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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, 2003 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
(Address of Principal Executive Offices) (Zip Code)
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
requirements for the past 90 days.
Yes [x] No [ ]
Number of shares of Common Stock outstanding as of July 29, 2003: 2,188,635.
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 "Narrative
Description of Business", "Management's Discussion and Analysis" and "Notes to
Consolidated Financial Statements" contained in VSE's Annual Report and Form
10-K for the fiscal year ended December 31, 2002 (Form 10-K) filed with the
Securities and Exchange Commission. 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 this Quarterly
Report on Form 10-Q to be filed by the company subsequent to the 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 (Unaudited)
Consolidated Balance Sheets
- ------------------------------------------------------------------------------
(in thousands except share amounts)
June 30, December 31,
2003 2002
---- ----
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . . $ 7,509 $ 4,210
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . . 15,402 17,524
Deferred tax assets . . . . . . . . . . . . . . . 1,259 1,313
Other current assets . . . . . . . . . . . . . . . 1,783 1,241
-------- --------
Total current assets . . . . . . . . . . . . . . 25,953 24,288
Property and equipment, net . . . . . . . . . . . . 3,303 3,483
Deferred tax assets . . . . . . . . . . . . . . . . 404 449
Intangible assets, net . . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . . 2,432 2,403
-------- --------
Total assets . . . . . . . . . . . . . . . . . . $ 33,146 $ 31,677
======== ========
Liabilities and Stockholders' Investment
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . $ 9,708 $ 8,785
Accrued expenses . . . . . . . . . . . . . . . . 4,466 4,654
Dividends payable . . . . . . . . . . . . . . . . 88 87
-------- --------
Total current liabilities . . . . . . . . . . . 14,262 13,526
Deferred compensation . . . . . . . . . . . . . . . 1,116 1,108
-------- --------
Total liabilities . . . . . . . . . . . . . . . 15,378 14,634
-------- --------
Commitments and contingencies
Stockholders' investment:
Common stock, par value $.05 per share, authorized
5,000,000 shares; issued 2,188,635 in 2003 and
2,185,760 shares in 2002 . . . . . . . . . . . . 109 109
Paid-in surplus . . . . . . . . . . . . . . . . . 3,590 3,558
Retained earnings . . . . . . . . . . . . . . . . 14,069 13,376
-------- --------
Total stockholders' investment . . . . . . . . . 17,768 17,043
-------- --------
Total liabilities and stockholders' investment . $ 33,146 $ 31,677
======== ========
The accompanying notes are an integral part of these financial statements.
-3-
VSE Corporation and Subsidiaries
Consolidated Financial Statements (Unaudited)
Consolidated Statements of Income For the three and six months ended June 30,
- --------------------------------------------------------------------------------
(in thousands except share amounts)
Three Months Six Months
2003 2002 2003 2002
---- ---- ---- ----
Revenues, principally from
contracts . . . . . . . . . . . $ 29,368 $ 36,353 $ 55,830 $ 65,433
Costs and expenses of
contracts . . . . . . . . . . . 28,608 35,835 54,373 64,651
--------- --------- --------- ---------
Gross profit . . . . . . . . . . 760 518 1,457 782
Selling, general and
administrative expenses . . . 48 35 90 63
Interest (income) expense . . . (15) 29 (31) 46
--------- --------- --------- ---------
Income before income taxes . . . 727 454 1,398 673
Provision for income taxes . . . 291 180 530 280
--------- --------- --------- ---------
Net income . . . . . . . . . . . $ 436 $ 274 $ 868 $ 393
========= ========= ========= =========
Basic earnings per share:
Net income . . . . . . . . . . $ 0.20 $ 0.12 $ .40 $ .18
========= ========= ========= =========
Basic weighted average shares
outstanding 2,188,635 2,173,790 2,187,841 2,163,826
========= ========= ========= =========
Diluted earnings per share:
Net income . . . . . . . . . . $ 0.20 $ 0.12 $ .39 $ .18
========= ========= ========= =========
Diluted weighted average shares
outstanding 2,220,333 2,199,866 2,222,576 2,188,685
========= ========= ========= =========
The accompanying notes are an integral part of these financial statements.
