SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2004 Commission File Number: 0-3676
VSE CORPORATION
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 54-0649263
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2550 Huntington Avenue
Alexandria, Virginia 22303-1499
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (703) 960-4600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.05 per share
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [x] No [ ]
The aggregate market value of outstanding voting stock held by nonaffiliates of
the Registrant as of June 30, 2004, was approximately $24.7 million based on the
last reported sales price of the Registrant's common stock on the Nasdaq
National Market as of that date.
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [x]
Number of shares of Common Stock outstanding as of March 9, 2005: 2,279,625.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [ ]
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders expected to be held on May 3, 2005, are incorporated by
reference into Part III of this report.
TABLE OF CONTENTS
Page
PART I
ITEM 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . 9
ITEM 3. Legal Proceedings . . . . . . . . . . . . . . . . . 9
ITEM 4. Submission of Matters to a Vote of Security Holders . . . 9
Executive Officers of the Registrant . . . . . . . . . . . 10
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters . . . . . . . . . . . . . . . . . . . 11
ITEM 6. Selected Financial Data . . . . . . . . . . . . . . . . . 13
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . 14
ITEM 8. Financial Statements and Supplementary Data . . . . . . . 30
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure . . . . . . . . . . . 52
PART III
ITEM 10. Directors and Executive Officers of the Registrant . . . . 52
ITEM 11. Executive Compensation . . . . . . . . . . . . . . . . . . 53
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management . . . . . . . . . . . . . . . . . . . . . . . . 53
ITEM 13. Certain Relationships and Related Transactions . . . . . . 53
ITEM 14. Principal Accountant Fees and Services . . . . . . . . . . 53
PART IV
ITEM 15. Exhibits, Financial Statement Schedules and Reports on
Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . 53
Signatures . . . . . . . . . . . . . . . . . . . . . . . . 55
2
Forward Looking Statements
This filing contains statements which, to the extent they are not
recitations of historical fact, constitute "forward looking statements" under
federal securities laws. All such statements are intended to be subject to the
safe harbor protection provided by applicable securities laws. For discussions
identifying some important factors that could cause actual VSE Corporation
("VSE" or the "Company" or the "Registrant") results to differ materially from
those anticipated in the forward looking statements contained in this filing,
see VSE's "Narrative Description of Business," "Management's Discussion and
Analysis," and "Notes to Consolidated Financial Statements." Readers are
cautioned not to place undue reliance on these forward looking statements,
which reflect management's analysis only as of the date hereof. The Company
undertakes no obligation to revise publicly these forward looking statements to
reflect events or circumstances that arise after the date hereof. Readers
should carefully review the risk factors described in other documents the
Company files from time to time with the Securities and Exchange Commission,
including the Quarterly Reports on Form 10-Q to be filed by the Company
subsequent to this Annual Report on Form 10-K and any Current Reports on Form
8-K filed by the Company.
Part I
ITEM 1. Business
(a) General Development of Business
VSE was incorporated in Delaware in 1959. The parent company primarily
serves as a centralized management and consolidating entity for the business
operations conducted by the Company's wholly owned subsidiaries and divisions.
Wholly owned subsidiaries include Energetics Incorporated ("Energetics") and
VSE Services International, Inc. ("VSI"). Unincorporated divisions include BAV
Division ("BAV"), Communications and Engineering Division ("CED"), Coast Guard
Division ("VCG"), Fleet Maintenance Division ("FMD"), GSA Services Division
("GSA Services"), Management Sciences Division ("MSD"), Ordnance Division
("Ordnance"), Systems Engineering Division ("SED"), Telecommunications
Technologies Division ("TTD"), and Value Systems Services Division ("VSS").
The term "VSE" or "Company" means VSE and its subsidiaries and divisions unless
the context indicates operations of the parent company only.
Energetics is currently VSE's only active subsidiary. VSE's wholly owned
subsidiaries, Human Resource Systems, Inc. ("HRSI") and Ship Remediation and
Recycling, Inc. ("SRR"), were dissolved in May, 2004. Active divisions through
the end of 2004 include BAV, VCG, CED, FMD, MSD, SED, and VSS. Upon finishing
work on its final contract in July 2004, TTD was classified as a discontinued
operation. As of December 31, 2004, VSI, GSA Services, Ordnance, and TTD are not
conducting any current business operations. Work contracted under GSA schedules
is performed directly by each of the operating divisions or subsidiaries.
The Company's business operations consist primarily of diversified
engineering, logistics, management, technical and equipment maintenance
3
services performed on a contract basis. Substantially all of the Company's
contracts are with agencies of the United States Government (the "government")
and other government prime contractors. The Company's customers also include
non-government organizations and commercial entities.
VSE seeks to provide its customers with competitive, cost-effective
solutions to specific problems. These problems generally require a detailed
technical knowledge of materials, processes, functional characteristics,
information systems, technology and products, and an in-depth understanding of
the basic requirements for effective systems and equipment. Customers are
generally billed for a specified level of effort incurred in performing a
project or providing a service.
(b) Financial Information
VSE operations are conducted within a single reporting segment and
financial information is presented on a company-wide basis. In 2004, all
business operations associated with the Company's TTD division ceased and
financial results of TTD are presented as discontinued operations. Financial
information for the three years ended December 31, 2004, appears in the
"Consolidated Statements of Operations" contained in this Form 10-K.
