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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 March 31, 2004 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 is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [x]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [x] No [ ]
Number of shares of Common Stock outstanding as of April 27, 2004: 2,218,886.
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 of Financial
Condition and Results of Operations" and "Notes to Consolidated Financial
Statements" contained in VSE's Annual Report and Form 10-K for the fiscal year
ended December 31, 2003 (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 and other Quarterly Reports on Form 10-Q to be filed
by the Company subsequent to its Annual Report on Form 10-K and any Current
Reports on Form 8-K filed by the Company.
-2-
PART I. Financial Information
Item 1. Financial Statements
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Balance Sheets
- -------------------------------------------------------------------------------
(in thousands except share and per share amounts)
March 31, December 31,
2004 2003
---- ----
(Unaudited)
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . . $ 10,233 $ 9,843
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . . 24,232 21,835
Deferred tax assets . . . . . . . . . . . . . . . 943 819
Other current assets . . . . . . . . . . . . . . . 1,396 1,379
-------- --------
Total current assets . . . . . . . . . . . . . . 36,804 33,876
Property and equipment, net . . . . . . . . . . . . 3,566 3,038
Deferred tax assets . . . . . . . . . . . . . . . . 254 297
Intangible assets, net . . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . . 2,602 2,511
-------- --------
Total assets . . . . . . . . . . . . . . . . . . $ 44,280 $ 40,776
======== ========
Liabilities and Stockholders' Investment
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . $ 17,704 $ 14,634
Accrued expenses . . . . . . . . . . . . . . . . 5,479 5,760
Dividends payable . . . . . . . . . . . . . . . . 89 88
-------- --------
Total current liabilities . . . . . . . . . . . 23,272 20,482
Deferred compensation . . . . . . . . . . . . . . . 1,276 1,236
-------- --------
Total liabilities . . . . . . . . . . . . . . . 24,548 21,718
-------- --------
Commitments and contingencies
Stockholders' investment:
Common stock, par value $.05 per share, authorized
5,000,000 shares; issued 2,218,886 in 2004 and
2,214,136 shares in 2003 . . . . . . . . . . . . 111 110
Paid-in surplus . . . . . . . . . . . . . . . . . 3,980 3,928
Deferred stock-based compensation . . . . . . . . (15) (17)
Retained earnings . . . . . . . . . . . . . . . . 15,656 15,037
-------- --------
Total stockholders' investment . . . . . . . . . 19,732 19,058
-------- --------
Total liabilities and stockholders' investment . $ 44,280 $ 40,776
======== ========
The accompanying notes are an integral part of these financial statements.
-3-
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Income (Unaudited)
- ------------------------------------------------------------------------------
(in thousands except share and per share amounts)
For the three months
ended March 31,
2004 2003
---- ----
Revenues, principally from contracts . . . . . . . . $ 42,610 $ 26,462
Costs and expenses of contracts . . . . . . . . . . 41,463 25,765
--------- ---------
Gross profit . . . . . . . . . . . . . . . . . . . . 1,147 697
Selling, general and administrative expenses . . . . 12 42
Interest income, net . . . . . . . . . . . . . . . . (19) (16)
--------- ---------
Income before income taxes . . . . . . . . . . . . . 1,154 671
Provision for income taxes . . . . . . . . . . . . . 446 239
--------- ---------
Net income . . . . . . . . . . . . . . . . . . . . . $ 708 $ 432
========= =========
Basic earnings per share:
Net income . . . . . . . . . . . . . . . . . . . . . $ 0.32 $ 0.20
========= =========
Basic weighted average shares outstanding 2,216,216 2,187,038
========= =========
Diluted earnings per share:
Net income . . . . . . . . . . . . . . . . . . . . . $ 0.31 $ 0.19
========= =========
Diluted weighted average shares outstanding 2,286,613 2,224,845
========= =========
The accompanying notes are an integral part of these financial statements.