-4-
VSE Corporation and Subsidiaries
Consolidated Financial Statements (Unaudited)
Consolidated Statements of Stockholders' Investment
- ----------------------------------------------------------------------------------
(in thousands except per share data)
Total
Common Stock Paid-In Retained Stockholders'
Shares Amount Surplus Earnings Investment
------ ------ ------- -------- ----------
Balance at
December 31, 2001 . . . . 2,150 $ 107 $ 3,294 $ 13,074 $ 16,475
Net income
for the year . . . . . . -- -- -- 652 652
Exercised stock options . . 33 2 213 -- 215
Tax benefit of
options exercised . . . . -- -- 22 -- 22
Issuance of stock . . . . . 3 -- 29 -- 29
Dividends declared
($.16) . . . . . . . . . -- -- -- (350) (350)
----- ------ ------- -------- --------
Balance at
December 31, 2002 . . . . 2,186 109 3,558 13,376 17,043
Net income
for the period . . . . . -- -- -- 868 868
Exercised stock options . . 3 -- 30 -- 30
Tax benefit of
options exercised . . . . -- -- 2 -- 2
Dividends declared
($.08) . . . . . . . . . -- -- -- (175) (175)
----- ------ ------- -------- --------
Balance at
June 30, 2003 . . . . . . 2,189 $ 109 $ 3,590 $ 14,069 $ 17,768
===== ====== ======= ======== ========
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 For the six months ended June 30,
- ------------------------------------------------------------------------------
(in thousands)
2003 2002
---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . $ 868 $ 393
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . 557 726
(Gain) loss on sale of property and equipment . . . . 5 9
Deferred taxes . . . . . . . . . . . . . . . . . . . 99 (271)
Tax benefit of options exercised . . . . . . . . . . 2 -
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable . . . . . . . . . . . . . . . . . 2,122 (5,053)
Other current assets and noncurrent assets . . . . . (641) 219
Increase (decrease) in:
Accounts payable . . . . . . . . . . . . . . . . . . 1,001 2,717
Accrued expenses . . . . . . . . . . . . . . . . . . (188) 334
------- -------
Net cash provided by (used in) operating
activities 3,825 (926)
------- -------
Cash flows from investing activities:
Purchase of property and equipment . . . . . . . . . . . (382) (245)
------- -------
Net cash used in investing activities (382) (245)
------- -------
Cash flows from financing activities:
Net proceeds from long-term bank loan . . . . . . . . . - 1,126
Dividends paid . . . . . . . . . . . . . . . . . . . . . (174) (174)
Proceeds from issuance of common stock . . . . . . . . . 30 257
------- -------
Net cash (used in) provided by financing activities (144) 1,209
------- -------
Net increase in cash and cash equivalents . . . . . . . . 3,299 38
Cash and cash equivalents at beginning of period . . . . 4,210 209
------- -------
Cash and cash equivalents at end of period . . . . . . . $ 7,509 $ 247
======= =======
The accompanying notes are an integral part of these financial statements.
-6-
VSE CORPORATION AND SUBSIDIARIES
CONDENSED 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, 2003 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2003. 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, 2002. 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.
Debt
VSE has a revolving loan agreement with a bank under which the company can
borrow up to $15 million, subject to a borrowing formula based on billed
receivables. Under the agreement, the company pays a fixed amount annual
commitment fee and interest on any borrowings at a prime-based rate or an
optional LIBOR-based rate. The current expiration date of the revolving loan
is May 31, 2005. The loan agreement contains 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. There were no amounts
borrowed under this loan agreement as of June 30, 2003 or December 31, 2002.
