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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended September 30, 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 October 29, 2004: 2,250,761.
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)
September 30, December 31,
2004 2003
---- ----
(Unaudited)
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . $ 6,174 $ 9,843
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . 48,578 21,835
Deferred tax assets . . . . . . . . . . . . . . 1,093 819
Other current assets . . . . . . . . . . . . . . 1,844 1,379
-------- --------
Total current assets . . . . . . . . . . . . . 57,689 33,876
Property and equipment, net . . . . . . . . . . . 4,326 3,038
Deferred tax assets . . . . . . . . . . . . . . . 288 297
Goodwill . . . . . . . . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . 2,582 2,511
-------- --------
Total assets . . . . . . . . . . . . . . . . . $ 65,939 $ 40,776
======== ========
Liabilities and Stockholders' Investment
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . $ 36,196 $ 14,634
Accrued expenses . . . . . . . . . . . . . . . . 6,639 5,760
Dividends payable . . . . . . . . . . . . . . . 111 88
-------- --------
Total current liabilities . . . . . . . . . . 42,946 20,482
Deferred compensation . . . . . . . . . . . . . . 1,228 1,236
-------- --------
Total liabilities . . . . . . . . . . . . . . 44,174 21,718
-------- --------
Commitments and contingencies
Stockholders' investment:
Common stock, par value $.05 per share, authorized
5,000,000 shares; issued 2,250,761 in 2004 and
2,214,136 shares in 2003 . . . . . . . . . . . 112 110
Paid-in surplus . . . . . . . . . . . . . . . . 4,488 3,928
Deferred stock-based compensation . . . . . . . (7) (17)
Retained earnings . . . . . . . . . . . . . . . 17,172 15,037
-------- --------
Total stockholders' investment . . . . . . . . 21,765 19,058
-------- --------
Total liabilities and stockholders'
investment . . . . . . . . . . . . . . . . . $ 65,939 $ 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 For the nine months
ended September 30, ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
Revenues, principally from
contracts . . . . . . . . . . . $ 62,223 $ 36,339 $ 158,869 $ 90,874
Costs and expenses of
contracts . . . . . . . . . . . 60,620 35,403 154,505 88,384
--------- --------- --------- ---------
Gross profit. . . . . . . . . . . 1,603 936 4,364 2,490
Selling, general and
administrative expenses . . . . 192 84 450 158
Interest income, net. . . . . . . (31) (18) (76) (49)
--------- --------- --------- ---------
Income before income taxes. . . . 1,442 870 3,990 2,381
Provision for income taxes. . . . 557 340 1,542 912
--------- --------- --------- ---------
Income from continuing
operations . . . . . . . . . . 885 530 2,448 1,469
Discontinued operations:
Loss from operations,
before income taxes . . . . . - (11) (2) (124)
Benefit for income taxes. . . . - (4) (1) (46)
--------- --------- --------- ---------
Loss from discontinued
operations . . . . . . . . . - (7) (1) (78)
--------- --------- --------- ---------
Net income. . . . . . . . . . . . $ 885 $ 523 $ 2,447 $ 1,391
========= ========= ========= =========
Basic earnings per share:
Income from continuing
operations $ 0.40 $ 0.24 $ 1.10 $ 0.67
Loss from discontinued
operations 0.00 0.00 0.00 (0.03)
--------- --------- --------- ---------
Net income . . . . . . . . . . . $ 0.40 $ 0.24 $ 1.10 $ 0.64
========= ========= ========= =========
Basic weighted average shares
outstanding 2,225,307 2,188,635 2,221,043 2,188,108
========= ========= ========= =========
Diluted earnings per share:
Income from continuing
operations $ 0.38 $ 0.23 $ 1.06 $ 0.65
Loss from discontinued
operations 0.00 0.00 0.00 (0.03)
--------- --------- --------- ---------
Net income . . . . . . . . . . . $ 0.38 $ 0.23 $ 1.06 $ 0.62
========= ========= ========= =========
Diluted weighted average
shares outstanding 2,301,040 2,235,779 2,297,866 2,227,026
========= ========= ========= =========
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 $19,058
Net income for the period - - - - 2,447 2,447
Exercised stock options 37 2 297 - - 299
Tax benefit of options
exercised - - 261 - - 261
Deferred stock-based
compensation - - 2 (2) - -