-4-
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Stockholders' Investment (Unaudited)
- ------------------------------------------------------------------------------------------
(in thousands except per share data)
Deferred Total
Common Stock Paid-In Stock-based Retained Stockholders'
Shares Amount Surplus Compensation Earnings Investment
------ ------ ------- ------------ -------- ----------
Balance at
December 31, 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 year - - - - 2,011 2,011
Exercised stock options 25 1 270 - - 271
Tax benefit of options
exercised - - 14 - - 14
Deferred stock-based
compensation - - 42 (42) - -
Amortization of deferred
stock-based compensation - - - 25 - 25
Issuance of stock 3 - 44 - - 44
Dividends declared ($.16) - - - - (350) (350)
----- ----- ------- ----- ------- -------
Balance at
December 31, 2003 2,214 110 3,928 (17) 15,037 19,058
Net income for the period - - - - 708 708
Exercised stock options 5 1 36 - - 37
Tax benefit of options
exercised - - 14 - - 14
Deferred stock-based
compensation - - 2 (2) - -
Amortization of deferred
stock-based compensation - - - 4 - 4
Dividends declared ($.04) - - - - (89) (89)
----- ----- ------- ----- ------- -------
Balance at
March 31, 2004 2,219 $ 111 $ 3,980 $ (15) $15,656 $19,732
===== ===== ======= ===== ======= =======
The accompanying notes are an integral part of these financial statements.
-5-
VSE Corporation and Subsidiaries
Consolidated Financial Statements (Unaudited)
Consolidated Statements of Cash Flows
- -------------------------------------------------------------------------------
(in thousands)
For the three months
ended March 31,
2004 2003
---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . $ 708 $ 432
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . 262 278
Loss on sale of property and equipment . . . . . . . - 4
Deferred taxes . . . . . . . . . . . . . . . . . . . (81) (68)
Tax benefit of options exercised . . . . . . . . . . 14 2
Amortization of deferred stock-based compensation . . 4 -
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable . . . . . . . . . . . . . . . . . (2,397) (885)
Other current assets and noncurrent assets . . . . . (108) (406)
Increase (decrease) in:
Accounts payable and deferred compensation . . . . . 3,110 (961)
Accrued expenses . . . . . . . . . . . . . . . . . . (281) (391)
------- -------
Net cash provided by (used in) operating activities 1,231 (1,995)
------- -------
Cash flows from investing activities:
Purchase of property and equipment . . . . . . . . . . . (790) (138)
------- -------
Net cash used in investing activities (790) (138)
------- -------
Cash flows from financing activities:
Dividends paid . . . . . . . . . . . . . . . . . . . . . (88) (87)
Proceeds from issuance of common stock . . . . . . . . . 37 30
------- -------
Net cash used in financing activities (51) (57)
------- -------
Net increase (decrease) in cash and cash equivalents . . . 390 (2,190)
Cash and cash equivalents at beginning of period . . . . 9,843 4,210
------- -------
Cash and cash equivalents at end of period . . . . . . . $10,233 $ 2,020
======= =======
The accompanying notes are an integral part of these financial statements.
-6-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three months ended March 31, 2004 are not necessarily indicative
of the results that may be expected for the year ending December 31, 2004. 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, 2003. The Company operates within one reportable segment.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Significant
estimates affecting the financial statements include the allowance for doubtful
accounts and accruals for loss contracts, contract disallowance and self insured
health claims.
Debt
VSE has a revolving loan agreement with a bank under which the Company can
borrow up to $15 million, subject to certain conditions, including a borrowing
formula based on billed receivables. Under the loan agreement, the Company pays
a fixed annual commitment fee and interest on any borrowings at a prime-based
rate or an optional LIBOR-based rate. The 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 March 31, 2004 or December 31, 2003.
There was no interest expense incurred on this loan in 2004 and 2003.
