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Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the three months ended July 3, 2010
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 333-145355
(VANGENT LOGO)
VANGENT, INC.
     
Delaware   20-1961427
(State or other jurisdiction of   (IRS Employer
incorporation or organization)   Identification No.)
4250 North Fairfax Drive
Suite 1200
Arlington, Virginia 22203
(703) 284-5600
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 þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer þ   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ
There were 100 shares of common stock of Vangent, Inc. issued and outstanding at July 3, 2010.
 
 

 

 


 

VANGENT, INC.
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 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2
Forward-Looking Statements
This quarterly report on Form 10-Q contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as expectation or belief concerning future events. Forward-looking statements are those that do not relate solely to historical fact. They include, but are not limited to, any statement that may predict, forecast, indicate or imply future results, performance, achievements or events. Words such as, but not limited to, “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “targets,” “projects,” “likely,” “will,” “would,” “could” and similar expressions or phrases identify forward-looking statements. All forward-looking statements involve risks and uncertainties. The Company cautions that these statements are further qualified by important economic, competitive, governmental and technological factors that could cause our business, strategy or actual results of operations or events to differ materially from those in the forward-looking statements, including, without limitation, changes in the demand for services that the Company provides; our ability to generate new business in the United States and abroad; activities of competitors; bid protests; changes in costs or operating expenses; our substantial debt; changes in the availability of and cost of capital; general economic and business conditions and the other factors set forth under Risk Factors in our annual report on Form 10-K for the year ended December 31, 2009. Accordingly, such forward-looking statements do not purport to be predictions of future events or circumstances, and there can be no assurance that any forward-looking statement contained herein will prove to be accurate. The Company undertakes no obligation, and specifically declines any obligation, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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PART I. FINANCIAL INFORMATION
ITEM 1.   FINANCIAL STATEMENTS
Vangent, Inc.
Condensed Consolidated Balance Sheets (Unaudited)
(in thousands, except share and per-share amounts)
                 
    July 3,     December 31,  
    2010     2009  
Assets
               
Current assets:
               
Cash and cash equivalents
  $ 37,533     $ 44,638  
Trade receivables, net
    140,212       109,846  
Prepaid expenses and other assets
    10,492       7,424  
Deferred contract costs
    1,358       2,929  
Assets of discontinued operations
    6,718       15,036  
 
           
Total current assets
    196,313       179,873  
 
               
Property and equipment, net
    22,914       25,124  
Intangible assets, net
    140,948       151,860  
Goodwill
    267,401       268,212  
Deferred debt financing costs and other
    7,355       8,433  
Assets of discontinued operations
          6,727  
 
           
Total assets
  $ 634,931     $ 640,229  
 
           
 
               
Liabilities and Stockholder’s Equity
               
Current liabilities:
               
Current portion of long-term debt
  $     $ 13,534  
Accounts payable and accrued liabilities
    75,422       64,849  
Accrued interest payable
    7,950       8,186  
Deferred tax liability
    4,412       5,628  
Deferred revenue
    4,288       3,976  
Liabilities of discontinued operations
    5,631       7,521  
 
           
Total current liabilities
    97,703       103,694  
 
               
Long-term debt, net of current portion
    406,754       406,832  
Other long-term liabilities
    5,009       7,194  
Deferred tax liability
    16,286       12,144  
Liabilities of discontinued operations
    199       502  
 
           
Total liabilities
    525,951       530,366  
 
           
 
               
Commitments and contingencies (Note 10)
               
 
               
Stockholder’s equity:
               
Common stock, $0.01 par value, 1,000 shares authorized, 100 shares issued and outstanding
           
Additional paid-in capital
    207,875       207,376  
Accumulated other comprehensive loss
    (13,815 )     (14,949 )
Accumulated deficit
    (85,080 )     (82,564 )
 
           
Total stockholder’s equity
    108,980       109,863  
 
           
Total liabilities and stockholder’s equity
  $ 634,931     $ 640,229  
 
           
See notes to condensed consolidated financial statements.

 

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Vangent, Inc.
Condensed Consolidated Statements of Operations (Unaudited)
(in thousands)
                                 
    Three Months Ended     Six Months Ended  
    July 3,     June 27,     July 3,     June 27,  
    2010     2009     2010     2009  
 
                               
Revenue
  $ 214,846     $ 135,115     $ 409,043     $ 267,988  
Cost of revenue
    182,459       115,918       340,685       223,284  
 
                       
 
                               
Gross profit
    32,387       19,197       68,358       44,704  
General and administrative expenses
    11,494       9,547       23,684       19,237  
Selling and marketing expenses
    5,447       4,386       11,122       8,529  
 
                       
 
                               
Operating income
    15,446       5,264       33,552       16,938  
Interest expense, net
    7,362       8,533       15,598       16,884  
 
                       
 
                               
Income (loss) from continuing operations before income taxes
    8,084       (3,269 )     17,954       54  
Provision for income taxes
    1,851       1,694       3,685       3,438  
 
                       
 
                               
Income (loss) from continuing operations
    6,233       (4,963 )     14,269       (3,384 )
Loss from discontinued operations, net of tax
    (14,348 )     (1,149 )     (16,785 )     (1,764 )
 
                       
 
                               
Net loss
  $ (8,115 )   $ (6,112 )   $ (2,516 )   $ (5,148 )
 
                       
See notes to condensed consolidated financial statements

 

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Vangent, Inc.
Condensed Consolidated Statements of Stockholder’s Equity and Comprehensive Loss (Unaudited)
(in thousands, except share amounts)
                                                 
                            Accumulated                
                    Additional     Other           Total  
    Common Stock     Paid-in     Comprehensive     Accumulated     Stockholder’s  
    Shares     Amount     Capital     Loss     Deficit     Equity  
 
                                               
Balance, December 31, 2008
    100     $     $ 206,328     $ (13,135 )   $ (48,556 )   $ 144,637  
Effect of hedging activities, net of tax
                      905             905  
Foreign currency translation adjustment
                      1,250             1,250  
Net loss
                            (5,148 )     (5,148 )
 
                                             
Total comprehensive loss
                                            (2,993 )
Equity-based compensation
                511                   511  
 
                                   
Balance, June 27, 2009
    100     $     $ 206,839     $ (10,980 )   $ (53,704 )   $ 142,155  
 
                                   
 
                                               
Balance, December 31, 2009
    100     $     $ 207,376     $ (14,949 )   $ (82,564 )   $ 109,863  
Effect of hedging activities, net of tax
                      2,466             2,466  
Foreign currency translation adjustment
                      (1,332 )           (1,332 )
Net loss
                            (2,516 )     (2,516 )
 
                                             
Total comprehensive loss
                                            (1,382 )
Equity-based compensation
                499                   499  
 
                                   
Balance, July 3, 2010
    100     $     $ 207,875     $ (13,815 )   $ (85,080 )   $ 108,980  
 
                                   

 

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Vangent, Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
                 
    Six Months Ended  
    July 3,     June 27,  
    2010     2009  
Cash flows from operating activities
               
Net loss
  $ (2,516 )   $ (5,148 )
Less: Loss from discontinued operations, net of tax
    (16,785 )     (1,764 )
 
           
Income (loss) from continuing operations
    14,269       (3,384 )
Adjustments to reconcile income (loss) from continuing operations to net cash provided by operating activities:
               
Amortization of intangible assets
    10,540       10,587  
Depreciation and amortization
    5,901       5,565  
Amortization of deferred debt financing costs
    1,126       1,126  
Equity-based compensation expense
    499       511  
Deferred income taxes
    3,360       3,028  
Changes in operating assets and liabilities:
               
Trade receivables
    (30,544 )     6,400  
Prepaid expenses and other assets
    (4,339 )     (4,682 )
Accounts payable and other liabilities
    13,045       (9,502 )
 
           
Continuing operations, net
    13,857       9,649  
Discontinued operations, net
    (2,870 )     (2,574 )
 
           
Net cash provided by operating activities
    10,987       7,075  
 
           
 
               
Cash flows from investing activities
               
Capital expenditures, continuing operations
    (3,526 )     (4,779 )
Discontinued operations, net
    (811 )     (1,760 )
 
           
Net cash used in investing activities
    (4,337 )     (6,539 )
 
           
 
               
Cash flows from financing activities
               
Repayment of senior secured term loan
    (13,612 )      
Other
    (53 )     (163 )
 
           
Net cash used in financing activities, continuing operations
    (13,665 )     (163 )
Effect of exchange rate changes on cash and cash equivalents
    (170 )     258  
 
           
Net increase (decrease) in cash and cash equivalents
    (7,185 )     631  
Total cash and cash equivalents, beginning of period
    45,584       21,134  
 
           
Total cash and cash equivalents, end of period
    38,399       21,765  
Less: Cash and cash equivalents, discontinued operations
    866       1,601  
 
           
Cash and cash equivalents, continuing operations
  $ 37,533     $ 20,164  
 
           
 
               
Supplemental noncash investing and financing activities
               
Leasehold improvements provided by lessor under operating leases
  $ 773     $ 347  
 
               
Supplemental cash flow information
               
Interest paid, continuing operations
  $ 15,226     $ 16,446  
Income taxes paid:
               
Continuing operations
    135       377  
Discontinued operations
    299       247  
See notes to condensed consolidated financial statements

 

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Vangent, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)
(dollars in thousands)
1. Organization and Basis of Presentation
Basis of Presentation
Vangent, Inc. (“Vangent” or “Company”) is a 100%-owned subsidiary of Vangent Holding Corp. Vangent Holding LLC is the majority shareholder of Vangent Holding Corp. Vangent Holding LLC is 90% owned by The Veritas Capital Fund III, L.P. and 10% owned by Pearson plc (“Pearson”).
The unaudited condensed consolidated financial statements include the accounts of the Company and its domestic and foreign subsidiaries and have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and note disclosures normally included in complete financial statements have been condensed or omitted pursuant to the applicable rules and regulations. The Company believes that all disclosures are adequate to make the information presented not misleading. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes thereto included in our annual report on Form 10-K for the year ended December 31, 2009.
All normal and recurring adjustments necessary to fairly present the financial position and results of operations as of and for the periods presented have been included. The results of operations presented are not necessarily indicative of the results to be expected for the full fiscal year or for any future periods. The Company uses estimates and assumptions in the preparation of its financial statements. The estimates are primarily based on historical experience and business knowledge and are revised as circumstances change. Actual results could differ materially from those estimates.
Nature of Operations
Vangent serves customers in the U.S. government, international governments, higher education, and the private sector. The Company’s primary customer focus is U.S. and international governmental agencies that utilize third-party providers to design, build and operate technologically advanced systems. The Department of Commerce represented 34%, Department of Health and Human Services represented 30%, and the Department of Education represented 13% of total revenue for the six months ended July 3, 2010.
Variable Interest Entities
The Company has interests in foreign joint ventures that provide government contract services in the United Kingdom and in the United Arab Emirates. In the United Kingdom arrangement, the Company has guaranteed joint venture performance under a fixed-priced subcontract and has committed to fund working capital requirements. Under the joint venture agreements the Company holds less than a majority ownership interest in the joint ventures; however, the Company is entitled to a majority of the income and losses of the joint ventures and has determined that it is the primary beneficiary of each of the joint ventures. The joint ventures are fully consolidated in the Company’s consolidated financial statements. Total assets of $2,041 and total liabilities of $511 of the joint ventures are included in the consolidated financial statements at July 3, 2010.
Fiscal Year and Quarterly Periods
The Company’s fiscal year begins on January 1 and ends on December 31. Quarterly periods are based on a four-week, four-week, five-week methodology ending on the Saturday nearest to the end of the quarter to align with the Company’s domestic business processes. The six-month period ended July 3, 2010, is 6 days, or 3%, longer that the corresponding period in 2009. Foreign subsidiaries are consolidated based on the calendar quarter.