-7-
VSE CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Earnings Per Share
Basic earnings per share has been computed by dividing net income available to
common stockholders by the weighted average number of shares of common stock
outstanding during each period. Shares issued during the period are weighted for
the portion of the period that they were outstanding. 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.
Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of SFAS No. 123." This
statement amends SFAS No. 123, "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The company has chosen to
continue to account for stock-based compensation using the intrinsic value
method prescribed in APB Opinion No. 25 and related interpretations.
Accordingly, compensation expense for stock options is measured as the excess,
if any, of the fair market value of the company's stock at the date of the grant
over the exercise price of the related option. The company adopted the annual
disclosure provisions of SFAS No. 148 in its financial reports for the year
ended December 31, 2002 and the interim disclosure provisions for its financial
reports beginning the quarter ended March 31, 2003.
-8-
VSE CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Had compensation costs for the company's stock options been determined based on
SFAS No. 123, "Accounting for Stock-Based Compensation," the company's net
income and earnings per share would have been as follows (in thousands, except
per share amounts):
Three Months Six Months
Ended June 30, Ended June 30,
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported $ 436 $ 274 $ 868 $ 393
Deduct: Total stock-based
compensation expense
determined under fair value based
method (SFAS No. 123) for all
awards, net of related tax effects (17) (5) (41) (33)
----- ----- ----- -----
Pro forma net income $ 419 $ 269 $ 827 $ 360
===== ===== ===== =====
Earnings per share:
Basic as reported $0.20 $0.12 $0.40 $0.18
Diluted as reported $0.20 $0.12 $0.39 $0.18
Basic pro forma $0.19 $0.12 $0.38 $0.17
Diluted pro forma $0.19 $0.12 $0.37 $0.16
Litigation
The company 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.
-9-
VSE CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Company Organization and Overview
Company Organization
The term "VSE" or "company" refers to VSE and its subsidiaries and divisions
unless the context indicates operations of the parent company only. VSE's
business operations consist primarily of services performed by the company's
wholly owned subsidiaries and unincorporated divisions. Active subsidiaries in
2003 include Energetics, Incorporated ("Energetics"), and Human Resource
Systems, Inc. ("HRSI"). Active divisions include BAV Division ("BAV"),
Coast Guard Division ("VCG") beginning in February 2002, Communications and
Engineering Division ("CED") beginning in February 2003, Fleet Maintenance
Division ("Fleet Maintenance"), Management Sciences Division ("MSD"), Systems
Engineering Division ("Systems Engineering", formerly Land Systems Division),
Telecommunications Technologies Division ("TTD"), and Value Systems Services
Division ("VSS"). In February 2003, VSE began phasing out the operations of TTD
and transferred some of its technical capabilities to other VSE divisions. As of
June 30, 2003, the sole HRSI contract had expired and HRSI's work was continued
on a new contract in another VSE division.
The company uses multiple operating divisions to bid on and perform contract
work. The use of these divisions enables the company to use an operating
structure that is flexible and well suited to perform certain types of contract
work. The company anticipates that it will continue using its operating
divisions to bid and perform new contract work to serve the needs of customers.
Management believes that this strategy will position the consolidated entity for
future revenue growth.
Overview of 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 services rendered by the company is the U.S. Department of
Defense ("Defense"), including agencies of the U.S. Army, Navy, and Air Force.
BAV is a major provider of logistics, training, and technical assistance in
support of the Navy's ship transfer program. VCG provides similar services to
the U.S. Coast Guard. Fleet Maintenance and VSS also support the Navy by
providing a variety of services including ship installation efforts, combat
systems inspections, ship repair and overhaul availability planning, harpoon
weapons management, ordnance alteration, air combat logistics, and outsourcing
decision assistance. Systems Engineering provides the Army with 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 and other
-10-
government agencies and commercial organizations with quality training services
for product, process, and management optimization.