(c) Narrative Description of Business
Services and Products
VSE engineering, logistics, management, equipment maintenance,
information technology, and technical services include a broad array of
capabilities and resources used in program planning; systems integration
support; configuration management; computer-aided drafting and design; design
and engineering, including prototype development; ship reactivation and
transfer support; logistics management; design and installation of intelligent
conference rooms; training, consulting and implementation support; quality
training services for product, process, and management optimization; technology
insertion; environmental management and support; technology research,
development and demonstration programs involving energy conservation and
efficiency; advanced technology transfers; technology roadmaps; and feasibility,
assessment and development programs.
Typical projects include sustaining engineering and maintenance support
for military vehicles and combat trailers; military equipment refurbishment and
modification; ship maintenance, repair, overhaul planning and follow-on
technical support; logistics management support; machinery condition analysis;
specification preparation for ship alterations and repairs; ship force crew
training; life cycle support for ships; ship communication systems; energy
conservation and advanced technology demonstration projects; technical data
package preparation; multimedia, computer LAN, and telecommunications systems;
cross-platform technical data, product data and technical manual support.
Contracts
Depending on solicitation requirements and other factors, VSE offers its
professional and technical services and products through various competitive
4
contract arrangements and business units which are responsive to customer
requirements and which may also provide an opportunity for diversification.
Such arrangements may include prime contracts, subcontracts, cooperative
arrangements, joint ventures, dedicated ventures, GSA schedules, dedicated cost
centers (divisions) and subsidiaries. Some of the contracts permit the
contracting agency to issue delivery orders or task orders in an expeditious
manner to satisfy relatively short-term requirements for engineering and
technical services. The services ordered pursuant to such arrangements are
normally performed and completed within one year.
Substantially all of the Company's revenues are derived from contract
services performed for the government. The U.S. Navy is VSE's largest single
customer. Other significant customers include the U.S. Army and the Department
of Energy. The Company's customers also include various other government
agencies, non-government organizations, and commercial entities.
VSE Revenues by Customer
(Dollars in Thousands)
2004 2003 2002
Customer Revenues % Revenues % Revenues %
- -------- -------- - -------- - -------- -
U.S. Navy . . . . . . $157,433 72.9 $ 93,957 70.6 $102,739 80.0
U.S. Army . . . . . . 27,384 12.7 16,374 12.3 5,718 4.4
Department of Energy . 10,578 4.9 11,405 8.6 11,660 9.1
U.S. Coast Guard . . . 8,498 3.9 4,946 3.7 1,895 1.5
U.S. Air Force . . . . 3,628 1.7 2,287 1.7 2,188 1.7
All other government . 6,535 3.0 2,408 1.8 3,315 2.6
Commercial and other . 1,955 0.9 1,682 1.3 902 0.7
-------- ----- -------- ----- -------- -----
Total $216,011 100.0 $133,059 100.0 $128,417 100.0
======== ===== ======== ===== ======== =====
The government's procurement practices in recent years have tended
toward the bundling of various work efforts under large comprehensive
("omnibus") management contracts. As a result, the growth opportunities
available to the Company have occurred in large, unpredictable increments. The
Company has pursued these larger efforts by assembling teams of subcontractors
to offer the range of technical competencies required by these omnibus
contracts. Typically the use of subcontractors and large material purchases on
government contracts does not allow for profit margins that are as high as on
work performed by company personnel. Accordingly, the use of such teaming
arrangements has lowered the Company's overall profit margins in recent years.
Although the government's practice of using omnibus contracts is expected to
continue, there are indications that the Company will have opportunities to
compete for smaller contracts requiring specific areas of expertise in the
future. VSE is positioned to pursue these opportunities while continuing to use
subcontractor teams to compete for the omnibus contracts.
As a result of the bundling trend described above, the Company has some
divisions for which revenues are derived predominantly from one major contract
effort. The Company's largest contract, performed by BAV, is with the U.S. Navy
and accounted for approximately 52%, 48%, and 56% of consolidated revenues in
2004, 2003, and 2002, respectively. This contract is a ten-year contract
awarded in 1995, and it has a total contract ceiling of over one billion
5
dollars. The Navy has issued a solicitation for proposals on a new contract for
the overall ship transfer program through a competitive solicitation process.
For further discussion, refer to "Longer Term Concerns" under Management
Outlook.
The Company's contracts with the government are typically cost plus fee,
time and materials, or fixed-price contracts. Revenues result from work
performed on these contracts by the Company's employees and from pass-through
of costs for material and work performed by subcontractors. Revenues on cost-
type contracts are recorded as contract allowable costs are incurred and fees
earned. Profits on cost-type contracts are equal to the fees that are earned.
The Company has a contract in its BAV Division for which contract terms
specify award fee payments that are determined by performance and level of
contract activity. Award fees under the BAV contract are made three times during
the year, and a contract modification authorizing the award fee payment is
issued subsequent to the period in which the work is performed. The Company does
not recognize award fee income until the contract modification authorizing the
award fee is certain. Due to such timing, and to fluctuations in the level of
revenues, profits as a percentage of revenues on this contract will fluctuate
from period to period.
Revenues for time and materials contracts are recorded on the basis of
contract allowable labor hours worked times the contract defined billing rates,
plus the cost of materials used in performance on the contract. Profits on time
and material contracts result from the difference between the cost of services
performed and the contract defined billing rates for these services.
Revenue recognition methods on fixed-price contracts will vary depending
on the nature of the work and the contract terms. On certain fixed-price
contracts revenues are recorded as costs are incurred, using the percentage-of-
completion method of accounting, since these contracts require design,
engineering, or manufacturing services performed to the customer's
specifications. Revenues on fixed-price service contracts are recorded as
services are provided. Revenues on fixed-price contracts that require delivery
of specific items may be recorded based on a price per unit as units are
delivered. Profits on fixed-price contracts result from the difference between
the incurred costs and the revenue earned.
