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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the Quarterly Period Commission File Number 1-9309
December 31, 2004 --------
-----------------
VERSAR Inc.
- -----------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 54-0852979
- --------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
6850 Versar Center
Springfield, Virginia 22151
- --------------------------------- ------------------------------------
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code (703)750-3000
-----------------------
Not Applicable
- -------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report.)
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
------ ------
Indicate by the check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act).
Yes No X
------ ------
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practical date.
Class of Common Stock Outstanding at January 31, 2005
--------------------- -------------------------------
$.01 par value 7,910,466
VERSAR, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
PAGE
----
PART I - FINANCIAL INFORMATION
ITEM 1 - Financial Statements
Consolidated Balance Sheets as of
December 31, 2004 and June 30, 2004 3
Consolidated Statements of Operations for
the Three-Month and Six-Month Periods Ended
December 31, 2004 and 2003 4
Consolidated Statements of Cash Flows
for the Six-Month Periods Ended December
31, 2004 and 2003 5
Notes to Consolidated Financial Statements 6-10
ITEM 2 - Management's Discussion and Analysis
of Financial Condition and Results of
Operations 11-15
ITEM 3 - Quantitative and Qualitative Disclosures
About Market Risk 16
ITEM 4 - Procedures and Controls 16
PART II - OTHER INFORMATION
ITEM 1 - Legal Proceedings 16-17
ITEM 4 - Submission of Matters to a Vote of
Stockholders 17
ITEM 6 - Exhibits and Reports on Form 8-K 17
SIGNATURES 18
EXHIBITS 19-36
2
VERSAR, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In Thousands)
December 31, June 30,
2004 2004
____________ ____________
ASSETS (Unaudited)
Current assets
Cash and cash equivalents $ 1,529 $ 817
Accounts receivable, net 15,950 14,144
Prepaid expenses and other
current assets 730 1,013
Deferred income taxes 168 168
____________ ____________
Total current assets 18,377 16,142
Property and equipment, net 2,094 2,108
Deferred income taxes 501 501
Goodwill 776 776
Other assets 535 558
____________ ____________
Total assets $ 22,283 $ 20,085
============ ============
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities
Accounts payable $ 6,566 $ 4,520
Billing in excess of revenue 387 433
Accrued salaries and vacation 1,534 1,967
Other liabilities 1,506 1,728
____________ ____________
Total current liabilities 9,993 8,648
Other long-term liabilities 1,163 1,163
Liabilities of discontinued
operations, net 79 209
____________ ____________
Total liabilities 11,235 10,020
____________ ____________
Stockholders' equity
Common stock, $0.01 par value;
30,000,000 shares authorized;
7,906,016 shares and 7,837,033
shares issued at December 31, 2004
and June 30, 2004, respectively;
7,890,511 and 7,821,528 shares
outstanding at December 31, 2004
and June 30, 2004, respectively 79 78
Capital in excess of par value 21,989 21,835
Accumulated deficit (10,948) (11,776)
Treasury stock (72) (72)
____________ ____________
Total stockholders' equity 11,048 10,065
____________ ____________
Total liabilities and
stockholders' equity $ 22,283 $ 20,085
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
3
VERSAR, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited - in thousands, except per share amounts)
For the Three-Month For the Six-Month
Periods Ended Periods Ended
December 31, December 31,
___________________ ___________________
2204 2003 2004 2003
_________ _________ _________ _________
GROSS REVENUE $ 19,048 $ 14,288 $ 38,161 $ 27,893
Purchased services and
materials, at cost 10,177 6,035 20,103 11,411
_________ _________ _________ _________
NET SERVICE REVENUE 8,871 8,253 18,058 16,482
Direct costs of services
and overhead 6,875 6,469 14,152 12,921
Selling, general and
administrative expense 1,565 1,385 3,055 2,765
_________ _________ _________ _________
OPERATING INCOME 431 399 851 796
OTHER EXPENSE
Interest expense 10 33 23 87
_________ _________ _________ _________
INCOME BEFORE TAX 421 366 828 709
Income tax expense --- --- --- ---
_________ _________ _________ _________
NET INCOME $ 421 $ 366 $ 828 $ 709
========= ========= ========= =========
NET INCOME PER SHARE -
BASIC $ 0.05 $ 0.05 $ 0.11 $ 0.10
========= ========= ========= =========
NET INCOME PER SHARE -
DILUTED $ 0.05 $ 0.05 $ 0.10 $ 0.09
========= ========= ========= =========
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING -
BASIC 7,880 7,262 7,862 7,261
========= ========= ========= =========
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING -
DILUTED 8,345 7,569 8,316 7,548
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
4
VERSAR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited - in thousands)
For the Six-Month
Periods Ended December 31
__________________________
2004 2003
____________ ____________
Cash flows from operating activities
Net income $ 828 $ 709
Adjustments to reconcile net income to
net cash used in operating activities
Depreciation and amortization 374 322
Loss on sale of property and equipment --- 1
Provision for doubtful accounts receivable 14 18
Changes in assets and liabilities
(Increase) decrease in accounts receivable (1,820) 1,173
Decrease in prepaids and other assets 328 487
Increase in accounts payable 2,046 115
Decrease in accrued salaries and vacation (433) (65)
Decrease in other liabilities (268) (1,808)
____________ ____________
Net cash provided by continuing
operations 1,069 952
Changes in net assets/liabilities of
discontinued operations (130) (2)
____________ ____________
Net cash provided by operating
activities 939 950
____________ ____________
Cash flows used in investing activities
Purchase of property and equipment (360) (221)
Increase in life insurance cash surrender
value (22) (28)
____________ ____________
Net cash used by investing activities (382) (249)
____________ ____________
Cash flows from financing activities
Net payments on bank line of credit --- (713)
Proceeds from issuance of the Company's
common stock 155 8
____________ ____________
Net cash provided by (used in)
financing activities 155 (705)
____________ ____________
Net increase (decrease) in cash and cash
equivalents 712 (4)
Cash and cash equivalents at the beginning
of the period 817 81
____________ ____________
Cash and cash equivalents at the end of
the period $ 1,529 $ 77
============ ============
Supplementary disclosure of cash flow
information:
Cash paid during the period for
Interest $ 15 $ 82
Income taxes 21 31
The accompanying notes are an integral part of these consolidated
financial statements.
