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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended March 31, 2005 Commission File Number: 0-3676
VSE CORPORATION
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 54-0649263
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2550 Huntington Avenue
Alexandria, Virginia 22303-1499
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (703) 960-4600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.05 per share
(Title of Class)
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [x]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [x] No [ ]
Number of shares of Common Stock outstanding as of April 27, 2005: 2,279,625.
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, 2004 (Form 10-K) filed with the Securities and Exchange
Commission. Readers are cautioned not to place undue reliance on these forward
looking statements, which reflect management's analysis only as of the date
hereof. The Company undertakes no obligation to publicly revise these forward
looking statements to reflect events or circumstances that arise after the date
hereof. Readers should carefully review the risk factors described in other
documents the Company files from time to time with the Securities and Exchange
Commission, including this and other Quarterly Reports on Form 10-Q to be filed
by the Company subsequent to its Annual Report on Form 10-K and any Current
Reports on Form 8-K filed by the Company.
-2-
PART I. Financial Information
Item 1. Financial Statements
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Balance Sheets
- -----------------------------------------------------------------------------
(in thousands except share and per share amounts)
March 31, December 31,
2005 2004
---- ----
(Unaudited)
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . . $ 44 $ 130
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . . 49,853 40,274
Contract inventories . . . . . . . . . . . . . . . 4,374 8,504
Deferred tax assets . . . . . . . . . . . . . . . 1,120 1,077
Other current assets . . . . . . . . . . . . . . . 1,523 1,595
-------- --------
Total current assets . . . . . . . . . . . . . . 56,914 51,580
Property and equipment, net . . . . . . . . . . . . 4,665 4,435
Deferred tax assets . . . . . . . . . . . . . . . . 410 312
Goodwill . . . . . . . . . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . . 3,184 2,971
-------- --------
Total assets . . . . . . . . . . . . . . . . . . $ 66,227 $ 60,352
======== ========
Liabilities and Stockholders' Investment
Current liabilities:
Bank notes payable . . . . . . . . . . . . . . . . $ - $ 1,578
Accounts payable . . . . . . . . . . . . . . . . . 33,151 26,853
Accrued expenses . . . . . . . . . . . . . . . . 7,216 7,452
Dividends payable . . . . . . . . . . . . . . . . 114 114
-------- --------
Total current liabilities . . . . . . . . . . . 40,481 35,997
Deferred compensation . . . . . . . . . . . . . . . 1,473 1,312
-------- --------
Total liabilities . . . . . . . . . . . . . . . 41,954 37,309
-------- --------
Commitments and contingencies
Stockholders' investment:
Common stock, par value $.05 per share, authorized
5,000,000 shares; issued 2,279,625 in 2005 and
2,276,688 shares in 2004 . . . . . . . . . . . . 114 114
Paid-in surplus . . . . . . . . . . . . . . . . . 4,917 4,879
Deferred stock-based compensation . . . . . . . . (2) (4)
Retained earnings . . . . . . . . . . . . . . . . 19,244 18,054
-------- --------
Total stockholders' investment . . . . . . . . . 24,273 23,043
-------- --------
Total liabilities and stockholders' investment . $ 66,227 $ 60,352
======== ========
The accompanying notes are an integral part of these balance sheets.