-7-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Accounting for Stock-based Compensation
The Company accounts for stock-based employee compensation using the intrinsic
value method prescribed in APB Opinion No. 25 and related interpretations. If
compensation costs for the Company's stock options had 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 Ended March 31,
2004 2003
---- ----
Net income, as reported $ 708 $ 432
Add: Total stock-based employee
compensation expense as reported
under intrinsic value method
(APB No. 25) for all awards, net
of related tax effects 3 --
Deduct: Total stock-based
compensation expense
determined under fair value based
method (SFAS No. 123) for all
awards, net of related tax effects (19) (24)
----- -----
Pro forma net income $ 692 $ 408
===== =====
Earnings per share:
Basic - as reported $0.32 $0.20
Diluted - as reported $0.31 $0.19
Basic - pro forma $0.31 $0.19
Diluted - pro forma $0.30 $0.18
Earnings Per Share
Basic earnings per share have been computed by dividing net income by the
weighted average number of shares of common stock outstanding during each
period. Shares issued during the period and shares reacquired during the period
are weighted for the portion of the period that they were outstanding. Diluted
earnings per share have been computed in a manner consistent with that of basic
earnings per share while giving effect to all potentially dilutive common shares
that were outstanding during each period. Potentially dilutive common shares
include incremental common shares issuable upon exercise of stock options.
-8-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended March 31,
2004 2003
---- ----
Basic weighted average
common shares outstanding 2,216,216 2,187,038
Diluted effect of options 70,397 37,807
--------- ---------
Diluted weighted average
common shares outstanding 2,286,613 2,224,845
========= =========
Litigation
The Company and its subsidiaries have, in the normal course of business, claims
against them. In the opinion of management, the resolution of any such 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
Executive Overview
VSE 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. Energetics Incorporated
("Energetics") is currently VSE's only active subsidiary. VSE's Human Resource
Systems, Inc. ("HRSI") subsidiary was active in 2003, but not in 2004. The sole
HRSI contract expired on May 31, 2003, and this work was continued on a new
contract in a VSE division. Active divisions include BAV Division ("BAV"), Coast
Guard Division ("VCG"), Communications and Engineering Division ("CED")
beginning in February 2003, Fleet Maintenance Division ("FMD"), Management
Sciences Division ("MSD"), Systems Engineering Division ("SED," formerly Land
Systems Division), and Value Systems Services Division ("VSS"). In February
2003, VSE began phasing out the operations of its Telecommunications
Technologies Division ("TTD") and expects all TTD contractual obligations will
be satisfied and operations will cease in 2004. Some of TTD's technical
capabilities have been transferred to other VSE divisions.
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 best positions the consolidated entity
for future revenue growth.
VSE 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. FMD supports 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,
and air combat logistics. VSS provides the Navy with outsourcing decision
assistance. SED 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,
other government agencies, and commercial organizations with quality training
services for product, process, and management optimization. CED provides
management oversight and coordinates support efforts for a variety of Department
of Defense agency work orders.
-10-
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.
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. TTD continued work
on uncompleted contracts during 2003 to satisfy its contractual obligations and
will finish work in 2004 before ceasing operations. Some of TTD's technical
capabilities were transferred to other VSE divisions. 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). If all options are exercised, this
contract has a potential total ceiling of $2.9 billion over an eight-year
period. The contract is a multiple award, indefinite delivery, indefinite
quantity contract, and VSE revenues from it are expected to be considerably less
than the contract ceiling amount. While actual revenue estimates for VSE from
this contract cannot be predicted, it is expected that this contract will
contribute to future VSE revenue growth.
Management Outlook
VSE believes that its short term outlook, based on expected revenue growth under
existing contracts, is more positive than in recent years. The Taiwan ship
transfer work on the BAV contract (see "BAV Contract" below) is expected to
contribute significantly to near term revenue growth. Revenues are also growing
in several of VSE's other divisions. VSE's company wide funded backlog at March
31, 2004, was approximately $147 million, as compared to approximately $83
million at December 31, 2003. Profit margins in most of VSE's divisions have
increased in recent quarters and are expected to improve further as the
Company's revenue base grows. The Company has a positive cash flow and cash of
approximately $10.2 million as of March 31, 2004. This positive short-term trend
is tempered by two areas of concern to management. The CED Rapid Response
support contract incurred pretax losses of approximately $963 thousand in 2003,
its first year of operation, and an additional $325 thousand during the first
three months of 2004 as additional task orders were funded. While management
has addressed this issue by adopting a less aggressive pricing strategy, this
contract may continue to incur losses in 2004. VSE has accrued liabilities of
approximately $275 thousand for probable future losses associated with this
contract's operations as of March 31, 2004. The second concern involves the
utilization of the Company's primary office facility. VSE does not always
occupy all of the space in its primary leased office facility and has from time
to time subleased parts of this facility to other tenants. During 2003, some of
the Company's larger subtenants did not renew their subleases with VSE, and
the facility remains underutilized as of March 31, 2004. The Company has had
-11-
some partial success in finding new tenants to sublease space and believes that
the majority of the available space will be subleased by the end of 2004, but
the potential exists for continued underutilization of the facility that could
negatively impact earnings in 2004.
