SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 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: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.05 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing require-
ments for the past 90 days. Yes [x] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [x]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
Number of shares of Common Stock outstanding as of August 1, 2006: 2,371,099.
VSE Corporation and Subsidiaries
________________________________________________________________________________
Forward Looking Statements
This filing contains statements which, to the extent they are not recitations of
historical fact, constitute "forward looking statements" under federal
securities laws. All such statements are intended to be subject to the safe
harbor protection provided by applicable securities laws. For discussions
identifying some important factors that could cause actual VSE Corporation
("VSE" or the "Company") results to differ materially from those anticipated in
the forward looking statements contained in this filing, see VSE's discussions
captioned "Business," "Risk Factors"," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Notes to Consolidated
Financial Statements" contained in VSE's Annual Report on Form 10-K for the
fiscal year ended December 31, 2005 filed with the Securities and Exchange
Commission (the "SEC"), together with the Annual Report on Form 10-K/A filed
with the SEC on March 31, 2006 (collectively, "Form 10-K").
Readers are cautioned not to place undue reliance on these forward looking
statements, which reflect management's analysis only as of the date hereof.
The Company undertakes no obligation to publicly revise these forward looking
statements to reflect events or circumstances that arise after the date hereof.
Readers should carefully review the risk factors described in other documents
the Company files from time to time with the SEC, including this and other
Quarterly Reports on Form 10-Q to be filed by the Company subsequent to its
Annual Report on Form 10-K and any Current Reports on Form 8-K filed by the
Company.
-2-
PART I. Financial Information
Item 1. Financial Statements
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Balance Sheets
-------------------------------------------------------------------------------
(in thousands except share and per share amounts)
June 30, December 31,
2006 2005
-------- --------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . . $ 5,076 $ 12,717
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . . 54,725 43,926
Contract inventories . . . . . . . . . . . . . . . 8,652 4,273
Deferred tax assets . . . . . . . . . . . . . . . 1,343 1,033
Other current assets . . . . . . . . . . . . . . . 3,098 2,205
-------- --------
Total current assets . . . . . . . . . . . . . . 72,894 64,154
Property and equipment, net . . . . . . . . . . . . 5,492 4,583
Deferred tax assets . . . . . . . . . . . . . . . . 931 682
Goodwill . . . . . . . . . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . . 3,903 3,393
-------- --------
Total assets . . . . . . . . . . . . . . . . . . $ 84,274 $ 73,866
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . $ 37,685 $ 29,752
Accrued expenses . . . . . . . . . . . . . . . . 10,562 12,178
Dividends payable . . . . . . . . . . . . . . . . 166 141
-------- --------
Total current liabilities . . . . . . . . . . . 48,413 42,071
Deferred compensation . . . . . . . . . . . . . . . 2,026 1,589
Other liabilities . . . . . . . . . . . . . . . . . 88 55
-------- --------
Total liabilities . . . . . . . . . . . . . . . 50,527 43,715
-------- --------
Commitments and contingencies
Stockholders' equity:
Common stock, par value $.05 per share, authorized
15,000,000 shares; issued and outstanding 2,371,099
in 2006 and 2,359,611 shares in 2005 . . . . . . 119 118
Paid-in capital . . . . . . . . . . . . . . . . . 6,738 6,348
Deferred stock-based compensation . . . . . . . . - (1)
Retained earnings . . . . . . . . . . . . . . . . 26,890 23,686
-------- --------
Total stockholders' equity . . . . . . . . . . . 33,747 30,151
-------- --------
Total liabilities and stockholders' equity . . . $ 84,274 $ 73,866
======== ========
The accompanying notes are an integral part of these balance sheets.
-3-
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Income (Unaudited)
------------------------------------------------------------------------------------
(in thousands except share and per share amounts)
For the three months For the six months
ended June 30, ended June 30,
2006 2005 2006 2005
--------- --------- --------- ---------
Revenues . . . . . . . . . . $ 94,844 $ 72,682 $ 158,144 $ 138,601
Costs and expenses of
contracts . . . . . . . . . 91,354 69,716 152,266 133,471
--------- --------- --------- ---------
Gross profit. . . . . . . . . 3,490 2,966 5,878 5,130
Selling, general and
administrative expenses . . 295 111 418 167
Interest income, net. . . . . (83) (22) (220) (41)
--------- --------- --------- ---------
Income before income taxes. . 3,278 2,877 5,680 5,004
Provision for income taxes. . 1,251 1,112 2,168 1,935
--------- --------- --------- ---------
Net income. . . . . . . . . . $ 2,027 $ 1,765 $ 3,512 $ 3,069
========= ========= ========= =========
Basic earnings per share:
Net income . . . . . . . . . $ 0.86 $ 0.76 $ 1.49 $ 1.34
========= ========= ========= =========
Basic weighted average shares
outstanding 2,366,712 2,310,864 2,364,001 2,295,182
========= ========= ========= =========
Diluted earnings per share:
Net income. . . . . . . . . . $ 0.84 $ 0.74 $ 1.45 $ 1.30
========= ========= ========= =========
Diluted weighted average
shares outstanding 2,420,224 2,377,254 2,426,734 2,365,668
========= ========= ========= =========
Dividends declared per share $ 0.07 $ 0.06 $ 0.13 $ 0.11
========= ========= ========= =========
The accompanying notes are an integral part of these financial statements.