 

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2. Discontinued Operations
At the end of 2009, Vangent completed an evaluation of its international business and committed to a plan to sell its business operations in Latin America. The condensed consolidated financial statements have been revised for all periods presented to report Latin America as discontinued operations. The discontinued operations include: Vangent Mexico, S.A. de C.V.; Vangent Servicios de Mexico, S.A. de C.V.; Vangent Argentina, S.A.; Vangent Venezuela, C.A.; Vangent Puerto Rico, Inc.; and Proyectos Prohumane México, S. A. de C. V.
A summary of assets and liabilities, revenue, and cost and expenses of the discontinued operations that are segregated and reported separately in the consolidated financial statements follows:
                 
    July 3,     December 31,  
    2010     2009  
Balance Sheet Data
               
Cash
  $ 866     $ 946  
Trade receivables
    10,236       9,323  
Other assets
    5,526       4,767  
Allowance for expected loss on disposal
    (9,910 )      
 
           
Total current assets
    6,718       15,036  
Property and equipment , net
          4,744  
Deferred income taxes and other
          1,983  
 
           
Total assets
    6,718       21,763  
Current liabilities
    5,631       7,521  
Long-term liabilities
    199       502  
 
           
Net assets of discontinued operations
  $ 888     $ 13,740  
 
           
                                 
    Three Months Ended     Six Months Ended  
    July 3,     June 27,     July 3,     June 27,  
    2010     2009     2010     2009  
Statements of Operations Data
                               
Revenue
  $ 7,075     $ 5,895     $ 14,210     $ 10,494  
Costs and expenses
    7,346       7,529       14,846       12,842  
Expected loss on disposal
    15,277             17,895        
Other (income) expense, net
    7       (38 )     (746 )     (18 )
 
                       
Loss from discontinued operations before income taxes
    (15,555 )     (1,596 )     (17,785 )     (2,330 )
Provision (benefit) for income taxes
    (1,207 )     (447 )     (1,000 )     (566 )
 
                       
Loss from discontinued operations, net of tax
  $ (14,348 )   $ (1,149 )   $ (16,785 )   $ (1,764 )
 
                       
Based on estimates of fair value of the discontinued operations, a charge for expected loss on disposal of $4,965 was recorded for the year ended December 31, 2009. The charge was calculated based on estimates of fair value, less cost to sell, compared with net assets of discontinued operations. The fair value estimates were revised in the second quarter of 2010 based on letters of intent from market participants that are potential buyers of the operations in Latin America. As a result, an additional charge of $17,895 for the expected loss on disposal was recorded for the six months ended July 3, 2010. Charges for the expected loss on disposal include $4,692 for cumulative translation losses recorded as part of other comprehensive loss for discontinued operations. The final adjustment to the expected loss on disposal will be recorded based on the terms and completion of a disposal transaction.
No corporate interest expense was allocated to the discontinued operations since there was no corporate debt specifically attributable to the operations. The senior secured credit facility provides that under certain circumstances a mandatory debt payment is required for 100% of the proceeds of qualifying asset dispositions. The terms of the ultimate disposition of the discontinued operations and other conditions will determine whether or not a mandatory debt payment will result.

 

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Discontinued Operations in Venezuela — Designation of Venezuelan Economy as Highly Inflationary
Revenue from Vangent Venezuela, C.A. was $617 for the three months and $1,007 for the six months ended July 3, 2010. Venezuela has experienced significant inflation in the last several years, and effective January 2010 the economy has been determined to be highly inflationary under U. S. generally accepted accounting principles. An economy is considered highly inflationary when cumulative three-year inflation exceeds 100% which occurred in the fourth quarter of 2009. As a result Vangent Venezuela uses the U.S. dollar as the functional currency effective January 2010 and net monetary assets held in bolivar fuertes are translated into U.S. dollars at each balance sheet date with remeasurement adjustments and any foreign currency transaction gains or losses recognized in income or expense. In June 2010, the Venezuelan government instituted foreign exchange controls that replaced the parallel or market rate, and Vangent began to use the foreign currency exchange rate controlled and regulated by the Central Bank of Venezuela under a system referred to as Sistema de Transacciones con Titulos en Moneda Extranjera, or SITME, in place of the parallel rate to consolidate Vangent Venezuela. Other income and expense, net, for discontinued operations includes net foreign currency gains from Vangent Venezuela of $162 for the three months and $53 for the six months ended July 3, 2010.
Discontinued Operations in Argentina — Variable Interest Entity
Vangent Argentina, S.A. has an interest in a joint venture in Argentina that began providing government services in the second quarter of 2009. Vangent Argentina and the joint venture partner have each guaranteed joint venture performance under a fixed-priced subcontract. Vangent Argentina holds less than a majority ownership interest in the joint venture and is entitled to 50% of the income and losses of the joint venture. Vangent Argentina has determined that it does not have the power to direct matters that most significantly impact the activities of the joint venture and that it is not the primary beneficiary of the joint venture. The joint venture is accounted for under the equity method of accounting as part of discontinued operations. Equity in net income of the joint venture of $385 for the three months and $777 for the six months ended July 3, 2010, is included in loss from discontinued operations. Investment in joint venture of $1,341, representing the Company’s maximum exposure to loss as of July 3, 2010, is included in assets of discontinued operations.
3. Recent Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”), Multiple-Deliverable Revenue Arrangements, to (i) provide guidance on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated; (ii) require an allocation of revenue using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence or third-party evidence of the selling price; and (iii) eliminate the residual method. The update becomes effective on a prospective basis in fiscal years beginning on or after June 15, 2010, with earlier application permitted. The Company does not expect that adoption will have a material effect on its results of operations or financial position.
In October 2009, the FASB issued an ASU, Certain Revenue Arrangements that Include Software Elements, that amends existing requirements to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality. The update becomes effective on a prospective basis in fiscal years beginning on or after June 15, 2010, with earlier application permitted. The Company does not expect that adoption will have a material effect on its results of operations or financial position.
In January 2010, the FASB issued an ASU, Improving Disclosures about Fair Value Measurements, requiring additional disclosures on fair value measurements. Disclosure requirements for transfers in and out of levels 1 and 2 of the hierarchy for fair value measurements, that became effective January 1, 2010, did not have a material effect on the Company’s results of operations or financial position. Disclosures about purchases, sales, issuance, and settlements in a rollforward of activity for level 3 fair value measurements are deferred until fiscal years beginning after December 15, 2010. The Company does not expect that adoption will have a material effect on its results of operations or financial position.
In April 2010, the FASB issued an ASU, Revenue Recognition — Milestone Method, to provide guidance on (i) defining a milestone; and (ii) determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. The guidance applies to research or development deliverables or units of accounting under which a vendor satisfies its performance obligations over a period of time, and when a portion or all of the consideration is contingent upon uncertain future events and circumstances. The guidance becomes effective on a prospective basis for milestones achieved in fiscal years beginning on or after June 15, 2010, with early adoption and retrospective application permitted. The Company does not expect that adoption will have a material effect on its results of operations or financial position.

 

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In June 2009, the FASB issued new requirements that are now part of the ASC topic on Consolidations, dealing with the consolidation of variable interest entities. The new requirements change how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated and requires a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. The new requirements became effective on January 1, 2010. Adoption did not have a material effect on the Company’s results of operations or financial position.
In July 2010, the FASB issued an ASU, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, to expand disclosures for exposure to credit losses from lending arrangements, including credit risks involved in financing receivables and allowances for credit losses. The new requirements will become effective in December 2010. The Company does not expect that adoption will have a material effect on its results of operations or financial position.
4. Trade Receivables
A summary of trade receivables and customers that represented 10% or more of trade receivables follows:
                 
    July 3,     December 31,  
    2010     2009  
Billed trade receivables
  $ 96,710     $ 74,929  
Billable trade receivables
    35,452       26,798  
Unbilled trade receivables pending completion of milestones, contract authorizations, or retainage
    7,992       7,432  
Other
    217       840  
 
           
 
    140,371       109,999  
Allowance for doubtful accounts
    (159 )     (153 )
 
           
Trade receivables, net
  $ 140,212     $ 109,846  
 
           
 
               
Trade accounts receivable from major customers
               
Department of Commerce
    31 %     * %
Department of Health and Human Services
    28 %     34 %
Department of Education
    13 %     16 %
 
     
*   Less than 10%.

 

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5. Intangible Assets
A summary of intangible assets follows:
                     
    Weighted            
    Average Life   July 3,     December 31,  
    (in years)   2010     2009  
Indefinite-life intangible assets
                   
Intellectual property
  Indefinite   $ 10,328     $ 10,328  
 
               
 
                   
Definite-life intangible assets
                   
Customer relationships
  10.7     200,729       201,101  
Other
  4     658       658  
 
               
 
        201,387       201,759  
Accumulated amortization
        (70,767 )     (60,227 )
 
               
Definite-life intangible assets, net
        130,620       141,532  
 
               
Intangible assets, net
      $ 140,948     $ 151,860  
 
               
Amortization of the unamortized balance of definite-life intangible assets for each of the next five years and thereafter is scheduled as follows:
         
Years Ending December 31        
2010 (remaining six months)
  $ 10,497  
2011
    20,702  
2012
    20,539  
2013
    20,539  
2014
    11,897  
Thereafter
    46,446  
 
     
 
  $ 130,620  
 
     
6. Long-Term Debt
A summary of long-term debt follows:
                 
    July 3,     December 31,  
    2010     2009  
Term loan, due February 14, 2013, with interest at variable rates (2.50% at July 3, 2010)
  $ 216,754     $ 230,366  
9 5/8% Senior subordinated fixed rate notes, due February 15, 2015
    190,000       190,000  
 
           
 
    406,754       420,366  
Less: current portion of term loan
          (13,534 )
 
           
Long-term debt, net of current portion
  $ 406,754     $ 406,832  
 
           
Scheduled maturities of long-term debt follow:
         
2011
  $  
2012
    1,711  
2013
    215,043  
2014
     
2015
    190,000  
 
     
 
  $ 406,754  
 
     
Senior Secured Credit Facility
At July 3, 2010, the senior secured credit facility consisted of a term loan of $216,754 due February 14, 2013, and, subject to certain limitations, an available revolving credit facility of up to $49,800 that expires February 14, 2012. There were no borrowings outstanding under the revolving credit facility at July 3, 2010, or December 31, 2009. A commitment fee of 0.5% per year is paid on the available unused portion of the revolving credit facility.