The longer term outlook for VSE centers on the uncertainty associated with the
renewal of the BAV contract. The U.S. Navy intends to solicit bids for a new
contract in 2004 and BAV will aggressively pursue the award of the new contract.
BAV is confident in its ability to win this award and continue work on the ship
transfer program; however, the size of this effort will entice other companies
to offer strong competition. Accordingly, there can be no assurance that BAV
will win the new contract. If BAV fails to win the new contract, VSE will suffer
a significant loss of future revenue and profits. To mitigate this risk, VSE is
exploring potential acquisition opportunities. The Company intends to continue
these efforts in 2004.
Government Procurement Policies and Practices
VSE's business is subject to the risks arising from economic conditions and
political factors that may impact the budgets and program funding of customers
served through VSE's contracts. VSE's revenues have historically been subject to
annual fluctuations resulting from changes in the level of Defense spending.
Future budgetary and funding decisions by government lawmakers or Defense
restructuring efforts could affect the types and level of services provided by
VSE to its government customers and could potentially have a material adverse
impact on the Company's results of operations or financial condition.
The revenues of the Company depend on its ability to win new contracts and on
the amount of work ordered by the government under the Company's existing
contracts. The Company's ability to win new contracts is affected by government
acquisition policies and procedures, including government procurement practices
that in some years have tended toward bundling work efforts under large
comprehensive ("omnibus") management contracts. This emphasis on large contracts
presents challenges to winning new contract work, including making it more
difficult for the Company to qualify as a bidder, increasing the level of
competition due to the award of fewer contracts, and forcing the Company into
competition with larger organizations that have greater financial resources and
larger technical staffs. Competing for these contracts requires the Company to
use teams of subcontractors to be able to offer the range of technical
competencies needed to do the work. While the use of subcontractors on a large
scale basis allows the Company to compete for this work, profit margins on
subcontract work are lower than on work performed by Company personnel, thereby
reducing the Company's overall profit margins. The use of subcontractors on
government contracts also raises certain performance and financial risks to VSE
in that government prime contractors are usually obligated to ensure compliance
with U.S. Government regulations relative to the performance by subcontractors.
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
-12-
exercise all of the option periods on a contract, and funding delays caused by
government political or administrative actions.
Beginning in 2004, Section 843 of the Defense Authorization Act will limit the
length of contracts awarded by the Defense Department to five years total. The
Company is unable to predict what impact this will have on future contract
awards and 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
transfer of Navy ships to foreign governments. This cost-plus contract is a
ten-year contract awarded in 1995 and has a total ceiling value of over one
billion dollars over the life of the contract. Revenues generated by this
contract accounted for approximately 50% and 51% of consolidated revenues during
the three month periods ended March 31, 2004 and 2003, respectively, and funded
backlog was approximately $104 million as of March 31, 2004, as compared to
approximately $48 million as of December 31, 2003. 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 certain. Due
to such timing, and to fluctuations in the level of revenues, profits as a
percentage of revenues will fluctuate from period to period. As of March 31,
2004, award fee has been recognized for work performed through the award fee
period ended December 31, 2003.
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. The U.S. Navy has approved the transfer of four U.S. Navy ships to
Taiwan, with work related to this transfer to be performed under the BAV
contract. This transfer is expected to result in an increase in the revenues of
BAV during the time this work is performed beginning in 2004. BAV has received
a contract delivery order related to this work in early 2004 of approximately
$100 million, of which $49 million is funded as of March 31, 2004.