-3-
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Income (Unaudited)
- -----------------------------------------------------------------------------
(in thousands except share and per share amounts)
For the three months
ended March 31,
2005 2004
---- ----
Revenues, principally from contracts . . . . . . . . $ 65,919 $ 42,609
Costs and expenses of contracts . . . . . . . . . . 63,755 41,462
--------- ---------
Gross profit . . . . . . . . . . . . . . . . . . . . 2,164 1,147
Selling, general and administrative expenses . . . . 56 12
Interest income, net . . . . . . . . . . . . . . . . (19) (19)
--------- ---------
Income before income taxes . . . . . . . . . . . . . 2,127 1,154
Provision for income taxes . . . . . . . . . . . . . 823 446
--------- ---------
Net income . . . . . . . . . . . . . . . . . . . . . $ 1,304 $ 708
========= =========
Basic earnings per share:
Net income . . . . . . . . . . . . . . . . . . . . . $ 0.57 $ 0.32
========= =========
Basic weighted average shares outstanding 2,279,326 2,216,216
========= =========
Diluted earnings per share:
Net income . . . . . . . . . . . . . . . . . . . . . $ 0.55 $ 0.31
========= =========
Diluted weighted average shares outstanding 2,353,954 2,286,613
========= =========
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, 2004 . . . . . 2,277 $ 114 $ 4,879 $ (4) $ 18,054 $ 23,043
Net income for the period . . - - - - 1,304 1,304
Exercised stock options . . . 3 - 26 - - 26
Tax benefit of options
exercised . . . . . . . . . - - 15 - - 15
Deferred stock-based
compensation . . . . . . . - - (3) 1 - (2)
Amortization of deferred
stock-based compensation . - - - 1 - 1
Dividends declared ($.05) . . - - - - (114) (114)
----- ----- ------- ----- -------- --------
Balance at
March 31, 2005 . . . . . . 2,280 $ 114 $ 4,917 $ (2) $ 19,244 $ 24,273
===== ===== ======= ===== ======== ========
The accompanying notes are an integral part of these financial statements.
-5-
VSE Corporation and Subsidiaries
Consolidated Financial Statements (Unaudited)
Consolidated Statements of Cash Flows
- -----------------------------------------------------------------------------
(in thousands)
For the three months
ended March 31,
2005 2004
---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . $ 1,304 $ 708
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . 326 262
Loss on sale of property and equipment . . . . . . . 2 -
Deferred taxes . . . . . . . . . . . . . . . . . . . (141) (81)
Tax benefit of options exercised . . . . . . . . . . 15 14
Amortization of deferred stock-based compensation . . (1) 4
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable . . . . . . . . . . . . . . . . . (9,579) (2,397)
Contract inventories . . . . . . . . . . . . . . . . 4,130 -
Other current assets and noncurrent assets . . . . . (141) (108)
Increase (decrease) in:
Accounts payable and deferred compensation . . . . . 6,459 3,110
Accrued expenses . . . . . . . . . . . . . . . . . . (236) (281)
------- -------
Net cash provided by operating activities 2,138 1,231
------- -------
Cash flows from investing activities:
Purchase of property and equipment . . . . . . . . . . . (558) (790)
------- -------
Net cash used in investing activities (558) (790)
------- -------
Cash flows from financing activities:
Net repayment of bank loans . . . . . . . . . . . . . . (1,578) -
Dividends paid . . . . . . . . . . . . . . . . . . . . . (114) (88)
Proceeds from issuance of common stock . . . . . . . . . 26 37
------- -------
Net cash used in financing activities (1,666) (51)
------- -------
Net (decrease) increase in cash and cash equivalents . . . (86) 390
Cash and cash equivalents at beginning of period . . . . 130 9,843
------- -------
Cash and cash equivalents at end of period . . . . . . . $ 44 $10,233
======= =======
The accompanying notes are an integral part of these financial statements.
-6-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three months ended March 31, 2005 are not necessarily indicative
of the results that may be expected for the year ending December 31, 2005. 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, 2004. 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.
Contract Inventories
The components of contract inventories as of March 31, 2005 and December 31,
2004 were as follows (in thousands):
2005 2004
---- ----
Raw material . . . . . . . . . . . . . . . . . . . $ - $4,783
Work in process . . . . . . . . . . . . . . . . . 10,668 3,721
------- ------
$10,668 $8,504
Less: Progress payments received . . . . . . . . (6,294) -
------- ------
Total contract inventories $ 4,374 $8,504
======= ======
Contract inventories consist of materials purchased, advances to suppliers, and
other expenditures for use in a contract to modify and apply a protective
system, the Tanker Ballistic Protection System ("TBPS"), to military vehicles
for the U.S. Army. This contract was awarded to VSE in November 2004.
-7-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Although these costs are classified as contract inventories for accounting
purposes, they are similar in nature to materials and direct supplies purchased
for use in performance on the Company's other contracts in that they are solely
and directly attributable to the contract and will be billed to the customer
within a relatively short time. These materials and direct supplies will not be
restocked to maintain any permanent inventory levels.