Backlog
Funded backlog for government contracts represents a measure of the
Company's potential future revenues and is defined as the total estimated value
of contracts that has been appropriated and funded by the procuring agencies,
less the amount of revenues that have already been recognized on such
contracts. VSE's funded backlog as of December 31, 2004, increased to
approximately $168 million, the highest backlog in the Company's history. Funded
backlog as of December 31, 2003 and 2002 was approximately $83 million and
$44 million, respectively. The increases in funded backlog during these years
are primarily due to increases in funding on the Company's existing contracts.
Changes in funded backlog on existing contracts are sometimes unpredictable due
to uncertainties associated with changing program requirements and the ultimate
availability of funds. The majority of the Company's funded backlog is expected
to be completed within one year.
6
In addition to the increases in funding on current contracts, there were
significant increases in total contract ceiling amounts available for use by
the Company resulting from large multiple award, indefinite delivery,
indefinite quantity contracts awarded by the U.S. Army and U.S. Navy to the
Company in 2004 and 2003. While the award of these contracts has increased the
opportunities available to VSE to pursue future work, the Company does not
believe that such opportunities are quantifiable until they are appropriated and
funded by the procuring agencies.
Marketing
VSE marketing activities are conducted by its professional staff of
engineers, analysts, program managers, contract administrators and other
personnel, with these activities centrally coordinated through the Company's
Business Development staff. Information concerning new programs and
requirements becomes available in the course of contract performance, through
formal and informal briefings, from participation in professional organizations,
and from literature published by the government, trade associations,
professional organizations and commercial entities.
Personnel
VSE services are provided by a staff of professional and technical
personnel having high levels of education, experience, training and skills.
As of February 28, 2005, VSE employed approximately 625 employees. Principal
categories of VSE technical personnel include (a) engineers, and technicians in
mechanical, electronic, chemical, industrial, energy and environmental services,
(b) information technology professionals in computer systems, applications and
products, configuration, change and data management disciplines, (c) technical
editors and writers, (d) multimedia and computer design engineers, (e) graphic
designers and technicians, and (f) logisticians. The expertise required by VSE
customers also frequently includes knowledge of government administrative
procedures. Many VSE employees have had experience as government employees or
have served in the U.S. armed forces. The Company considers its relationships
with employees to be excellent.
Competition and Risks
The professional and technical services industry in which VSE is engaged
is very competitive. There are a substantial number of other organizations,
including large, diversified firms with greater financial resources and larger
technical staffs, which are capable of providing essentially the same services
as those offered by VSE. Such companies may be publicly owned or privately held
or may be divisions of much larger organizations, including large manufacturing
corporations.
Government agencies have placed emphasis on awarding contracts of the
types performed by VSE on a competitive basis as opposed to a sole source or
other non-competitive basis. Most, but not all, of the significant contracts
currently performed by VSE were either initially awarded on a competitive basis
or have been renewed at least once on a competitive basis. Government agencies
also order work through contracts awarded by the General Services Administration
("GSA"). GSA provides a schedule of services at fixed prices which may be
ordered outside of the solicitation process. The Company has four GSA schedule
contracts for different classes of services, but there is no assurance
regarding the level of work which may be obtained by VSE under these contract
arrangements. Government budgets, and in particular the budgets of certain
government agencies, can also affect competition in VSE's business. A
reallocation of government spending priorities or a general decline in
government budgets can result in lower levels of potential business for VSE and
its competitors, thereby intensifying competition for the remaining business.
7
It is not possible to predict the extent and range of competition that
VSE will encounter as a result of changing economic or competitive conditions,
customer requirements, or technological developments. VSE believes the principal
competitive factors for the professional and technical services business in
which it is engaged are technical and financial qualifications, quality and
innovation of services and products, past performance, and low price.
The government acquisition policies and procedures often emphasize
factors that can present challenges to VSE's efforts to win new business, and
may make it difficult for VSE to qualify as a potential bidder. For example,
past performance may be used to exclude entrance into new government markets,
and multiple-award schedules may result in unequal contract awards between
successful contractors.
In addition, VSE's business with the government is subject to the risk
that one or more of the Company's potential contracts or contract extensions may
be awarded by the contracting agency to a small or disadvantaged or minority-
owned business pursuant to set-aside programs administered by the Small Business
Administration, or may be bundled into omnibus contracts for very large
businesses. These risks can potentially have an adverse effect on revenue growth
and profit margins.
Government contract business is subject to funding delays, extensions,
and moratoriums caused by political and administrative disagreements. To date,
the effect of such negotiations and disagreements on the Company has not been
material, but no assurances can be given about such risks with respect to future
years.
Government contracts are subject to termination at the government's
convenience, which means that the government may terminate the contract at any
time, without cause. If a government contract is terminated for convenience, the
contractor is generally reimbursed for its allowable costs to the date of
termination and is paid a proportionate amount of the stipulated profit or fee
for the work actually performed. VSE has not suffered any material losses or
disruptions of its business due to government terminations for convenience.
VSE's business is subject to the risks arising from global economic and
political conditions associated with potential foreign customers served through
the Company's contracts with the U.S. Government. For example, economic
slowdowns or political unrest in certain countries served under the BAV contract
could potentially affect sales.
A large percentage of VSE's contract work is performed by subcontractors,
which raises certain performance and financial risks to VSE. While subcontractor
terms generally specify the terms and performance for which the subcontractor
is liable to VSE, in the event of any unsatisfactory performance on the part of
8
subcontractors, the Company still must bear the cost to ensure satisfactory
performance on its prime contracts.