The original BAV contract ending date was in 2005. The Navy recently modified
the original contract for the purpose of ensuring continuity of work with
respect to the transfer of ships to Taiwan. The modification provided
contractual coverage for this specific work effort into 2007. The U.S. Navy has
announced that it intends to issue a new contract for the overall ship transfer
program through a competitive bidding process that will begin in 2004. BAV does
not expect that the Navy will award the new contract until after 2004. There can
be no assurance that BAV will win the award for the follow-on contract. If BAV
fails to win this new contract award, it could have a material adverse impact
on the Company's future results of operations and financial condition.
-13-
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 adversely affect sales.
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
adversely 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 three months ended March 31, 2004 and 2003, revenues
associated with BAV contract sales to Egypt accounted for approximately 26% and
37% of the Company's revenues, respectively. Revenues in 2004 are expected to
include large amounts of BAV contract sales to both Egypt and Taiwan. In
addition to the effect on BAV contract work, international tensions can also
affect work by FMD on U.S. Navy ships when they are deployed outside of U.S.
Navy facilities and are unavailable for maintenance work during this time
period. Adverse results arising from these global economic and political risks
could potentially have a material adverse impact on the Company's results of
operations.
Concentration of Revenues (in thousands)
For the three months ended March 31,
2004 2003
Source of Revenue Revenues % Revenues %
- ----------------- -------- - -------- -
BAV Egypt $ 11,242 26% $ 9,841 37%
BAV Taiwan 8,038 19% 1,601 6%
BAV Other 1,974 5% 2,083 8%
-------- ---- -------- ----
Total BAV 21,254 50% 13,525 51%
VSE Other 21,356 50% 12,937 49%
-------- ---- -------- ----
Total Revenues $ 42,610 100% $ 26,462 100%
======== ==== ======== ====
Critical Accounting Policies
VSE's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require VSE
to make estimates and assumptions. The Company believes the following critical
accounting polices affect our more significant judgments, estimates and
assumptions used in the preparation of its consolidated financial statements.
Revenue Recognition
Substantially all of the Company's services are performed for its customers on
a contract basis. The three primary types of contracts used are cost-type
contracts, time and materials contracts, and fixed-price contracts (70%, 18% and
12%, respectively, of the Company's revenues in 2003). 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.
-14-
Revenues on cost-type contracts are recorded as contract allowable costs are
incurred and fees earned. Profits on cost-type contracts are equal to the fees
that are earned. The BAV contract terms specify award fee payments that are
determined by performance and level of contract activity. Award fees are made
three times during the year and a contract modification authorizing the award
fee payment is issued subsequent to the period in which the work is performed.
The Company does not recognize award fee income until the contract modification
authorizing the award fee is certain. Due to such timing, and to
fluctuations in the level of revenues, profits as a percentage of revenues on
this contract will fluctuate from period to period.
Revenues for time and materials contracts are recorded on the basis of contract
allowable labor hours worked times the contract defined billing rates, plus the
cost of materials used in performance on the contract. Profits on time and
material contracts result from the difference between the cost of services
performed and the contract defined billing rates for these services. Revenues on
fixed-price service 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 will occasionally perform work at risk, which is work that is
performed prior to the government formalizing funding for such work. Revenue
related to work performed at risk is not recognized until it can be reliably
estimated and its realization is probable. VSE recognizes this "risk funding" as
revenue when the associated costs are incurred or the work is performed. As of
March 31, 2004, VSE has recognized approximately $498 thousand in risk funding.
VSE believes that it will receive funding for all of this risk funding revenue.
VSE is at risk of loss for any risk funding not received. The Company provides
for anticipated losses on contracts by a charge to income during the period in
which losses are first identified.
Long-Lived Assets
In assessing the recoverability of long-lived assets, including goodwill and
other intangibles, VSE must make assumptions regarding estimated future cash
flows and other factors to determine the fair value of the respective assets.
