:
Income from continuing operations . . . $ .61 $ .84 $ .78 $ .99
Loss from discontinued operations . . . - - - -
------- ------- -------- --------
Net income per share . . . . . . . . . . $ .61 $ .84 $ .78 $ .99
======= ======= ======== ========
Weighted average shares outstanding . . 2,433 2,420 2,421 2,423
======= ======= ======== ========
2005 Quarters
-------------
1st 2nd 3rd 4th
--- --- --- ---
Revenues . . . . . . . . . . . . . . . . $65,919 $72,682 $ 76,600 $ 64,938
Gross profit . . . . . . . . . . . . . . $ 2,164 $ 2,966 $ 2,717 $ 2,512
Income from continuing operations . . . $ 1,304 $ 1,765 $ 1,587 $ 1,513
Loss from discontinued operations . . . - - - -
------- ------- -------- --------
Net income . . . . . . . . . . . . . . . $ 1,304 $ 1,765 $ 1,587 $ 1,513
======= ======= ======== ========
Basic earnings per share:
Income from continuing operations . . . $ .57 $ .76 $ .68 $ .64
Loss from discontinued operations . . . - - - -
------- ------- -------- --------
Net income per share . . . . . . . . . . $ .57 $ .76 $ .68 $ .64
======= ======= ======== ========
Weighted average shares outstanding . . 2,279 2,311 2,348 2,351
======= ======= ======== ========
Diluted earnings per share:
Income from continuing operations . . . $ .55 $ .74 $ .66 $ .63
Loss from discontinued operations . . . - - - -
------- ------- -------- --------
Net income per share . . . . . . . . . . $ .55 $ .74 $ .66 $ .63
======= ======= ======== ========
Weighted average shares outstanding . . 2,354 2,377 2,417 2,419
======= ======= ======== ========
54
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
ITEM 9A. Controls and Procedures
As of the end of the period covered by this report, based on our
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 forms.
There was no change in our internal control over financial reporting
during our fourth quarter of fiscal 2006 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
ITEM 9B. Other Information
None.
PART III
Except as otherwise indicated below, the information required by Items
10, 11, 12, 13 and 14 of Part III of Form 10-K has been omitted in reliance of
General Instruction G(3) to Form 10-K and is incorporated herein by reference
to the Company's definitive proxy statement relating to its Annual Meeting of
Stockholders scheduled for May 1, 2007 (the "Proxy Statement") to be filed
with the SEC.
ITEM 10. Directors and Executive Officers of the Registrant
The information required by this Item is incorporated by reference to
the Proxy Statement.
ITEM 11. Executive Compensation
The information required by this Item is incorporated by reference to
the Proxy Statement except for the text thereof under the captions
"Compensation Committee Report" and "Performance Graph."
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management
Except for the "Equity Compensation Plan Information" disclosed in Item
5(d) above, the information required by this Item is incorporated by reference
to the Proxy Statement.
ITEM 13. Certain Relationships and Related Transactions
The information required by this Item is incorporated by reference to
the Proxy Statement.
55
ITEM 14. Principal Accountant Fees and Services
The information required by this Item is incorporated by reference to
the Proxy Statement.
PART IV
ITEM 15. Exhibits, Financial Statement and Schedules
1. Financial Statements
The consolidated financial statements are listed under Item 8 of
this report.
2. Supplemental Financial Statement Schedules
Schedules not included herein have been omitted because of
the absence of conditions under which they are required or because the
required information, where material, is shown in the consolidated financial
statements, notes to the consolidated financial statements, or supplementary
financial information.
3. Exhibits
See "Exhibit Index" hereinafter contained and incorporated by
reference.
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: March 2, 2007 By: /S/ D. M. Ervine
---------------------------
D. M. Ervine
Chairman, President,
Chief Executive Officer 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 the Registrant
and in the capacities and on the dates indicated.