-4-
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Stockholders' Equity (Unaudited)
--------------------------------------------------------------------------------------------
(in thousands except per share data)
Deferred Total
Common Stock Paid-In Stock-Based Retained Stockholders'
Shares Amount Capital Compensation Earnings Equity
------ ------ ------- ------------ -------- ------
Balance at
December 31, 2005 . . . . . 2,360 $ 118 $ 6,348 $ (1) $ 23,686 $ 30,151
Net income for the period . . - - - - 3,512 3,512
Stock-based compensation . . 2 - 182 - - 182
Exercised stock options . . . 9 1 116 - - 117
Excess tax benefits from
share-based payment
arrangements. . . . . . . . - - 92 - - 92
Deferred stock-based
compensation . . . . . . . - - - 1 - 1
Dividends declared ($.13) . . - - - - (308) (308)
----- ----- ------- ----- -------- --------
Balance at
June 30, 2006 . . . . . . . 2,371 $ 119 $ 6,738 $ - $ 26,890 $ 33,747
===== ===== ======= ===== ======== ========
The accompanying notes are an integral part of these financial statements.
-5-
VSE Corporation and Subsidiaries
Consolidated Financial Statements (Unaudited)
Consolidated Statements of Cash Flows
------------------------------------------------------------------------------
(in thousands)
For the six months
ended June 30,
2006 2005
------- -------
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . $ 3,512 $ 3,069
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . 791 660
Loss on sale of property and equipment . . . . . . . 8 2
Deferred taxes . . . . . . . . . . . . . . . . . . . (559) (205)
Stock-based compensation . . . . . . . . . . . . . . 182 -
Tax benefit of options exercised . . . . . . . . . . - 662
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable, net. . . . . . . . . . . . . . . (10,799) (2,185)
Contract inventories . . . . . . . . . . . . . . . . (4,379) 3,135
Other current assets and noncurrent assets . . . . . (1,453) (1,115)
Increase (decrease) in:
Accounts payable and deferred compensation . . . . . 8,370 (1,960)
Accrued expenses . . . . . . . . . . . . . . . . . . (1,616) 5,039
Other liabilities . . . . . . . . . . . . . . . . . . 33 28
------- -------
Net cash (used in) provided by operating activities (5,910) 7,130
------- -------
Cash flows from investing activities:
Purchase of property and equipment . . . . . . . . . . . (1,658) (805)
------- -------
Net cash used in investing activities (1,658) (805)
------- -------
Cash flows from financing activities:
Net repayment of bank loans . . . . . . . . . . . . . . - (1,578)
Dividends paid . . . . . . . . . . . . . . . . . . . . . (283) (228)
Excess tax benefits from share-based
payment arrangements . . . . . . . . . . . . . . . . . 92 -
Proceeds from the exercise of options of common stock . 118 533
------- -------
Net cash used in financing activities (73) (1,273)
------- -------
Net (decrease) increase in cash and cash equivalents . . . (7,641) 5,052
Cash and cash equivalents at beginning of period . . . . 12,717 130
------- -------
Cash and cash equivalents at end of period . . . . . . . $ 5,076 $ 5,182
======= =======
The accompanying notes are an integral part of these financial statements.
-6-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three and six months ended June 30, 2006 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2006. For further information refer to the consolidated financial statements
and footnotes thereto included in the VSE Corporation Annual Report on Form 10-K
for the year ended December 31, 2005. The Company operates within one reportable
segment.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Significant
estimates affecting the financial statements include the allowance for doubtful
accounts, accruals for loss contracts, contract disallowance reserves, self
insured health claims and estimated cost to complete on firm fixed-price
contracts.
Contract Inventories
The components of contract inventories as of June 30, 2006 and December 31, 2005
were as follows (in thousands):
2006 2005
---- ----
Work in process . . . . . . . . . . . . . . . . . . . . $ 8,652 $ 9,965
Less: Progress payments and customer
advances received . . . . . . . . . . . . . . . . - (5,692)
------- -------
Total contract inventories $ 8,652 $ 4,273
======= =======
Contract inventories consist of materials purchased, advances to suppliers, 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.
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.
-7-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 June 30,
2006 and December 31, 2005 included applicable indirect cost burdens, including
general and administrative costs totaling approximately $1.2 million and $1.3
million, respectively. Indirect cost burdens, including general and
administrative costs charged to cost of sales from inventories for the periods
ended June 30, 2006 and December 31, 2005 totaled $1.9 million and $3.4 million,
respectively.
Debt
VSE has a loan agreement with a bank under which credit is made available to the
Company in the form of revolving loan amounts or letters of credit. The amount
of credit available to the Company is $15 million, subject to certain
conditions, including a borrowing formula based on billed receivables. The
expiration date of the loan agreement is May 31, 2008.
The loan agreement contains terms whereby the Company may borrow against the
revolving loan and at any time and from time to time can prepay such borrowings
in whole or in part without premium or penalty. There are collateral require-
ments 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
June 30, 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 June 30, 2006 and
December 31, 2005, there were no revolving loan amounts outstanding. There was
one letter of credit for approximately $192 thousand in effect as of
December 31, 2005 that expired in May 2006. There were no letters of credit in
effect as of June 30, 2006. Interest expense incurred on the loan for the six
months ended June 30, 2006 and 2005 was approximately $0 and $2 thousand,
respectively.
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 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.
Stock Option Plans
On December 30, 2005, the board of directors of VSE Corporation (the "Board")
discontinued, until and unless the Board determined otherwise, awarding options,
both discretionary and nondiscretionary, to purchase VSE Stock under
-8-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
VSE's 2004 Stock Option Plan (the "2004 Plan"). The options outstanding under
the 2004 Plan, as of December 30, 2005, were not affected by this Board action.
In addition, the options to purchase 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.
2004 Stock Option Plan
As of June 30, 2006 options issued under the 2004 Plan for 66,750 shares of VSE
Stock remain outstanding. Each option granted under the 2004 Plan was issued at
the fair market value of VSE Stock on the date of grant. Each option vests 25%
on date of award and 25% on each anniversary date thereafter, becoming 100%
vested as of the third anniversary date of award. The 2004 Plan will terminate
on the earliest of May 1, 2014, or the date on which all options issued under
the 2004 Plan have been exercised, expire, or have been terminated.