If these estimates or their related assumptions change in the future, VSE may be
required to record impairment charges for these assets not previously recorded.
Goodwill
Goodwill and intangible assets with indefinite lives are instead subject to a
review for impairment at least annually. As of March 31, 2004, the Company had
approximately $1.1 million of unamortized goodwill associated with its
acquisition of Energetics in 1995. 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.
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Contingencies
From time to time VSE is subject to proceedings, lawsuits and other claims
related to environmental, labor and other matters. VSE is required to assess the
likelihood of any adverse judgments or outcomes to these contingencies as well
as potential ranges of probable losses and establish reserves accordingly. The
amount of reserves required may change in future periods due to new developments
in each matter or changes in approach to a matter such as a change in settlement
strategy.
Income Taxes
The carrying value of VSE net deferred tax assets is based on assumptions
regarding VSE's ability to generate sufficient future taxable income to utilize
these deferred tax assets. If the estimates and related assumptions regarding
VSE's future taxable income change in the future, VSE may be required to record
valuation allowances against its deferred tax assets, resulting in additional
income tax expense.
Results of Operations
The following table sets forth certain items, including consolidated revenues,
pretax income and net income, and the changes in these items for the three month
periods ended March 31, 2004 and 2003 (in thousands):
2004
Compared
to
2004 2003 2003
---- ---- ----
Revenues . . . . . . . . . . . . . . . . . $42,610 $26,462 $16,148
======= ======= =======
Income before income taxes . . . . . . . . $ 1,154 $ 671 $ 483
Provision for income taxes . . . . . . . . 446 239 207
------- ------- -------
Net income . . . . . . . . . . . . . . . $ 708 $ 432 $ 276
======= ======= =======
Revenues increased by approximately 61% for the three month period ended March
31, 2004, as compared to the same period of 2003. The primary reasons for the
increase in revenues were 1) an increase in work performed under the BAV
contract, including increased revenues associated with the Taiwan ship transfer;
2) the CED Rapid Response contract received work orders that generated revenues
in 2004, as compared to the prior year when the contract was awarded in February
of 2003 and did not generate revenues in that year's first three months; and 3)
increased levels of work performed by FMD due primarily to the Navy's elevated
readiness requirements. Work requirements and revenues also increased
significantly in other VSE divisions, including SED, VCG, and MSD. Revenues of
Energetics and VSS were relatively unchanged. The loss of revenues associated
with the phase out of TTD was not significant in relation to total company
revenues.
Pretax income increased by approximately 72% for the three months ended
March 31, 2004, as compared to the same period of 2003. The increase in pre-tax
income was primarily due to 1) the increase in revenues and the profits
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associated with these additional revenues; 2) higher profit margins in SED, FMD,
MSD, and Energetics attributable in part to the revenue growth and the Company's
ability to spread corporate fixed costs over a larger revenue base; and 3) the
elimination of any significant losses in TTD in 2004 as compared to TTD pre-tax
losses of approximately $161 thousand in the same period of 2003. The increase
in pre-tax income in this period was partially offset by losses incurred on the
CED Rapid Response support contract.
Financial Condition
VSE's financial condition did not change materially during the three months
ended March 31, 2004. The Company's largest assets are its cash and cash
equivalents and its accounts receivable. The largest liabilities are its
accounts payable and accrued expenses. Accounts receivable increased
approximately $2.4 million, and accounts payable increased approximately $3.1
million during the first three months of 2004 due to an increase in the level of
work in March 2004 and the associated billings to customers and subcontractor
payments required to perform this work. Cash and cash equivalents increased
approximately $390 thousand in the first three months of 2004 as a result of a
combination of 1) net income; 2) the timing of customer billings and
subcontractor activity and associated payments and expenditures associated with
facilities expansion, improvement, and repairs. The increase in total
stockholders' investment in this period resulted primarily from earnings and
dividend activity and from the exercise of stock options.