 

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Borrowings under the senior secured credit facility bear interest at a rate equal to, at the Company’s option, either: (i) the base rate, as defined, plus an applicable margin of 1.00-1.50%, or (ii) the adjusted LIBOR, as defined, plus an applicable margin of 2.00-2.50% (2.00% at July 3, 2010). Borrowings are subject to mandatory prepayment with (i) 100% of the net cash proceeds of certain asset sales; (ii) 50% of the net cash proceeds of equity offerings or capital contributions subject to certain exceptions; (iii) 100% of the net cash proceeds of additional debt; and (iv) a percentage of annual excess cash flow, as defined. Payments resulting from the annual excess cash flow requirement are due 90 days following the year end. Based on the excess cash flow calculation for the year ended December 31, 2009, a mandatory payment of $13,612 was made March 31, 2010. Since the excess cash flow requirement is based on annual cash flow, it is not possible to estimate the amount, if any, that would become payable in March 2011 or March 2012.
Borrowings are secured by accounts receivable, cash, intellectual property and other assets and are guaranteed jointly and severally, by all existing and future domestic subsidiaries. Foreign subsidiaries do not guarantee the borrowings. The senior secured credit facility contains various customary affirmative and negative covenants and events of default, including, but not limited to, restrictions on the disposal of assets, incurring additional indebtedness or guaranteeing obligations, paying dividends, creating liens on assets, making investments, loans or advances, and compliance with a maximum consolidated leverage ratio. As of July 3, 2010, the Company was in compliance with all of the affirmative and negative covenants.
The more restrictive covenants relate to (i) loans and advances by Vangent, Inc. to non-guarantor subsidiaries, and (ii) compliance with a maximum allowable consolidated leverage ratio. At July 3, 2010, the cumulative amount of net loans to and investments in Vangent Mexico, S.A. de C.V., a non-guarantor subsidiary, by Vangent, Inc. amounted to $9,124 compared with the maximum allowable amount of $10,000 for loans to or investments in non-guarantor subsidiaries under the senior secured credit facility. The consolidated leverage ratio, as defined in the senior secured credit facility, is based on consolidated indebtedness, as defined, reduced by unrestricted cash and cash equivalents in excess of $5,000, divided by adjusted EBITDA (earnings before interest, taxes, depreciation and amortization, adjusted for certain unusual and non-recurring items, as defined) for a twelve-month period. At July 3, 2010, the consolidated leverage ratio was 4.34 to 1, compared with the maximum allowable ratio of 5.75 to 1 applicable to the period. The maximum allowable consolidated leverage ratio steps down to 5.50 to 1 at December 31, 2010.
9 5/8% Senior Subordinated Notes
In February 2007, the Company completed an offering of $190,000 principal amount of 9 5/8% senior subordinated notes due February 15, 2015. Interest accrues at the fixed rate of 9 5/8% and is paid semi-annually. The notes are general unsecured obligations of the Company and are subordinated to all existing and future senior loans including borrowings under the senior secured credit facility. The notes are guaranteed, jointly and severally, by all existing and future domestic subsidiaries. Foreign subsidiaries do not guarantee the notes.
The Company may redeem all or part of the notes at any time prior to February 15, 2011, at a redemption price of 100% of the principal amount plus an applicable premium, as defined and additional interest, as defined. The notes are redeemable at the option of the Company at the redemption price of 104.8125% of the principal amount on or after February 15, 2011, 102.4063% on or after February 15, 2012, and 100% on or after February 15, 2013.

 

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7. Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss and a summary of changes in accumulated other comprehensive loss for hedging activities follows:
                 
    July 3,     December 31,  
    2010     2009  
Accumulated other comprehensive loss
               
Effect of hedging activities, net of tax:
               
Continuing operations — Interest rate swap agreements
  $ (2,481 )   $ (4,634 )
Discontinued operations — Foreign currency forward contracts
    (79 )     (392 )
 
           
 
    (2,560 )     (5,026 )
 
               
Foreign currency cumulative translation adjustments:
               
Continuing operations
    (6,642 )     (5,287 )
Discontinued operations
    (4,613 )     (4,636 )
 
           
 
    (11,255 )     (9,923 )
 
           
Total accumulated other comprehensive loss
  $ (13,815 )   $ (14,949 )
 
           
                         
    Hedging Activities  
    Continuing     Discontinued        
    Operations     Operations        
          Foreign        
    Interest     Currency        
Summary of changes in accumulated other   Rate     Forward        
comprehensive loss for hedging activities   Swaps     Contracts     Total  
Balance, December 31, 2009
  $ (4,634 )   $ (392 )   $ (5,026 )
Change in fair value
    (622 )     (8 )     (630 )
Reclassification of loss to interest expense
    2,775             2,775  
Reclassification of loss to discontinued operations — cost of revenue
          321       321  
 
                 
Balance, July 3, 2010
  $ (2,481 )   $ (79 )   $ (2,560 )
 
                 
8. Derivative Instruments, Hedging Activities and Financial Instruments
Vangent, Inc. uses derivative financial instruments to manage interest rate risk and Vangent Mexico, S.A. de C.V., a 100%-owned subsidiary included as part of discontinued operations, has used derivative instruments to manage certain foreign currency exchange rate risks. Interest rate swap agreements are used as cash-flow hedges of interest rate risk associated with variable-rate borrowings under the senior secured credit facility. Foreign currency contracts have been used to hedge exchange rate risks associated with purchase commitments and obligations in currencies other than the Mexican peso. Derivatives can involve credit risk from the possible non-performance by the parties. At July 3, 2010, the fair values of the derivative contracts resulted in derivative liabilities, and the fair value liabilities reflect the Company’s credit adjusted discount rate. The Company does not enter into derivative transactions for trading or speculative purposes.
For derivative financial instruments that qualify as a cash-flow hedge, the effective portion of the gain/loss is reported as a component of other comprehensive income/loss (“OCI”) and is subsequently reclassified to the statements of operations in the period or periods in which the hedged transaction affects the statement of operations.
Interest Rate Swap Agreements on Variable-Rate Term Loan
The Company has entered into interest rate swap agreements with a commercial bank to hedge fluctuations in LIBOR interest rates on a portion of the term loan borrowing under the senior secured credit facility. The Company exchanged its variable LIBOR interest rate for a fixed interest rate. At July 3, 2010, an interest rate swap agreement at the notional amount of $150,000 to pay fixed interest at the rate of 3.28% and to receive variable interest based on three-month LIBOR was outstanding and scheduled to mature in February 2011.

 

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The Company documented its risk management objective and nature of the risks being hedged and designated the interest rate swaps as cash flow hedges at inception of the agreements. The Company performs a quarterly analysis of the effectiveness of the hedge transactions and has concluded that the hedging relationship is highly effective due to the consistency of critical terms of the interest rate swap agreements and related term loan under the senior secured credit facility. The fair value of the interest rate swap liability was $2,481 at July 3, 2010, and $4,657 at December 31, 2009. The unrealized loss on interest rate swaps was $2,481 at July 3, 2010, all of which included in accumulated OCI in the consolidated statement of stockholder’s equity and is expected to be reclassified to interest expense over the next twelve months.
Discontinued Operations — Foreign Currency Contracts
In 2009, Vangent Mexico entered into foreign currency forward exchange contracts with a commercial bank to hedge fluctuations in the Mexican peso exchange rates. At July 3, 2010, there were no foreign currency forward exchange contracts outstanding.
Vangent Mexico documented its risk management objective and nature of the risks being hedged for foreign currency contracts that qualify as cash flow hedges at inception of the agreements. Some of the foreign currency hedge contracts no longer qualify as cash flow hedges since it is probable that a forecasted transaction will not occur, and cost of revenue for discontinued operations for the six months ended July 3, 2010, includes a loss of $89 reclassified from OCI for contracts that no longer qualify. For hedge contracts that do qualify as cash flow hedges, an unrealized loss of $79 at July 3, 2010, is included in accumulated OCI in the consolidated statement of stockholder’s equity and is expected to be reclassified to cost of revenue over the next twelve months.
Derivative Instruments and Hedging Activities
A tabular disclosure of the fair values of derivative instruments reported in the balance sheet and the effect of derivative instruments on the statements of operations follows:
                     
Balance Sheet Data  
        Fair Value of  
        Liability Derivatives  
        July 3,     December 31,  
Derivative Contracts   Balance Sheet Location   2010     2009  
Derivatives that qualify as cash flow hedges
                   
Interest rate swap agreements
  Accrued liabilities   $ 2,481     $ 4,657  
Foreign currency forward contracts
  Accrued liabilities, discontinued operations           251  
 
                   
Derivatives that do not qualify as cash flow hedges
                   
Foreign currency forward contracts
  Accrued liabilities, discontinued operations           88  

 

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Statements of Operations Data  
                            Amount of Gain  
                            (Loss) Recognized  
    Amount of Gain                     in Income on  
    (Loss)                 Location of Gain (Loss)   Derivative  
    Recognized in         Amount of Gain     Recognized in Income on   (Ineffective  
    OCI on     Location of Gain (Loss)   (Loss) Reclassified     Derivative (Ineffective   Portion and  
    Derivative     Reclassified from   from Accumulated     Portion and Amount   Amount Excluded  
    (Effective     Accumulated OCI into   OCI into Income     Excluded from Effectiveness   from Effectiveness  
Derivative Contracts   Portion)     Income (Effective Portion)   (Effective Portion)     Testing)   Testing)  
 
                               
Three Months Ended July 3, 2010
                               
 
                               
Derivatives that qualify as cash flow hedges
                   
 
                               
Interest rate swap agreements
    $10     Interest expense     $(1,108 )   Interest expense     $—  
 
                               
Foreign currency forward contracts
        Cost of revenue,
discontinued operations
    (13 )        
 
                               
Derivatives that do not qualify as cash flow hedges
                   
 
                               
Foreign currency forward contracts
                  Cost of revenue,
discontinued operations
     
 
                               
Three Months Ended June 27, 2009
                   
 
                               
Derivatives that qualify as cash flow hedges
                   
 
                               
Interest rate swap agreements
    806     Interest expense     (1,585 )   Interest expense     23  
 
                               
Foreign currency forward contracts
    (480 )   Cost of revenue     (27 )        
 
                               
 
                               
Six Months Ended July 3, 2010
                               
 
                               
Derivatives that qualify as cash flow hedges
                   
 
                               
Interest rate swap agreements
    (622 )   Interest expense     2,775     Interest expense     23  
 
                               
Foreign currency forward contracts
    (8 )   Cost of revenue,
discontinued operations
    (321 )        
 
                               
Derivatives that do not qualify as cash flow hedges
                   
 
                               
Foreign currency forward contracts
                  Cost of revenue,
discontinued operations
    (89 )
 
                               
Six Months Ended June 27, 2009
                               
 
                               
Derivatives that qualify as cash flow hedges
                   
 
                               
Interest rate swap agreements
    (1,152 )   Interest expense     (2,793 )   Interest expense     48  
 
                               
Foreign currency forward contracts
    (763 )   Cost of revenue     (27 )        

 

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Fair Value Measurements
Fair value is the price that would be received to sell an asset or to transfer a liability in an orderly transaction between market participants at the measurement date. A summary of the bases used to measure financial assets and financial liabilities reported at fair value on a recurring basis in the consolidated balance sheets follows:
                 
    July 3,     December 31,  
    2010     2009  
Liabilities
               
Level 1 - Quoted prices in active markets for identical items
  $     $  
Level 2 - Significant other observable inputs:
               
Interest rate swap agreements
    2,481       4,657  
Foreign currency forward contracts
          339  
Level 3 - Significant unobservable inputs
           
Financial Instruments
The fair values of financial instruments at July 3, 2010, follow:
                 
    Carrying        
    Amount     Fair Value  
Long-term debt
               
Variable-rate term loan under the senior secured credit facility
  $ 216,754     $ 216,754  
9 5/8% senior subordinated notes, due February 15, 2015
    190,000       181,212  
 
           
 