Raw material inventories consist of advances to suppliers for materials on this
contract but on which work has not yet begun. Work in process contract
inventories consist of amounts for materials, supplies and other expenditures
for which work has been performed but for which the end unit has not yet been
completed and accepted. Work in process contract inventory includes applicable
indirect cost burdens, including general and administrative costs, of
approximately $1 million and $442 thousand as of March 31, 2005 and December 31,
2004, respectively.
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, 2006. 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. As of March 31, 2005,
there were no amounts outstanding under this loan agreement. Amounts outstanding
under this loan agreement as of December 31, 2004 were approximately
$1.6 million, which was paid in January, 2005. Interest expense incurred on the
loan for the three months ending March 31, 2005 and 2004 was approximately
$1 thousand and $0, respectively.
Accounting for Stock-based Compensation
The Company has adopted the disclosure-only provisions of SFAS 123, "Accounting
for Stock-Based Compensation," as amended by SFAS 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure." Accordingly, the Company
accounts for stock-based compensation under Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations, using the intrinsic value method. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS 123 to all stock-based
employee compensation (in thousands, except per share amounts):
-8-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended March 31,
2005 2004
---- ----
Net income, as reported $1,304 $ 708
Add: Total stock-based employee
compensation expense as reported
under intrinsic value method
(APB No. 25) for all awards, net
of related tax effects - 3
Deduct: Total stock-based
compensation expense
determined under fair value based
method (SFAS No. 123) for all
awards, net of related tax effects (62) (19)
------ -----
Pro forma net income $1,242 $ 692
====== =====
Earnings per share:
Basic - as reported $0.57 $0.32
Diluted - as reported $0.55 $0.31
Basic - pro forma $0.54 $0.31
Diluted - pro forma $0.53 $0.30
In December 2004, the Financial Accounting Standards Board issued SFAS 123(R),
"Share-Based Payment," which is a revision to SFAS 123. SFAS 123(R) supersedes
APB Opinion No. 25 and amends SFAS 95, "Statement of Cash Flows." Generally,
the approach in SFAS 123(R) is similar to the approach described in SFAS 123.
However, SFAS 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the income statement based
on their fair values. Pro forma disclosure is no longer an alternative. The
Company can adopt SFAS 123(R) in one of two ways - the modified prospective
method or the modified retrospective method. The Company will adopt SFAS 123(R)
on January 1, 2006 and is currently evaluating the alternative methods.
The impact of adoption of SFAS 123(R) cannot be predicted at this time because
it will depend on levels of share-based payments granted in the future.
However, had we adopted SFAS 123(R) in prior periods, the impact of that
standard would have approximated the impact of SFAS 123 as described in the
disclosure of pro forma net income and earnings per share above. SFAS 123(R)
also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will
reduce net operating cash flows and increase net financing cash flows in periods
after adoption. While the Company cannot estimate what those amounts
-9-
will be in the future (because they depend on, among other things, when
employees exercise stock options), the amount of operating cash flows recognized
for the three month periods ending March 31, 2005 and 2004 for such excess tax
deductions were approximately $15 thousand and $14 thousand, respectively.
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.
Three Months Ended March 31,
2005 2004
---- ----
Basic weighted average
common shares outstanding 2,279,326 2,216,216
Diluted effect of options 74,628 70,397
--------- ---------
Diluted weighted average
common shares outstanding 2,353,954 2,286,613
========= =========
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.
-10-
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Executive Overview
VSE Organization
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.
The term "VSE" or "Company" refers to VSE and its subsidiaries and divisions
unless the context indicates operations of the parent company only.
Energetics Incorporated ("Energetics") is currently VSE's only active
subsidiary. Active divisions as of March 31, 2005 include BAV Division ("BAV"),
Coast Guard Division ("VCG"), Communications and Engineering Division ("CED"),
Fleet Maintenance Division ("FMD"), Management Sciences Division ("MSD"),
Systems Engineering Division ("SED"), and, Information Assurance Division
("IAD", formerly Value Systems Services Division or "VSS").
VSE also has several other subsidiaries and divisions that were inactive as of
March 31, 2005.