Available Information
Copies of our Annual Reports on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and amendments to those reports are filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934 and are available free of charge through VSE's website www.vsecorp.com as
soon as reasonably practicable after the reports are electronically filed with
the Securities Exchange Commission.
ITEM 2. Properties
VSE's principal executive and administrative offices are located in a
five-story building in Alexandria, Virginia, leased by VSE through April 30,
2008. This building contains approximately 127,000 square feet of engineering,
shop, and administrative space. VSE also provides services and products from
approximately 15 other U.S. leased facilities located near customer sites to
facilitate communications and enhance project performance. These facilities are
generally occupied under short-term leases and currently include an aggregate
of approximately 139,000 square feet of office and warehouse space. VSE
employees often provide services at customer facilities, limiting VSE's
requirement for additional space. BAV provides services from several locations
outside of the United States, generally at foreign shipyards.
VSE owns and operates an engineering test center in Ladysmith, Virginia,
consisting of approximately 45 acres of land and multiple storage and vehicle
maintenance buildings totaling approximately 17,000 square feet of space. This
property is used by VSE to test military equipment for which VSE provides system
technical support or other engineering services; to provide maintenance and
refurbishment services for military equipment; and to supplement Alexandria,
Virginia, office and shop facilities.
ITEM 3. Legal Proceedings
VSE and its subsidiaries have, in the normal course of business, certain
claims against them and against other parties. In the opinion of management,
the resolution of these claims will not have a material adverse effect on the
Company's results of operations or financial position.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of stockholders, through the
solicitation of proxies or otherwise, during the three-month period ended
December 31, 2004.
9
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information concerning the executive
officers of the Registrant as of March 9, 2005. Each person named has served
as an executive officer of VSE, or has served in a similar executive capacity
in VSE, for more than the past five years, except for Mr. Dacus who joined VSE
in 2001 and previously served as an officer of VSE from 1984 to 1991. From 1991
to 2001, Mr. Dacus served as an officer in four high technology service
companies. Mr. Dacus's career includes over 30 years experience in managing high
technology engineering programs and projects.
The executive officers are chosen annually to serve until the first
meeting of the Board of Directors following the next annual meeting of
stockholders and until their successors are elected and have qualified, or
until death, resignation or removal, whichever is sooner.
Name Age Position with Registrant
- ---- --- ------------------------
Thomas G. Dacus . . . . . . . . 59 Senior Vice President and Director,
Federal Group
Donald M. Ervine . . . . . . . 68 Chairman and Chief Executive Officer,
President and Chief Operating Officer
Robert J. Kelly . . . . . . . . 67 VSE Director; Chairman and President,
Energetics Incorporated and Director,
Energy and Environment Group
James M. Knowlton . . . . . . . 62 Executive Vice President and
Director, International Group
Thomas R. Loftus . . . . . . . 49 Senior Vice President and Chief
Financial Officer
Craig S. Weber . . . . . . . . 60 Executive Vice President, Chief
Administrative Officer, and Secretary
10
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder
Matters
(a) Market Information
The Company's common stock (par value $.05 per share) is traded in the
Nasdaq National Market System, trading symbol, "VSEC," Newspaper listing,
"VSE."
The following table sets forth the range of high and low sales price
information on VSE common stock for each quarter and annually during the last
two years based on information reported by the Nasdaq National Market System.
Quarter Ended High Low Dividends
------------- ---- --- ---------
2003:
March 31 . . . . . . . $13.98 $ 8.15 $.04
June 30 . . . . . . . 12.79 7.81 .04
September 30 . . . . . 13.85 10.26 .04
December 31 . . . . . 13.50 10.52 .04
For the Year $13.98 $ 7.81 $.16
2004:
March 31 . . . . . . $19.10 $12.35 $.04
June 30 . . . . . . . 27.00 14.62 .05
September 30 . . . . . 33.91 14.00 .05
December 31 . . . . . 33.91 22.56 .05
For the Year $33.91 $12.35 $.19
(b) Holders
There were approximately 1,265 stockholders of VSE common stock as of
February 1, 2005, consisting of approximately 268 stockholders of record plus
the number of beneficial owner proxy sets provided in connection with VSE's 2004
Annual Meeting of Stockholders held on May 3, 2004, to (a) brokers, banks, and
nominees and (b) participants in the VSE Corporation Employee ESOP/401(k) Plan.
(c) Dividends
Cash dividends were declared at the rate of $.04 per share for the
quarter ending March 31, 2004 and $.05 per share for the quarters ending
June 30, 2004, September 30, 2004 and December 31, 2004. Pursuant to VSE's bank
loan agreement (see Note 8 of "Notes to Consolidated Financial Statements"),
the payment of cash dividends by VSE is subject to annual rate restrictions.
VSE has paid cash dividends each year since 1973.
11
(d) Equity Compensation Plan Information
The following table provides information about the Company's equity
compensation plans as of December 31, 2004:
Number of Shares
Remaining
Available for
Number of Weighted Future Issuance
Shares to be Average Under Equity
Issued upon Exercise Compensation Plans
Exercise of Price of (excluding shares
Outstanding Outstanding reflected in
Options (1) Options column (a))
Plan Category (a) (b) (c) (2)
- ------------- ----------- ----------- -----------------
Equity compensation
plans approved by
shareholders . . . . . 274,438 $13.47 280,000
Equity compensation
plan not approved
by shareholders . . . . - - -
------- ------ -------
Total 274,438 $13.47 280,000
======= ====== =======
(1) Includes options covering 70,000 shares of VSE stock granted as of
January 1, 2005.