5
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(A) Basis of Presentation
The accompanying consolidated financial statements are
presented in accordance with the requirements of Form 10-Q and
consequently do not include all of the disclosures normally
required by generally accepted accounting principles or those
normally made in Versar, Inc.'s Annual Report on Form 10-K filed
with the United States Securities and Exchange Commission. These
financial statements should be read in conjunction with the
Company's Annual Report filed on Form 10-K for the year ended
June 30, 2004 for additional information.
Effective July 1, 2004, the Company changed its fiscal reporting
period from the last day of the calendar month end to the last
Friday closest to the calendar month end. As such, the first and
second quarters of fiscal year 2005 ended on October 1, and
December 31, 2004, respectively.
The accompanying consolidated financial statements include the
accounts of Versar, Inc. and its wholly-owned subsidiaries
("Versar" or the "Company"). All significant intercompany
balances and transactions have been eliminated in consolidation.
The financial information has been prepared in accordance with
the Company's customary accounting practices. In the opinion of
management, the information reflects all adjustments necessary
for a fair presentation of the Company's consolidated financial
position as of December 31, 2004, and the results of operations
for the three and six-month periods ended December 31, 2004 and
2003. The results of operations for such periods, however, are
not necessarily indicative of the results to be expected for a
full fiscal year.
(B) Accounting Estimates
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of
America 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 may differ
from those estimates.
(C) Contract Accounting
Contracts in process are stated at the lower of actual cost
incurred plus accrued profits or net estimated realizable value
of incurred costs, reduced by progress billings. The Company
records income from major fixed-price contracts, extending over
more than one accounting period, using the percentage-of-
completion method. During performance of such contracts,
estimated final contract prices and costs are periodically
reviewed and revisions are made as required. The effects of
these revisions are included in the periods in which the
revisions are made. On cost-plus-fee contracts, revenue is
recognized to the extent of costs incurred plus a proportionate
amount of fee earned, and on time-and-material contracts, revenue
is recognized to the extent of billable rates times hours
delivered plus material and other reimbursable costs incurred.
Losses on contracts are recognized when they become known.
Disputes arise in the normal course of the Company's business on
projects where the Company is contesting with customers for
collection of funds because of events such as delays, changes in
contract specifications and question of cost allowability or
collectibility. Such disputes, whether claims or unapproved
change orders in the process of negotiation, are recorded at the
lesser of their estimated net realizable value or actual costs
incurred and only when realization is probable and can be
reliably estimated. Claims against the Company are recognized
where loss is considered probable and reasonably determinable in
amount. Management reviews outstanding receivables on a regular
basis and assesses the need for reserves taking into
consideration past collection history and other events that bear
on the collectibility of such receivables.
(D) Income Taxes
At December 31, 2004, the Company had approximately $4.5 million
in deferred tax assets which primarily relate to net operating
loss and tax credit carryforwards. Since the Company had
experienced losses in previous
6
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
years, management recorded a valuation allowance of approximately
$3.8 million against the net deferred tax asset. The valuation
allowance is adjusted periodically based upon management's
assessment of the Company's ability to derive benefit from the
deferred tax assets.
(E) Debt
In September 2003, Versar entered into a new line of credit
facility with United Bank (the Bank) that provides for advances
up to $5,000,000 based upon qualifying receivables. Interest on
the borrowings is based on prime plus one and a half percent
(6.5% as of December 31, 2004). The credit facility is
guaranteed by the Company and each subsidiary individually and is
collectively secured by accounts receivable, equipment and
intangibles, plus all insurance policies on property constituting
collateral. There were no outstanding borrowings on the credit
facility as of December 31, 2004. The credit facility is subject
to renewal in November 2005. The credit facility has certain
covenants related to the maintenance of financial ratios. These
covenants require a minimum tangible net worth of $6,500,000, a
maximum total liabilities to tangible net worth ratio not to
exceed 2.5 to 1; and a minimum current ratio of at least 1.25 to
1. Failure to meet the covenant requirements gives the Bank the
right to demand the amount due under the credit facility, which
may impact the Company's ability to finance its working capital
requirements. At December 31, 2004, the Company was in
compliance with the financial covenants.
(F) Discontinued Operations
In fiscal year 1998, the Company discontinued a significant
portion of the operations of Science Management Corporation (SMC).