  $ 406,754     $ 397,966  
 
           
Interest rate swap agreements to pay fixed and receive variable
               
Accrued liabilities
  $ 2,481     $ 2,481  
 
           
The carrying amount of the variable-rate term loan under the senior secured credit facility approximates fair value. The fair value of the 9 5/8% senior subordinated notes is based on quoted market prices. At July 3, 2010, the quoted market price was $95.375 per $100 reflecting a yield of 11.1%. The fair value of interest rate swap agreements and foreign currency forward contracts is based on quoted prices for similar assets or liabilities in active markets adjusted for non-performance risk. The carrying amounts of other financial instruments, including cash and cash equivalents, accounts receivable, and accounts payable and accrued liabilities, approximate fair value due to their short term nature.
9. Income Taxes
The provision for income taxes is composed of U.S. federal, state and local and foreign income taxes. The provision for income taxes of $3,685 for the six months ended July 3, 2010, was reduced by $2,180 for a change in the tax valuation allowance for deferred tax assets resulting from the utilization of a portion of the net operating loss carryforward against taxable income earned for the six months ended July 3, 2010.
A tax valuation allowance is recorded against deferred tax assets when it is more likely than not that a tax benefit will not be realized in the future. The assessment requires judgment with respect to tax benefits that may be realized. The Company considers all available positive and negative evidence, including future reversals of temporary differences, projected future taxable income, tax planning strategies, and recent financial results. The Company has concluded as of July 3, 2010, based upon all available evidence, that it is more likely than not that the U.S. deferred tax assets will not be realizable. The tax valuation allowance amounted to $42.5 million at July 3, 2010. In the event the Company determines in a future period that realization of deferred tax benefits, primarily net operating loss carryforwards, is more likely than not, all or a portion of the tax valuation allowance would be reversed. A reversal or reduction to the tax valuation allowance would be recorded as a reduction to the provision for income taxes
Deferred tax liabilities aggregated $20,698 at July 3, 2010, and were primarily related to an indefinite lived asset (goodwill) that is amortized for tax purposes, but is not amortized for financial accounting and reporting purposes.
The ASC topic on Income Taxes prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken, or expected to be taken, in a tax return. Vangent is indemnified and is not liable for any income taxes that relate to the pre-acquisition periods prior to February 15, 2007. There was no liability for unrecognized tax benefits at July 3, 2010. Vangent does not expect changes in unrecognized tax benefits, if any, within the next twelve months to have a material impact on the provision for income taxes or the effective tax rate.

 

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Vangent and its subsidiaries conduct business and are subject to income taxes in the United States and certain foreign countries. Vangent’s income tax returns for 2009, 2008, and 2007 are subject to examination by federal, state, local, or foreign tax authorities. Interest and penalties, if any, relating to income taxes are charged to the provision for income taxes.
10. Commitments and Contingencies
Payments to the Company by U. S. Government agencies on cost-plus contracts are provisional and are subject to adjustment based on audits performed by the Defense Contract Audit Agency. Audits of incurred cost submissions for the years 2005 to 2009 are open. The Company is also subject to audits, legal proceedings, investigations and claims arising out of the ordinary course of business and accrues a liability if an unfavorable outcome is probable. In the opinion of management, resolution of such matters is not expected to have a material effect on the Company’s results of operations or financial position.
11. Equity-Based Compensation
No stock options are authorized and no stock options have been granted by Vangent.
Certain members of management of Vangent and outside directors of Vangent Holding Corp. have been granted Class B membership interests in Vangent Holding LLC, the majority shareholder of Vangent Holding Corp. which in turn owns all of Vangent’s common stock. At July 3, 2010, the outstanding balance of grants of Class B membership interests represented 5.3% of the profit interests in Vangent Holding LLC. Pursuant to the terms of the operating agreement governing Vangent Holding LLC, the Class B membership interests are subject to a five-year vesting schedule, except in the event of a change of control. The unvested portion of Class B membership interests resulting from forfeitures reverts to the holders of Class A membership interests in Vangent Holding LLC. Class B membership interests are granted with no exercise price or expiration date. Holders of Class B membership interests are entitled to receive their respective proportional interest of all distributions made by Vangent Holding LLC provided the holders of the Class A membership interests have received an 8% per annum internal rate of return on their invested capital. Grants of Class B membership interests are limited to 7.5% of the profits interest in Vangent Holding LLC in the aggregate.
A summary of activity for grants and the outstanding balance of Class B membership interests in Vangent Holding LLC follows:
                         
    Class B             Fair Value of  
    Membership             Class B  
    Interests             Membership  
    Available for     Class B Interests     Interests at Date of  
    Grant     Outstanding     Grant  
Balance, December 31, 2009
    2.0 %     5.6 %   $ 5,602  
Granted
                 
Forfeited
    0.2       (0.3 )     (178 )
 
                 
Balance, July 3, 2010
    2.2 %     5.3 %   $ 5,424  
 
                 
 
                       
At July 3, 2010:
                       
Vested
            2.9 %        
Not yet vested
            2.4          
 
                     
 
            5.3 %        
 
                     

 

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Vangent charges equity-based compensation expense for awards of Class B membership interests in Vangent Holding LLC granted to its employees and independent directors. Equity-based compensation expense is amortized on a straight-line basis over the total requisite service period for the award. The unamortized amount of equity-based compensation expense was $1,927 at July 3, 2010, and amortization is scheduled as follows:
         
Years Ending December 31        
2010 (remaining six months)
  $ 491  
2011
    981  
2012
    321  
2013
    120  
2014
    14  
 
     
 
  $ 1,927  
 
     
12. Related Party Transactions
Vangent is a 100%-owned subsidiary of Vangent Holding Corp. Vangent Holding LLC is the majority shareholder in Vangent Holding Corp. and is 90% owned by The Veritas Capital Fund III, L.P.
Robert B. McKeon is the sole member of the board of directors of Vangent, is chairman of the board of Vangent Holding Corp., and is the president of Veritas Capital Partners III, LLC. Mr. Ramzi Musallam is a director of Vangent Holding Corp. and is a partner at Veritas Capital.
Certain members of management of Vangent and certain outside directors of Vangent Holding Corp. have been granted Class B membership interests in Vangent Holding LLC, the majority shareholder in Vangent Holding Corp.
Vangent pays an annual management fee of $1,000 to Veritas Capital, of which $500 was paid for the six months ended July 3, 2010, along with fees of $43 for advisory services and expenses.
Vangent Argentina, a foreign subsidiary of Vangent, Inc., has an interest in an unconsolidated joint venture in Argentina. Vangent Argentina and the joint-venture partner have each guaranteed joint venture performance under a fixed-priced subcontract. Vangent Argentina provided contract services of $206 to the joint venture for the six months ended July 3, 2010.
13. Business Segments and Major Customers
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
Vangent reports operating results and financial data for three business segments: the Government Group; the International Group; and the Human Capital Group. Government Group customers are primarily U.S. federal agencies. The Government Group assists civilian, defense and intelligence agencies as well as government related entities with the design and execution of information and technology strategy, helps develop and maintain their complex, mission critical systems and delivers a wide range of business process outsourcing solutions. The International Group provides consulting, systems integration and business process outsourcing solutions to both commercial and foreign local and central government customers. The Human Capital Group designs, builds, and operates workforce solutions that automate and improve the recruitment, assessment, selection and development of a customer’s workforce.

 

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A summary of revenue and operating income (loss) by business segment follows (dollars in thousands):
                                 
    Three Months Ended     Six Months Ended  
    July 3,     June 27,     July 3,     June 27,  
    2010     2009     2010     2009  
Revenue by business segment
                               
Government Group
  $ 198,677     $ 115,581     $ 375,914     $ 233,347  
International Group
    11,148       10,539       22,973       20,258  
Human Capital Group
    5,834       10,364       11,969       16,857  
Elimination
    (813 )     (1,369 )     (1,813 )     (2,474 )
 
                       
Total revenue
  $ 214,846     $ 135,115     $ 409,043     $ 267,988  
 
                       
 
                               
Operating income (loss) by business segment
                               
Government Group
  $ 15,966     $ 6,057     $ 34,835     $ 18,351  
International Group
    8       (111 )     70       (110 )
Human Capital Group
    (522 )     (669 )     (1,342 )     (1,285 )
Corporate
    (6 )     (13 )     (11 )     (18 )
 
                       
Total operating income
    15,446       5,264       33,552       16,938  
Interest expense, net
    7,362       8,533       15,598       16,884  
 
                       
Income (loss) from continuing operations before income taxes
  $ 8,084     $ (3,269 )   $ 17,954     $ 54  
 
                       
 
                               
Depreciation and amortization
                               
Government Group
  $ 7,183     $ 6,891     $ 14,488     $ 13,903  
International Group
    568       771       1,295       1,498  
Human Capital Group
    333       368       658       740  
 
                       
Total depreciation and amortization
  $ 8,084     $ 8,030     $ 16,441     $ 16,141  
 
                       
 
                               
Revenue from major customers as a percent of total revenue
                               
Department of Commerce
    42 %     *       34 %     *  
Department of Health and Human Services
    25 %     42 %     30 %     44 %
Department of Education
    11 %     16 %     13 %     18 %
Department of Defense
    *       12 %     *       10 %
 
     
*   Less than 10%.
14. Condensed Issuer and Non-Guarantor Financial Information
In connection with the acquisition by Veritas Capital and the related financing, Vangent, Inc. (“Issuer”) issued $190,000 of 9 5/8% senior subordinated notes due 2015. The notes were sold to qualified institutional buyers pursuant to Rule 144A under the Securities Act and to non-U.S. persons pursuant to Regulation S under the Securities Act. The assets and liabilities of the guarantors have been transferred to Vangent, Inc., and, accordingly, their financial statements are not presented separately. The following subsidiaries of the Issuer do not guarantee the notes (“Non-Guarantors”) and are reported as part of continuing operations: Vangent Canada Limited and Vangent, Ltd. In addition, the following subsidiaries of the Issuer do not guarantee the notes (“Non-Guarantors”) and are reported as part of discontinued operations: Vangent Mexico, S.A. de C.V.; Vangent Servicios de Mexico, S.A. de C.V.; Vangent Argentina, S.A.; Vangent Venezuela, C.A.; Vangent Puerto Rico, Inc.; and Proyectos Prohumane México, S. A. de C. V. Condensed combining balance sheets, statements of operations, and statements of cash flows for the Issuer and for the Non-Guarantors follow:

 

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Issuer and Non-Guarantor Financial Information
Condensed Combining Balance Sheets (Unaudited)
                                                                 
    July 3, 2010     December 31, 2009  
            Non-                             Non-              
            Guar-     Elimin-                     Guar-     Elimin-        
    Issuer     antors     ations     Total     Issuer     antors     ations     Total  
Assets
                                                               
Current assets:
                                                               
Cash and cash equivalents
  $ 34,662     $ 2,871     $     $ 37,533     $ 41,098     $ 3,540     $     $ 44,638  
Trade receivables, net
    133,754       6,458             140,212       101,410       8,436             109,846  
Prepaid expenses and other
    9,705       2,145             11,850       8,594       1,759             10,353  
Assets of discontinued operations
          6,718             6,718             15,036             15,036  
 
                                               
Total current assets
    178,121       18,192             196,313       151,102       28,771             179,873  
Property and equipment, net
    20,877       2,037             22,914       22,499       2,625             25,124  
Intangible assets, net
    134,450       6,498             140,948       144,764       7,096             151,860  
Goodwill
    258,905       8,496             267,401       258,905       9,307             268,212  
Deferred debt financing costs and other
    7,301       54             7,355       8,379       54             8,433  
Investment in and advances to Non-Guarantor subsidiaries
    20,698             (20,698 )           37,299             (37,299 )      
Assets of discontinued operations
                                  6,727             6,727  
 
                                               
Total assets
  $ 620,352     $ 35,277     $ (20,698 )   $ 634,931     $ 622,948     $ 54,580     $ (37,299 )   $ 640,229  
 
                                               
 
                                                               
Liabilities and Stockholder’s Equity
                                                               
Current liabilities:
                                                               