1998 Stock Option Plan
As of June 30, 2006, options issued under the 1998 Plan for 121,125 shares of
VSE Stock remain outstanding. The 1998 Plan will terminate on the earliest of
May 6, 2008, or the date on which all options issued under the 1998 Plan have
been exercised, expire, or have been terminated.
Accounting for Stock-based Compensation
Prior to January 1, 2006, the Company had followed the provisions of SFAS 123,
"Accounting for Stock-Based Compensation," as amended by SFAS 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure." Accordingly, the
Company accounted for stock-based compensation under Accounting Principles Board
(APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations, using the intrinsic value method. Effective January 1, 2006,
the Company adopted the fair value recognition provisions of FASB Statement
No. 123(R), "Share-Based Payment", using the modified-prospective-transition
method. Under that transition method, compensation cost recognized as of
June 30, 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 period ended June 30, 2006, was approximately $78 thousand lower or
approximately $.03 per share basic and 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
June 30, 2006 is approximately $307 thousand, to be recognized over
approximately 1.50 years.
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. Approximately $92 thousand in excess tax
benefits classified as cash provided by financing activities for the six
-9-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
months ended June 30, 2006 would have been classified as cash provided by
operating activities if the company had not adopted SFAS 123(R).
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(R)
to options granted under the Company's stock option plans for the periods ending
June 30, 2005. For purposes of this pro forma disclosure, the value of the
options is estimated using a Black-Scholes-Merton option-pricing formula and
amortized to expense over the options' vesting periods.
Three Months Six Months
Ended June 30, Ended June 30,
2005 2005
---- ----
Net income, as reported $1,765 $3,069
Add: Total stock-based employee
compensation expense as reported
under intrinsic value method
(APB No. 25) for all awards, net
of related tax effects - -
Deduct: Total stock-based
compensation expense
determined under fair value based
method (SFAS No. 123) for all
awards, net of related tax effects (50) (112)
------ ------
Pro forma net income $1,715 $2,957
====== ======
Earnings per share:
Basic - as reported $ 0.76 $ 1.34
Diluted - as reported $ 0.74 $ 1.30
Basic - pro forma $ 0.74 $ 1.29
Diluted - pro forma $ 0.72 $ 1.25
The fair value of the options was estimated on the date of grant using the
Black-Scholes option pricing model. The following assumptions were used in the
pricing calculations for 2005. In 2006, no such assumptions were made as no
options were granted:
2005
----
Risk free interest rate 3.28%
Dividend yield 0.79%
Expected life 3 years
Expected volatility 60.50%
-10-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Set forth below is a summary of the Company's stock option activity for the six
months ended June 30, 2006 and 2005:
Weighted Weighted
Average Average
Exercise Exercise
2006 Price 2005 Price
---- ----- ---- -----
Number of shares under
stock options:
Outstanding at beginning of period 197,563 $15.83 211,625 $ 9.51
Granted . . . . . . . . - - 70,000 25.17
Exercised . . . . . . . (9,688) 12.02 (69,812) 7.65
Forfeited . . . . . . - - (4,750) 11.90
------- ------ ------- ------
Outstanding at end of period 187,875 $16.02 207,063 $15.38
======= ====== ======= ======
Exercisable at end of period 136,750 $14.06 107,626 $13.91
======= ====== ======= ======
2006 2005
---- ----
Weighted average remaining
contractual life 2 Years 3 Years
Weighted average fair
value of options granted - $4.70
The aggregate intrinsic values of outstanding, exercisable and exercised shares
as of June 30, 2006 and 2005 are as follows (in thousands):
2006 2005
---- ----
Outstanding shares $2,582 $3,502
Exercisable shares $2,148 $2,184
Exercised shares $ 94 $ 68
The total fair value of shares vested during the second quarter of 2006 and 2005
was $0 and approximately $163 thousand, respectively.
Set forth below is a summary of the Company's nonvested stock option activity
for the six months ended June 30, 2006 and 2005:
Weighted Weighted
Average Average
Grant Date Grant Date
2006 Fair Value 2005 Fair Value
---- ---------- ---- ----------
Nonvested stock at beginning
of period 51,125 $ 8.41 49,687 $ 3.66
Granted - - 70,000 10.37
Vested - - (17,500) 10.37
Forfeited - - (2,750) 3.13
------ ------ ------- ------
Nonvested stock at end
of period 51,125 $ 8.41 99,437 $ 7.22
====== ====== ======= ======
-11-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Earnings Per Share
Basic earnings per share have been computed by dividing net income by the
weighted average number of shares of common stock outstanding during each
period. Shares issued during the period and shares reacquired during the period
are weighted for the portion of the period that they were outstanding. Diluted
earnings per share have been computed in a manner consistent with that of basic
earnings per share while giving effect to all potentially dilutive common
shares that were outstanding during each period. Potentially dilutive common
shares include incremental common shares issuable upon exercise of stock
options.
Three Months Six Months
Ended June 30, Ended June 30,
2006 2005 2006 2005
---- ---- ---- ----
Basic weighted average
common shares outstanding 2,366,712 2,310,864 2,364,001 2,295,182
Diluted effect of options 53,512 66,390 62,733 70,486
--------- --------- --------- ---------
Diluted weighted average
common shares outstanding 2,420,224 2,377,254 2,426,734 2,365,668
========= ========= ========= =========
Litigation
The Company is a party to or has property subject to litigation during the
normal course of business. In the opinion of management, the resolution of any
such litigation 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.
-12-
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Executive Overview
VSE Organization
VSE's business operations consist primarily of services performed by the
Company's unincorporated divisions and wholly owned subsidiary. The Company uses
multiple operating entities to bid on and perform contract work. The 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"), Fleet Maintenance
Division ("FMD"), Management Sciences Division ("MSD"), Systems Engineering
Division ("SED"), and Engineering and Logistics Division ("ELD") beginning in
2006. Energetics Incorporated ("Energetics") is currently VSE's only active
subsidiary.