Amortization of deferred
stock-based compensation - - - 12 - 12
Dividends declared ($.14) - - - - (312) (312)
----- ---- ------ ---- ------- -------
Balance at
September 30, 2004 2,251 $112 $4,488 $ (7) $17,172 $21,765
===== ==== ====== ==== ======= =======
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 nine months
ended September 30,
2004 2003
---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . $ 2,447 $ 1,391
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization . . . . . . . . . . . . 977 866
Loss on sale of property and equipment . . . . . . . - 5
Deferred taxes . . . . . . . . . . . . . . . . . . . (265) 184
Tax benefit of options exercised . . . . . . . . . . 261 2
Amortization of deferred stock-based compensation . . 12 -
Changes in operating assets and liabilities:
(Increase) in:
Accounts receivable, net . . . . . . . . . . . . . . (26,743) (2,560)
Other current assets and noncurrent assets . . . . . (536) (344)
Increase in:
Accounts payable and deferred compensation . . . . . 21,554 4,730
Accrued expenses . . . . . . . . . . . . . . . . . . 879 340
------- -------
Net cash (used in) provided by operating activities (1,414) 4,614
------- -------
Cash flows from investing activities:
Purchase of property and equipment . . . . . . . . . . . (2,265) (530)
------- -------
Net cash used in investing activities . . . . . . . (2,265) (530)
------- -------
Cash flows from financing activities:
Dividends paid . . . . . . . . . . . . . . . . . . . . . (289) (262)
Proceeds from issuance of common stock . . . . . . . . . 299 30
------- -------
Net cash provided by (used in) financing activities 10 (232)
------- -------
Net (decrease) increase in cash and cash equivalents . . . (3,669) 3,852
Cash and cash equivalents at beginning of period . . . . 9,843 4,210
------- -------
Cash and cash equivalents at end of period . . . . . . . $ 6,174 $ 8,062
======= =======
The accompanying notes are an integral part of these financial statements.
-6-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three and nine months ended September 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 September 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 Nine Months
Ended September 30, Ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
Net income, as reported $ 885 $ 523 $2,447 $1,391
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 -- 7 --
Deduct: Total stock-based
compensation expense
determined under fair value based
method (SFAS No. 123) for all
awards, net of related tax effects (19) (21) (57) (62)
------ ------ ------ ------
Pro forma net income $ 868 $ 502 $2,397 $1,329
====== ====== ====== ======
Earnings per share:
Basic - as reported $ 0.40 $ 0.24 $ 1.10 $ 0.64
Diluted - as reported $ 0.38 $ 0.23 $ 1.06 $ 0.62
Basic - pro forma $ 0.39 $ 0.23 $ 1.08 $ 0.61
Diluted - pro forma $ 0.38 $ 0.22 $ 1.04 $ 0.60
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 Nine Months
Ended September 30, Ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
Basic weighted average
common shares outstanding 2,225,307 2,188,635 2,221,043 2,188,108
Diluted effect of options 75,733 47,144 76,823 38,918
--------- --------- --------- ---------
Diluted weighted average
common shares outstanding 2,301,040 2,235,779 2,297,866 2,227,026
========= ========= ========= =========
Discontinued Operations
The Company ceased business operations in its Telecommunications Technology
Division ("TTD") during the three months ended September 30, 2004, as all
contract activity was completed in this component. Revenues and costs from TTD
operations, together with the related tax benefits, have been reclassified as a
loss from discontinued operations in the current and prior periods on the
Company's consolidated statements of income. Approximately $4 thousand net
current assets related to TTD were included in the September 30, 2004 balance
sheet, comprised primarily of receivables.
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. The Company uses
multiple operating entities to bid on and perform contract work. The use of an
operating structure with multiple entities gives the Company certain competitive
advantages and the flexibility to pursue a diverse business base.
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").