(2) Excludes 281,933 shares of issued and outstanding shares of VSE Common
Stock (par value $.05 per share) held by the VSE Corporation Employee
ESOP/401(k) Plan, which shares may be transferred to Plan participants on
retirement or termination of VSE employment or pursuant to ESOP diversification.
12
ITEM 6. Selected Financial Data
(In thousands, except per share data)
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Revenues, principally from contracts . . . . . $216,011 $133,059 $128,417 $103,490 $121,456
======== ======== ======== ======== ========
Income from continuing operations . . . . . . $ 3,445 $ 2,090 $ 1,585 $ 547 $ 1,797
(Loss) income from discontinued operations . . (1) (79) (933) 308 (829)
-------- -------- -------- -------- --------
Net income . . . . . . . . . . . . . . . $ 3,444 $ 2,011 $ 652 $ 855 $ 968
======== ======== ======== ======== ========
Basic earnings per common share:
Income from continuing operations . . . . . $ 1.54 $ .96 $ .73 $ .26 $ .85
Loss (income) from discontinued operations . - (.04) (.43) .14 (.39)
-------- -------- -------- -------- --------
Net income . . . . . . . . . . . . . . . $ 1.54 $ .92 $ .30 $ .40 $ .46
======== ======== ======== ======== ========
Diluted earnings per common share:
Income from continuing operations . . . . . $ 1.49 $ .94 $ .72 $ .26 $ .85
Loss (income) from discontinued operations . - (.04) (.42) .14 (.39)
-------- -------- -------- -------- --------
Net income . . . . . . . . . . . . . . . 1.49 $ .90 $ .30 $ .40 $ . 46
======== ======== ======== ======== ========
Working Capital . . . . . . . . . . . . . . . $ 15,583 $ 13,394 $ 10,762 $ 8,807 $ 8,364
======== ======== ======== ======== ========
Total assets . . . . . . . . . . . . . . . . . $ 60,352 $ 40,776 $ 32,075 $ 33,209 $ 31,523
======== ======== ======== ======== ========
Long-term debt . . . . . . . . . . . . . . . . $ - $ - $ - $ 351 $ -
======== ======== ======== ======== ========
Stockholders' investment . . . . . . . . . . . $ 23,043 $ 19,058 $ 17,043 $ 16,475 $ 15,793
======== ======== ======== ======== ========
Cash dividends per common share . . . . . . . $ .19 $ .16 $ .16 $ .16 $ .16
======== ======== ======== ======== ========
This consolidated summary of selected financial data should be read in
conjunction with Management's Discussion and Analysis of the Financial
Condition and Results of Operations included in Item 7 of this Form 10-K and
with the Consolidated Financial Statements and related Notes included in Item 8
in this Form 10-K. The historical results set forth in this Item 6 are not
necessarily indicative of the results of operations to be expected in the
future.
13
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Executive Overview
VSE Organization
VSE's business operations consist primarily of services performed by the
Company's wholly owned subsidiaries and unincorporated divisions. The Company
uses multiple operating entities to bid on and perform contract work. The use
of an operating structure with multiple entities gives the Company certain
competitive advantages and the flexibility to pursue a diverse business base.
The term "VSE" or "Company" refers to VSE and its subsidiaries and divisions
unless the context indicates operations of the parent company only.
Energetics Incorporated ("Energetics") is currently VSE's only active
subsidiary. VSE's Human Resource Systems, Inc. ("HRSI") subsidiary was active
in 2003 and 2002. The sole HRSI contract expired on May 31, 2003, and this work
was continued on a new contract in a VSE division. HRSI was dissolved in 2004.
Active divisions through the end of 2004 include BAV Division ("BAV"), Coast
Guard Division ("VCG"), Communications and Engineering Division ("CED")
beginning in February 2003, Fleet Maintenance Division ("FMD"), Management
Sciences Division ("MSD"), Systems Engineering Division ("SED"), and Value
Systems Services Division ("VSS"). Beginning in 2005, the Company transferred
the operations of VSS to another division and will rename and position VSS for
other business pursuits.
VSE also has several other subsidiaries and divisions that were inactive
in 2004, but had contract activity in prior years.
TTD Discontinued Operations
In February 2003, VSE decided to terminate operations of its
Telecommunications Technologies Division ("TTD") due to declining revenues and
significant losses sustained by this division. TTD continued work on uncompleted
contracts during 2003 and 2004 to satisfy its contractual obligations and upon
finishing work in July 2004 TTD was classified as a discontinued operation. Some
of TTD's technical capabilities were transferred to other VSE divisions. The
loss of revenue associated with the termination of TTD operations is not
significant compared to total VSE revenue, while the elimination of TTD losses
will improve VSE profits.
VSE Customers and Services
The Company is engaged principally in providing engineering, design,
logistics, management and technical services to the U.S. Government (the
"government"), other government prime contractors, and commercial entities.
The largest customer for the services rendered by the Company is the U.S.
Department of Defense ("Defense"), including agencies of the U.S. Army, Navy,
and Air Force. Other customers include the Department of Homeland Security, the
U.S. Postal Service, the Department of Energy, and the Department of Treasury.
The majority of VSE's work is performed for the U.S. Navy. BAV is a major
provider of logistics, training, and technical assistance in support of the
Navy's ship transfer program (see "BAV Contract" below). FMD supports the Navy
14
by providing a variety of services including ship installation efforts, combat
systems inspections, ship repair and overhaul availability planning, harpoon
weapons management, ordnance alteration, and air combat logistics. VSS has
provided the Navy with outsourcing decision assistance. VCG provides services to
the U.S. Coast Guard that are similar to the work performed by BAV for the Navy.