Current portion of long-term debt
  $     $     $     $     $ 13,534     $     $     $ 13,534  
Accounts payable and other liabilities
    85,257       6,815             92,072       74,655       8,154       (170 )     82,639  
Liabilities of discontinued operations
    53       9,806       (4,228 )     5,631       1,230       9,564       (3,273 )     7,521  
 
                                               
Total current liabilities
    85,310       16,621       (4,228 )     97,703       89,419       17,718       (3,443 )     103,694  
Long-term debt, net of current portion
    406,754                   406,754       406,832                   406,832  
Other long-term liabilities
    4,959       50             5,009       7,132       62             7,194  
Deferred tax liability
    14,349       1,937             16,286       9,702       2,442             12,144  
Liabilities of discontinued operations
          199             199             502             502  
 
                                               
Total liabilities
    511,372       18,807       (4,228 )     525,951       513,085       20,724       (3,443 )     530,366  
Total stockholder’s equity
    108,980       16,470       (16,470 )     108,980       109,863       33,856       (33,856 )     109,863  
 
                                               
Total liabilities and stockholder’s equity
  $ 620,352     $ 35,277     $ (20,698 )   $ 634,931     $ 622,948     $ 54,580     $ (37,299 )   $ 640,229  
 
                                               

 

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Issuer and Non-Guarantor Financial Information
Condensed Combining Statements of Operations (Unaudited)
                                                                 
    Three Months Ended July 3, 2010     Three Months Ended June 27, 2009  
            Non                             Non              
            Guar-     Elimin-                     Guar-     Elimin-        
    Issuer     antors     ations     Total     Issuer     antors     ations     Total  
Revenue
  $ 203,765     $ 11,081     $     $ 214,846     $ 124,737     $ 10,378     $     $ 135,115  
Cost of revenue
    172,792       9,667             182,459       106,555       9,363             115,918  
 
                                               
Gross profit
    30,973       1,414             32,387       18,182       1,015             19,197  
General and administrative expenses
    10,439       1,055             11,494       9,137       410             9,547  
Selling and marketing expenses
    4,972       475             5,447       3,945       441             4,386  
 
                                               
Operating income
    15,562       (116 )           15,446       5,100       164             5,264  
Interest expense, net
    7,483       (121 )           7,362       8,562       (29 )           8,533  
Equity in net income (loss) of Non-Guarantor subsidiaries
    (15,394 )           15,394             (758 )           758        
 
                                               
Income (loss) from continuing operations before income taxes
    (7,315 )     5       15,394       8,084       (4,220 )     193       758       (3,269 )
Provision for income taxes
    1,715       136             1,851       1,645       49             1,694  
 
                                               
Income (loss) from continuing operations
    (9,030 )     (131 )     15,394       6,233       (5,865 )     144       758       (4,963 )
Income (loss) from discontinued operations, net of tax
    915       (15,263 )           (14,348 )     (247 )     (902 )           (1,149 )
 
                                               
Net loss
  $ (8,115 )   $ (15,394 )   $ 15,394     $ (8,115 )   $ (6,112 )   $ (758 )   $ 758     $ (6,112 )
 
                                               
                                                                 
    Six Months Ended July 3, 2010     Six Months Ended June 27, 2009  
            Non                             Non              
            Guar-     Elimin-                     Guar-     Elimin-        
    Issuer     antors     ations     Total     Issuer     antors     ations     Total  
Revenue
  $ 386,188     $ 22,855     $     $ 409,043     $ 247,974     $ 20,014     $     $ 267,988  
Cost of revenue
    320,942       19,743             340,685       205,465       17,819             223,284  
 
                                               
Gross profit
    65,246       3,112             68,358       42,509       2,195             44,704  
General and administrative expenses
    22,027       1,657             23,684       18,468       769             19,237  
Selling and marketing expenses
    10,103       1,019             11,122       7,597       932             8,529  
 
                                               
Operating income
    33,116       436             33,552       16,444       494             16,938  
Interest expense, net
    15,768       (170 )           15,598       16,915       (31 )           16,884  
Equity in net income (loss) of Non-Guarantor subsidiaries
    (17,070 )           17,070             (887 )           887        
 
                                               
Income (loss) from continuing operations before income taxes
    278       606       17,070       17,954       (1,358 )     525       887       54  
Provision for income taxes
    3,430       255             3,685       3,282       156             3,438  
 
                                               
Income (loss) from continuing operations
    (3,152 )     351       17,070       14,269       (4,640 )     369       887       (3,384 )
Income (loss) from discontinued operations, net of tax
    636       (17,421 )           (16,785 )     (508 )     (1,256 )           (1,764 )
 
                                               
Net loss
  $ (2,516 )   $ (17,070 )   $ 17,070     $ (2,516 )   $ (5,148 )   $ (887 )   $ 887     $ (5,148 )
 
                                               

 

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Issuer and Non-Guarantor Financial Information
Condensed Combining Statements of Cash Flows (Unaudited)
                                                                 
    Six Months Ended July 3, 2010     Six Months Ended June 27, 2009 (1)  
            Non                             Non              
            Guar-     Elimin-                     Guar-     Elimin-        
    Issuer     antors     ations     Total     Issuer     antors     ations     Total  
Cash flows from operating activities
                                                               
Continuing operations, net
  $ 10,960     $ 2,897     $       13,857     $ 8,392     $ 1,257     $     $ 9,649  
Discontinued operations, net
          (2,870 )           (2,870 )           (2,574 )           (2,574 )
 
                                               
Net cash used in operating activities
    10,960       27             10,987       8,392       (1,317 )           7,075  
 
                                               
 
Cash flows from investing activities
                                                               
Loans from Vangent, Inc. to Vangent Mexico, net
    (850 )           850             (1,245 )           1,245        
Capital expenditures
    (2,933 )     (593 )           (3,526 )     (4,614 )     (165 )           (4,779 )
 
                                               
Continuing operations, net
    (3,783 )     (593 )     850       (3,526 )     (5,859 )     (165 )     1,245       (4,779 )
Discontinued operations, net
          (811 )           (811 )           (1,760 )           (1,760 )
 
                                               
Net cash used in investing activities
    (3,783 )     (1,404 )     850       (4,337 )     (5,859 )     (1,925 )     1,245       (6,539 )
 
                                               
 
Cash flows from financing activities
                                                               
Repayment of senior secured loan
    (13,612 )                 (13,612 )                        
Other
    (53 )                 (53 )     (130 )                 (130 )
 
                                               
Continuing operations, net
    (13,665 )                 (13,665 )     (130 )                 (130 )
Discontinued operations, net
          850       (850 )                 1,212       (1,245 )     (33 )
 
                                               
Net cash provided by (used in) financing activities
    (13,665 )     850       (850 )     (13,665 )     (130 )     1,212       (1,245 )     (163 )
 
                                               
Effect of exchange rate changes on cash and cash equivalents
    51       (221 )           (170 )           258             258  
 
                                               
Net increase (decrease) in cash and cash equivalents
    (6,437 )     (748 )           (7,185 )     2,403       (1,772 )           631  
Total cash and cash equivalents, beginning of period
    41,099       4,485             45,584       15,519       5,615             21,134  
 
                                               
Total cash and cash equivalents, end of period
    34,662       3,737             38,399       17,922       3,843             21,765  
Less: Cash and cash equivalents, discontinued operations
          866             866             1,601               1,601  
 
                                               
Cash and cash equivalents, continuing operations
  $ 34,662     $ 2,871     $     $ 37,533     $ 17,922     $ 2,242     $     $ 20,164  
 
                                               
 
     
(1)  
Certain amounts previously reported for cash flows for the Issuer and for the Non-Guarantor subsidiaries for the six months ended June 27, 2009, have been reclassified.
15. Subsequent Events
Senior Secured Credit Facility
On July 28, 2010, Vangent and the banks that are party to the senior secured credit facility entered into an amendment that allows for the sale of Vangent’s Latin American operations, expands the amounts allowed for acquisitions to $75.0 million per acquisition and to $175 million in the aggregate, and reduces the mandatory prepayment requirement from net cash proceeds of equity offerings to 25% from 50% as long as the consolidated leverage ratio, as defined, is below 4.00 to 1. Vangent agreed to pay lender fees and expenses of $1.8 million in connection with the amendment.
Acquisition
On August 5, 2010, Vangent executed an agreement of merger to acquire all the issued and outstanding stock of Buccaneer Computer Systems & Service, Inc. for a purchase price of $65.0 million, subject to a working capital adjustment. Buccaneer is an information technology firm providing solutions to both government and corporate clients. Vangent intends to fund the acquisition with a combination of cash on hand and the remainder with borrowings under its senior secured revolving credit facility. The acquisition is expected to close during the third quarter of 2010, subject to customary closing conditions, as defined in the merger agreement. The purchase of Buccaneer will be accounted for under the acquisition method of accounting under which the assets and liabilities acquired, including intangible assets for customer relationships, will be recorded at their fair values, and operating results of Buccaneer will be included in Vangent’s financial statements from the date of acquisition. The excess of the acquisition cost over the fair value of net assets acquired will be allocated to goodwill.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements contained elsewhere in this quarterly report on Form 10-Q and the Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited consolidated financial statements and notes thereto, included in our annual report on Form 10-K for the year ended December 31, 2009.
Overview
We are a leading provider of information management and business process outsourcing services to several U.S. public health care and other civilian government agencies, as well as selected U.S. defense and intelligence agencies, foreign governments and private sector entities. We design, build and operate mission-critical systems and processes to seamlessly deliver vital information, services and programs to our customers and their constituents. Most of our revenue is generated from long-term contracts that typically have duration of approximately five years, including option years. As of July 3, 2010, our total contract backlog was $1.7 billion, compared with $2.1 billion at December 31, 2009.
The Department of Commerce (“DoC”) represented 34%, the Department of Health and Human Services (“HHS”) represented 30%, and the Department of Education (“DoED”) represented 13% of total revenue for the six months ended July 3, 2010. We manage our business through three segments: the Government Group; the International Group; and the Human Capital Group.
The Government Group is our largest segment and has many years of experience in providing information management and business process outsourcing to several civilian and defense agencies of the federal government, including a 29-year history with the Department of Education, over 10 years with the Defense Information Systems Agency and eight years with the Centers for Medicare and Medicaid Services (“CMS”). The Government Group is also responsible for the development, management, analysis and dissemination of healthcare information to the public sector and is one of the largest non-government providers of health information in the United States The Government Group represented 92% of total revenue for the six months ended July 3, 2010.
The International Group serves government customers, primarily in the United Kingdom and Canada, and provides consulting, systems integration, business process outsourcing, and the management of data, identity, revenue and human capital. As of July 3, 2010, the Company’s business operations in Latin America were held for sale and are classified as discontinued operations in the condensed consolidated financial statements. These operations were formerly part of the International Group. The International Group represented 5% of total revenue for the six months ended July 3, 2010.
The Human Capital Group designs, builds, and operates workforce solutions that automate and improve the recruitment, assessment, selection, training and development of a customer’s workforce. We provide solutions that automate pre-employment screening which improves the quality and retention of new employees and reduces the cost and time associated with workforce planning and hiring. The Human Capital Group represented 3% of total revenue for the six months ended July 3, 2010.
Discontinued Operations
At the end of 2009, Vangent completed an evaluation of its international business and made the determination to sell its business operations in Latin America. The condensed consolidated financial statements have been revised for all periods presented to report Latin America as discontinued operations. The discontinued operations include: Vangent Mexico, S.A. de C.V.; Vangent Servicios de Mexico, S.A. de C.V.; Vangent Argentina, S.A.; Vangent Venezuela, C.A.; Vangent Puerto Rico, Inc.; and Proyectos Prohumane México, S. A. de C. V.