TTD Discontinued Operations
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 and 2004 to satisfy its contractual
obligations and upon finishing work in July 2004 TTD was classified as a
discontinued operation. Some of TTD's technical capabilities were transferred to
other VSE divisions. The loss of revenue associated with the termination of TTD
operations is not significant compared to total VSE revenue, while the
elimination of TTD losses will improve VSE profits.
VSE Customers and Services
The Company is engaged principally in providing engineering, design, logistics,
management and technical services to the U.S. Government (the "government"),
other government prime contractors, and commercial entities. The largest
customer for the services rendered by the Company is the U.S. Department of
Defense ("Defense"), including agencies of the U.S. Army, Navy, and Air Force.
Other customers include the Department of Homeland Security, the U.S. Postal
Service, the Department of Energy, and the Department of Treasury.
The majority of VSE's work is performed for the U.S. Navy. BAV is a major
provider of logistics, training, and technical assistance in support of the
Navy's ship transfer program. 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
-10-
outsourcing decision assistance. VCG provides services to the U.S. Coast Guard
that are similar to the work performed by BAV for the Navy.
VSE also performs a significant amount of its work for the U.S. Army. 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, as well as 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 on a large Army
contract.
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 including design, installation,
management and support for voice, data, multimedia and related projects to
various government agencies and commercial organizations.
Management Outlook
VSE is experiencing a record setting year for revenues and profits in 2004, and
based on projected revenue growth under existing contracts, is expecting this
trend to continue into 2005. The Taiwan ship transfer work on the BAV contract
(see "BAV Contract" below) is the primary reason for higher revenues in 2004 and
is expected to continue to contribute significantly to near term revenue growth.
Revenues in several of VSE's other divisions continue to grow. Funded contract
backlog is an indicator of near term revenue performance. VSE's funded contract
backlog began to increase in late 2003 and increased further in early 2004. The
higher backlog levels have been maintained through September 30, 2004. VSE's
company wide funded contract backlog at September 30, 2004, was approximately
$161 million, as compared to approximately $83 million at December 31, 2003.
Contract funding, and the revenue that results from it, is dependent on having
contract ceiling availability. VSE has increased its contract ceiling
availability significantly in 2003 and 2004 with the award of two large multiple
award contracts. (See "Significant Multiple-Award Contracts" below.) 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.
Two areas of concern to management earlier in the year have improved. CED
incurred losses in 2003 on the Rapid Response Support contract during its first
year of operation and during the first nine months of 2004, due primarily to low
revenue levels and to costs associated with the start-up of the division. CED's
losses have decreased as the division has moved beyond the start-up phase and
revenue levels have increased for both this division and on a company-wide
basis. The Company expects CED to begin contributing to overall profitability in
late 2004; however, the potential exists for future losses in CED if revenue
expectations are not met. VSE has accrued liabilities of approximately $205
thousand for probable future losses associated with
-11-
contract operations in this division as of September 30, 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, which has resulted in some losses to the Company in 2003 and
2004 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 in the near future, but a portion of the
facility remains underutilized as of September 30, 2004. VSE has accrued
liabilities of approximately $51 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.
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 has issued a solicitation for bids on a new follow-on contract in 2004 and
BAV is aggressively pursuing 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 and 2005.
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 $1
billion over the life of the contract. 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 variation primarily due to changes in the level of
activity associated with the Navy's ship transfer program.
During its life, this contract has been the Company's single largest revenue
producer, and revenues generated by this contract accounted for approximately
54% and 48% of consolidated revenues during the nine month periods ended
September 30, 2004 and 2003, respectively. 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 has resulted in an
increase in the revenues of BAV of approximately 96% during the first nine
months of 2004 as compared to the same period in 2003. The Taiwan ship transfer
effort is expected to continue to provide BAV with elevated revenue levels in
2005 and into 2006. Funded backlog on the BAV contract was
-12-
approximately $72 million as of September 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. 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. Award fees are made three
times during the year. Accordingly, the Company typically has three quarterly
reporting periods during a year that include the recognition of BAV award fee
income and one quarterly reporting period that does not include BAV award fee
income. Due to such timing, and to fluctuations in the level of revenues,
profits as a percentage of revenues will fluctuate from period to period. The
three month periods ended September 30, 2004 and 2003 do not include BAV award
fee income.