VSE also performs a significant amount of its work for the U.S. Army. SED
provides the Army with equipment refurbishment services, military vehicle
protection systems, engineering and technical support for ground weapons,
logistics and training services, material procurement support, and prototype
development support for combat vehicles. MSD provides the Army, as well as other
government agencies and commercial organizations, with quality training services
for product, process, and management optimization. CED provides management
oversight and coordinates support efforts for a variety of government work
orders on a large Army contract.
The Company has also provided support services to the U.S. Postal
Service for over twenty years and is continuing to support this customer through
its SED Division. Energetics is focused on providing the Department of Energy
and other government and industry customers with expert consulting services in
environmental management and energy supply, resource management, and
conservation. The Company also provides support services to the U.S. Department
of Treasury and has offered products, services, and support in network,
multimedia, and audio-visual technology including design, installation,
management and support for voice, data, multimedia and related projects to
various government agencies and commercial organizations.
BAV Contract
VSE's BAV Division has a contract with the U.S. Navy to provide
engineering, technical and logistical support services associated with the sale,
lease, or transfer of Navy ships to foreign governments. This cost-plus contract
was awarded as a ten-year contract in 1995 and has a total ceiling value of over
$1 billion. The level of revenues and associated profits resulting from fee
income generated by this contract varies depending on a number of factors,
including the timing of ship transfers and associated support services ordered
by foreign governments and economic conditions of potential customers worldwide.
The Company has experienced significant quarterly and annual revenue
fluctuations and anticipates that future quarterly and annual revenues will be
subject to variation primarily due to changes in the level of activity
associated with the Navy's ship transfer program.
During its life, this contract has been the Company's single largest
revenue producer. Revenues generated by this contract have typically accounted
for approximately 40% to 50% of VSE's consolidated revenues, and during 2004 and
2003 the contract accounted for approximately 52% and 48% of consolidated
revenues, respectively. One of the major efforts currently conducted under this
contract is the transfer of four U.S. Navy ships to Taiwan. The original BAV
contract is scheduled to end in 2005. The Navy has issued a solicitation for
proposals on a new contract for the overall ship transfer program through a
competitive solicitation process. For further discussion, refer to "Longer Term
Concerns" under Management Outlook.
15
Contract terms specify award fee payments to BAV that are determined by
performance and level of contract activity. A contract modification authorizing
the award fee payment is issued subsequent to the period in which the work is
performed. The Company does not recognize award fee income until the contract
modification authorizing the award fee is certain. Award fees are made three
times during the year. Accordingly, the Company typically has three quarterly
reporting periods during a year that include the recognition of BAV award fee
income and one quarterly reporting period that does not include BAV award fee
income. Due to such timing, and to fluctuations in the level of revenues,
profits as a percentage of revenues will fluctuate from period to period.
Government Procurement Policies and Practices
VSE's business is subject to the risks arising from economic conditions
and political factors that may impact the budgets and program funding of
customers served through VSE's contracts. VSE's revenues have historically been
subject to annual fluctuations resulting from changes in the level of Defense
spending. Future budgetary and funding decisions by government lawmakers or
Defense restructuring efforts could affect the types and level of services
provided by VSE to its government customers and could have a material adverse
impact on the Company's results of operations.
The Company's revenues depend on the ability of the Company to win new
contracts and on the amount of work ordered by the government under the
Company's existing contracts. The Company's ability to win new contracts is
affected by government acquisition policies and procedures, including government
procurement practices that in some years have tended toward bundling work
efforts under large comprehensive ("omnibus") management contracts. This
emphasis on large contracts presents challenges to winning new contract work,
including making it more difficult for the Company to qualify as a bidder,
increases in the level of competition due to the award of fewer contracts, and
forcing the Company into competition with larger organizations that have greater
financial resources and larger technical staffs. Competing for these contracts
requires the Company to use teams of subcontractors to be able to offer the
range of technical competencies needed to do the work. While the use of
subcontractors on a large scale basis allows the Company to compete for this
work, profit margins on subcontract work are lower than on work performed by
company personnel, thereby reducing the Company's overall profit margins. The
use of subcontractors on government contracts also raises certain performance
and financial risks to VSE in that government prime contractors are usually
obligated to ensure compliance with U.S. Government regulations relative to
the performance by subcontractors.
Company revenues over a period of time can also depend on the length of
its contracts. The length of time for which a government contract is issued can
vary depending on changes in contracting regulations and other factors. During
2004, the Defense Department issued rules and rule clarifications limiting the
length of contracts to five years and then later extended this limit to ten
years. The Company is unable to predict what impact these changes will have on
future contract awards and revenues.
Other government procurement practices that can affect the Company's
revenues are the use of past performance criteria that may preclude entrance
into new government markets and government social programs that limit contract
work to small, woman, or minority owned businesses. Additional risk factors that
16
could potentially affect the Company's results of operations are the
government's right to terminate contracts for convenience, the government's
right to not exercise all of the option periods on a contract, and funding
delays caused by government political or administrative actions.