TTD Discontinued Operations
In February 2003, VSE decided to terminate operations of its Telecommunications
Technologies Division ("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. There was no material impact on the quarters ended March 31, 2005
or 2004.
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,
-11-
ordnance alteration, and air combat logistics. 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, military vehicle
protection systems, 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
more than 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 also provides support services to the U.S. Department
of Treasury and 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.
BAV Ship Transfer Program
VSE's BAV Division provides the U.S. Navy with engineering, technical and
logistical support services associated with the sale, lease, or transfer of Navy
ships to foreign governments. The original contract associated with this program
was a ten-year cost-plus contract awarded in 1995 with a total ceiling value of
more than $1 billion. BAV was awarded a second contract in April 2005 to
continue work on this program. The new contract is a five-year cost-plus
contract with a total ceiling value of approximately $544 million. The level of
revenues and associated profits resulting from fee income generated by this
program 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 program has been the Company's single largest revenue
producer. Revenues generated by this program have typically accounted for
approximately 40% to 50% of consolidated VSE revenues, and revenues generated by
this program accounted for approximately 45% and 50% of consolidated revenues
during the three month periods ended March 31, 2005 and 2004, respectively. The
transfer of four U.S. Navy ships to Taiwan currently conducted under this
program is a major contributor to the Company's revenues in 2005 and 2004. The
original BAV contract is scheduled to end in 2005. VSE expects the Navy to begin
issuing orders on the new contract in the second quarter of 2005 and to cease
issuing new orders on the original contract at that time. BAV will continue work
associated with the transfer of four ships to Taiwan under delivery orders
previously issued on the original contract. For further discussion, refer to
"Longer Term Concerns" under Management Outlook.
-12-
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 per 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 March 31, 2005 and 2004 include BAV award fee income.
TBPS Program
In November 2004, VSE's SED Division was awarded a fixed-price letter contract
by the U.S. Army to begin work on a program to provide a protection system for
Army vehicles, the Tanker Ballistic Protection System ("TBPS"). Under this
program, SED will apply a Fuel Tank Self-Sealing System and necessary Add-on
Armor Panels for Army Fuel Dispensing Tankers as protection from damage
resulting from hostile fire. Testing and preparatory work on this program was
conducted in November and December 2004 and the TBPS was applied to the first
tanker in January 2005. SED received a definitized $34.9 million firm fixed
price per unit contract to formalize contract coverage and additional funding in
March 2005. The Company also received a second fixed-price letter contract and
is in negotiations with the Army for a second definitized contract under this
program that would increase the amount of work by adding more tankers to be
included in the program. This program is expected to contribute significantly to
revenue growth in 2005 while also presenting new risks and challenges to VSE's
business.
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
-13-
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
responsible for performing to the requirements of the contract and ensuring
compliance with U.S. Government regulations relative to the performance by
subcontractors.
Other government procurement practices that can affect the Company's revenues
are 1) the length of contracts issued, which may vary depending on changes in
contracting regulations and other factors; 2) the use of past performance
criteria that may preclude entrance into new government markets; and
3) 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.
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 Ship Transfer Program could potentially affect
sales. Failure by the government of a potential foreign customer to approve and
fund acquisition of U.S. Navy ships serviced under the this program could affect
sales. In any one year, a significant amount of the Company's revenues may
result from sales on the BAV Ship Transfer Program to a single foreign
government. BAV sales to Egypt have historically comprised a large percentage of
the Company's total sales in any one year. Work associated with the transfer of
four ships to Taiwan under the BAV Ship Transfer Program during 2004 also
comprised a large percentage of total sales, and is expected to also comprise a
large percentage of 2005 sales.
Concentration of Continuing Revenues
------------------------------------
(in thousands)
--------------
For the three months ended March 31,
2005 2004
Source of Revenue Revenues % Revenues %
----------------- -------- - -------- -
BAV Egypt $ 13,009 20 $ 11,242 26
BAV Taiwan 15,788 24 8,038 19
BAV Other 644 1 1,974 5
-------- --- -------- ---
Total BAV $ 29,441 45 $ 21,254 50
VSE Other 36,478 55 21,355 50
-------- --- -------- ---
Total Revenues $ 65,919 100 $ 42,609 100
======== === ======== ===
The current international situation posed by potential terrorist activity and
the continuing conflict in the Middle East could potentially increase the
political risks for revenues from both the BAV Ship Transfer and TBPS Programs.