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 four ships to Taiwan. The modification provided
contractual coverage for this specific work effort into 2007. The Navy has
issued a solicitation for bids on a new contract for the overall ship transfer
program through a competitive bidding process. The bid submission date is in
the fourth quarter of 2004 and award will be made after a period of evaluation
by the Navy. BAV is preparing to submit a bid and is confident in its ability to
win the award of the new contract, but there is a risk that the award could be
made to another bidder.
Significant Multiple-Award Contracts
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). The contract enhances the Company's
revenue producing capabilities by allowing it to provide services through any of
VSE's operating entities or through third party subcontractors for various end
user government customers. If all options are exercised, this contract has a
potential total ceiling of $2.9 billion over an eight-year period. This is a
multiple award, indefinite delivery, indefinite quantity contract, and VSE is
one of several awardees eligible to share in the potential contract ceiling
amount. This contract has generated revenue of approximately $18.7 million and
$6.6 million during the nine month periods ended September 30, 2004 and 2003,
respectively.
In September 2004, FMD was awarded a contract by the U.S. Navy to provide
engineering and technical services to support Naval Sea Systems Command
maintenance, overhaul, repair, and alteration of systems aboard ships. This is
a multiple award, indefinite delivery, indefinite quantity, cost-plus-fixed-fee
contract with a total contract ceiling amount of $1.022 billion over a five-year
period if all option periods are exercised. VSE is one of seven awardees
eligible to share in the potential total contract ceiling amount.
While future VSE revenue from these two contracts cannot be predicted with
certainty, the award of these contracts provides the Company with the
opportunity to compete for work that is expected to contribute to future
revenue growth.
-13-
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
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.
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
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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 Continuing Revenues
(in thousands)
For the nine months ended September 30,
---------------------------------------
2004 2003
Source of Revenue Revenues % Revenues %
----------------- -------- - -------- -
BAV Egypt $ 37,406 23% $ 31,879 35%
BAV Taiwan 43,774 28% 5,635 6%
BAV Other 5,306 3% 6,754 7%
-------- ---- -------- ----
Total BAV $ 86,486 54% $ 44,268 48%
VSE Other 72,383 46% 46,606 52%
-------- ---- -------- ---
Total Revenues $158,869 100% $ 90,874 100%
======== ==== ======== ====
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 (approximately 74% of revenues), time and materials contracts
(approximately 12% of revenues), and fixed-price contracts (approximately 14% of
revenues). Revenues result from work performed on these contracts by the
Company's employees and from pass-through of costs for material and work
performed by subcontractors.
Revenues on cost-type contracts are recorded as contract allowable costs are
incurred and fees earned. Profits on cost-type contracts are equal to the fees
that are earned. The BAV contract terms specify award fee payments that are
determined by performance and level of contract activity. Award fees are made
three times during the year and a contract modification authorizing the award
fee payment is issued subsequent to the period in which the work is
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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
certain other fixed-price contracts are recorded as costs are incurred, using
the percentage-of-completion method of accounting, since these contracts require
design, engineering, or manufacturing services performed to the customer's
specifications. 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
September 30, 2004, VSE has recognized approximately $145 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 September 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.
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.
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Income Taxes
The carrying value of VSE net deferred tax assets is based on assumptions
regarding VSE's ability to generate sufficient future taxable income to utilize
these deferred tax assets. If the estimates and related assumptions regarding
VSE's future taxable income change, VSE may be required to record valuation
allowances against its deferred tax assets, resulting in additional income tax
expense.
