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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 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 July 30, 2004: 2,225,011.
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.
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PART I. Financial Information
Item 1. Financial Statements
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Balance Sheets
- -----------------------------------------------------------------------------
(in thousands except share and per share amounts)
June 30, December 31,
2004 2003
---- ----
(Unaudited)
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . $ 6,975 $ 9,843
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . 37,975 21,835
Deferred tax assets . . . . . . . . . . . . . . 1,154 819
Other current assets . . . . . . . . . . . . . . 1,139 1,379
-------- --------
Total current assets . . . . . . . . . . . . . 47,243 33,876
Property and equipment, net . . . . . . . . . . . 4,226 3,038
Deferred tax assets . . . . . . . . . . . . . . . 196 297
Intangible assets, net . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . 2,593 2,511
-------- --------
Total assets . . . . . . . . . . . . . . . . . $ 55,312 $ 40,776
======== ========
Liabilities and Stockholders' Investment
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . $ 27,607 $ 14,634
Accrued expenses . . . . . . . . . . . . . . . . 5,796 5,760
Dividends payable . . . . . . . . . . . . . . . 111 88
-------- --------
Total current liabilities . . . . . . . . . . 33,514 20,482
-------- --------
Deferred compensation . . . . . . . . . . . . . . 1,238 1,236
-------- --------
Total liabilities . . . . . . . . . . . . . . 34,752 21,718
-------- --------
Commitments and contingencies
Stockholders' investment:
Common stock, par value $.05 per share, authorized
5,000,000 shares; issued 2,225,011 in 2004 and
2,214,136 shares in 2003 . . . . . . . . . . . 111 110
Paid-in surplus . . . . . . . . . . . . . . . . 4,060 3,928
Deferred stock-based compensation . . . . . . . (10) (17)
Retained earnings . . . . . . . . . . . . . . . 16,399 15,037
-------- --------
Total stockholders' investment . . . . . . . . 20,560 19,058
-------- --------
Total liabilities and stockholders'
investment . . . . . . . . . . . . . . . . . $ 55,312 $ 40,776
======== ========
The accompanying notes are an integral part of these financial statements.
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VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Income (Unaudited)
- -------------------------------------------------------------------------------
(in thousands except share and per share amounts)
For the three months For the six months
ended June 30, ended June 30,
2004 2003 2004 2003
---- ---- ---- ----
Revenues, principally from
contracts . . . . . . . . . $ 54,042 $ 29,368 $ 96,652 $ 55,830
Costs and expenses of
contracts . . . . . . . . . 52,431 28,608 93,894 54,373
--------- --------- --------- ---------
Gross profit. . . . . . . . . 1,611 760 2,758 1,457
Selling, general and
administrative expenses . . 245 48 257 90
Interest income, net. . . . . (26) (15) (45) (31)
--------- --------- --------- ---------
Income before income taxes. . 1,392 727 2,546 1,398
Provision for income taxes. . 538 291 984 530
--------- --------- --------- ---------
Net income. . . . . . . . . . $ 854 $ 436 $ 1,562 $ 868
========= ========= ========= =========
Basic earnings per share:
Net income . . . . . . . . . $ 0.38 $ 0.20 $ 0.70 $ 0.40
========= ========= ========= =========
Basic weighted average shares
outstanding 2,221,559 2,188,635 2,218,887 2,187,841
========= ========= ========= =========
Diluted earnings per share:
Net income. . . . . . . . . . $ 0.37 $ 0.20 $ 0.68 $ 0.39
========= ========= ========= =========
Diluted weighted average
shares outstanding 2,305,911 2,220,333 2,296,262 2,222,576
========= ========= ========= =========
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, 2003 2,214 $ 110 $ 3,928 $ (17) $ 15,037 $19,058
Net income for the period - - - - 1,562 1,562
Exercised stock options 11 1 91 - - 92
Tax benefit of options
exercised - - 39 - - 39
Deferred stock-based
compensation - - 2 (2) - -
Amortization of deferred
stock-based compensation - - - 9 - 9
Dividends declared ($.09) - - - - (200) (200)
----- ----- ------- ----- -------- -------
Balance at
June 30, 2004 2,225 $ 111 $ 4,060 $ (10) $ 16,399 $20,560
===== ===== ======= ===== ======== =======
The accompanying notes are an integral part of these financial statements.