 

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Nature of Our Contracts
Contracts funded by U.S. government agencies represented 89% of total revenue for the six months ended July 3, 2010, compared with 83% for the corresponding period in 2009. The continuation and renewal of our existing government contracts and new government contracts are, among other things, contingent upon the availability of adequate funding for the various federal government agencies with which we do business. Refer to our annual report on Form 10-K for the year ended December 31, 2009, for additional information concerning our business and the factors that could impact federal government spending and our federal government contracting business.
We have cost-plus, fixed-price and time and materials contracts. Fixed-priced contracts generally offer a higher profit margin opportunity but involve higher risks associated with potential cost overruns. Revenue from each type of contract as a percent of total revenue follows:
                                 
    Three Months Ended     Six Months Ended  
    July 3,     June 27,     July 3,     June 27,  
    2010     2009     2010     2009  
Cost-plus
    72 %     51 %     69 %     51 %
Fixed-price
    24 %     44 %     27 %     44 %
Time and materials
    4 %     5 %     4 %     5 %
 
                       
 
    100 %     100 %     100 %     100 %
 
                       
The increases in cost-plus contracts for the three and six months ended July 3, 2010, is due to work performed on the 2010 U.S. Census contract.
Contract Backlog
Total contract backlog is the amount of revenue we expect to realize over the remaining term of our contracts. We include in backlog task orders awarded, but not contract ceiling values, under government-wide acquisition contracts or indefinite delivery, indefinite quantity contracts. Funded backlog is the portion for which funding has been authorized. Most of our federal government contracts allow the customer the option of extending the period of performance for a period of one or more years. A summary of contract backlog by business segment follows (in millions):
                                 
    July 3, 2010     December 31, 2009  
    Total     Funded     Total     Funded  
Government Group
  $ 1,410.8     $ 136.7     $ 1,782.6     $ 313.4  
International Group
    264.9       181.4       291.2       196.8  
Human Capital Group
    10.3       10.3       7.1       7.1  
Discontinued operations
    58.3       58.3       44.9       44.9  
 
                       
 
  $ 1,744.3     $ 386.7     $ 2,125.8     $ 562.2  
 
                       
The decline in total contract backlog of $381.5 million, or 18%, from December 31, 2009, reflects revenue earned on major contracts awarded in prior years, including contracts with the Centers for Medicare and Medicaid Services and the U.S. 2010 Census contract, and a slowdown in the level of U.S. government contract opportunities and awards.
Critical Accounting Policies
The process of preparing financial statements in conformity with generally accepted accounting principles requires the use of estimates and judgments to determine certain of the assets, liabilities, revenue and expenses. These estimates and judgments are based upon what we believe is the best information available at the time. Estimates and judgments could change materially as conditions within and beyond our control change. Accordingly, actual results could differ materially from those estimates. The critical accounting estimates and judgments used in the preparation of the condensed consolidated financial statements are described in our annual report on Form 10-K for the year ended December 31, 2009: revenue recognition and cost estimation on long-term contracts; definite-life intangible assets; goodwill and an indefinite-life intangible asset; equity-based compensation; and income taxes.

 

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A significant change in critical accounting estimates and judgments resulted in a charge of $17.9 million for the six months ended July 3, 2010, representing an addition to the expected loss on disposal of discontinued operations based on fair value estimates. The fair value estimates were revised based on letters of intent from market participants that are potential buyers of the discontinued operations in Latin America.
Goodwill and Indefinite-Life Intangible Asset
Vangent performs annual impairment assessments of goodwill for each reporting unit, or segment, and of the indefinite-life intangible asset (not subject to amortization) of the Human Capital Group in the fourth quarter of each year based on estimated fair values or more frequently if indicators of impairment exist. Fair values are determined using the income approach based on a discounted cash flow methodology. The Human Capital Group experienced an operating loss of $1.3 million and a negative operating margin of 11% for the six months ended July 3, 2010, and an operating loss of $5.1 million and a negative operating margin of 15%, including impairment charges that reduced the carrying amount of goodwill to fair value, for the year ended December 31, 2009. The remaining balance of goodwill for the Human Capital Group was $8.5 million and indefinite-life intangible asset was $10.3 million at July, 3, 2010. Continuing adverse changes in expected operating results and/or unfavorable changes in economic factors used to estimate fair values could result in non-cash impairment charges for the Human Capital Group in a future period.
Tax Valuation Allowance
A tax valuation allowance is recorded against deferred tax assets when it is more likely than not that a tax benefit will not be realized in the future. The assessment requires judgment with respect to tax benefits that may be realized. The Company considers all available positive and negative evidence, including future reversals of temporary differences, projected future taxable income, tax planning strategies, and recent financial results. The Company has concluded as of July 3, 2010, based upon all available evidence, that it is more likely than not that the U.S. deferred tax assets will not be realizable. The tax valuation allowance amounted to $42.5 million at July 3, 2010. The Company has recently experienced positive trends in its continuing operating performance, and the positive trends may continue in future periods. In the event the Company determines in a future period that realization of deferred tax benefits, primarily net operating loss carryforwards, is more likely than not, all or a portion of the tax valuation allowance would be reversed. A reversal or reduction to the tax valuation allowance would be recorded as a reduction to the provision for income taxes.
Recent Accounting Pronouncements
Reference is made to the notes to the condensed consolidated financial statements for information on recent accounting pronouncements.

 

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Results of Operations
Statements of operations data follow (dollars in thousands):
                                                 
    Three Months Ended     Six Months Ended  
    July 3,     June 27,     Increase     July 3,     June 27,     Increase  
    2010     2009     (Decrease)     2010     2009     (Decrease)  
Statements of Operations Data
                                               
Revenue
  $ 214,846     $ 135,115     $ 79,731     $ 409,043     $ 267,988     $ 141,055  
Cost of revenue
    182,459       115,918       66,541       340,685       223,284       117,401  
 
                                   
Gross profit
    32,387       19,197       13,190       68,358       44,704       23,654  
General and administrative expenses
    11,494       9,547       1,947       23,684       19,237       4,447  
Selling and marketing expenses
    5,447       4,386       1,061       11,122       8,529       2,593  
 
                                   
Operating income
    15,446       5,264       10,182       33,552       16,938       16,614  
Interest expense, net
    7,362       8,533       (1,171 )     15,598       16,884       (1,286 )
 
                                   
Income (loss) from continuing operations before income taxes
    8,084       (3,269 )     11,353       17,954       54       17,900  
Provision for income taxes
    1,851       1,694       157       3,685       3,438       247  
 
                                   
Income (loss) from continuing operations
    6,233       (4,963 )     11,196       14,269       (3,384 )     17,653  
Loss from discontinued operations, net of tax
    (14,348 )     (1,149 )     (13,199 )     (16,785 )     (1,764 )     (15,021 )
 
                                   
Net loss
  $ (8,115 )   $ (6,112 )   $ (2,003 )   $ (2,516 )   $ (5,148 )   $ 2,632  
 
                                   
 
                                               
Statements of Operations Data as a Percent of Revenue
                                               
Revenue
    100.0 %     100.0 %             100.0 %     100.0 %        
Cost of revenue
    84.9       85.8               83.3       83.3          
 
                                       
Gross profit margin
    15.1       14.2               16.7       16.7          
General and administrative expenses
    5.3       7.1               5.8       7.2          
Selling and marketing expenses
    2.5       3.2               2.7       3.2          
 
                                       
Operating income margin
    7.2       3.9               8.2       6.3          
Interest expense, net
    3.5       6.3               3.8       6.3          
 
                                       
Income (loss) from continuing operations before income taxes
    3.8       (2.4 )             4.4                
Provision for income taxes
    0.8       1.3               0.9       1.3          
 
                                       
Income (loss) from continuing operations
    2.9       (3.7 )             3.5       (1.3 )        
Loss from discontinued operations, net of tax
    (6.7 )     (0.8 )             (4.1 )     (0.6 )        
 
                                       
Net loss
    (3.8) %     (4.5) %             (0.6) %     (1.9) %        
 
                                       

 

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Three and Six Months Ended July 3, 2010 and June 27, 2009
Overview
The Company’s fiscal year begins on January 1 and ends on December 31. Quarterly periods are based on a four-week, four-week, five-week methodology ending on the Saturday nearest to the end of the quarter to align with the Company’s domestic business processes. There are 184 days in the six-month period ended July 3, 2010, compared with 178 days in the corresponding period in 2009. Results of operations cover a period that is 6 days, or 3%, longer than the corresponding period in 2009. Foreign subsidiaries are consolidated based on the calendar quarter.
Revenue
A summary of revenue by business segment follows (dollars in thousands):
                                                                 
    Three Months Ended     Six Months Ended  
    July 3,     June 27,     Increase (Decrease)     July 3,     June 27,     Increase (Decrease)  
    2010     2009     Amount     Percent     2010     2009     Amount     Percent  
Revenue by business segment
                                                         
Government Group
  $ 198,677     $ 115,581     $ 83,096       72 %   $ 375,914     $ 233,347     $ 142,567       61 %
International Group
    11,148       10,539       609       6 %     22,973       20,258       2,715       13 %
Human Capital Group
    5,834       10,364       (4,530 )     (44) %     11,969       16,857       (4,888 )     (29 )%
Elimination
    (813 )     (1,369 )     556       (41) %     (1,813 )     (2,474 )     661       (27 )%
 
                                               
 
  $ 214,846     $ 135,115     $ 79,731       59 %   $ 409,043     $ 267,988     $ 141,055       53 %
 
                                               
 
                                                               
Business segment revenue as a percent of total revenue
                                       
Government Group
    92.5 %     85.5 %                     91.9 %     87.1 %                
International Group
    5.2       7.8                       5.6       7.6                  
Human Capital Group
    2.7       7.7                       2.9       6.3                  
Elimination
    (0.4 )     (1.0 )                     (0.4 )     (1.0 )                
 
                                               
 
    100.0 %     100.0 %                     100.0 %     100.0 %                
 
                                               
The Department of Commerce (“DoC”) represented 34%, the Department of Health and Human Services (“HHS”) represented 30%, and the Department of Education (“DoED”) represented 13% of total revenue for the six months ended July 3, 2010.
The increases in Government Group revenue for the three and six months ended July 3, 2010, compared with the corresponding periods in 2009 reflect the following:
    Revenue from DoC contracts increased $85.9 million for the three months and $134.7 million for the six months from the processing of census forms and data capture under the 2010 U.S. Census contract that is scheduled to be substantially completed in the third quarter of 2010.
    Revenue from HHS contracts, primarily Centers for Medicare and Medicaid Services (“CMS”), declined $2.2 million for the three months but increased $3.4 million for the six months.
    Revenue from Department of Defense (“DoD”) contracts declined $2.3 million for the three months but increased $1.1 million for the six months.
    Revenue from DoED increased $1.6 million for the three months and $4.8 million for the six months primarily from contracts with the Office of Federal Student Aid.
    Revenue from a contract with the Department of State (“DoS”) for the National Passport Information Center increased $1.5 million for the six months.
In addition, the six month period is 3% longer than the corresponding period in 2009. The increases were partially offset by reductions of $1.8 million for the three months and $3.4 million for the six months from the Employee Retirement Income Security Act (“ERISA”) contracts with the Department of Labor (“DoL”).