The company has also provided support services to the U.S. Postal Service for
over twenty years and is continuing to support this customer through its VSS
Division. Energetics is focused on providing the Department of Energy and other
government and industry customers with expert consulting services in
environmental management and energy supply, resource management, and
conservation. TTD has offered products, services, and support in network,
multimedia, and audio-visual technology. This includes design, installation,
management and support for voice, data, multimedia and related projects. VSE
will transfer many of the technical capabilities of TTD to other divisions when
TTD operations cease.
Substantially all of the company's services are performed for its customers on
a contract basis and revenue is recorded as services are performed. 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. 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. Revenues on certain
fixed-price services contracts are recorded as services are provided. Revenues
on other fixed-price contracts are recorded as costs are incurred, using the
percentage-of-completion method of accounting. Profits on fixed-price contracts
result from the difference between the incurred costs and the revenue earned.
The company has a contract in its BAV Division for which contract terms specify
award fee payments to BAV 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 contract modification authorizing the award fee is issued.
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.
The company will occasionally perform work at risk, which is work that is
performed prior to formalizing terms for such work. Potential 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 and the work is performed. As of June 30,
2003, VSE has recognized approximately $507 thousand in risk funding. The
company provides for anticipated losses on contracts by a charge to income
during the period in which losses are first identified.
VSE's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require
-11-
us to make estimates and assumptions. In addition to our revenue recognition
policy, discussed under "Overview of Services" above, we believe the following
critical accounting polices affect our more significant judgments, estimates
and assumptions used in the preparation of our consolidated financial state-
ments.
Long-Lived Assets
In assessing the recoverability of long-lived assets, including goodwill and
other intangibles, we make assumptions regarding estimated future cash flows and
other factors to determine the fair value of the respective assets. If the
estimates and related assumptions change in the future, we may be required to
record impairment charges to write-down the carrying value of these assets.
Contingencies
From time to time we are subject to proceedings, lawsuits, and other claims
related to environmental, labor, and other matters. We are required to assess
the likelihood of any adverse judgments or outcomes to these contingencies as
well as potential ranges of probable losses and establish reserves accordingly.
The amount of reserves required may change in future periods due to new
developments in each matter or changes in approach to a matter such as a change
in settlement strategy.
Income Taxes
The carrying value of our net deferred tax assets is based on assumptions
regarding our ability to generate sufficient future taxable income to utilize
these deferred tax assets. If the estimates and related assumptions regarding
our future taxable income change in the future, we may be required to record
valuation allowances against our 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, and the changes in these items for the three and
six month periods ended June 30, 2003 and 2002 (in thousands):
2003
Compared
to
2002
Three Months Six Months ----
Ended June 30, Ended June 30, Three Six
2003 2002 2003 2002 Months Months
---- ---- ---- ---- ------ ------
Revenues . . . . . . . $29,368 $36,353 $55,830 $65,433 $(6,985) $(9,603)
======= ======= ======= ======= ======= =======
Income before income
taxes . . . . . . . $ 727 $ 454 $ 1,398 $ 673 $ 273 $ 725
Provision for income
taxes . . . . . . . 291 180 530 280 111 250
------- ------- ------- ------- ------- -------
Net income . . . . . $ 436 $ 274 $ 868 $ 393 $ 162 $ 475
======= ======= ======= ======= ======= =======
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Revenues declined by approximately 19% and 15% for the three and six month
periods ended June 30, 2003, as compared to the same periods of 2002. The
primary reasons for the decrease in revenues were 1) a reduction in BAV
revenue due to work ordered by certain client countries in 2002 that was not
repeated in 2003, 2) a reduction in Fleet Maintenance revenue due to a decrease
in the amount of subcontract work in 2003 as compared to 2002, and 3) reduced
revenue associated with the decision to phase out the operations of TTD.