-5-
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Cash Flows (Unaudited)
- -------------------------------------------------------------------------------
(in thousands)
For the six months
ended June 30,
2004 2003
---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . $ 1,562 $ 868
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization . . . . . . . . . . . . 569 557
Loss on sale of property and equipment . . . . . . . - 5
Deferred taxes . . . . . . . . . . . . . . . . . . . (234) 99
Tax benefit of options exercised . . . . . . . . . . 39 2
Amortization of deferred stock-based compensation . . 9 -
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable . . . . . . . . . . . . . . . . . (16,140) 2,520
Other current assets and noncurrent assets . . . . . 158 (571)
Increase (decrease) in:
Accounts payable and deferred compensation . . . . . 12,975 931
Accrued expenses . . . . . . . . . . . . . . . . . . 36 (586)
------- -------
Net cash (used in) provided by operating activities (1,026) 3,825
------- -------
Cash flows from investing activities:
Purchase of property and equipment . . . . . . . . . . . (1,757) (382)
------- -------
Net cash used in investing activities (1,757) (382)
------- -------
Cash flows from financing activities:
Dividends paid . . . . . . . . . . . . . . . . . . . . . (177) (174)
Proceeds from issuance of common stock . . . . . . . . . 92 30
------- -------
Net cash used in financing activities (85) (144)
------- -------
Net (decrease) increase in cash and cash equivalents . . . (2,868) 3,299
Cash and cash equivalents at beginning of period . . . . 9,843 4,210
------- -------
Cash and cash equivalents at end of period . . . . . . . $ 6,975 $ 7,509
======= =======
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-Qand Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three and six months ended June 30, 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 June 30, 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 Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
---- ---- ---- ----
Net income, as reported $ 854 $ 436 $1,562 $ 868
Add: Total stock-based employee
compensation expense as reported
under intrinsic value method
(APB No. 25) for all awards, net
of related tax effects 2 -- 5 --
Deduct: Total stock-based
compensation expense
determined under fair value based
method (SFAS No. 123) for all
awards, net of related tax effects (19) (17) (38) (41)
------ ------ ------ ------
Pro forma net income $ 837 $ 419 $1,529 $ 827
====== ====== ====== ======
Earnings per share:
Basic as reported $ 0.38 $ 0.20 $ 0.70 $ 0.40
Diluted as reported $ 0.37 $ 0.20 $ 0.68 $ 0.39
Basic pro forma $ 0.38 $ 0.19 $ 0.69 $ 0.38
Diluted pro forma $ 0.36 $ 0.19 $ 0.67 $ 0.37
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-
Three Months Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
---- ---- ---- ----
Basic weighted average
common shares outstanding 2,221,559 2,188,635 2,218,887 2,187,841
Diluted effect of options 84,352 31,698 77,375 34,735
--------- --------- --------- ---------
Diluted weighted average
common shares outstanding 2,305,911 2,220,333 2,296,262 2,222,576
========= ========= ========= =========
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,"), 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 equipment refurbishment services,
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 government 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 SED
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. The Company 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, at which time, TTD will be
accounted for as a discontinued operation. 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, this contract has generated revenue in 2004
and 2003 and VSE expects it to contribute to future 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 June
30, 2004, was approximately $150 million, as compared to approximately $83
million at December 31, 2003. Profit contributions in most of VSE's divisions
have increased in recent quarters and are expected to improve further as the
Company's revenue base grows. 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 $374 thousand during the first six months of 2004,
due primarily to low revenue levels and an aggressive pricing strategy
associated with the start-up of the contract. Profitability on this contract is
expected to improve as revenue levels continue to increase for both this
contract and on a company-wide basis and as less aggressive pricing strategies
are required, however, the contract may continue to incur some losses in 2004.
VSE has accrued liabilities of approximately $232 thousand for probable future
losses associated with this contract's operations as of June 30, 2004. The
second concern involves the
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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, which has
resulted in some losses to the Company during the time that the space has been
vacant. VSE has subleased some of the vacant office space to new tenants in 2004
and believes that the majority of the available space will be subleased by the
end of 2004, but the facility remains underutilized as of June 30, 2004. VSE has
accrued liabilities of approximately $74 thousand for estimated future losses
associated with this underutilization. The potential exists for continued
underutilization of the facility that could have a further negative impact on
earnings in 2004.
The longer term outlook for VSE centers on the uncertainty associated with the
renewal of the BAV contract. (See discussion in "BAV Contract" below.) 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
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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
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 54% and 52% of consolidated revenues during the six
month periods ended June 30, 2004 and 2003, respectively, and funded backlog was
approximately $93 million as of June 30, 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 June 30, 2004, award fee
has been recognized for work performed through the award fee period ended
April 30, 2004.