International tensions can also affect work by FMD on U.S. Navy ships when they
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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.
Management Outlook
The growth trend established by VSE's record high revenues and profits in 2004
is expected to continue in 2005. The major contributors to 2005 results are
expected to be: 1) a continuation of the Taiwan Ship Transfer work performed by
BAV; 2) performance on the TBPS Program; and 3) additional work provided by
Other Significant Contracts.
Taiwan Ship Transfer. The Taiwan ship transfer effort is entering its second
full year and is expected to continue to contribute significantly to BAV revenue
levels in 2005. Funded backlog on the original BAV contract was approximately
$50 million as of March 31, 2005.
TBPS Program. Most of the work on the initial $34.9 million contract on the
TBPS Program is expected to be completed in 2005. Additionally, the second
contract under this program, currently under negotiation, is also expected to
begin generating revenue in 2005. Work on this program is expected to provide
significant increases to Company revenues in 2005.
Other Significant Contracts. VSE has three multi-year, multiple award,
indefinite delivery, indefinite quantity contracts that have large nominal
ceiling amounts with no funding committed at the time of award. VSE is one of
several awardees on each contract. While future VSE revenue from these contracts
cannot be predicted with certainty, the award of these contracts provides the
Company with the opportunity to compete for work that could contribute to future
revenue growth, including new work in 2005. These three contracts are described
below.
VSE's CED Division has a multi-year Rapid Response support contract issued 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 approximately $2.9 billion over an
eight-year period. While it is not likely that the full ceiling amount will be
realized, this contract has generated revenues for VSE of approximately
$8.5 million and $5 million during the three months ended March 31, 2005 and
2004, respectively. Funded backlog on this contract as of March 31, 2005 is
approximately $30 million. VSE continues to pursue new orders on this contract
that present promising revenue opportunities for the future.
VSE's FMD Division has a contract with the U.S. Navy, SeaPort Enhanced, which
includes a five-year base period and two five-year option periods. This contract
is a procurement vehicle for the Navy to use for ordering services from a wide
range of contractors to support all phases of naval ship and shipboard weapons
systems acquisition and life-cycle support. While this award does not guarantee
any revenues for VSE, the Company is one of several contractors eligible to bid
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for services during the life of the contract. VSE received the first delivery
order on this contract, for approximately $300 thousand, in February 2005.
FMD also has a contract with 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 contract has a total contract ceiling
amount of $1.022 billion over a five-year period if all option periods are
exercised. VSE is one of several awardees eligible to share in the potential
total contract ceiling amount. During February and March 2005, FMD was awarded
delivery orders for approximately $44 million in work on this contract.
Funded Backlog
Revenue increases in government contracting businesses are typically preceded by
increases in contract funding ("Bookings") and a build-up of funded contract
backlog. VSE's Bookings and funded backlog during the first three months of 2005
have remained at levels that give the Company a firm basis for continued revenue
growth in 2005.
(in millions)
-------------
Bookings for the three months ended March 31, 2005 . . . . . $68
Funded backlog as of March 31, 2005 . . . . . . . . . . . . $169
Revenues for the three months ended March 31, 2005 . . . . . $66
Longer Term Concerns
While 2005 is shaping up to be another strong year, VSE will be challenged to
sustain the revenue growth experienced during 2004 and 2005 as the Company heads
into 2006 and subsequent years. Certain work efforts that have supported VSE's
growth in 2004 and that are expected to contribute significant revenues in 2005
are due to expire in the near future. Most of the current contract work on the
TBPS program is expected to be completed by the end of 2005. The Taiwan Ship
Transfer work is expected to continue at approximately the same level of effort
through 2005 and 2006 and then be substantially completed in early 2007. VSE is
exploring potential acquisition opportunities to mitigate the future loss of
revenues associated with the expiration of the TBPS Program and the Taiwan Ship
Transfer work. The Company intends to continue these efforts in 2005.
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.