Revenues also declined for Energetics, HRSI, and VSS. The revenues of Systems
Engineering, MSD, and VCG increased for the period. While the increased revenues
in these divisions were not significant in proportion to total company revenues,
the increases in MSD and VCG were significant in proportion to the prior year
revenues of these two divisions.
Pretax income increased by approximately 60% and 108% for the three and six
month periods ended June 30, 2003, as compared to the same periods of 2002. The
increase in pre-tax income for the three month period was primarily due to a
reduction in the losses associated with TTD work. The increase in pre-tax income
for the six month period was primarily due to a reduction in the losses
associated with TTD and Fleet Maintenance work and to improved profitability in
MSD. The company-wide pretax income increases were partially offset by
operational costs associated with CED and by profit reductions associated with
the decline in revenues.
BAV Contract. VSE's BAV Division has a contract with the U.S. Navy to provide
engineering, technical and logistical support services associated with the sale,
lease, or other transfer of Navy ships to foreign governments. This contract is
a ten-year contract awarded in 1995, and it has the potential to generate total
revenues of over one billion dollars from 1995 through 2005. BAV has recognized
revenues on this contract of approximately $490 million through June 30, 2003,
resulting in a backlog of potential future revenues of approximately $570
million. The amount of this backlog that was funded at June 30, 2003 was
approximately $35 million. The contract accounted for approximately 53% and 49%
of consolidated revenues from operations during the six months ended June 30,
2003 and 2002, respectively. The level of revenues and associated profits
resulting from fee income generated by this contract 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 significant variations primarily due to changes in
the level of activity on this contract. See "Global Economic Conditions and
Political Factors" below for further discussion of potential impacts on future
revenues associated with this contract. Contract terms specify award fee
payments to BAV 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 contract modification authorizing the award fee is issued. As
of June 30, 2003, award fee has been recognized for work performed through the
award fee period ending April 30, 2003. Due to such timing, and to fluctuations
in the level of revenues, profits as a percentage of revenues will fluctuate
from period to period.
-13-
Business Terminations and New Business Start-ups. In February 2003, VSE decided
to terminate operations of TTD due to declining revenues and significant losses
sustained by this division. In 2002, TTD experienced a revenue decline of
approximately 26% and a pretax loss of approximately $2.1 million, including a
loss associated with the impairment of intangible assets of $576 thousand. TTD
will continue work on uncompleted contracts until all contractual obligations
are satisfied, expected to be in 2003 or 2004. Some of TTD's technical
capabilities will be transferred to other VSE divisions. Revenues from TTD
represented approximately 2% and 6% of total company revenues during the six
months ended June 30, 2003 and 2002, respectively. The loss of future revenue
associated with the termination of TTD operations is not expected to be
significant compared to total future VSE revenue, while the elimination of TTD
losses is expected to improve future VSE profits.
In January 2003, VSE formed its Communications and Engineering Division (CED)
upon the award of a multi-year Rapid Response support contract by the U.S. Army
Communications-Electronics Command (CECOM). Although this contract has a
potential total ceiling of $2.9 billion over an eight-year period if all options
are exercised, it is a multiple award, indefinite delivery, indefinite quantity
contract. Accordingly, while the contract is expected to contribute future
revenue growth, actual revenue estimates cannot be predicted and are unlikely to
approach the ceiling amount.
In February 2002, VCG began work for the U.S. Coast Guard under a contract that
has potential to generate total revenues of approximately $25.4 million over
five years. During the six months ended June 30, 2003 and 2002, revenues from
VCG accounted for approximately 4% and 1%, respectively, of total company
revenues. While this contract is not expected to significantly increase total
company revenues, the potential for higher profit margins on this fixed price
work is expected to contribute to an increase in the company's overall profit
margins.
Government Procurement Policies and Practices
VSE's business is subject to the risks arising from domestic 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.
Company revenues depend on the ability of the company 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/multiple award") 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, increases in
the level of competition due to the award of fewer contracts, and forcing the
company into competition with larger organizations
-14-
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.