As such, the Company disposed of portions of SMC and wound down the
remaining assets and liabilities. The remaining liability at
December 31, 2004 of $79,000 is primarily related to
wind down the remaining benefit plans obligations of SMC.
(G) Contingencies
Versar and its subsidiaries are parties to various legal
actions arising in the normal course of business. The Company
believes that the ultimate resolution of these legal actions will
not have a material adverse effect on its consolidated financial
condition and results of operations. (See Part II, Item 1 -
Legal Proceedings).
In September 2002, the Company recorded a non-recurring
charge of $800,000 to reduce the Company's overall cost structure
and to reduce costs in non-performing divisions. The costs
included $450,000 for severance payments to terminated employees
and $350,000 for costs to restructure certain leased facilities.
Approximately $148,500 and $192,200 in severance payments were
made in fiscal years 2003 and 2004, with a remaining liability
balance of $109,200, which will be disbursed in fiscal year 2005.
In addition, $82,000 and $131,000 of the facilities restructure
reserve was reduced as a result of modifying existing long term
leases in Texas, Chicago, and California facilities in fiscal
years 2003 and 2004. The balance of $137,000 is expected to be
utilized to reduce the facility costs for expected vacant space
that was previously subleased at the Company's headquarters in
Springfield, Virginia in fiscal year 2005.
Versar Board of Directors approved a two-year employment
agreement of Mr. Theodore M. Prociv as the Chief Executive
Officer, President and Director of the Company effective December
31, 2004. The agreement is filed as an exhibit in the Form 10Q
for period ended December 31, 2004.
(H) Goodwill and Other Intangible Assets
On January 30, 1998, Versar completed the acquisition of The
Greenwood Partnership, P.C. subsequently renamed (Versar Global
Solutions, Inc. or VGSI). The transaction was accounted for as a
purchase. Goodwill resulting from this transaction was approximately
$1.1 million. In fiscal year 2003, the Company adopted the Statement
of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets" which
7
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
eliminated the amortization of goodwill, but does require the
Company to test such goodwill for impairment annually.
Currently, the carrying value of goodwill is approximately
$776,000 relating to the acquisition of VGSI, which is now part
of the Engineering & Construction (E&C) reporting unit. In
performing its goodwill impairment analysis, management has
utilized a discounted cash flow model to determine the estimated
fair value of the E&C reporting unit. This model requires
management, among other things, to estimate future revenue and
expenses of the E&C reporting unit based upon current contract
backlog and projected growth resulting from new business.
Management engages outside professionals and valuation experts,
as necessary, to assist in performing this analysis.
For fiscal years 2004 and 2003, management concluded, based
upon its impairment analysis, that goodwill relating to the E&C
reporting unit was not impaired. Goodwill impairment testing for
fiscal year 2005 will be performed in the fourth quarter.
(I) Net Income Per Share
Basic net income per common share is computed by dividing
net income by the weighted average number of common shares
outstanding during the period. Diluted net income per common
share also includes common stock equivalents outstanding during
the period if dilutive. The Company's common stock equivalents
shares consist of stock options.
For the Three-Month For the Six-Month
Periods Ended Periods Ended
December 31, December 31,
____________________ ____________________
2004 2003 2004 2003
_________ _________ _________ _________
Weighted average
common shares
outstanding - basic 7,880,100 7,262,072 7,862,369 7,260,928
Assumed exercise of
options
(treasury stock
method) 465,017 307,393 453,973 287,360
_________ _________ _________ _________
Weighted average
common shares
outstanding -
basic/diluted 8,345,118 7,569,465 8,316,342 7,548,288
========= ========= ========= =========
(J) Common Stock
The Company issued 68,983 shares of common stock upon the
exercise of stock options during the first six months of fiscal
year 2005. Total proceeds from the exercise of such stock
options were approximately $155,000.
Effective January 1, 2005, the Company implemented an
Employee Stock Purchase Plan (ESPP) to allow eligible employees
of Versar the opportunity to acquire an ownership interest in the
Company's common stock. Through the Plan, employees may purchase
shares of Versar common stock from the open market at 90% of its
fair market value. The Plan qualifies as an "employee stock
purchase plan" under Section 423 of the Internal Revenue Code.
(K) Recently Issued Accounting Standards
In December 2004, Financial Accounting Standard Board ("FASB")
issued Statement of Financial Accounting Standard ("SFAS") 123
(Revised 2004), "Shared-Based Payment". Revised SFAS 123
addresses the requirements of an entity to measure the cost of
employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award. The
cost of such award will be recognized over the period during
which an employee is required to provide services in exchange for
the award. The Company will be required to adopt this Statement
during the first quarter of fiscal year 2006. The Company is
currently evaluating the impact that this pronouncement will have
on its future operations.
8
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
In December 2004, FASB issued SFAS 151, "Inventory Costs an
amendment of ARB No. 43, Chapter 4". This Statement requires
abnormal amounts of idle facility expense, freight, handling
costs and wasted material be recognized as current-period charges
regardless of whether they meet the criterion of "so abnormal".