Revenue recognition methods on fixed-price contracts will vary depending on the
nature of the work and the contract terms. On some fixed-price contracts
revenues are recorded as costs are incurred, using the percentage-of-completion
method of accounting. Revenues on fixed-price service contracts are recorded as
services are provided. Revenues on fixed-price contracts that require delivery
of specific items are recorded based on a price per unit as units are delivered.
Profits on fixed-price contracts result from the difference between the incurred
costs and the revenue earned.
Revenues by contract type for the three months ended March 31, 2005 and 2004
were as follows (in thousands):
Contract Type Revenues % Revenues %
------------- -------- - -------- -
Cost-type . . . . . $42,903 65 $29,827 70
Time and materials. 12,516 19 7,669 18
Fixed-price . . . . 10,500 16 5,113 12
------- --- ------- ---
$65,919 100 $42,609 100
======= === ======= ===
The Company will occasionally perform work at risk, which is work that is
performed prior to the government formalizing funding for such work. Revenue
related to work performed at risk is not recognized until it can be reliably
estimated and its realization is probable. VSE recognizes this "risk funding" as
revenue when the associated costs are incurred or the work is performed. As of
March 31, 2005, VSE has recognized approximately $257 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.
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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 March 31, 2005, 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.
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, VSE may be required to record valuation
allowances against its deferred tax assets, resulting in additional income tax
expense.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board issued SFAS 123(R),
"Share-Based Payment," which is a revision to SFAS 123. SFAS 123(R) supersedes
APB Opinion No. 25 and amends SFAS 95, "Statement of Cash Flows." Generally, the
approach in SFAS 123(R) is similar to the approach described in SFAS 123.
However, SFAS 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the income statement based
on their fair values. Pro forma disclosure is no longer an alternative. The
Company can adopt SFAS 123(R) in one of two ways - the modified prospective
method or the modified retrospective method. The Company will adopt SFAS 123(R)
on January 1, 2006 and is currently evaluating the alternative methods.
The impact of adoption of SFAS 123(R) cannot be predicted at this time because
it will depend on levels of share-based payments granted in the future.
However, had we adopted SFAS 123(R) in prior periods, the impact of that
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standard would have approximated the impact of SFAS 123 as described in the
disclosure of pro forma net income and earnings per share above. SFAS 123(R)
also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will
reduce net operating cash flows and increase net financing cash flows in periods
after adoption. While the Company cannot estimate what those amounts will be in
the future (because they depend on, among other things, when employees exercise
stock options), the amount of operating cash flows recognized for the three
month periods ending March 31, 2005 and 2004 for such excess tax deductions were
approximately $15 thousand and $14 thousand, respectively.
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 three month periods ended March 31, 2005 and 2004 (in
thousands):
2005
Compared
to
2005 2004 2004
---- ---- ----
Revenues . . . . . . . . . . . . . . . . . $65,919 $42,609 $23,310
======= ======= =======
Income before income taxes . . . . . . . . $ 2,127 $ 1,154 $ 973
Provision for income taxes . . . . . . . . 823 446 377
------- ------- -------
Net income . . . . . . . . . . . . . . . $ 1,304 $ 708 $ 596
======= ======= =======
Revenues increased by approximately 55% for the three month period ended
March 31, 2005, as compared to the same period of 2004. The primary reasons for
the increase in revenues were 1) an increase in work performed under the BAV
Ship Transfer Program, including revenues associated with the Taiwan ship
transfer; 2) work attributable to the TBPS program; 3) increased levels of work
performed by FMD on its U. S. Navy contracts; and 4) an increase in work
performed on the CED Rapid Response contract.
Income before income taxes increased by approximately 84% for the three month
period ended March 31, 2005, as compared to the same period of 2004. The
increase was primarily due to profits associated with work on the TBPS program,
profits associated with the increased revenues of BAV and FMD, and a decrease in
the losses incurred by CED in 2005 as compared to 2004.
Financial Condition
VSE's financial condition did not change materially during the three months
ended March 31, 2005. The Company's largest assets are its accounts receivable
and inventories. The largest liabilities are its accounts payable and accrued
expenses. Accounts receivable increased approximately $9.6 million, and accounts
payable increased approximately $6.3 million during the first three months of
2005 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. Inventories declined approximately $4.1 million during the first
three months of 2005 as materials and supplies were used to complete protection
systems for vehicles on the TBPS Program.