Generally, fees earned and profit margins on revenues that are derived from
non-labor items such as materials, travel costs, and subcontracted services
used to satisfy contract requirements, if any, are significantly lower than fees
and profits on labor generated revenues. While the use of subcontractor teams on
a large scale basis allows the company to compete for larger contracts, profit
margins on this work tends to be lower than on work performed by company
personnel, thereby reducing the company's overall profit margins. Additionally,
reliance on subcontractors can introduce risk of performance issues different
from performance risk on the company's labor generated revenues.
Other government procurement practices that can affect the company's revenues
are the use of past performance criteria that may preclude entrance into new
government markets and 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.
Risk funding revenue recognized for the six months ended June 30, 2003, is $507
thousand. Risk funding revenue represents certain costs for work performed at
risk which are not reimbursable under current contracts. VSE believes that it
will receive formal contractual coverage through execution of contract
documentation or amendments increasing funding for all of this risk funding
revenue. If formal contractual coverage is not received, VSE is at risk of loss
for any risk funding coverage not received.
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 contract could affect sales. The current
international situation posed by potential terrorist activity and the continuing
conflict in the Middle East could increase the political risks associated with
BAV contract revenues. Failure by the government of a potential foreign customer
to approve and fund acquisition of U.S. Navy ships serviced under the BAV
contract could affect sales. In any one year, a significant amount of the
company's revenues may result from sales on the BAV contract to a single foreign
government. During the six months ended June 30, 2003 and 2002, revenues
associated with BAV contract sales to Egypt accounted for approximately 37% and
28% of the company's revenues, respectively. In addition to the effect on BAV
contract work, international tensions can also affect work by Fleet Maintenance
on U.S. Navy ships when deployed outside of U.S. Navy facilities and are
unavailable for maintenance work during this time period. Severe adverse results
arising from these global economic and political risks could potentially have a
material adverse impact on the company's results of operations.
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Financial Condition
VSE's financial condition did not change materially during the six months ended
June 30, 2003. The company's largest asset is its accounts receivable and its
largest liabilities are its accounts payable and accrued expenses. Accounts
receivable decreased at June 30, 2003, as compared to December 31, 2002, while
accounts payable and cash increased due to normal fluctuations in the timing of
receivables collections and vendor payments activity. Other assets and
liabilities remained substantially unchanged. The increase in total
stockholders' investment during this period resulted primarily from earnings and
from the exercise of stock options, offset by dividends declared.
Liquidity and Capital Resources
Cash Flows
2003. Cash and cash equivalents increased by approximately $3.3 million during
the six months ended June 30, 2003. The increase in cash and cash equivalents
during this period resulted from cash provided by operating activities of
approximately $3.8 million, cash used in investing activities of approximately
$382 thousand, and cash used in financing activities of approximately $144
thousand. Investing activities consisted of purchases of property and equipment,
net of dispositions. Financing activities consisted of dividend payments and
proceeds received from the issuance of common stock.
2002. Cash and cash equivalents increased by approximately $38 thousand during
the six month period ended June 30, 2002. The increase in cash and cash
equivalents during this period resulted from cash provided by financing
activities of approximately $1.2 million, cash used in operating activities of
approximately $926 thousand, and cash used in investing activities of
approximately $245 thousand. Significant financing activities included an
increase of approximately $1.1 million in bank loan borrowings. Investing
activities consisted of purchases of property and equipment, net of
dispositions.
The difference between cash provided by operating activities of approximately
$3.8 million in 2003 as compared to approximately $926 thousand used in
operating activities in 2002 is primarily due to changes in the levels of
accounts receivable and accounts payable resulting from fluctuations in contract
activity and receivables collections and to an increase in net income.
Quarterly cash dividends at the rate of $.04 per share were declared during the
six months ended June 30, 2003. Under its bank loan agreement, VSE's payment of
cash dividends is subject to a maximum annual rate. VSE has paid cash dividends
each year since 1973.