Global Economic Conditions and Political Factors
VSE's business is subject to the risks arising from global economic
conditions and political factors associated with current and potential customers
served through VSE's contracts with the U.S. Government. An economic slowdown in
countries served under the BAV contract could potentially affect sales. The
current international situation posed by potential terrorist activity and the
continuing conflict in the Middle East could potentially increase the political
risks associated with BAV contract revenues. Failure by the government of a
potential foreign customer to approve and fund acquisition of U.S. Navy ships
serviced under the BAV contract could affect sales. In any one year, a
significant amount of the Company's revenues may result from sales on the BAV
contract to a single foreign government. BAV contract sales to Egypt have
historically represented a large percentage of the Company's total sales in any
one year. Work associated with the transfer of four ships to Taiwan under the
BAV contract during 2004 also represented a large percentage of total sales, and
is expected to also represent a large percentage of 2005 sales. If BAV is
successful in winning the new follow-on contract for this work, future years'
revenues are expected to include large amounts of BAV contract sales to both
Egypt and Taiwan. In addition to the effect on BAV revenues, international
tensions can also affect work by FMD on U.S. Navy ships when they are deployed
away from U.S. Navy facilities and are unavailable for maintenance work during
this time period. Adverse results arising from these global economic and
political risks could have a material adverse impact on the Company's results of
operations.
Concentration of Revenues From Continuing Operations
(in thousands)
2004 2003 2002
Source of Revenue Revenues % Revenues % Revenues %
- ----------------- -------- - -------- - -------- -
BAV Egypt . . . . $ 50,250 23.3 $ 44,190 33.2 $ 38,170 29.7
BAV Taiwan . . . 56,038 25.9 12,368 9.3 5,825 4.5
BAV Other . . . . 6,675 3.1 7,259 5.5 28,077 21.9
-------- ----- -------- ----- -------- -----
Total BAV 112,963 52.3 63,817 48.0 72,072 56.1
VSE Other . . . . 103,048 47.7 69,242 52.0 56,345 43.9
-------- ----- -------- ----- -------- -----
Total Revenues $216,011 100.0 $133,059 100.0 $128,417 100.0
======== ===== ======== ===== ======== =====
Management Outlook
A Record Year
VSE experienced a record setting year for revenues and profits in 2004.
The Taiwan ship transfer work on the BAV contract is the primary reason for
higher revenues in 2004. This transfer has resulted in an increase in the
revenues of BAV of approximately 77% during 2004 as compared to 2003. The CED
Rapid Response contract (see "Significant Contract Awards" below) and FMD's
continuing work on Navy programs contributed significantly to increased revenues
17
for 2004. Revenues in several of VSE's other divisions also showed strong growth
in 2004. See "Results of Operations" below for a more detailed discussion of
2004 results.
Prospects for Continued Growth
There are several indications that VSE will continue to increase its
revenues and profits in 2005. These indicators include:
Taiwan Ship Transfer
The Taiwan ship transfer effort is expected to continue to provide BAV
with elevated revenue levels in 2005 and into 2006. Funded backlog on the BAV
contract was approximately $71 million as of December 31, 2004, as compared to
approximately $48 million as of December 31, 2003.
TBPS Program
In November 2004, VSE's SED Division was awarded a fixed-price letter
contract by the U.S. Army to begin work on a program to provide a protection
system for Army vehicles, the Tanker Ballistic Protection System ("TBPS"). Under
this program, SED will apply a Fuel Tank Self-Sealing System and necessary Add-
on Armor Panels for Army Fuel Dispensing Tankers as protection from damage
resulting from hostile fire. The Army subsequently modified the original letter
contract to increase the number of tankers to be modified and has funded this
program for approximately $17 million as of December 31, 2004. Testing and
preparatory work on this program was conducted in November and December 2004 and
the TBPS was applied to the first tanker in January 2005. Accordingly, SED began
recognizing revenue on this contract based on units delivered in January 2005.
SED expects to receive a definitive contract and additional funding in early
2005 to formalize contract coverage. There is also the possibility that the
Army may increase the scope of work by adding more tankers to be included in
the program, which would further increase the work performed by SED. This
program presents new risks and challenges to VSE's business while also
increasing the potential for greater revenue growth and profitability in 2005.
Significant Contract Awards
In 2003 and 2004, VSE received three contract awards with large ceiling
amounts. These are multiyear, multiple award, indefinite delivery, indefinite
quantity contracts, with no funding committed at the time of award. VSE is one
of several awardees on each contract. In general, VSE's realized revenues from
these contracts are significantly below their respective ceiling amounts and
future VSE revenue from these contracts cannot be predicted with certainty.
These contract awards, however, provide VSE with opportunities to compete for
work that may contribute significantly to future revenue growth.
In January 2003, VSE formed its Communications and Engineering Division
(CED) upon the award of a multiyear Rapid Response support contract by the
U.S. Army Communications-Electronics Command (CECOM). The contract enhances
the Company's revenue producing capabilities by allowing it to provide services
through any of VSE's operating entities or through third party subcontractors
for various end user government customers. If all options are exercised, this
contract has a potential total ceiling of approximately $2.9 billion over an
eight-year period. While it is not likely that the full ceiling amount will be
18
realized, this contract has generated revenues for VSE of approximately
$27 million and $12 million during 2004 and 2003, respectively.
In April 2004, FMD was awarded a contract by the U.S. Navy, SeaPort
Enhanced, which includes a five-year base period and two five-year option
periods. This contract is a procurement vehicle for the Navy to use for
ordering services from a wide range of contractors to support all phases of
naval ship and shipboard weapons systems acquisition and life-cycle support.
While this award does not guarantee any revenues for VSE, the Company is one of
several contractors eligible to bid for services during the life of the
contract. This contract has not generated any revenue for the Company as of
December 31, 2004.
In September 2004, FMD was awarded a contract by the U.S. Navy to provide
engineering and technical services to support Naval Sea Systems Command
maintenance, overhaul, repair, and alteration of systems aboard ships. This
contract has a total contract ceiling amount of $1.022 billion over a five-year
period if all option periods are exercised. This contract has not generated
any revenue for the Company as of December 31, 2004.