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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 $86 thousand during the
three months ended March 31, 2005. The decrease in cash and cash equivalents
during this period resulted from cash used in financing activities of
approximately $1.7 million, cash used in investing activities of approximately
$558 thousand, and cash provided by operating activities of approximately
$2.1 million. Financing activities consisted of repayment of amounts previously
borrowed on the Company's bank loan of approximately $1.6 million, dividend
payments, and proceeds received from the issuance of common stock due to the
exercise of stock options. Investing activities consisted of expansion and
improvement of facilities of approximately $172 thousand and purchases of
property and equipment, net of dispositions, of approximately $386 thousand.
Cash and cash equivalents increased by approximately $390 thousand during the
three months ended March 31, 2004. The increase in cash and cash equivalents
during this period resulted from cash provided by operating activities of
approximately $1.2 million, cash used in investing activities of approximately
$790 thousand, and cash used in financing activities of approximately
$51 thousand. Investing activities consisted of expansion and improvement of
facilities of approximately $499 thousand and purchases of property and
equipment, net of dispositions, of approximately $291 thousand. Financing
activities consisted of dividend payments and proceeds received from the
issuance of common stock.
The difference between cash provided by operating activities of approximately
$2.1 million in 2005 as compared to approximately $1.2 million in 2004 is
primarily due to: 1) an increase in net income; and 2) changes in the levels
of accounts receivable, inventories, and accounts payable resulting from
increases in revenue and the timing of associated material purchases,
subcontractor payments, and receivables collections.
Quarterly cash dividends were paid at the rate of $.05 per share during the
three months ended March 31, 2005. 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
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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.
Upon beginning work on the TBPS program, the Company acquired inventories
consisting of materials, supplies, and other expenditures for which end units
have not yet been completed and accepted. Although these costs are classified
as inventories for accounting purposes, they are similar in nature to materials
and direct supplies purchased for use in performance on the Company's other
contracts in that they are solely and directly attributable to the contract and
will be billed to the customer within a relatively short time. All of the
inventories are expected to be liquidated, billed, and collected in 2005 or
early 2006. These materials and direct supplies will not be restocked to
maintain any permanent inventory levels.
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.
VSE's external sources of liquidity consist of a revolving bank loan agreement
that provides loan financing based on the Company's accounts receivable (see
"Notes to Consolidated Financial Statements"). The bank financing complements
the internal sources of liquidity by providing increasing levels of borrowing
capacity as accounts receivable levels increase. The bank loan agreement
provided loan financing up to a maximum commitment of $15 million as of
March 31, 2005. The Company has determined that the $15 million commitment is
adequate to cover current and future liquidity requirements.
Performance of work under the BAV Ship Transfer Program, the TBPS program, 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
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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 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-15(e)) are effective as
of March 31, 2005 to ensure that information required to be disclosed by the
Company's management, including its principal executive officer and principal
financial officer, as appropriate, to allow timely decisions regarding required
disclosure. There were no significant changes in the Company's internal control
over financial reporting or other factors that could significantly affect these
controls subsequent to the date of their evaluation and there were no corrective
actions with regard to significant deficiencies and material weaknesses.
PART II. Other Information
Item 1. Legal Proceedings
The Company and its subsidiaries have, in the normal course of business, claims
against them. In the opinion of management, the resolution of any such claims
will not have a material adverse effect on the Company's results of operations
or financial position.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit No.
-----------
10.1 Employment Agreement dated as of February 10, 2005, by and between
Energetics Incorporated and James E. Reed
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 February 25, 2005, to
report its financial results for the fiscal year ended December 31, 2004.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has omitted all other items contained in "Part II. Other Information"
because such other items are not applicable or are not required if the answer is
negative or because the information required to be reported therein has been
previously reported.
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VSE CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VSE CORPORATION
Date: April 27, 2005 /s/ D. M. Ervine
______________________________________
D. M. Ervine
Chairman, President,
Chief Executive Officer and
Chief Operating Officer
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