Sources of 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
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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 generally do not present collection problems. Accounts
receivable levels can also be affected by contract retainages, differences
between the provisional billing rates authorized by the government compared to
the costs actually incurred by the company, government delays in processing
administrative paperwork for contract funding, and the timing of large materials
purchases and subcontractor efforts used in performance on company's
contracts. Accounts payable arise primarily from purchases of subcontractor
services and materials used by the company in the performance of its contract
work. 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. A decrease in accounts receivable associated with the timing of
receivables collections in several divisions, including BAV, contributed to an
increase in internally generated cash flows during this period. Internal
liquidity is also affected by the acquisition of capital assets for office and
computer support, facilities improvements, and by the payment of cash dividends.
Purchases of capital assets for office and computer support and facilities
improvements during the six months ended June 30, 2003 did not substantially
affect internal liquidity.
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 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,
2003. While performance of work under the BAV contract has the potential to
cause substantial requirements for working capital, the company has determined
that cash flows from future operations and the $15 million bank commitment are
adequate to cover current and future liquidity requirements.
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 and furniture and fixtures. The overall impact of
inflation on replacement costs of such property and equipment is expected to
be insignificant.
Goodwill
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS No. 142"). SFAS No. 142 modifies the accounting rules governing
goodwill and intangible assets with indefinite lives. Under SFAS No. 142,
goodwill is no longer subject to amortization over its estimated useful life and
intangible assets with indefinite lives are no longer amortized over an
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arbitrary number of years. Goodwill and intangible assets with indefinite
lives are instead subject to a review for impairment at least annually. The
effective date for VSE's implementation of SFAS No. 142 was January 1, 2002.
As of June 30, 2003, the company had approximately $1.1 million of unamortized
goodwill associated with its acquisition of Energetics in 1995. The goodwill was
being amortized prior to the adoption of SFAS No. 142. In 2002, the company
stopped amortizing the goodwill. As of June 30, 2003, the company has not
recognized any reduction to the goodwill due to the impairment rules associated
with SFAS No. 142. 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.
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 changes
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 arrange-
ment, future interest rate changes could potentially have such 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 to BAV 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 virtually non-existent. Accordingly, the company does not
believe that it is exposed to any material foreign currency risk.
Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of SFAS No. 123." This
statement amends SFAS No. 123, "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The company has chosen to
continue to account for stock-based compensation using the intrinsic value
method prescribed in APB Opinion No. 25 and related interpretations.
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Accordingly, compensation expense for stock options is measured as the excess,
if any, of the fair market value of the company's stock at the date of the
grant over the exercise price of the related option. The company adopted the
annual disclosure provisions of SFAS No. 148 in its financial reports for the
year ended December 31, 2002 and the interim disclosure provisions for its
financial reports beginning the quarter ended March 31, 2003.
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VSE CORPORATION AND SUBSIDIARIES
Item 3. Quantitative and Qualitative Disclosures About Market Risks
Inapplicable
Item 4. Controls and Procedures
Based on their most recent evaluation, which was completed within 90 days of the
filing of this Form 10-Q, the company's Chief Executive Officer and Chief
Financial Officer believe the company's disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) are effective to ensure that
information required to be disclosed by the company's management, including its
principal executive officer and principal financial officer, as appropriate, to
allow timely decisions regarding required disclosure. There were no significant
changes in the company's internal control over financial reporting or other
factors that could significantly affect these controls subsequent to the date of
their evaluation and there were no corrective actions with regard to significant
deficiencies and material weaknesses.
PART II. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
None.
(b) Reports on Form 8-K.
On April 29, 2003, the Registrant filed a Current Report on Form 8-K to announce
the financial results of the first quarter 2003.
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
/s/ D. M. Ervine
Date: July 29, 2003 _____________________________________
D. M. Ervine
Chairman, President,
Chief Executive Officer and
Chief Operating Officer
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