In addition, this Statement requires that allocation of fixed
production overhead to the costs of conversion be based on the
normal capacity of the production facilities. This pronouncement
will be effective for fiscal year 2006. However, as the Company
does not include amounts of idle facility expense, freight,
handling costs and wasted material in its inventory, the adoption
of SFAS 151 is not expected to have a material impact on the
Company's financial position or results of operations.
(L) Stock Based Compensation
The Company accounts for employee stock option grants using
the intrinsic method in accordance with Accounting Principles
Board (APB) Opinion No. 25 "Accounting for Stock Issued to
Employees" and related interpretations. Accordingly compensation
expense, if any, is measured as the excess of the underlying
stock price over the exercise price on the date of grant. The
Company complies with the disclosure option of Statement of
Financial Accounting Standards (SFAS) No. 123 "Accounting for
Stock-Based Compensation", as amended by SFAS No. 148 "Accounting
for Stock-Based Compensation - Transition and Disclosure" which
requires pro-forma disclosure of compensation expense associated
with stock options under the fair value method.
The Company's pro forma information follows (in thousands,
except per share data):
For the Three-Month For the Six-Month
Periods Ended Periods Ended
December 31, December 31,
____________________ ____________________
2004 2003 2004 2003
_________ _________ _________ _________
Net income, as reported $ 421 $ 366 $ 828 $ 709
Less: Total Stock-Based
Compensation determined
under the fair-value
based method (112) (87) (209) (161)
Pro-forma net income 309 279 619 548
Net income per share -
basic, as reported $ 0.05 $ 0.05 $ 0.11 $ 0.10
Pro-forma net income per
share - basic 0.04 0.04 0.08 0.08
Net income per share -
diluted, as reported $ 0.05 $ 0.05 $ 0.10 $ 0.09
Pro-forma net income
per share 0.04 0.04 0.07 0.07
(M) Business Segments
Effective July 1, 2004, the Company renamed and made minor
organizational changes to its business segments. The
Environmental Business segment has been renamed the
Infrastructure and Management Services segment and now includes
the Company's Pennsylvania, Ohio, and Arizona offices which were
formerly part of the Architecture and Engineering business segment.
The Architecture and Engineering business segment has been renamed the
Engineering and Construction segment and is now focused on larger
construction projects. The Defense segment has been renamed the
National Security segment. Previous year segment information has been
reclassified to conform to the current presentation.
The Infrastructure and Management Services segment provides
a full range of services including remediation/corrective
actions, site investigations, professional and management
services. The Engineering and Construction segment provides
engineering, design and construction management to government and
commercial facilities. The National Security segment provides
expertise in developing, testing and providing personal
protection equipment, and detecting and destroying biological and
chemical agents.
9
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Management evaluates and measures the performance of its business
segments based on net service revenue and operating income. As
such, selling, general and administrative expenses, interest and
income taxes have not been allocated to the Company's business
segments.
Summary financial information for each of the Company's
segments follows:
For the Three-Month For the Six-Month
Periods Ended Periods Ended
December 31, December 31,
____________________ ____________________
2004 2003 2004 2003
_________ _________ _________ _________
GROSS REVENUE
_____________
Infrastructure and
Management Services $ 10,423 $ 11,340 $ 21,307 $ 21,684
Engineering and Construction 6,891 1,086 12,624 2,633
National Security 1,734 1,862 4,230 3,576
_________ _________ _________ _________
$ 19,048 $ 14,288 $ 38,161 $ 27,893
========= ========= ========= =========
NET SERVICE REVENUE
___________________
Infrastructure and
Management Services $ 6,281 $ 6,295 $ 12,821 $ 12,218
Engineering and Construction 1,290 738 2,283 1,644
National Security 1,300 1,220 2,954 2,620
_________ _________ _________ _________
$ 8,871 $ 8,253 $ 18,058 $ 16,482
========= ========= ========= =========
OPERATING INCOME(A)
________________
Infrastructure and
Management Services $ 1,358 $ 1,418 $ 2,766 $ 2,650
Engineering and Construction 610 100 908 318
National Security 28 266 232 593
_________ _________ _________ _________
1,996 1,784 3,906 3,561
Selling, general and
administrataive expenses 1,565 1,385 3,055 2,765
_________ _________ _________ _________
$ 431 $ 399 $ 851 $ 796
========= ========= ========= =========
(A)Operating income is defined as net service revenue less direct
costs of services and overhead.
IDENTIFIABLE ASSETS December 31, June 30,
___________________ 2004 2004
____________ ___________
Infrastructure and Management
Services $ 8,988 $ 10,856
Engineering and Construction 8,170 3,762
National Security 1,918 2,997
Corporate and Other 3,207 2,470
____________ ___________
$ 22,283 $ 20,085
============ ===========
10
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations
Results of Operations
_____________________
Second Quarter Comparison of Fiscal Year 2005 and 2004
______________________________________________________
This report contains certain forward-looking statements which are
based on current expectations. Actual results may differ
materially. The forward-looking statements include those
regarding the continued award of future work or task orders from
government and private clients, cost controls and reductions, the
expected resolution of delays in billing of certain projects, and
the possible impact of current and future claims against the
Company based upon negligence and other theories of liability.