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.
Navy - The majority of VSE's work is performed for the U.S. Navy. BAV is a
major provider of logistics, training, and technical assistance in support of
the Navy's Foreign Military Sales ("FMS") ship transfer program. FMD supports
the Navy by providing a variety of services, including ship systems installation
efforts, combat systems inspections, ship repair and overhaul availability
planning, weapons management, ordnance alterations, and air combat logistics.
Army/Army Reserve - VSE also performs a significant amount of its work for the
U.S. Army and U.S. Army Reserve. VSE, through SED and ELD, provides these
customers equipment refurbishment services, military vehicle protection systems,
engineering and technical support for ground weapons, logistics and training
services, material procurement support, and prototype development support for
combat vehicles. MSD provides the Army, as well as other government agencies and
commercial organizations, with training services in quality systems and product,
process, and management optimization. CED provides management oversight and
coordinates support efforts for a variety of government work orders on a large
Army contract.
Other - Energetics provides the Department of Energy and other government and
industry customers with expert consulting services that typically include
program planning and analysis, R&D management services, technology assessment
and performance metrics, communications and outreach, and conference planning.
VCG provides services to the U.S. Coast Guard that are similar to the work
performed by BAV for the U.S. Navy and its FMS customers. The Company provides
support and other services to the U.S. Air Force, U.S. Postal Service and U.S.
Department of Treasury.
BAV Ship Transfer Program
VSE's BAV Division provides the U.S. Navy with program management, engineering,
technical and logistical support services associated with the sale, lease, and
transfer of Navy ships to foreign governments. This program has been the
Company's single largest revenue producer. Revenues generated by this program
have typically accounted for a significant percentage of VSE's consolidated
revenues. Revenues from this program accounted for approximately 37% and 43% of
consolidated revenues during the six month periods ended June 30, 2006 and 2005,
respectively. The level of revenues and associated profits
-13-
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 has been a major contributor to the Company's
revenues in 2005 and 2004, and has continued contributing to the Company's
revenues in 2006.
The original contract associated with this program was a ten-year cost-plus
award fee contract awarded in 1995 with a total ceiling value of more than $1
billion. BAV was awarded a second contract in April 2005 to continue work on
this program. The new contract is a five-year cost-plus award fee contract with
a total ceiling value of approximately $544 million. The Navy began issuing
orders on the new contract in the second quarter of 2005 and ceased issuing
orders for new work on the original contract at that time. BAV will continue
work associated with the transfer of four ships to Taiwan under delivery orders
previously issued on the original contract until the work is completed and all
four ships are delivered to Taiwan.
Contract terms under both the original and new contracts specify base fee
payments and award fee payments to BAV. Base fee payments are determined by
level of contract activity and base fee income is recognized each month. Award
fee payments are determined by performance and level of contract activity. A
contract modification authorizing the award fee payment is issued subsequent to
the period in which the work is performed. The Company does not recognize award
fee income until the fees are fixed and determinable, generally upon contract
notification confirming the award fee. Award fees are made three times during
the year. Accordingly, the Company typically has three quarterly reporting
periods per year that include the recognition of BAV award fee income and one
quarterly reporting period that does not include BAV award fee income. Due to
such timing, and to fluctuations in the level of revenues, profits as a
percentage of revenues will fluctuate from period to period. The Company
recognized BAV award fee income in the three month periods ended June 30 and
March 31, 2006. In 2005, the Company recognized BAV award fee income in each of
the three month periods ended March 31, June 30, and December 31 and did not
recognize any BAV award fee income in the three month period ended September 30.
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 Fuel Tank Self-Sealing
System and necessary Add-on Armor Panels for Army Fuel Dispensing Tankers as
protection from hostile fire. Delivery of completed vehicle protection systems
began in January 2005.
SED has performed on the TBPS program under multiple firm fixed price per unit
contracts. Subsequent to program implementation, VSE has received modifications
to consolidate contracting activity into fewer contracts and to adjust the
number of tankers based on Army tanker availability and needs, and the
possibility remains that there may be future contract modifications as the
Army's needs change. The total contract ceiling value on the TBPS Program
contracts is approximately $75 million, and the remaining available contract
ceiling on the TBPS Program contracts is approximately $32 million as of
June 30, 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 has
provided significant revenues in 2006. The work performed on this program also
significantly increases the amount of fixed price contract work performed by the
Company. In general, fixed price contract work has higher risk and profit
-14-
margins than work on other contract types. Accordingly, the TBPS program has
presented, and is expected to continue to present, 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.
The task order for this program is time and materials, with substantially all of
the services provided by CED's subcontractor. CED will provide 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 is expected to contribute significantly
to VSE's revenues in 2006 and 2007, however, VSE's profit margins on subcontract
work are generally 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 ("omnibus") management contracts. This emphasis on large contracts
presents challenges to winning new contract work, including making it more
difficult for the Company to qualify as a bidder, increasing the level of
competition due to the award of fewer contracts, and forcing the Company into
competition with larger organizations that have greater financial resources and
larger technical staffs. Competing for these contracts requires the Company to
use teams of subcontractors to be able to offer the range of technical
competencies needed to do the work. While the use of subcontractors on a large
scale basis allows the Company to compete for this work, profit margins on
subcontract work are lower than on work performed by Company personnel, thereby
reducing the Company's overall profit margins.
The use of subcontractors on government contracts also raises certain
performance and financial risks to VSE because government prime contractors are
responsible for performing to the requirements of the contract and ensuring
compliance with U.S. Government regulations relative to the performance by
subcontractors.