Liquidity and Capital Resources
Cash Flows
Cash and cash equivalents increased by approximately $390 thousand during the
three months ended March 31, 2004. The increase in cash and cash equivalents
during this period resulted from cash provided by operating activities of
approximately $1.2 million, cash used in investing activities of approximately
$790 thousand, and cash used in financing activities of approximately $51
thousand. Investing activities consisted of expansion and improvement of
facilities of approximately $499 thousand and purchases of property and
equipment, net of dispositions, of approximately $291 thousand. Financing
activities consisted of dividend payments and proceeds received from the
issuance of common stock.
Cash and cash equivalents decreased by approximately $2.2 million during the
three months ended March 31, 2003. The decrease in cash and cash equivalents
during this period resulted from cash used in operating activities of
approximately $2 million, cash used in investing activities of approximately
$138 thousand, and cash used in financing activities of approximately $57
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.
The difference between cash provided by operating activities of approximately
$1.2 million in 2004 as compared to cash used in operating activities
approximately $2 million in 2003 is primarily due to changes in the levels of
accounts receivable and accounts payable resulting from increases in revenue
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and associated subcontractor activity and receivables collections, and from an
increase in net income.
Quarterly cash dividends at the rate of $.04 per share were paid during the
three months ended March 31, 2004. 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.
Liquidity
The Company's internal sources of liquidity result primarily from operating
activities, specifically from changes in the level of revenues and associated
accounts receivable and accounts payable from period to period, and from
profitability. Significant increases or decreases in revenue and accounts
receivable and accounts payable can cause significant increases or decreases in
internal liquidity. Accounts receivable arise primarily from billings made by
the Company to the government or other government prime contractors for services
rendered and payments received on accounts receivable represent the principal
source of cash for the Company. Accounts receivable levels can be affected 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 the 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. Payments made on accounts payable, along
with payments made to satisfy employee payroll and payroll associated expenses,
make up the principal cash requirements of the Company. Accounts payable levels
can be affected by changes in the level of contract work performed by the
Company and by the timing of large materials purchases and subcontractor efforts
used in performance on the Company's contracts. Other cash requirements include
the acquisition of capital assets for office and computer support, facilities
improvements, and the payment of cash dividends. The Company invested
approximately $499 thousand related to expansion and improvement of facilities
at two locations during the three months ended March 31, 2004, and plans
additional spending of approximately $250 thousand in 2004. These expenditures
are for the expansion of its facility in Ladysmith, Virginia in support of the
expected growth in its System Engineering Division and improvements at its
primary office facility in Alexandria, Virginia.
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
March 31, 2004. The Company has determined that the $15 million commitment
is adequate to cover current and future liquidity requirements. The Company has
not borrowed against this loan in 2004 or 2003.
Performance of work under the BAV contract has the potential to cause
substantial requirements for working capital; however, management believes that
current cash surpluses, cash flows from future operations, and the bank loan
commitment are adequate to meet current operating cash requirements.
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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.
Disclosures About Market Risk
Interest Rates
VSE's bank loan financing provides available borrowing to the Company at
variable interest rates. The Company has not borrowed significant amounts on
the loan in recent years. Accordingly, the Company does not believe that any
movement in interest rates would have a material impact on future earnings or
cash flows. If VSE were to significantly increase borrowings on the current
loan arrangement, future interest rate changes could potentially have 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 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.
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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 Securities Exchange Act of 1934 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, claims
against them. In the opinion of management, the resolution of any such 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.
Exhibit No.
-----------
10.1 Employment Agreement dated as of March 10, 2004, by and between VSE
Corporation and Thomas G. Dacus
10.2 VSE Corporation Deferred Supplemental Compensation Plan effective
January 1, 1994, and as amended through March 9, 2004
31.1 Section 302 CEO Certification
31.2 Section 302 CFO and PAO Certification
32.1 Section 906 CEO Certification
32.2 Section 906 CFO and PAO Certification
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(b) Reports on Form 8-K.
The Registrant filed a Current Report on Form 8-K on February 26, 2004, in which
the Registrant furnished its financial results for the fiscal year 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
Date: April 28, 2004 /s/ D. M. Ervine
______________________________________
D. M. Ervine
Chairman, President,
Chief Executive Officer and
Chief Operating Officer
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