Forward-looking statements involve numerous risks and
uncertainties that could cause actual results to differ
materially, including, but not limited to, the possibilities that
the demand for the Company's services may decline as a result of
possible changes in general and industry specific economic
conditions and the effects of competitive services and pricing;
the possibility the Company will not be able to perform work
within budget or contractual limitations; one or more current or
future claims made against the Company may result in substantial
liabilities; the possibility the Company will not be able to
attract and retain key professional employees; changes to or
failure of the Federal government to fund certain programs in
which the Company participates; and such other risks and
uncertainties as are described in reports and other documents
filed by the Company from time to time with the Securities and
Exchange Commission.
Gross revenues for the second quarter of fiscal year 2005
were $19,048,000, a $4,760,000 (33%) increase over that reported
in the second quarter of fiscal year 2004. The increase is
attributable to significantly increased construction work in the
Engineering and Construction business segment of approximately
$5,805,000, as discussed further under the heading "Financial
Trends", which was in part offset by reduction in mold
remediation work in the Infrastructure and Management Services
business segment. The Engineering and Construction gross revenue
increases are attributable to roof replacement work in San Diego
and other construction projects in support of the Air Force.
Purchased services and materials increased by $4,142,000
(69%) in the second quarter of fiscal year 2005 compared to that
reported in the second quarter of fiscal year 2004. As mentioned
above, the increase was due to increased subcontractor activity
in the Engineering and Construction business segment in support
of the Air Force and other government agencies.
Net service revenue is derived by the deducting of the costs
of purchased services from gross revenue. Versar considers it
appropriate to analyze operating margins and other ratios in
relation to net service revenue, because such revenues reflect
the actual work performed by the Company's labor force. Net
service revenues increased by 7% in the second quarter of fiscal
year 2005 primarily due to the profit on the increased
subcontracted construction activities as mentioned above.
Direct costs of services and overhead include the cost to
Versar of direct and overhead staff, including recoverable and
unallowable costs that are directly attributable to contracts.
The percentage of these costs to net service revenue decreased to
77.5% in the second quarter of fiscal year 2005 compared to 78.4%
in the second quarter of fiscal year 2004. The decrease was
primarily due to the growth in the Engineering and Construction
segments net revenue.
Selling, general and administrative expenses approximated
17.6% of net service revenue in the second quarter of fiscal year
2005, compared to 16.8% in fiscal year 2004. The increase is
primarily due to additional staffing costs with the addition of a
corporate compliance function to the Company.
Operating income for the second quarter of fiscal year 2005
was $431,000, a 8% increase over that reported in the prior
fiscal year. The increase is due to the improved operating
results in the Engineering and Construction segment which were in
part offset by lower operating results in the National Security
business segment.
11
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
Interest expense for the second quarter of fiscal year 2005
was $10,000, a decrease of $23,000 (70%) over that reported in
the prior fiscal year. The decrease was due to the Company's
improved financial performance, which has resulted in the Company
paying off the Company's line of credit and significantly reducing
the Company's reliance on its working capital line to manage the
Company's working capital requirements.
Versar's net income for the second quarter of fiscal year
2005 was $421,000 compared to $366,000 in the prior fiscal year.
The improved earnings were primarily attributable to the increase
in gross revenue as well as the reduced interest costs in the
second quarter of fiscal year 2005.
Six Months Comparison of Fiscal Years 2005 and 2004
___________________________________________________
Gross revenues for the first six months of fiscal year 2005
increased by $10,268,000 (37%) compared to gross revenue in the
first six months of fiscal year 2004. The increase is
attributable to significantly higher construction work in the
Engineering and Construction business segment of approximately
$9,991,000, as discussed further under the heading "Financial
Trends", which was in part offset by reduced mold remediation
work in the Infrastructure and Management Services business
segment.
The increase in gross revenue in the Engineering and
Construction business segment is attributable to roof replacement
work in San Diego, the construction of a specialized material
handling facility, and other construction projects in support of
the Air Force.
Purchased services and materials increased by $8,692,000
(76%) in the first six months of fiscal year 2005 compared to
that reported in the first six months of fiscal year 2004. As
mentioned above, the increase was due to increased subcontractor
activity in the Engineering and Construction business segment in
support of the Air Force and other government agencies.
Net service revenues increased by 10% in the first six
months of fiscal year 2005 primarily due to the profit on the
higher subcontracted construction activities as mentioned above.
Direct costs of services and overhead include the cost to Versar
of direct and overhead staff, including recoverable and
unallowable costs that are directly attributable to contracts.
The percentage of these costs to net service revenue for 2005
remained comparable to 2004.
Selling, general and administrative expenses approximated 16.9%
of net service revenue in the first six months of fiscal year
2005, compared to 16.8% in fiscal year 2004. The percentage of
these costs to net service revenue for 2005 remained comparable
to 2004.
Operating income for the first six months of fiscal year
2005 was $851,000, a 7% increase over that reported in the prior
fiscal year. The increase is primarily due to improved operating
results in the Engineering and Construction business segment,
which were, in part, offset by lower operating results in the
National Security business segment due to continued reduced
business volume in the chemical and biological laboratories. The
Company anticipates that the business shortfalls in the National
Security segment will reverse themselves by the end of the third
quarter of fiscal year 2005.
Interest expense for the first six months of fiscal year
2005 was $23,000, a decrease of $64,000 (74%) over that reported
in the prior fiscal year. The decrease was due to the Company's
improved financial performance, which has resulted in the Company
paying off the Company's line of credit during the fourth quarter
of fiscal year 2004.