 

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The increases in International Group revenue for the three and six months ended July 3, 2010, reflect higher revenue from contracts in the United Kingdom partly offset by lower revenue from contracts in Canada. Changes in foreign currency exchange rates increased revenue for the six months by $1.5 million, compared with the average exchange rates prevailing during the corresponding period in 2009.
The reductions in Human Capital Group revenue for the three and six months ended July 3, 2010, reflect the completion of a foreign military contract with the U.S. Air Force to modernize the Royal Saudi Air Force learning infrastructure.
Cost of Revenue
The increases in cost of revenue for the three and six months ended July 3, 2010, reflect costs incurred for contract work performed under the U.S. 2010 Census contract with DoC. The average number of employees increased 49% primarily from increased temporary staffing in connection with the U.S. Census contract. The six-month period is 3% longer than the corresponding period in 2009, and changes in foreign exchange rates increased costs of the International Group by $1.3 million.
The increase in the gross profit margin, or the ratio of gross profit to revenue, to 15.1% for the three months ended July 3, 2010, compared with 14.2 % for the corresponding period in 2009, reflects changes in the mix of contracts. The gross profit margin remained at 16.7% for the six months ended July 3, 2010, the same as for the corresponding period in 2009.
General and Administrative Expenses
The increases in general and administrative expenses for the three and six months ended July 3, 2010, reflects higher accrued expenses for annual incentive compensation awards and an increase in consulting fees. Incentive compensation expense is accrued based upon the level of operating results compared to established targets; there was no incentive compensation expense accrued for the corresponding periods in 2009. The six-month period is 3% longer than the corresponding period in 2009.
As a percentage of revenue, general and administrative expenses declined to 5.8% for the six months ended July 3, 2010, compared with 7.2% for the corresponding period in 2009, reflecting the revenue earned on the U.S. Census contract for which there was minimal incremental general and administrative expenses.
Selling and Marketing Expenses
The increase in selling and marketing expenses for the three and six months ended July 3, 2010, reflects an increase of 29% in the number of new business development employees in the Government Group in the six month period.

 

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Operating Income
A summary of operating income by business segment follows (dollars in thousands):
                                                                 
    Three Months Ended     Six Months Ended  
    July 3,     June 27,     Increase (Decrease)     July 3,     June 27,     Increase (Decrease)  
    2010     2009     Amount     Percent     2010     2009     Amount     Percent  
Operating income (loss) by business segment
                                           
Government Group
  $ 15,966     $ 6,057     $ 9,909       164 %   $ 34,835     $ 18,351     $ 16,484       90 %
International Group
    8       (111 )     119       %     70       (110 )     180       %
Human Capital Group
    (522 )     (669 )     147       22 %     (1,342 )     (1,285 )     (57 )     (4 )%
Corporate
    (6 )     (13 )     7       %     (11 )     (18 )     7       %
 
                                               
 
  $ 15,446     $ 5,264     $ 10,182       193 %   $ 33,552     $ 16,938     $ 16,614       98 %
 
                                               
 
                                                               
Operating margin by business segment
                                             
Government Group
    8.0 %     5.2 %                     9.3 %     7.9 %                
International Group
    0.1 %     (1.1) %                     0.3 %     (0.5) %                
Human Capital Group
    (9.0) %     (6.5) %                     (11.2) %     (7.6) %                
The increases in Government Group operating income for the three and six months ended July 3, 2010, primarily reflect work on the 2010 U.S. Census contract with DoC that is scheduled to be substantially completed in the third quarter of 2010. Award fees earned under cost-plus contracts, including the 2010 U.S. Census contract, increased $8.3 million for the three months and $14.3 million for the six months, compared with the corresponding periods in 2009. In addition, the six month period is 3% longer than the corresponding period in 2009. The increase in operating income for the six months was partly offset by (i) a reduction of $2.4 million in operating income resulting from upfront development costs on fixed-price ERISA contracts with DoL, and (ii) higher accrued expenses of $2.7 million for incentive compensation compared with the corresponding period in 2009 when no incentive compensation was earned or accrued.
International Group operating results continue to reflect breakeven operating margins as higher income in the United Kingdom was partly offset with lower income from Canada.
The continuing operating loss for the Human Capital Group for the three and six months ended July 3, 2010, reflects the adverse impact of lower revenue from completion of the Royal Saudi Air Force contract in the 2010 periods and reductions in training needs and customer hiring patterns from continued high unemployment levels.
Interest Expense, Net
The reductions in interest expense, net, reflect reductions of $0.9 million for the three months and $1.4 million for the six months ended July 3, 2010, from lower average interest rates and a reduction in February 2010 in the notional amount and the average interest rate on the hedged portion of the term loan. The reduction for the six months was partly offset by the period that is 3% longer than the corresponding period in 2009 resulting in $0.5 million of additional interest expense.
Provision for Income Taxes
A summary of the provision for income taxes follows (in thousands):
                                                 
    Three Months Ended     Six Months Ended  
    July 3,     June 27,     Increase     July 3,     June 27,     Increase  
    2010     2009     (Decrease)     2010     2009     (Decrease)  
Provision for income taxes excluding tax valuation allowance
  $ 2,961     $ 6     $ 2,955     $ 5,865     $ 1,022     $ 4,843  
Tax valuation allowance
    (1,110 )     1,688       (2,798 )     (2,180 )     2,416       (4,596 )
 
                                   
Total provision for income taxes
  $ 1,851     $ 1,694     $ 157     $ 3,685     $ 3,438     $ 247  
 
                                   

 

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The provision for income taxes is composed of U.S. federal, state and local and foreign income taxes. The provision for income taxes for the six months ended July 3, 2010, was reduced by $2.2 million for a change in the tax valuation allowance for deferred tax assets resulting from the utilization of a portion of the net operating loss carryforward against taxable income earned for the six months ended July 3, 2010. The Company has concluded as of July 3, 2010, based upon all available evidence, that it is more likely than not that the U.S. deferred tax assets will not be realizable. The tax valuation allowance amounted to $42.5 million at July 3, 2010. In the event the Company determines in a future period that realization of deferred tax benefits, primarily net operating loss carryforwards, is more likely than not, all or a portion of the tax valuation allowance would be reversed. A reversal or reduction to the tax valuation allowance would be recorded as a reduction to the provision for income taxes.
Discontinued Operations
A summary of revenue, cost and expenses for discontinued operations that are segregated and reported separately in the condensed consolidated financial statements follows (in thousands):
                                                 
    Three Months Ended     Six Months Ended  
    July 3,     June 27,     Increase     July 3,     June 27,     Increase  
    2010     2009     (Decrease)     2010     2009     (Decrease)  
Revenue
  $ 7,075     $ 5,895     $ 1,180     $ 14,210     $ 10,494     $ 3,716  
Costs and expenses
    7,346       7,529       (183 )     14,846       12,842       2,004  
Expected loss on disposal
    15,277             15,277       17,895             17,895  
Other (income) expense, net
    7       (38 )     45       (746 )     (18 )     (728 )
 
                                   
Loss from discontinued operations before income taxes
    (15,555 )     (1,596 )     (13,959 )     (17,785 )     (2,330 )     (15,455 )
Provision (benefit) for income taxes
    (1,207 )     (447 )     (760 )     (1,000 )     (566 )     (434 )
 
                                   
Loss from discontinued operations net of tax
  $ (14,348 )   $ (1,149 )   $ (13,199 )   $ (16,785 )   $ (1,764 )   $ (15,021 )
 
                                   
Revenue and costs and expenses for discontinued operations are denominated in multiple foreign currencies, primarily the Mexican Peso, and are significantly affected by foreign currency exchange rate changes.
The increases in revenue from discontinued operations for the three and six months ended July 3, 2010, resulted primarily from a contract with Mexico’s social security agency that was in the start up phase and experienced operational delays in the corresponding periods in 2009. Although revenue from Mexico increased, revenue continues to be adversely affected by continuing low member enrollments under the contract with Mexico’s social security agency. The increases were partially offset by the completion of a contract in Mexico in March 2010. Changes in foreign currency exchange rates, primarily the Mexican Peso, reduced revenue by $0.6 million, or 4%, for the six months, compared with the average exchange rates prevailing during the corresponding period in 2009.
The increase in costs and expenses from discontinued operations for the six months ended July 3, 2010, resulted from the contract with Mexico’s social security agency that was in the start up phase with operational delays in the corresponding period in 2009. Cost and expenses exceeded revenue resulting in a negative operating margin for each of the three and six month periods. Efforts continue to stabilize the operational aspects of the social security contract in Mexico and to achieve breakeven operating results.
Based on estimates of fair value of the discontinued operations, a charge for expected loss on disposal of $5.0 was recorded for the year ended December 31, 2009. The charge was calculated based on estimates of fair value, less cost to sell, compared with net assets of discontinued operations. The fair value estimates were revised in the second quarter of 2010 based on letters of intent from market participants that are potential buyers of the operations in Latin America. As a result, an additional charge of $17.9 million for the expected loss on disposal was recorded for the six months ended July 3, 2010. Charges for the expected loss on disposal include $4.7 million for cumulative translation losses recorded as part of other comprehensive loss for discontinued operations. The final adjustment to expected loss on disposal will be recorded based on the terms and completion of a disposal transaction.

 

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Other income from discontinued operations for the six months ended July 3, 2010, includes equity in net income of $0.8 million from a joint venture in Argentina that began operating in the second quarter of 2009.
Liquidity and Capital Resources
Our primary sources of liquidity are available cash and cash equivalents, a line of credit under the revolving credit facility, and cash flows from operating activities. Cash and cash equivalents amounted to $37.5 million at July 3, 2010. Subject to certain limitations, including compliance with the maximum allowable limits under the leverage ratio covenant under the senior secured credit facility, availability of the line of credit under the revolving credit facility was $49.8 million at July 3, 2010. Based on our current planned level of operations, we believe our cash and cash equivalents, cash flow from operations, and available line of credit will be adequate to meet our liquidity needs for at least the next twelve months, including scheduled interest payments, scheduled lease payments and noncancelable purchase commitments, and planned capital expenditures.
On August 5, 2010, Vangent executed an agreement of merger to acquire all the issued and outstanding stock of Buccaneer Computer Systems & Service, Inc. for a purchase price of $65.0 million. Vangent intends to fund the acquisition with a combination of cash on hand and the remainder with borrowings under its senior secured revolving credit facility.
Cash and cash equivalents are composed of cash in banks and highly liquid instruments with original maturities of 90 days or less. Cash equivalents or marketable securities are comprised of repurchase agreements and money market securities with major commercial banks under which cash is primarily invested in U.S. Treasury and U.S. government agency securities. The Company does not invest in high yield or high risk securities. Cash in bank accounts at times may exceed federally insured limits.
Long-Term Debt
Refer to the notes to the condensed consolidated financial statements for information on long-term debt, revolving credit facility, scheduled maturities of long-term debt, affirmative and negative covenants including the maximum allowable consolidated leverage ratio, interest rate swap agreements on variable-rate term loan, and the fair value of the interest rate swap liability.
Long-term debt of $406.8 million at July 3, 2010, is scheduled to mature as follows: (i) the term loan of $216.8 million under the senior secured credit facility is scheduled to mature in February 2013, and (ii) senior subordinated fixed rate notes of $190.0 million are scheduled to mature in February 2015. Our ability to generate sufficient cash flow from operations to repay long-term debt when it matures, or to refinance our debt when it matures, depends on numerous factors beyond our control, including those discussed under Risk Factors reported in our annual report on Form 10-K for the year ended December 31, 2009. In view of current credit market conditions and the credit ratings assigned to our outstanding debt and corporate credit by credit rating agencies, in the event we were to refinance the senior secured credit facility or the senior subordinated notes, we would likely encounter higher interest rates and limited availability of debt financing capacity.
Debt Covenants
The more restrictive debt covenants relate to (i) compliance with a maximum allowable consolidated leverage ratio, and (ii) loans and advances to non-guarantor subsidiaries. At July 3, 2010, the cumulative amount of net loans to and investments in Vangent Mexico, S.A. de C.V., a non-guarantor subsidiary, by Vangent, Inc. amounted to $9.1 million, compared with the maximum allowable amount of $10.0 million for loans to or investments in non-guarantor subsidiaries under the senior secured credit facility. The consolidated leverage ratio, as defined in the senior secured credit facility, is based on consolidated indebtedness, as defined, reduced by unrestricted cash and cash equivalents in excess of $5.0 million, divided by adjusted EBITDA (earnings before interest, taxes, depreciation and amortization, and adjusted for certain unusual and non-recurring items, as defined) for a twelve-month period. At July 3, 2010, the consolidated leverage ratio was 4.34 to 1, compared with the maximum allowable ratio of 5.75 to 1 applicable to the period. The maximum allowable consolidated leverage ratio steps down to 5.50 to 1 at December 31, 2010.

