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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 September 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 October 28, 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
Consolidated Balance Sheets
- ---------------------------------------------------------------------------------
(in thousands except share and per share amounts)
September 30, December 31,
2003 2002
---- ----
(Unaudited)
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . . $ 8,062 $ 4,210
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . . 20,055 17,524
Deferred tax assets . . . . . . . . . . . . . . . 1,288 1,313
Other current assets . . . . . . . . . . . . . . . 1,537 1,241
-------- --------
Total current assets . . . . . . . . . . . . . . 30,942 24,288
Property and equipment, net . . . . . . . . . . . . 3,142 3,483
Deferred tax assets . . . . . . . . . . . . . . . . 290 449
Intangible assets, net . . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . . 2,451 2,403
-------- --------
Total assets . . . . . . . . . . . . . . . . . . $ 37,879 $ 31,677
======== ========
Liabilities and Stockholders' Investment
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . $ 13,482 $ 8,785
Accrued expenses . . . . . . . . . . . . . . . . 4,965 4,654
Dividends payable . . . . . . . . . . . . . . . . 0 87
-------- --------
Total current liabilities . . . . . . . . . . . 18,447 13,526
Deferred compensation . . . . . . . . . . . . . . . 1,141 1,108
-------- --------
Total liabilities . . . . . . . . . . . . . . . 19,588 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 . . . . . . . . . . . . . . . . 14,592 13,376
Total stockholders' investment . . . . . . . . . 18,291 17,043
-------- --------
Total liabilities and stockholders' investment . $ 37,879 $ 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 nine months ended September 30,
- -----------------------------------------------------------------------------------
(in thousands except per share amounts)
Three Months Nine Months
2003 2002 2003 2002
---- ---- ---- ----
Revenues, principally from
contracts . . . . . . . . . . . $ 36,391 $ 37,836 $ 92,221 $ 103,269
Costs and expenses of
contracts . . . . . . . . . . . 35,482 37,352 89,855 102,003
--------- --------- --------- ---------
Gross profit . . . . . . . . . . 909 484 2,366 1,266
Selling, general and
administrative expenses . . . 68 59 158 122
Interest (income) expense, net . (18) (3) (49) 43
--------- --------- --------- ---------
Income before income taxes . . . 859 428 2,257 1,101
Provision for income taxes . . . 336 171 866 451
--------- --------- --------- ---------
Net income . . . . . . . . . . . $ 523 $ 257 $ 1,391 $ 650
========= ========= ========= =========
Basic earnings per share:
Net income . . . . . . . . . . $ 0.24 $ 0.12 $ 0.64 $ 0.30
========= ========= ========= =========
Basic weighted average shares
outstanding 2,188,635 2,181,540 2,188,108 2,169,140
========= ========= ========= =========
Diluted earnings per share:
Net income . . . . . . . . . . $ 0.23 $ 0.12 $ 0.62 $ 0.30
========= ========= ========= =========
Diluted weighted average shares
outstanding 2,235,779 2,204,803 2,227,026 2,192,599
========= ========= ========= =========
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
($.16) . . . . . . . . . -- -- -- (350) (350)
----- ------ ------- -------- --------
Balance at
December 31, 2002 . . . . 2,186 109 3,558 13,376 17,043
Net income
for the period . . . . . -- -- -- 1,391 1,391
Exercised stock options . . 3 -- 30 -- 30
Tax benefit of
options exercised . . . . -- -- 2 -- 2
Dividends declared
($.08) . . . . . . . . . -- -- -- (175) (175)
----- ------ ------- -------- --------
Balance at
September 30, 2003 . . . 2,189 $ 109 $ 3,590 $ 14,592 $ 18,291
===== ====== ======= ======== ========
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 nine months ended September 30,
- -------------------------------------------------------------------------------
(in thousands)
2003 2002
---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . $ 1,391 $ 650
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . 866 998
Loss on sale of property and equipment . . . . . . . 5 8
Deferred taxes . . . . . . . . . . . . . . . . . . . 184 (6)
Tax benefit of options exercised . . . . . . . . . . 2 21
Change in operating assets and liabilities:
Increase in:
Accounts receivable . . . . . . . . . . . . . . . . . (2,531) (54)
Other current assets and noncurrent assets . . . . . (389) (34)
Increase in:
Accounts payable and deferred compensation . . . . . 4,775 2,575
Accrued expenses . . . . . . . . . . . . . . . . . . 311 446
------- -------
Net cash provided by operating activities 4,614 4,604
------- -------
Cash flows from investing activities:
Purchase of property and equipment . . . . . . . . . . . (530) (347)
------- -------
Net cash used in investing activities (530) (347)
------- -------
Cash flows from financing activities:
Net payments of long-term bank loan . . . . . . . . . . - (351)
Dividends paid . . . . . . . . . . . . . . . . . . . . . (262) (261)
Proceeds from issuance of common stock . . . . . . . . . 30 201
------- -------
Net cash used in financing activities (232) (411)
------- -------
Net increase in cash and cash equivalents . . . . . . . . 3,852 3,846
Cash and cash equivalents at beginning of period . . . . 4,210 209
------- -------