Name Title Date
-------------------------------------------------------------------------------
/s/ Donald M. Ervine Chairman, President, March 2, 2007
---------------------------- Chief Executive Officer,
Donald M. Ervine Chief Operating Officer
/s/ Craig S. Weber Executive Vice President, March 2, 2007
---------------------------- Chief Administrative
Craig S. Weber Officer, Secretary
/s/ Thomas R. Loftus Executive Vice President and March 2, 2007
---------------------------- Chief Financial Officer
Thomas R. Loftus (Principal Financial and
Accounting Officer)
/s/ Clifford M. Kendall Director March 2, 2007
----------------------------
Clifford M. Kendall
/s/ Calvin S. Koonce Director March 2, 2007
----------------------------
Calvin S. Koonce
/s/ James F. Lafond Director March 2, 2007
----------------------------
James F. Lafond
/s/ David M. Osnos Director March 2, 2007
----------------------------
David M. Osnos
/s/ Jimmy D. Ross Director March 2, 2007
----------------------------
Jimmy D. Ross
/s/ Bonnie K. Wachtel Director March 2, 2007
----------------------------
Bonnie K. Wachtel
57
EXHIBIT INDEX
Reference No. Exhibit No.
per Item 601 of in this
Regulation S-K Description of Exhibit Form 10-K
-------------- ---------------------- ---------
3 Articles of incorporation and by-laws
Restated Certificate of Incorporation of VSE
Corporation dated as of February 6, 1996 *
By-Laws of VSE Corporation as amended through
November 1, 2005 *
4 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) *
9 Voting trust agreement Not Applicable
10 Material contracts
Employment Agreement entered into as of December 10,
1997, by and between VSE Corporation and
Craig S. Weber (Exhibit VIII to form 10-K dated
March 7, 2001) *
Employment Agreement entered into as of October 21,
1998, by and between VSE Corporation and
Donald M. Ervine (Exhibit VI to Form 10-K dated
March 18, 1999) *
Employment Agreement entered into as of June 3,
1999, by and between VSE Corporation and
James M. Knowlton (Exhibit V to Form 10-K dated
March 15, 2000) *
Employment Agreement dated as of March 10, 2004,
By and between VSE Corporation and Thomas G. Dacus
(Exhibit 10.1 to form 10-Q dated April 28, 2004) *
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) *
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 1998 Stock Option Plan (Appendix A to
Registrant's definitive proxy statement for the Annual
Meeting of Stockholders held on May 6, 1998) *
VSE Corporation 1998 Non-employee Directors Stock Plan
(Appendix B to Registrant's definitive proxy statement
for the Annual Meeting of Stockholders held on May 6, 1998) *
VSE Corporation 2004 Stock Option Plan (Appendix B to
Registrant's definitive proxy statement for the Annual
Meeting of Stockholders held on May 3, 2004) *
VSE Corporation 2004 Non-employee Directors Stock Plan
(Appendix C to Registrant's definitive proxy statement
for the Annual Meeting of Stockholders held on
May 3, 2004) *
13 Annual report to security holders, Form 10-Q
or selected quarterly data Exhibit 13
16 Letter re change in certifying accountant Not Applicable
18 Letter re change in accounting principles Not Applicable
21 Subsidiaries of the Registrant Exhibit 21
12 Statements re computation of ratios Not Applicable
22 Published report regarding matters submitted
to vote of security holders Not Applicable
23.1 Consent of independent registered public accounting
firm Exhibit 23.1
58
EXHIBIT INDEX
Reference No. Exhibit No.
per Item 601 of in this
Regulation S-K Description of Exhibit Form 10-K
-------------- ---------------------- ---------
24 Power of attorney Not Applicable
31.1 Section 302 CEO Certification Exhibit 31.1
31.2 Section 302 CFO and PAO Certification Exhibit 31.2
32.1 Section 906 CEO Certification Exhibit 32.1
32.2 Section 906 CFO and PAO Certification Exhibit 32.2
99 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 *
*Document has been filed as indicated and is incorporated by reference herein.
59