Other government procurement practices that can affect the Company's revenues
are: 1) the length of contracts issued, which may vary depending on changes in
contracting regulations and other factors; 2) the use of past performance
criteria that may preclude entrance into new government markets; and
3) government social programs that limit contract work to small, woman, or
minority owned businesses. Additional risk factors that could potentially affect
the Company's results of operations are the government's right to terminate
contracts for convenience, the government's right to not exercise
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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 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 and 2005
comprised a large percentage of total revenues, and 2006 revenues under this
program are expected to be significant to the Company.
The current international situation posed by potential terrorist activity and
the continuing conflict in the Middle East could increase the political risks
for revenues from the BAV Ship Transfer, TBPS, and CED Army Equipment Support
Programs.
Concentration of Revenues From Continuing Operations
(in thousands)
For the six months ended June 30,
---------------------------------
2006 2005
Source of Revenue Revenues % Revenues %
----------------- -------- - -------- -
BAV Egypt . . . . . . . . $ 24,792 16% $ 25,955 19%
BAV Taiwan . . . . . . . 29,969 19% 31,642 23%
BAV Other . . . . . . . . 4,248 2% 1,721 1%
-------- ---- -------- ----
Total BAV 59,009 37% 59,318 43%
TBPS Program . . . . . . 14,200 9% 16,819 12%
CED Army Equipment Support 28,366 18% - -
VSE Other . . . . . . . . 56,569 36% 62,464 45%
-------- ---- -------- ----
Total Revenues $158,144 100% $138,601 100%
======== ==== ======== ====
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. The equipment refurbishment services offered by
ELD are subject fluctuation resulting from changes in U.S. military actions
internationally. Adverse results arising from these global economic and
political risks could impact the Company's results of operations.
Management Outlook
The growth trend established by VSE's record high revenues and profits in 2004
and 2005 is expected to continue in 2006. The major contributors to 2006 results
are expected to be: 1) a continuation of the Taiwan Ship Transfer work
performed by BAV; 2) performance on the TBPS Program; 3) new work performed on
the CED Army Equipment Support Program; 4) growth in ELD's Equipment
Refurbishment Services provided to the U. S. Army Reserve; 5) additional work
provided by Other Significant Contracts; and 6) Potential New Contract
Opportunities.
Taiwan Ship Transfer. The Taiwan ship transfer effort is expected to continue
through late 2006, allowing BAV to maintain revenue levels in 2006 similar to
2005. Funded backlog on the BAV Ship Transfer Program was approximately $93
million as of June 30, 2006.
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TBPS Program. SED began delivery of completed vehicle protection systems on
this program in 2005, and work on the program increased during the first three
quarters of 2005. Changes in production schedules can result from operating in
an uncertain and volatile environment in Iraq, changing Army needs, technical
specification issues, and facility location changes. Such changes caused work on
this program to level off during the fourth quarter of 2005 and the first
quarter of 2006. Production levels increased again beginning in the second
quarter of 2006 and the program is expected to generate increased levels of
revenue in 2006. Funded backlog on the TBPS program was approximately $32
million as of June 30, 2006.
CED Army Equipment Support Program. This program is new work and is expected to
increase Company revenues in 2006. During the first quarter of 2006, work on
this program was transitioned from a predecessor contract to CED's contract task
order, and CED's revenue from this program increased in the second quarter.
Additional increases in revenue from this program are projected for the next six
months, and most of the $139 million base year task order is expected to be
completed in 2006. The contract task order for this program is incrementally
funded, with funded backlog of approximately $66 million as of June 30, 2006.
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 revenues from these services have increased during the first six months of
2006 and ELD is expecting further increases in 2006 and future years.
Other Significant Contracts. VSE has three multiyear, multiple award, indefinite
delivery, indefinite quantity contracts that have large nominal ceiling amounts
with no funding committed at the time of award. VSE is one of several awardees
on each contract. While future VSE revenue from these contracts cannot be
predicted with certainty, the award of these contracts provides the Company with
the opportunity to compete for work that may contribute to future revenue
growth, including new work in 2006. 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 not likely that the full
ceiling amount will be realized, this contract has generated revenues for VSE
of approximately $37 million and $27 million during 2005 and 2004, respectively.
The CED Army Equipment Support Program is expected to add significantly to this
contract's and the Company's revenues in 2006. 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 order 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
June 30, 2006, FMD has generated only minor amounts of revenue from this
contract. In May 2006, FMD was awarded a $20.5 million, three-year order on this
contract to support the Navy's Joint Program Office for Cartridge Actuated
Devices and Propellant Actuated Devices. Work on this order began in June 2006
and is expected to contribute to 2006 and future years revenue growth.
FMD also has a contract, awarded in September 2004, with the U.S. Navy to
provide engineering and technical services to support Naval Sea Systems Command
maintenance, overhaul, repair, and alteration of systems aboard ships.
-17-
This contract has a total nominal contract ceiling amount of $1.022 billion over
a five-year period if all option periods are exercised. VSE is one of several
awardees eligible to share in the potential total contract ceiling amount. Since
the date of the contract award, FMD has been awarded delivery orders with
ceilings valued at approximately $44 million on this contract, of which
approximately $37 million has been funded. Although it is not likely that the
full $1.022 billion ceiling amount will be realized, this contract presents
potential future revenue opportunities.
Potential New Contract Opportunities. VSE has several significant proposals that
have been submitted to the government for evaluation and award and proposals
that are being prepared for submission to the government that would, if awarded
to VSE, represent opportunities for additional growth. VSE is confident that it
can win one or more of these opportunities.
Funded Backlog
Revenue increases in government contracting businesses are typically preceded by
increases in contract funding ("Bookings") and a build-up of funded contract
backlog. VSE's Bookings and funded backlog are continuing at levels that give
the Company a firm basis for continued revenue growth in 2006.
(in millions)
-----------
Bookings for the six months ended June 30, 2006 $147
Funded backlog as of June 30, 2006 $264
Revenues for the six months ended June 30, 2006 $158
Longer Term
The growth in VSE revenue and profits during 2004 and 2005, and the expected
continuation of this growth in 2006, will present the Company with both
challenges and opportunities for future years.