Cash and cash equivalents at end of period . . . . . . . $ 8,062 $ 4,055
======= =======
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 nine months ended September 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 generally accepted
accounting principles 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 September 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 for the three and nine
months ended September 30, 2003 and 2002, respectively (in thousands, except per
share amounts):
Three Months Nine Months
Ended September 30, Ended September 30,
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported $ 523 $ 257 $1,391 $ 650
Deduct: Total stock-based
compensation expense
determined under fair value based
method (SFAS No. 123) for all
awards, net of related tax effects (21) (22) (62) (54)
------ ------ ------ ------
Pro forma net income $ 502 $ 235 $1,329 $ 596
====== ====== ====== ======
Earnings per share:
Basic as reported $ 0.24 $ 0.12 $ 0.64 $ 0.30
Diluted as reported $ 0.23 $ 0.12 $ 0.62 $ 0.30
Basic pro forma $ 0.23 $ 0.11 $ 0.61 $ 0.27
Diluted pro forma $ 0.22 $ 0.11 $ 0.60 $ 0.27
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-
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. The
sole HRSI contract expired on May 31, 2003 and this 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 government agencies and commercial organizations
with quality training services for product, process, and management optimiza-
tion. CED provides
-10-
management oversight and coordinates support efforts for a variety of Department
of Defense agency work orders.
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
has transferred many of the technical capabilities of TTD to Systems Engineering
and other divisions, which continue to perform some of this type of work.
Critical Accounting Policies
VSE's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require us
to make estimates and assumptions. We believe the following critical accounting
polices affect our more significant judgments, estimates and assumptions used
in the preparation of our consolidated financial statements.
Revenue Recognition
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.
Award fee income for this contract has typically been recognized in the first,
second and fourth quarters of each year.
-11-
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 September 30,
2003, VSE has recognized approximately $445 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.
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.
-12-
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
nine month periods ended September 30, 2003 and 2002 (in thousands):
2003
Compared
to
2002
Three Months Nine Months -----------------
Ended September 30, Ended September 30, Three Nine
2003 2002 2003 2002 Months Months
---- ---- ---- ---- ------ ------
Revenues . . . . . . $36,391 $37,836 $ 92,221 $103,269 $(1,445) $(11,048)
======= ======= ======== ======== ======= ========
Income before income
taxes . . . . . . $ 859 $ 428 $ 2,257 $ 1,101 $ 431 $ 1,156
Provision for income
taxes . . . . . . 336 171 866 451 165 415
------- ------- -------- -------- ------- --------
Net income . . . . $ 523 $ 257 $ 1,391 $ 650 $ 266 $ 741
======= ======= ======== ======== ======= ========
Revenues declined by approximately 4% and 11% for the three- and nine- month
periods ended September 30, 2003, as compared to the same periods of 2002. The
primary reasons for the decrease in revenues for the three-month period were a
reduction in BAV revenue due to work ordered by certain client countries in 2002
that was not repeated in 2003 and reduced revenue associated with the decision
to phase out the operations of TTD. Revenues also declined for HRSI and VSS. The
declines in revenues of the previously mentioned divisions were partially offset
by the revenues generated by the start up of CED and an increase in the revenues
of Energetics, Systems Engineering, MSD, and VCG compared to the prior year
three-month period. While the increased revenues in these divisions were not
significant in proportion to total company revenues, the increases in Systems
Engineering, MSD, and VCG were significant in proportion to the prior year
revenues of these divisions.
The primary reasons for the decrease in revenues for the nine-month period 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 declines in
revenues of the previously mentioned divisions were partially offset by the
revenues generated by the start up of CED and an increase in the revenues of
Systems Engineering, MSD, and VCG compared to the prior year nine-month period.
While the increased revenues in Systems Engineering, MSD, and VCG were not
significant in proportion to total company revenues, the increases were
significant in proportion to the prior year revenues of each of these divisions.
Pretax income increased by approximately 101% and 105% for the three- and nine-
month periods ended September 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
revenue and profit increases in Systems Engineering, MSD and VCG,
-13-
increased profitability on Fleet Maintenance work, and a reduction in the losses
associated with TTD work. These same factors, along with a reduction in losses
on certain Fleet Maintenance work during the first two quarters of 2003, were
the primary reasons for the increase in profits during the nine month period.