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.
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
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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.
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 or 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. 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 six months ended June 30,
--------------------------------
2004 2003
Source of Revenue Revenues % Revenues %
----------------- -------- - -------- -
BAV Egypt $ 23,996 25% $ 20,624 37%
BAV Taiwan 25,411 26% 3,075 5%
BAV Other 3,046 3% 5,532 10%
-------- ---- -------- ----
Total BAV $ 52,453 54% $ 29,231 52%
VSE Other 44,199 46% 26,599 48%
-------- ---- -------- ---
Total Revenues $ 96,652 100% $ 55,830 100%
======== ==== ======== ====
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. Revenues
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result from work performed on these contracts by the Company's employees and
from pass-through of costs for material and work performed by subcontractors.
Revenues on cost-type contracts are recorded as contract allowable costs are
incurred and fees earned. Profits on cost-type contracts are equal to the fees
that are earned. The BAV contract terms specify award fee payments that are
determined by performance and level of contract activity. Award fees are made
three times during the year and a contract modification authorizing the award
fee payment is issued subsequent to the period in which the work is performed.
The Company does not recognize award fee income until the 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
June 30, 2004, VSE has recognized approximately $24 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 subject to a review for
impairment at least annually. The Company performs its annual impairment test on
September 30. As of June 30, 2004, the Company had approximately $1.1 million
of goodwill associated with its acquisition of Energetics in 1995. The Company
has not recognized any reduction to the goodwill due to the impairment rules. If
at some time in the future it is determined that impairment has occurred, such
impairment could potentially have a 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 six month
periods ended June 30, 2004 and 2003 (in thousands):
2004
Compared
to
2003
Three Months Six Months ----
Ended June 30, Ended June 30, Three Six
2004 2003 2004 2003 Months Months
---- ---- ---- ---- ------ ------
Revenues . . . . . . . $54,042 $29,368 $96,652 $55,830 $24,674 $40,822
======= ======= ======= ======= ======= =======
Income before income
taxes . . . . . . . $ 1,392 $ 727 $ 2,546 $ 1,398 $ 665 $ 1,148
Provision for income
taxes . . . . . . . 538 291 984 530 247 454
------- ------- ------- ------- ------- -------
Net income . . . . . $ 854 $ 436 $ 1,562 $ 868 $ 418 $ 694
======= ======= ======= ======= ======= =======
Revenues increased by approximately 84% and 73% for the three month and six
month periods ended June 30, 2004, respectively, as compared to the same
periods 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 had not yet begun to
receive any significant amount of work; and 3) increased levels of work
performed by FMD due primarily to the Navy's elevated readiness requirements.
Work requirements and revenues also increased in SED and MSD. The loss of
revenues associated with the phase out of TTD was not significant in relation
to total Company revenues.
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Pretax income increased by approximately 91% and 82% for the three month and six
month periods ended June 30, 2004, as compared to the same periods of 2003. The
increases in pretax income were primarily due to 1) the increases in revenues;
2) higher profit margins in SED, FMD, and Energetics attributable in part to the
revenue growth and the Company's ability to spread corporate costs over a larger
revenue base; and 3) the elimination of any significant losses in TTD in 2004 as
compared to TTD pretax losses of approximately $30 thousand and $190 thousand in
the three and six month periods ended June 30, 2003. The increase in pretax
income for the six month period was partially offset by losses incurred on
the CED Rapid Response support contract and by an increase in selling, general
and administrative expenses primarily attributable to costs associated with
vacant facilities.
Financial Condition
VSE's financial condition did not change materially during the six months ended
June 30, 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. Cash and cash equivalents decreased approximately $2.9
million, accounts receivable increased approximately $16.1 million, and accounts
payable increased approximately $13 million during the first six months of 2004
due primarily to the increase in the level of business activity and the
associated billings to customers and subcontractor payments required to perform
this work. The change 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 decreased by approximately $2.9 million during the six
months ended June 30, 2004. The decrease in cash and cash equivalents during
this period resulted from cash used in investing activities of approximately
$1.8 million, cash used in operating activities of approximately $1 million, and
cash used in financing activities of approximately $85 thousand. Investing
activities consisted of expansion and improvement of facilities of approximately
$669 thousand and purchases of property and equipment, net of dispositions, of
approximately $1.1 million. Financing activities consisted of dividend payments
and proceeds received from the issuance of common stock.