The biggest challenge that VSE faces in future years is the ability to sustain
its recent level of growth. Certain work efforts that have supported VSE's
growth in 2004, 2005 and in the six month period ended June 30, 2006, are due
to expire in the future. VSE has received significant contributions to its
revenue growth in 2004 from the Taiwan Ship Transfer work and in 2005 from both
the Taiwan Ship Transfer work and the TBPS Program work. These two programs and
the CED Army Equipment Support Program are expected to be the largest
contributors to VSE revenue in 2006. 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. 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. In addition to proposals that
the Company currently has under evaluation and in preparation, VSE is currently
tracking multiple bidding opportunities for new contract work. Additionally, the
larger revenue level and capital base improves the Company's ability to pursue
larger programs and potential acquisition opportunities.
Recent Accounting Pronouncements
Share-Based Payment
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
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based on their fair values. The Company adopted SFAS 123(R), using the modified
prospective method, on January 1, 2006.
The impact of adopting SFAS 123(R) is expected to decrease income before income
taxes by approximately $252 thousand in 2006. The amount of stock-based
compensation expense for the six months ended June 30, 2006 was $126 thousand.
SFAS 123(R) also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under the old method. The amount of financing
cash flows from benefits of tax deductions in excess of recognized compensation
cost for the six months ended June 30, 2006 was $92 thousand. The amount of
operating cash flows from benefits of tax deductions in excess of recognized
compensation cost for the six months ended June 30, 2005 was $662 thousand.
On December 30, 2005, VSE's board of directors (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 separately as an adjustment
to the opening balance of retained earnings in the year of adoption. The Company
is in the process of reviewing and evaluating FIN 48, and therefore the ultimate
impact of its adoption is not yet known.
Critical Accounting Policies
VSE's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require VSE
to make estimates and assumptions. The Company believes the following critical
accounting polices affect our more significant judgments, estimates and
assumptions used in the preparation of its consolidated financial statements.
Revenue Recognition
Substantially all of the Company's services are performed for its customers on a
contract basis. The three primary types of contracts used are cost-type
contracts, time and materials contracts, and fixed-price contracts. Revenues
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.
-19-
Revenues for time and materials contracts are recorded on the basis of contract
allowable labor hours worked times the contract defined billing rates, plus the
cost of materials used in performance on the contract. Profits on time and
material contracts result from the difference between the cost of services
performed and the contract defined billing rates for these services.
Revenue recognition methods on fixed-price contracts will vary depending on the
nature of the work and the contract terms. On certain fixed-price contracts
revenues are recorded as costs are incurred, using the percentage-of-completion
method of accounting, because 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.
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
over the life of the contract. The amount of costs classified as a current asset
as of June 30, 2006 is approximately $803 thousand.
Revenues by contract type for the six months ended June 30, 2006 and 2005 were
as follows (in thousands):
2006 2005
Contract Type Revenues % Revenues %
------------- -------- - -------- -
Cost-type . . . . . $ 81,058 51 $ 85,420 62
Time and materials. 57,182 36 29,644 21
Fixed-price . . . . 19,904 13 23,537 17
-------- --- -------- ---
$158,144 100 $138,601 100
======== === ======== ===
The Company will occasionally perform work at risk, which is work that is
performed prior to the government formalizing funding for such work. Revenue
related to work performed at risk is not recognized until it can be reliably
estimated and its realization is probable. VSE recognizes this "risk funding" as
revenue when the associated costs are incurred or the work is performed. VSE is
at risk of loss for any risk funding not received. The Company provides for
anticipated losses on contracts by a charge to income during the period in which
losses are first identified. As of June 30, 2006, VSE has recognized
approximately $109 thousand in risk funding. VSE believes that it will receive
funding for all or substantially all of this risk funding revenue.
Long-Lived Assets
In assessing the recoverability of long-lived assets, including goodwill and
other intangibles, VSE must make assumptions regarding estimated future cash
flows and other factors to determine the fair value of the respective assets. If
these estimates or their related assumptions change in the future, VSE may be
required to record impairment charges for these assets not previously recorded.
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 June 30, 2006, the Company had approximately $1.1 million of
goodwill associated with its acquisition of Energetics in 1995. The Company has
not recognized any reduction to the goodwill due to the impairment rules. If at
some time in the future it is determined that impairment has occurred, such
impairment could potentially have a 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
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well as potential ranges of probable losses and establish reserves accordingly.
The amount of reserves required may change in future periods due to new
developments in each matter or changes in approach to a matter such as a change
in settlement strategy.
Income Taxes
The carrying value of VSE net deferred tax assets is based on assumptions
regarding VSE's ability to generate sufficient future taxable income to utilize
these deferred tax assets. If the estimates and related assumptions regarding
VSE's future taxable income change, VSE may be required to record valuation
allowances against its deferred tax assets, resulting in additional income tax
expense.
Results of Operations
The following table sets forth certain items, including consolidated revenues,
pretax income and net income from continuing operations, and the changes in
these items for the six month periods ended June 30, 2006 and 2005
(in thousands):
2006
Increase
Compared
to
2005
Three Months Six Months ----------------
Ended June 30, Ended June 30, Three Six
2006 2005 2006 2005 Months Months
---- ---- ---- ---- ------ ------
Revenues . . . . . . $94,844 $72,682 $158,144 $138,601 $22,162 $19,543
======= ======= ======== ======== ======= =======
Income before income
taxes . . . . . . $ 3,278 $ 2,877 $ 5,680 $ 5,004 $ 401 $ 676
Provision for income
taxes . . . . . . 1,251 1,112 2,168 1,935 139 233
------- ------- -------- -------- ------- -------
Income from continuing
operations . . . . $ 2,027 $ 1,765 $ 3,512 $ 3,069 $ 262 $ 443
======= ======= ======== ======== ======= =======
Revenues increased by approximately 30% and 14% for the three and six month
periods ended June 30, 2006, as compared to the same periods of 2005. A
substantial portion of the increases in revenues 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 and
Energetics services also contributed to the Company's increases in revenues. The
increases in revenues were partially offset by decreased revenues associated
with a decrease in work performed under the TBPS Program, a decrease in the
level of work on FMD's Navy contracts, and a decrease in the level of work on
VCG's contract with the U.S. Coast Guard.