Versar's net income for the first six months of fiscal year
2005 was $828,000 compared to $709,000 in the prior fiscal year.
The improved earnings were primarily attributable to the increase
in gross revenue as well as the reduced interest costs in the
second quarter of fiscal year 2005.
12
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
Liquidity and Capital Resources
_______________________________
The Company's working capital as of December 31, 2004
approximated $8,384,000, an increase of $890,000 (12%). The
increase is primarily due to improved earnings in the first six
months of fiscal year 2005. In addition, the Company's current
ratio at December 31, 2004 was 1.84, which was slightly lower
than that reported on June 30, 2004 due to the increase in
receivables as a result of the 37% increase in gross revenues in
the first six months of fiscal year 2005.
In September 2003, Versar entered into a new line of credit
facility with United Bank (the Bank) that provides for advances
up to $5,000,000 based upon qualifying receivables. Interest on
the borrowings is based on prime plus one and a half percent
(6.5% as of December 31, 2004). The credit facility is
guaranteed by the Company and each subsidiary individually and is
collectively secured by accounts receivable, equipment and
intangibles, plus all insurance policies on property constituting
collateral. The credit facility is subject to renewal in
November 2005. The credit facility has certain covenants related
to the maintenance of financial ratios. These covenants require
a minimum tangible net worth of $6,500,000, a maximum total
liabilities to tangible net worth ratio not to exceed 2.5 to 1;
and a minimum current ratio of at least 1.25 to 1. Failure to
meet the covenant requirements gives the Bank the right to demand
the amount due under the line of credit, which may impact the
Company's ability to finance its working capital requirements.
At December 31, 2004, the Company was in compliance with the
financial covenants.
We believe that our cash and cash equivalents on hand and
current borrowing capacity, together with anticipated cash flows
from operations, is sufficient to meet our liquidity needs for
the next twelve months. There can be no assurance, however, that
amounts available in the future from our sources of liquidity
will be sufficient to meet future capital needs.
Financial trends
________________
From fiscal year 2002 to 2004, the net service revenue of the
Company continued to decline as the Company wound down the Army
STEPO suit production contract in the National Security business
segment. With increased funded contract backlog in the fourth
quarter of fiscal year 2004 and the first quarter of fiscal year
2005, the Company began to reverse that trend. Multi-million
dollar contracts were awarded to the Engineering and Construction
business segment. These included roofing projects in San Diego
in support of Defense Logistic Agency and hurricane emergency
response in various locations in Florida. Recently, the Company
was awarded $3 million on construction oversight work in Iraq.
The Company anticipates that both gross and net revenues will
continue to increase in fiscal year 2005 as a result of the
increased Engineering and Construction work. Such continued
growth is dependent upon winning additional follow-on projects
and additional new contracts in order to keep the funded contract
backlog at levels that would support such continued growth.
Management continues to pursue many business opportunities to
continue such growth, but can give no assurances that this will
be achieved.
There are a number of risk factors or uncertainties that
could significantly impact our financial performance including
the following:
* General economic or political conditions;
* Threatened or pending litigation;
* The timing of expenses incurred for corporate initiatives;
* Employee hiring, utilization, and turnover rates;
* The seasonality of spending in the federal government and
commercial clients;
* Delays in project contracted engagements;
* Unanticipated contract changes impacting profitability;
* Reductions in prices by our competitors;
* The ability to obtain follow on project work;
13
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
* Our failure to properly manage projects resulting in additional
costs;
* The impact of a negative government audit potentially impacting
our costs, reputation and ability to work with the federal
government;
* Loss of key personnel;
* The ability to compete in a highly competitive environment; and
* Diversion of federal funding to Iraq.
Critical Accounting Policies and Related Estimates That Have a
______________________________________________________________
Material Effect on Versar's Consolidated Financial Statements
_____________________________________________________________
Below is a discussion of the accounting policies and related
estimates that we believe are the most critical to understanding
our consolidated, financial position, and results of operations
which require management judgments and estimates, or involve
uncertainties. Information regarding our other accounting
policies is included in the notes to our consolidated financial
statements included in our annual report filed on form 10-K.
Revenue recognition: Contracts in process are stated at the
lower of actual costs incurred plus accrued profits or net
estimated realizable value of costs, reduced by progress
billings. On cost-plus fee contracts, revenue is recognized to
the extent of costs incurred plus a proportionate amount of fee
earned, and on time-and material contracts, revenue is recognized
to the extent of billable rates times hours delivered plus
material and other reimbursable costs incurred. The Company
records income from major fixed-price contracts, extending over
more than one accounting period, using the percentage-of-
completion method. During the performance of such contracts,
estimated final contract prices and costs are periodically
reviewed and revisions are made as required. Fixed price
contracts can be significantly impacted by changes in contract
performance, contract delays, liquidated damages and penalty
provisions, and contract change orders, which may potentially
impact the revenue recognition on a project. Losses on contracts
are recognized in the period when they become known.
From time to time we may proceed with work based on customer
direction pending finalization and signing of contractual funding
documents. We have an internal process for approving any such
work. The Company recognizes revenue based on actual costs
incurred to the extent that the funding is assessed as probable.
In evaluating the probability of funding being received, we
consider our previous experiences with the customer,
communications with the customer regarding funding status, and
our knowledge of available funding for the contract or program.