Cash and cash equivalents increased by approximately $3.3 million during the six
months ended June 30, 2003. The increase in cash and cash equivalents during
this period resulted from cash provided by operating activities of approximately
$3.8 million, cash used in investing activities of approximately $382 thousand,
and cash used in financing activities of approximately $144 thousand. Investing
activities consisted of purchases of property and equipment, net of
dispositions. Financing activities consisted of dividend payments and proceeds
received from the issuance of common stock.
-17-
The difference between cash used in operating activities of approximately
$1 million in 2004 as compared to cash provided by operating activities of
approximately $3.8 million in 2003 is primarily due to changes in the levels of
accounts receivable and accounts payable resulting from increases in revenue and
associated subcontractor activity.
Quarterly cash dividends at the rate of $.04 per share were paid during the six
months ended June 30, 2004. The Board of Directors of VSE declared an increase
in the quarterly cash dividend on the Company's common stock to a rate of $.05
per share effective with the dividend to be paid on August 18, 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 $669 thousand related to expansion and improvement of facilities
at two locations during the six months ended June 30, 2004, and plans additional
spending of approximately $72 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
June 30, 2004. The Company has determined
-18-
that the $15 million commitement 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.
Inflation and Pricing
Most of the contracts performed by VSE provide for estimates of future labor
costs to be escalated for any option periods provided by the contracts, while
the non-labor costs included in such contracts are normally considered
reimbursable at cost. VSE property and equipment consists principally of
computer systems equipment, furniture and fixtures, and land and improvements.
The overall impact of inflation on replacement costs of such property and
equipment is not expected to be material to VSE's future results of operations
or financial condition.
Disclosures About Market Risk
Interest Rates
VSE's bank loan financing provides available borrowing to the Company at
variable interest rates. The Company has not borrowed significant amounts on the
loan in recent years. Accordingly, the Company does not believe that any
movement in interest rates would have a material impact on future earnings or
cash flows. If VSE were to significantly increase borrowings on the current loan
arrangement, future interest rate changes could potentially have a material
impact.
Foreign Currency
While a significant amount of the Company's business results from the services
provided by BAV related to the transfer of ships to foreign governments, the BAV
contract payments are made by the U.S. Government in U.S. dollars. Additionally,
most funding requirements to support work performed or services purchased in
foreign countries are made in U.S. dollars, and the 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 as of June 30, 2004,
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, allows 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 4. Submission of Matters to a Vote of Security Holders
The 2004 annual meeting of the Company's stockholders was held on May 3, 2004
for the following purposes:
1. To elect eight directors to serve until the next annual meeting of
stockholders and until their successors are duly elected and qualified;
2. To ratify the appointment of Ernst & Young LLP as VSE's independent
certified public accountants for the year ending December 31, 2004;
3. To approve the adoption of the VSE 2004 Stock Option Plan; and
4. To approve the adoption of the VSE 2004 Directors Stock Plan.
All of the Company's eight nominees as directors were elected, and the other
three matters referenced above were approved by the stockholders. The voting
results were as follows:
-20-
Shares Voted
----------------------------------------
Withhold/ Broker
For Against Abstain Non-Votes
- ---------------------------------------------------------------------------
1. Nominee
-------
Donald M. Ervine 1,967,735 -- 15,990 113,348
Robert J. Kelly 1,973,945 -- 9,780 113,348
Clifford M. Kendall 1,973,945 -- 9,780 113,348
Calvin S. Koonce 1,973,945 -- 9,780 113,348
James F. Lafond 1,973,945 -- 9,780 113,348
David M. Osnos 1,973,945 -- 9,780 113,348
Jimmy D. Ross 1,973,945 -- 9,780 113,348
Bonnie K. Wachtel 1,973,945 -- 9,780 113,348
2. Ernst & Young LLP appointment 1,956,874 13,168 1,578 113,348
3. Approve 2004 Stock Option Plan 1,471,787 118,723 1,828 497,686
4. Approve Directors Stock Plan 1,499,377 89,011 17,774 497,686
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit No.
10.1 Employment Agreement dated as of July 1, 2004, by and between VSE
Corporation and Thomas R. Loftus
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
(b) Reports on Form 8-K.
The Registrant filed a Current Report on Form 8-K on April 28, 2004, which
included a press release announcing financial results for the first quarter of
2004 which ended March 31, 2004.
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: July 30, 2004 /s/ D. M. Ervine
______________________________________
D. M. Ervine
Chairman, President,
Chief Executive Officer and
Chief Operating Officer
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