Income before income taxes increased by approximately 14% for both the three
month and six month periods ended June 30, 2006, as compared to the same periods
of 2005. The increases were primarily due to increases in profits on the BAV
Ship Transfer Program, on the FMD contract work, and from Energetics. Also, the
ability to spread corporate fixed costs over the larger revenue base contributed
to an increase in profits.
Financial Condition
VSE's financial condition did not change materially during the six months ended
June 30, 2006. The Company's largest assets are its accounts receivable and the
largest liabilities are its accounts payable and accrued expenses. Accounts
receivable increased approximately $10.8 million, and accounts payable increased
approximately $7.9 million during the first six months of 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, and
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the timing of associated billings to customers and subcontractor payments
required to perform this work.
The change in total stockholders' equity in this period resulted from earnings
and dividend activity and from the exercise of stock options. In June 2006,
VSE's Board of Directors 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 June 30, 2006, the Company had not purchased any of these
shares.
Liquidity and Capital Resources
Cash Flows
Cash and cash equivalents decreased by approximately $7.6 million during the
six months ended June 30, 2006. The decrease in cash and cash equivalents during
this period resulted from cash used in operating activities of approximately
$5.9 million, cash used in investing activities of approximately $1.7 million,
and cash used in financing activities of approximately $73 thousand. Investing
activities consisted of expansion and improvement of facilities of approximately
$191 thousand and purchases of property and equipment, net of dispositions, of
approximately $1.5 million. Financing activities consisted of dividend payments
and proceeds received from the issuance of VSE Stock under stock incentive
plans.
Cash and cash equivalents increased by approximately $5.1 million during the six
months ended June 30, 2005. The increase in cash and cash equivalents during
this period resulted from cash provided by operating activities of approximately
$7.1 million, cash used in financing activities of approximately $1.3 million,
and cash used in investing activities of approximately $800 thousand. Financing
activities consisted of repayment of amounts previously borrowed on the
Company's bank loan of approximately $1.6 million, dividend payments, and
proceeds received from the issuance of VSE Stock upon the exercise of stock
options. Investing activities consisted of expansion and improvement of
facilities of approximately $179 thousand and purchases of property and
equipment, net of dispositions, of approximately $626 thousand.
The difference between cash used in operating activities of approximately $5.9
million in 2006 as compared to cash provided by operating activities of
approximately $7.1 million in 2005 is primarily due to an increase in the level
of contract inventories on the TBPS program and to a decrease in the level of
accrued expenses in 2006 as compared to 2005.
Quarterly cash dividends were paid at the rate of $.12 per share during the six
months ended June 30, 2006. Cash dividends of $.07 per share were declared in
June 2006 to be paid in August 2006. Pursuant to its bank loan agreement, the
payment of cash dividends by VSE is subject to annual rate restrictions. VSE
has paid cash dividends each year since 1973.
Liquidity
The Company's internal sources of liquidity result primarily from operating
activities, specifically from changes in the level of revenues and associated
accounts receivable, inventories, and accounts payable from period to period,
and from profitability. Significant increases or decreases in revenue and
accounts receivable, inventories, 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
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the Company, differences between billable amounts authorized by contract terms
compared to costs actually incurred by the Company, and government delays in
processing administrative paperwork for contract funding.
Work on the TBPS program requires the Company to acquire inventories consisting
of materials, supplies, and other expenditures for which end units have not yet
been completed and accepted. Although these costs are classified as inventories
for accounting purposes, they are similar in nature to materials and direct
supplies purchased for use in performance on the Company's other contracts in
that they are solely and directly attributable to the contract and will be
billed to the customer within a relatively short time. All of the inventories
are expected to be liquidated, billed, and collected as vehicle protection
systems are completed and accepted by the government customer. These materials
and direct supplies will not be restocked to maintain any permanent inventory
levels.
Accounts payable arise primarily from purchases of subcontractor services and
materials used by the Company in the performance of its contract work. Payments
made on accounts payable, along with payments made to satisfy employee payroll
and payroll associated expenses, make up the principal cash requirements of the
Company. Accounts payable levels can be affected by changes in the level of
contract work performed by the Company and by the timing of large materials
purchases and subcontractor efforts used in performance on the Company's
contracts.
Other cash requirements include income tax payments, the acquisition of capital
assets for shop, office and computer support, and the payment of cash dividends.
From time to time, the Company also invests in the expansion, improvement, and
maintenance of its operational and administrative facilities.
VSE's external sources of liquidity consist of a revolving bank loan agreement
that provides loan financing based on the Company's accounts receivable (see
"Notes to Consolidated Financial Statements"). The bank financing complements
the Company's internal sources of liquidity by providing increasing levels of
borrowing capacity as accounts receivable levels increase. The bank loan
agreement provided loan financing up to a maximum commitment of $15 million as
of June 30, 2006. The Company has determined that the current $15 million
commitment amount is adequate to cover known current and future liquidity
requirements.
Performance of work under the Company's larger contracts that require
significant amounts of subcontractor or material purchases have the potential
to cause substantial requirements for working capital; however, management
believes that cash flows from operations and the bank loan commitment are
adequate to meet current operating cash requirements.