 

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Interest Rate Swaps on Variable-Rate Term Loan under Senior Secured Credit Facility
The Company has entered into interest rate swap agreements to hedge fluctuations in LIBOR interest rates on a portion of the term loan borrowing under the senior secured credit facility. The Company exchanged its variable LIBOR interest rate for a fixed interest rate. At July 3, 2010, the total notional amount of the pay-fixed/receive-variable interest rate swap agreements was $150.0 million scheduled to mature in February 2011.
The fair value of the net interest rate swap liability was $2.5 million at July 3, 2010, all of which represents an unrealized loss that is reported in accumulated other comprehensive loss in the consolidated statement of stockholder’s equity. The fair value is based on quoted prices for swaps in active markets adjusted for non-performance risks. The Company does not hold or issue derivative financial instruments for speculative purposes.
Working Capital
A summary of working capital follows (in thousands):
                         
                    Effect on  
    July 3,     December 31,     Working  
    2010     2009     Capital  
Cash and cash equivalents
  $ 37,533     $ 44,638     $ (7,105 )
Trade receivables, net
    140,212       109,846       30,366  
Prepaid expenses and other
    11,850       10,353       1,497  
Current portion of long-term debt
          (13,534 )     13,534  
Accounts payable and accrued liabilities
    (75,422 )     (64,849 )     (10,573 )
Accrued interest payable
    (7,950 )     (8,186 )     236  
Other liabilities
    (8,700 )     (9,604 )     904  
Discontinued operations, net
    1,087       7,515       (6,428 )
 
                 
Net working capital
  $ 98,610     $ 76,179     $ 22,431  
 
                 
Cash Flows
A summary of net cash flows follows (in thousands):
                         
    Six Months Ended  
    July 3,     June 27,     Increase  
    2010     2009     (Decrease)  
Net cash provided by (used in)
                       
Operating activities:
                       
Continuing operations
  $ 13,857     $ 9,649     $ 4,208  
Discontinued operations
    (2,870 )     (2,574 )     (296 )
Investing activities:
                       
Continuing operations
    (3,526 )     (4,779 )     1,253  
Discontinued operations
    (811 )     (1,760 )     949  
Financing activities:
                       
Continuing operations
    (13,665 )     (163 )     (13,502 )
Net Cash Provided by (Used in) Operating Activities
In assessing cash flows from operating activities for continuing operations, we consider several principal factors: (i) income or loss from continuing operations, (ii) adjustments for non-cash charges, primarily amortization of intangible assets, depreciation and amortization of property and equipment, and deferred income taxes, and (iii) the extent to which trade receivables, accounts payable and other liabilities, or other working capital components increase or decrease.

 

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Net cash provided by in operating activities for continuing operations was $13.9 million for the six months ended July 3, 2010, compared with $9.6 million for the corresponding period in 2009. Income/loss from continuing operations adjusted for non-cash charges generated operating cash flow of $35.7 million for the six months ended July 3, 2010, compared with $17.4 million for the corresponding period in 2009.
The increase in net cash flow from operating activities for the six months ended July 3, 2010, was partially offset by an increase in trade receivables of $30.5 million, or 28%, compared with December 31, 2009. The increase resulted from higher revenue, primarily the U.S. Census contract, and the timing of collections from customers. Trade receivables at July 3, 2010, reflect DSO (days sales outstanding) of 59 days, compared with 57 days at December 31, 2009. For the corresponding period in 2009, a reduction in trade receivables of $6.4 million contributed to net cash flow from operating activities.
An increase in accounts payable and other liabilities of $13.0 million contributed to cash flow from operating activities for the six months ended July 3, 2010. A reduction of $9.5 million in accounts payable and other liabilities reduced cash flow from operating activities for the corresponding period in 2009; the reduction reflects payments of $6.3 million for incentive compensation that had been earned and accrued in 2008. There were no payments for incentive compensation in 2010 as there were no liabilities for incentive compensation earned or accrued for 2009. The timing of payments to vendors affects the level of accounts payable and the effect on operating cash flow, including the level of activities with small-business vendors and subcontractors that require more frequent cash payments.
Discontinued operations used net cash flow of $2.9 million for operating activities for the six months ended July 3, 2010. The net loss from discontinued operations of $16.8 million for the six months reflects a noncash charge of $17.9 million for expected loss on disposal based on letters of intent from market participants. For the corresponding period in 2009, discontinued operations used net cash flow of $2.6 million for operating activities.
Net Cash Used in Investing Activities
Net cash used in investing activities reflects capital expenditures of $3.5 million for continuing operations for the six months ended July 3, 2010, and $4.8 million for the corresponding period in 2009 for contractual and general infrastructure requirements. Capital expenditures for discontinued operations were $0.8 million for the six months ended July 3, 2010, and $1.8 million for the corresponding period in 2009 primarily for a contract in Mexico. Total capital expenditures of $14.0 million are expected for 2010.
Net Cash Used in Financing Activities
Net cash used in financing activities of $13.7 million for continuing operations for the six months ended July 3, 2010, reflects a mandatory term loan payment under the senior secured credit facility resulting from excess cash flow for 2009. Based on the excess cash flow for 2008, there was no excess cash flow payment required in 2009.
Contractual Obligations
Contractual commitments to make future cash payments under long-term debt agreements, contracts, and contingent commitments at July 3, 2010, follow (in millions):
                                                 
            Payments Due by Year  
            2010 (remaining     2011 and     2013 and              
    Total     six months)     2012     2014     2015     Thereafter  
Long-term debt:
                                               
Term loan under senior secured credit facility due February 2013 (1)
  $ 216.8     $     $ 1.7     $ 215.1     $     $  
Senior subordinated notes due 2015
    190.0                         190.0        
Interest relating to long-term debt (2)
    109.9       14.1       48.8       37.8       9.2        
Operating leases
    73.6       11.0       31.8       13.7       3.4       13.7  
Purchase and other contractual commitments (3)
    18.9       8.9       10.0                    
 
                                   
 
  $ 609.2     $ 34.0     $ 92.3     $ 266.6     $ 202.6     $ 13.7  
 
                                   
 
     
(1)   Scheduled payments for the term loan under the senior secured credit facility do not give effect to possible future mandatory prepayments in March 2011 or March 2012 that could result from excess cash flow from the prior calendar year.

 

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(2)   Future interest payments consist of interest on the variable-rate term loan under the senior secured credit facility based on the prevailing rate of 2.50% at July 3, 2010, the estimated future payments based on fair value of the related interest rate swaps, and interest based on the fixed rate of 9 5/8 % for the senior subordinated notes.
 
(3)   Purchase and other contractual commitments represent the minimum noncancelable obligations under service and other agreements, primarily information technology and telecommunications services.
Variable Interest Entities
The Company has interests in foreign joint ventures that provide government contract services in foreign countries. In certain arrangements, the Company and the joint-venture partner have each guaranteed joint venture performance under fixed-priced subcontracts and each has committed to fund its contractual share of joint venture working capital requirements. Over the next twelve months, the Company does not expect any material adverse impact to its consolidated financial condition or results of operations from its performance guaranty under the fixed-priced contracts or its working capital commitments.
Off-Balance Sheet Arrangements
As of July 3, 2010, there were no off-balance sheet arrangements other than operating leases for office facilities and equipment for which future minimum lease payments aggregated $73.6 million.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in market risk from the information provided under Quantitative and Qualitative Disclosures about Market Risk in our annual report on Form 10-K for the year ended December 31, 2009.
ITEM 4T. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, has evaluated our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in reports that we file or submit under the Securities Exchange Act are: (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms; and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
During the three months ended July 3, 2010, there have been no changes in the internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

 

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PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to legal proceedings, investigations and claims arising out of the ordinary course of business and accrues a liability if an unfavorable outcome is probable. In the opinion of management, resolution of such matters is not expected to have a material effect on the Company’s results of operations or financial position.
ITEM 1A. RISK FACTORS
There have been no material changes in risk factors from the information provided under Risk Factors in our annual report on Form 10-K for the year ended December 31, 2009.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 5. OTHER INFORMATION
Entry into a Material Definitive Agreement
On August 5, 2010, Vangent, Inc. (“Vangent”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) by and among VBCSS Acquisition Corp., a wholly owned subsidiary of Vangent (“Merger Sub”), Buccaneer Computer Systems & Service, Inc., a Virginia corporation (“Buccaneer”), the majority shareholder of Buccaneer and the agent of Buccaneer’s shareholders. Pursuant to the terms of the Merger Agreement, Merger Sub will be merged with and into Buccaneer, and as a result Buccaneer will continue as the surviving corporation and be a wholly owned subsidiary of Vangent (the “Merger”).
As of the closing date of the Merger, Vangent will acquire all outstanding shares of Buccaneer stock in exchange for aggregate consideration of approximately $65.0 million (the “Merger Consideration”). The Merger Consideration is subject to adjustment based on the working capital position of Buccaneer on the closing date of the Merger. Pursuant to the Merger Agreement: (i) $3.0 million of the Merger Consideration will be placed in escrow and will be used to satisfy certain tax obligations of Buccaneer, and (ii) $5.0 million of the Merger Consideration will be withheld from the Merger Consideration due to the majority shareholder for a period of fifteen months to satisfy certain potential indemnification obligations of the majority shareholder of Buccaneer. Vangent intends to fund the acquisition with a combination of cash on hand and borrowings under its senior secured revolving credit facility.
The Merger Agreement contains customary representations and warranties and pre-closing covenants. The completion of the Merger is subject to a number of customary closing conditions including, among others, the absence of certain governmental restraints, approval by Buccaneer’s shareholders and the absence of a material adverse effect on Buccaneer. The Merger Agreement also includes termination provisions for each of Buccaneer and Vangent and provides that, in certain specified circumstances, Vangent must pay Buccaneer a termination fee of $1.6 million. The Merger is expected to close during the third quarter of 2010.

 

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ITEM 6. EXHIBITS
     
Exhibit    
Number   Description
31.1*  
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
 
31.2*  
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
 
32.1*  
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
 
32.2*  
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
     
*   Filed herewith.
SIGNATURE
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.
         
  Vangent, Inc.
 
 
August 5, 2010  /s/ James C. Reagan    
  James C. Reagan   
  Senior Vice President and Chief Financial Officer
(Principal Financial and Principal Accounting Officer) 
 
 

 

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EXHIBIT INDEX
         
Exhibit    
Number   Description
  31.1    
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  31.2    
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  32.1    
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
 
  32.2    
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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