If funding is not assessed as probable, costs are expensed as
they are incurred.
There is the possibility that there will be future and
currently unforeseeable significant adjustments to our estimated
contract revenues, costs and margins for fixed price contracts,
particularly in the later stages of these contracts. It is most
likely that such adjustments could occur in our growing
Engineering and Construction business segment. Such adjustments
are common in the construction industry given the nature of the
contracts. These adjustments could either positively or
negatively impact our estimates due to the circumstances
surrounding the negotiations of change orders, the impact of
schedule slippage, subcontractor claims and contract disputes
which are normally resolved at the end of the contract.
Adjustments to the financial statement are made when they are known.
Allowance for doubtful accounts: Disputes arise in the
normal course of the Company's business on projects where the
Company is contesting with customers for collection of funds
because of events such as delays, changes in contract
specifications and questions of cost allowability or
collectibility. Such disputes, whether claims or unapproved
change orders in process of negotiation, are recorded at the
lesser of their estimated net realizable value or actual costs
incurred and only when realization is probable and can be
reliably estimated. Claims against the Company are recognized
where loss is considered probable and reasonably determinable in
amount. Management reviews outstanding receivables on a regular
basis and assesses the need for reserves, taking into
consideration past collection history and other events that bear
on the collectibility of such receivables.
14
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
Deferred tax valuation allowance: The Company has
approximately $4.5 million in deferred tax assets of which a $3.8
million valuation allowance has been established against such
assets. Management provides for a valuation allowance until such
time it can conclude more likely than not that the Company will
derive a benefit from such assets. The valuation allowance is
adjusted as necessary based upon the Company's ability to
generate taxable income, including management's ability to
implement tax strategies that will enable the Company to benefit
from such deferred tax assets.
In the first quarter of fiscal year 2003, management
implemented a cost restructure plan to improve the operating
performance of the Company. The cost reductions, along with
stronger revenue, resulted in $1.3 million operating income in
fiscal year 2004, a $1 million improvement from the prior year
operating income of $262,000. As the likelihood of utilizing
deferred tax assets increased, management reduced the tax
valuation allowance from $4.1 million to $3.8 million in fiscal
year 2004.
Goodwill and other intangible assets: On January 30, 1998,
Versar completed the acquisition of The Greenwood Partnership,
P.C. subsequently renamed (Versar Global Solutions, Inc. or
VGSI). The transaction was accounted for as a purchase.
Goodwill resulting from this transaction was approximately $1.1
million. In fiscal year 2003, the Company adopted the Statement
of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets" which eliminated the amortization of
goodwill, but does require the Company to test such goodwill for
impairment annually. Currently, the carrying value of goodwill
is approximately $776,000 relating to the acquisition of VGSI,
which is now part of the Engineering and Construction (E&C)
reporting unit. In performing its goodwill impairment analysis,
management has utilized a discounted cash flow model to determine
the estimated fair value of the (E&C) reporting unit. This model
requires management, among other things, to estimate future
revenue and expenses of the E&C reporting unit based upon current
contract backlog and projected growth resulting from new
business. Management engages outside professionals and valuation
experts, as necessary, to assist in performing this analysis.
Should the E&C reporting unit financial performance not meet
estimates, then impairment of goodwill would have to be further
assessed to determine whether the write down to the asset would
be warranted. If such a write down were to occur, it would
negatively impact the Company's financial position and results of
operations. However, it would not impact the Company's cash flow
or financial debt covenants.
During fiscal years 2004 and 2003, management concluded, based
upon its impairment analysis, that goodwill relating to the E&C
reporting unit was not impaired.
Impact of Inflation
___________________
Versar seeks to protect itself from the effects of
inflation. The majority of contracts the Company performs are
for a period of a year or less or are cost plus fixed-fee type
contracts and, accordingly, are less susceptible to the effects
of inflation. Multi-year contracts provide for projected
increases in labor and other costs.
Commitments and Contingencies
_____________________________
In September 2002, the Company recorded a non-recurring
charge of $800,000 to reduce the Company's overall cost structure
and to reduce costs in non-performing divisions. The costs
included $450,000 for severance payments to terminated employees
and $350,000 for costs to restructure certain leased facilities.
Approximately $148,500 and $192,200 in severance payments were
made in fiscal years 2003 and 2004, with a remaining liability
balance of $109,200, which will be disbursed in fiscal year 2005.
In addition, $82,000 and $131,000 of the facilities restructure
reserve was reduced as a result of modifying existing long term
leases in Texas, Chicago, and California facilities in fiscal
years 2003 and 2004. The balance of $137,000 is expected to be
utilized to reduce the facility costs for expected vacant space
that previously was subleased at the Company's headquarters in
Springfield, Virginia in fiscal year 2005.
15
Item 3 - Quantitative and Qualitative Disclosures About Market
Risk
There have been no material changes regarding the Company's
market risk position from the information provided on Form 10-K
for the fiscal year end June 30, 2004.
Item 4 - Procedures and Controls
As of the last day of the period covered by this report, the
Company carried out an evaluation, under the supervision of the
Company's Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Exchange Act Rule
13a-15. Based upon that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective, as of such
date, to ensure that required information will be disclosed on a
timely basis in its reports under the Exchange Act.