Contractual Obligations
In January 2006, the Company signed a five-year facility lease for shop, office
and warehouse space in Long Beach, Mississippi to begin in April 2006 for an
aggregate amount of $668 thousand. In April 2006, the Company signed an addendum
to this lease to increase the amount of space leased and to defer the start date
to May 2006. The revised aggregate amount of the lease is $1.116 million.
In May 2006, the Company signed a three-year facility lease for shop and office
space in Ladysmith, Virginia to begin in June 2006 for an aggregate amount of
$360 thousand. The Company simultaneously entered into a Real Estate Purchase
Agreement for this property that gives the Company a 180 day option to buy the
leased property for an amount of approximately $1.5 million.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" contained in VSE's Annual Report on Form 10-K for the fiscal year
ended December 31, 2005 for a summary of the Company's other contractual
obligations.
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Asset Purchase Agreement
In July 2006, VSE pursuant to an agreement with Giordano Automation Corp.
("Giordano") purchased certain assets of Giordano, including proprietary
software, intellectual property rights, training materials, certain fixed
assets, licenses, and warranties. The purchase price was $575 thousand. The
acquisition of these assets will allow the Company to pursue certain business
opportunities.
Inflation and Pricing
Most of the contracts performed by VSE provide for estimates of future labor
costs to be escalated for any option periods provided by the contracts, while
the non-labor costs included in such contracts are normally considered
reimbursable at cost. VSE property and equipment consists principally of
computer systems equipment, furniture and fixtures, and land and improvements.
The overall impact of inflation on replacement costs of such property and
equipment is not expected to be material to VSE's future results of operations
or financial condition.
Disclosures About Market Risk
Interest Rates
VSE's bank loan financing provides available borrowing to the Company at
variable interest rates. The Company has not borrowed significant amounts on the
loan in recent years. Accordingly, the Company does not believe that any
movement in interest rates would have a material impact on future earnings or
cash flows. If VSE were to significantly increase borrowings on the current loan
arrangement, future interest rate changes could potentially have a material
impact.
Foreign Currency
While a significant amount of the Company's business results from the services
provided by BAV related to the transfer of ships to foreign governments, the BAV
contract payments are made by the U.S. Government in U.S. dollars. Additionally,
most funding requirements to support work performed or services purchased in
foreign countries are made in U.S. dollars, and the disbursements that are made
in foreign currencies are reimbursable to BAV in post conversion dollars.
Foreign currency transactions of other VSE divisions or subsidiaries are
minimal. Accordingly, the Company does not believe that it is exposed to any
material foreign currency risk.
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VSE CORPORATION AND SUBSIDIARIES
Item 3. Quantitative and Qualitative Disclosures About Market Risks
See "Disclosures About Market Risk" in Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Item 4. Controls and Procedures
As of the end of the period covered by this report, based on management's
evaluation, with the participation of VSE Corporation's Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the disclosure controls and
procedures (as defined in Rules 13a-15(e) or 15d - 15(e) under the Securities
Exchange Act of 1934, as amended) our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures are
effective in ensuring that information required to be disclosed by us in reports
filed or submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and regulations.
There was no change in our internal control over financial reporting during our
second quarter of fiscal 2006 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
PART II. Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The Registrant did not purchase any of its equity securities during the period
covered by this report.
Under the Registrant's bank loan agreement dividends may be paid in an annual
aggregate amount of $.60 per share, provided there is no default under the loan
agreement.
Item 4. Submission of Matters to a Vote of Security Holders
The 2006 annual meeting of the Company's stockholders was held on May 2, 2006,
for the following purposes:
1. To elect seven directors to serve until the next annual meeting of
stockholders and until their successors are duly elected and qualified;
2. To approve an amendment to VSE's Restated Certificate of Incorporation to
increase the authorized number of shares of VSE Common Stock, par value $.05
per share, from 5,000,000 shares to 15,000,000 shares;
3. To To approve the adoption of the VSE Corporation 2006 Restricted Stock
Plan; and
4. To ratify the appointment of Ernst & Young LLP as VSE's independent
certified public accountants for the fiscal year ending December 31, 2006.
All of the Company's seven nominees were elected as directors, the amendment to
VSE's Restated Certificate of Incorporation was approved, the adoption of the
VSE Corporation 2006 Restricted Stock Plan was approved, and the appointment of
Ernst & Young LLP as VSE's independent certified public accountants for the year
ending December 31, 2006, was ratified. Voting results were as follows:
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Shares Voted
--------------------------------------------
Withhold/ Broker
For Against Abstain Non-Votes
--------------------------------------------
1. Nominee
Donald M. Ervine 2,142,536 -- 10,099 113,436
Clifford M. Kendall 2,142,591 -- 10,044 113,436
Calvin S. Koonce 2,142,745 -- 9,890 113,436
James F. Lafond 2,142,081 -- 10,554 113,436
David M. Osnos 2,108,507 -- 44,128 113,436
Jimmy D. Ross 2,142,745 -- 9,890 113,436
Bonnie K. Wachtel 2,142,595 -- 10,040 113,436
2. Amendment to Restated
Certificate of
Incorporation 1,865,288 281,030 6,515 113,239
3. VSE Corporation 2006
Restricted Stock Plan 1,494,782 68,797 12,795 689,698
4. Ernst & Young LLP
appointment 2,136,720 9,628 6,287 113,436
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit No.
-----------
3.1 Certificate of Amendment of the Restated Certificate of
Incorporation of VSE Corporation
31.1 Section 302 CEO Certification
31.2 Section 302 CFO and PAO Certification
32.1 Section 906 CEO Certification
32.2 Section 906 CFO and PAO Certification
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has omitted all other items contained in "Part II. Other Information"
because such other items are not applicable or are not required if the answer is
negative or because the information required to be reported therein has been
previously reported.
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VSE CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VSE CORPORATION
Date: August 1, 2006 /s/ D. M. Ervine
__________________________________
D. M. Ervine
Chairman, President,
Chief Executive Officer and
Chief Operating Officer
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