Results of Operations
The following table sets forth certain items, including consolidated revenues,
pretax income and net income from continuing operations, and the changes in
these items for the nine month periods ended September 30, 2004 and 2003 (in
thousands):
2004
Compared
to
2003
Three Months Nine Months ----------------
Ended September 30, Ended September 30, Three Nine
2004 2003 2004 2003 Months Months
---- ---- ---- ---- ------ ------
Revenues . . . . . . $62,223 $36,339 $158,869 $ 90,874 $25,884 $67,995
======= ======= ======== ======== ======= =======
Income before income
taxes . . . . . . $ 1,442 $ 870 $ 3,990 $ 2,381 $ 572 $ 1,609
Provision for income
taxes . . . . . . 557 340 1,542 912 217 630
Income from Continuing ------- ------- -------- -------- ------- -------
operations . . . . $ 885 $ 530 $ 2,448 $ 1,469 $ 355 $ 979
======= ======= ======== ======== ======= =======
Revenues increased by approximately 71% and 75% for the three month and nine
month periods ended September 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 throughout the full nine month
period in 2004, as compared to the prior year when the contract was awarded in
February of 2003 and did not begin to receive any significant amount of work
until September; and 3) increased levels of work performed by FMD due in part to
the Navy's elevated readiness requirements. Work requirements and revenues also
increased in SED, MSD and VCG.
Income before income taxes increased by approximately 66% and 68% for the three
month and nine month periods ended September 30, 2004, as compared to the same
periods of 2003. The increases were primarily due to 1) profits earned on the
increased 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) a decrease in the losses
incurred by CED in 2004 as compared to 2003 due to the increased CED and
company-wide revenues and to improved CED margins as the
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division matures beyond the start-up phase. The increase for the nine month
period was partially offset by an increase in selling, general and
administrative expenses primarily attributable to costs associated with vacant
facilities.
Discontinued Operations
In July 2004, all business operations associated with the Company's TTD division
ceased. Accordingly, prior period consolidated financial statements have been
restated to reflect the financial results of TTD as discontinued operations. The
revenues, costs and expenses of TTD have been excluded from the respective
captions in the Consolidated Statement of Operations. The loss from discontinued
operations associated with TTD, net of tax, in the nine month periods ended
September 30, 2004 and 2003 was $1 thousand and $78 thousand, respectively.
Financial Condition
VSE's financial condition did not change materially during the nine months ended
September 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 $3.7 million, accounts receivable increased approximately $26.7
million, and accounts payable increased approximately $21.6 million during the
first nine 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 $3.7 million during the
nine months ended September 30, 2004. The decrease in cash and cash equivalents
during this period resulted from cash used in investing activities of
approximately $2.3 million, cash used in operating activities of approximately
$1.4 million, and cash provided by financing activities of approximately $10
thousand. Investing activities consisted of expansion and improvement of
facilities of approximately $755 thousand and purchases of property and
equipment, net of dispositions, of approximately $1.5 million. Financing
activities consisted of dividend payments and proceeds received from the
issuance of common stock due to the exercise of stock options.
Cash and cash equivalents increased by approximately $3.9 million during the
nine months ended September 30, 2003. The increase in cash and cash equivalents
during this period resulted from cash provided by operating activities of
approximately $4.6 million, cash used in investing activities of approximately
$530 thousand, and cash used in financing activities of approximately $232
thousand. Investing activities consisted of purchases of property and equipment.
Financing activities consisted of dividend payments
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and proceeds received from the issuance of common stock due to the exercise of
stock options.
The difference between cash used in operating activities of approximately $1.4
million in 2004 as compared to cash provided by operating activities of
approximately $4.6 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 were paid at the rate of $.04 per share during the six
months ended June 30, 2004, and $.05 per share during the three months ended
September 30, 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 $755 thousand related to expansion and
improvement of facilities at two locations during the nine months ended
September 30, 2004 and has plans to invest an additional amount of approximately
$465 thousand during the remainder of 2004 or early 2005. These investments were
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.
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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, which
expires May 31, 2005, provided loan financing up to a maximum commitment of $15
million as of September 30, 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 and other contracts requiring large
subcontract or material expenditures have 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 September 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 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit No.
-----------
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 August 2, 2004, which
included a press release announcing financial results for the second quarter of
2004 which ended June 30, 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: October 29, 2004 /s/ D. M. Ervine
_____________________________________
D. M. Ervine
Chairman, President,
Chief Executive Officer and
Chief Operating Officer
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