There were no changes in the Company's internal control over
financial reporting during the last quarter that have materially
affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
In August 1997, Versar entered into a contract with the Trustees
for the Enviro-Chem Superfund Site (the "Superfund Site"), which
provided that, based upon an existing performance specification,
Versar would refine the design, and construct and operate a soil
vapor extraction system. During the performance of the contract,
disputes arose between Versar and the Trustees regarding the
scope of work. Eventually, Versar was terminated by the Trustees
for convenience. The Trustees then failed to pay certain
invoices and retainages due Versar.
On March 19, 2001, Versar instituted a lawsuit against the
Trustees and three environmental consulting companies in the U.S.
District Court of the Eastern District of Pennsylvania, entitled
Versar, Inc. v. Roy O. Ball, Trustee, URS Corporation,
Environmental Resources Management and Environ Corp., No.
01CV1302. Versar, in seeking to recover amounts due under the
remediation contract from the Trustees of the Superfund Site,
claimed breach of contract, interference with contractual
relationships, negligent misrepresentations, breach of good faith
and fair dealing, unjust enrichment and implied contract. Mr.
Ball and several defendants moved to dismiss the action or, in
the alternative, transfer the action to the U.S. District Court
for the Southern District of Indiana, where, on April 20, 2001,
the two Trustees had filed suit against Versar in the U.S.
District Court for the Southern District of Indiana, entitled,
Roy O. Ball and Norman W. Bernstein, Trustees v. Versar, Inc.,
Case No. IPO1-0531 C H/G. The Trustees alleged breach of
contract and breach of warranty with respect to the remediation
contract and asked for a declaratory judgment on a number of the
previously stated claims.
On July 12, 2001, the Federal District Court in Pennsylvania
granted defendants' motion to transfer the Pennsylvania lawsuit
and consolidate the two legal actions in Indiana. The Company
filed an answer and counterclaim to the Indiana lawsuit. The
plaintiffs and third-party defendants filed Motions to Dismiss
the Company's counterclaim. The court granted the motions in
part and denied them in part. Versar amended its answer and
counterclaim. In the meantime, plaintiffs filed a Motion for
Partial Summary Judgment which the Judge granted in part and
denied in part. The Judge held that certain agreements entered
into by the parties prevented Versar from recovering certain
amounts under its counterclaim but that Versar could pursue its
claim for fraud in other areas. Written and oral discovery has
commenced and has continued for several years. The court
recently granted Versar's demand that the Trustees supply
requested information and documents. Versar continues to seek
additional discovery compliance by the Trustees. Discovery has
been completed. Motions for summary judgement are expected to
be filed by both parties. The trial, which was set for May 2005
will be rescheduled. Based upon discussions with outside
counsel, management does not believe that the ultimate resolution
under the Trustees' lawsuit will have a materially adverse effect
on the Company's consolidated financial condition and results of
operations.
16
Versar and its subsidiaries are parties from time to time to
various other legal actions arising in the normal course of
business. The Company believes that any ultimate unfavorable
resolution of these legal actions will not have a material
adverse effect on its consolidated financial condition and
results of operations.
Item 4 - Submission of Matters to a Vote of Stockholders
The Company's Annual Meeting of Stockholders (the "Annual
Meeting") was held on November 17, 2004. The matters voted on at
the Annual Meeting were as follows:
(1) The Election of Directors
The election of ten nominees to serve as directors of the
Company was approved as indicated below:
For Withheld
___________ ___________
Robert L. Durfee 6,700,952 63,180
Fernando V. Galaviz 6,729,865 34,267
James L. Gallagher 6,732,023 32,109
James V. Hansen 6,692,302 71,830
Amoretta M. Hoeber 6,668,958 95,174
Paul J. Hoeper 6,730,623 33,509
Michael Markels, Jr. 6,642,737 121,395
Amir A. Metry 6,669,971 94,161
Theodore M. Prociv 6,730,623 33,509
(2) To approve the adoption of the Versar, Inc. Employee Stock
Purchase Plan:
For Against Abstain
___________ ___________ ___________
3,687,175 138,717 23,454
Broker Non-Votes 2,914,786
(3) Ratify the appointment of Grant Thornton LLP as independent
accountants for fiscal year 2005 was ratified as follows:
For Against Abstain
___________ ___________ ___________
6,715,785 39,400 8,947
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
10.113 - Employment Agreement effective December 31,
2004 between Registrant and Theodore M. Prociv.
31.1 and 31.2 - Certification pursuant to Securities
Exchange Act Section 13a-14.
32.1 and 32.2 - Certification under Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Form 8-K, which reported the Company's annual Results of
Operations and Financial Condition, was furnished to, but not
filed with the Securities and Exchange Commission on
November 10, 2004.
Form 8-K, which reported the Company's Employee Stock Purchase
Plan Definitive Agreement, was filed with the Securities and
Exchange Commission on November 17, 2004.
17
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.
VERSAR, INC.
____________
(Registrant)
/S/ Theodore M. Prociv
By:________________________
Theodore M. Prociv
Chief Executive Officer,
President, and Director
/S/ Lawrence W. Sinnott
By:________________________
Lawrence W. Sinnott
Senior Vice President,
Chief Financial Officer,
Treasurer, and Principal
Accounting Officer
Date: February 11, 2005
18