The company-wide pretax income increases were partially offset by operational
and start up losses associated with CED, including pre-tax losses of
approximately $167 thousand recognized in this third quarter due to accounting
rules requiring the accrual of certain contract losses anticipated in the fourth
quarter of 2003.
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 $505 million through September 30,
2003, resulting in a backlog of potential future revenues of approximately $555
million. The amount of this backlog that was funded at September 30, 2003 was
approximately $39 million. The contract accounted for approximately 48% and 54%
of consolidated revenues from operations during the nine months ended
September 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 September 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. Award fee income for this contract has
typically been recognized in the first, second and fourth quarters of each year.
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 complete all work orders and satisfy all contractual obligations prior to
ceasing operations as a VSE division, which is expected to occur in early 2004.
Some of TTD's technical capabilities have been transferred to other VSE
divisions. Revenues from TTD represented approximately 1% and 5% of total
company revenues during the nine months ended September 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
-14-
losses is expected to improve overall company profitability in the current and
future years as compared to 2002.
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). This is a multiple award, indefinite
delivery, indefinite quantity contract with a potential total ceiling of $2.9
billion over an eight-year period if all options are exercised. While the
contract is expected to contribute future revenue growth, actual revenues are
likely to occur in large unpredictable increments, and total revenues from the
contract are unlikely to approach the ceiling amount. The contract requires VSE
to seek out prospective work orders that can be performed for the customer. This
requires VSE to incur some front end marketing costs and to incur ongoing
administrative costs to manage the division. These costs have caused losses at
the division level for CED, particularly upon the start up of the contract.
Revenues generated to date and expected future revenues from this contract will
absorb fixed corporate costs, which in turn is expected to result in revenue and
profit increases for VSE on a company wide basis. Revenue from this contract
accounted for approximately 17% and 7% of total revenues during the three-month
and nine-month periods ended September 30, 2003, respectively.
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 nine months ended September 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 that have greater financial
resources and larger technical staffs. Competing for these contracts requires
the company to use teams of subcontractors to be
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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 accrued at September 30, 2003, is $445 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 nine months ended September 30, 2003 and 2002, revenues
associated with BAV contract sales to Egypt accounted for approximately 35% and
27% 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 nine months ended
September 30, 2003. The company's largest assets are its cash and accounts
receivable and its largest liabilities are its accounts payable and accrued
expenses. Cash, accounts receivable, and accounts payable increased at September
30, 2003, as compared to December 31, 2002, due to normal fluctuations in the
timing of receivables collections and vendor payments activity. Earnings also
contributed to increases in cash balances. 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
Cash and cash equivalents increased by approximately $3.9 million during the
nine months ended September 30, 2003. The increase in cash and cash equivalents
during this period resulted from cash provided by operating activities of
approximately $4.6 million, cash used in investing activities of approximately
$530 thousand, and cash used in financing activities of approximately $232
thousand. Investing activities consisted of purchases of property and equipment.
Financing activities consisted of dividend payments and proceeds received from
the issuance of common stock.
Cash and cash equivalents increased by approximately $3.8 million during the
nine-month period ended September 30, 2002. The increase in cash and cash
equivalents during this period resulted from cash provided by operating
activities of approximately $4.6 million, cash used in financing activities of
approximately $410 thousand, and cash used in investing activities of
approximately $347 thousand. Financing activities consisted of a decrease of
approximately $351 thousand in bank loan borrowings, dividends paid of
approximately $261 thousand, and proceeds from the issuance of common stock of
approximately $201 thousand. Investing activities consisted of purchases of
property and equipment, net of dispositions.
Cash provided by operating activities of approximately $4.6 million in both 2003
and 2002 resulted from earnings and changes in the levels of accounts receivable
and accounts payable due to fluctuations in contract activity and receivables
collections.
Quarterly cash dividends at the rate of $.04 per share were paid in February,
May and August of 2003. In October 2003, a dividend was declared of $.04 per
share, payable in November 2003. The dividend paid in November 2002 was
declared prior to September 30, 2002. 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. Changes in accounts payable and
accounts receivable 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 nine months ended
September 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
September 30, 2003. While performance of work under the BAV and CED contracts
have 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 September 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 September 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
arrangement, 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
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
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 1. Legal Proceedings
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.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
None.
(b) Reports on Form 8-K.
On September 18, 2003 the Registrant filed a Current Report on Form 8-K to
report the text of notice to directors and executive officers dated
September 15, 2003, regarding temporary suspension of trading in the
Registrant's common stock during the Blackout Period from October 28, 2003,
through November 21, 2003, related to conversion of recordkeeping trust and
investment services of the Registrant's employee retirement benefit plan.
On July 31, 2003, the Registrant filed a Current Report on Form 8-K to announce
the financial results of the second 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: October 28, 2003 _____________________________________
D. M. Ervine
Chairman and CEO,
President and COO
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