Increases in Bookings and Funded Backlog
Revenue increases in government contracting businesses such as that
experienced by VSE in 2004 are typically preceded by increases in contract
funding ("Bookings") and a build-up of funded contract backlog. VSE's Bookings
and funded backlog began to increase in late 2003 and continued increasing
through the end of 2004, giving the Company a firm basis for a continuation in
revenue growth in 2005.
(in $ millions)
2004 2003 2002
---- ---- ----
Bookings . . . . . . . . . . . . . . . . 303 181 116
Funded Backlog . . . . . . . . . . . . . 168 83 44
Revenues . . . . . . . . . . . . . . . . 216 133 128
Previous Concerns Mitigated
Two areas of concern to management at the beginning of 2004 have shown
improvement and are of less concern going into 2005. CED incurred losses in 2003
on the Rapid Response Support contract during its first year of operation and
during the first nine months of 2004, due primarily to low revenue levels and
to costs associated with the start-up of the division. CED's losses have
decreased as the division has moved beyond the start-up phase and revenue levels
have increased for both this division and on a company-wide basis. CED revenues
are expected to continue to have a positive impact on overall Company
profitability in 2005; however, the potential exists for future losses in CED
if revenue expectations are not met. VSE has accrued liabilities of
approximately $158 thousand against any future losses associated with CED
operations as of December 31, 2004.
The second concern involved the utilization of the Company's primary
office facility. VSE does not always occupy all of the space in its primary
leased office facility and has from time to time subleased parts of this
19
facility to other tenants. During 2003, some of the Company's larger subtenants
did not renew their subleases with VSE, which resulted in some losses to the
Company in 2003 and 2004 during the time that the space was vacant. VSE was
successful in efforts to sublease a majority of the vacant office space to new
tenants in 2004 and believes that more vacant space will be subleased in the
near future, but a portion of the facility remains underutilized as of
December 31, 2004. The remaining vacant space presents a risk that could have a
negative impact on future earnings; however, the Company believes it has
adequate accrued liabilities of approximately $48 thousand for estimated future
losses associated with this underutilization.
Longer Term Concerns
The original BAV contract ending date was in 2005. In 2003, the Navy
modified the contract expiration date from 2005 to 2007 to ensure continuity of
work with respect to the Taiwan Ship Transfer. The Navy has issued a
solicitation for proposals on a new contract for the overall ship transfer
program through a competitive solicitation process. While BAV has submitted a
proposal and believes it has an excellent chance to win the new contract award,
there is a risk that the award could be made to another contractor. The award
will be made after a period of evaluation by the Navy. The uncertainty
associated with the award of the new BAV contract significantly affects the
longer term outlook for VSE. If BAV fails to win the new contract, VSE will
suffer a substantial reduction in its annual revenue and profits attributable to
this program.
The Company's revenues and profits increased significantly in 2004 and
are expected to increase further in 2005. There is a possibility that some of
the programs contributing significantly to VSE revenues and profits in these
years will expire after 2005. The expiration of these programs will present
challenges for the company to sustain the same level of revenue and profit
growth beyond 2005.
To mitigate these risks, VSE is submitting proposals to win new work and
is exploring potential acquisition opportunities.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board issued
SFAS 123(R), "Share-Based Payment," which is a revision to SFAS 123, "Accounting
for Stock-Based Compensation." SFAS 123(R) supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and amends SFAS 95, "Statement of
Cash Flows." Generally, the approach in SFAS 123(R) is similar to the approach
described in SFAS 123. However, SFAS 123(R) requires all share-based payments
to employees, including grants of employee stock options, to be recognized in
the income statement based on their fair values. Pro forma disclosure is no
longer an alternative.
The Company can adopt SFAS 123(R) in one of two ways - the modified
prospective method or the modified retrospective method. The Company will adopt
SFAS 123(R) on July 1, 2005 and is currently evaluating the alternative methods.
As permitted by SFAS 123, the Company currently accounts for share-based
payments to employees using APB Opinion No. 25's intrinsic value method and, as
20
such, generally recognizes no compensation cost for employee stock options.
The impact of adoption of SFAS 123(R) cannot be predicted at this time because
it will depend on levels of share-based payments granted in the future.
However, had the Company adopted SFAS 123(R) in prior periods, the impact of
that standard would have approximated the impact of SFAS 123 as described in
the disclosure of pro forma net income and earnings per share in Note 1 to the
Company's consolidated financial statements. SFAS 123(R) also requires the
benefits of tax deductions in excess of recognized compensation cost to be
reported as a financing cash flow, rather than as an operating cash flow as
required under current literature. This requirement will reduce net operating
cash flows and increase net financing cash flows in periods after adoption.
While the Company cannot estimate what those amounts will be in the future
(because they depend on, among other things, when employees exercise stock
options), the amount of operating cash flows recognized for the years ending
December 31, 2004, 2003 and 2002 for such excess tax deductions
were approximately $433 thousand, $14 thousand, and $22 thousand for 2004, 2003
and 2002, respectively.
Critical Accounting Policies
VSE's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require VSE
to make estimates and assumptions. The Company believes the following critical
accounting polices affect our more significant judgments, estimates and
assumptions used in the preparation of its consolidated financial statements.
Revenue Recognition
Substantially all of the Company's services are performed for its
customers on a contract basis. The three primary types of contracts used are
cost-type contracts, time and materials contracts, and fixed-price contracts.
Revenues result from work performed on these contracts by the Company's
employees and from pass-through of costs for material and work performed by
subcontractors.
Revenues on cost-type contracts are recorded as contract allowable costs
are incurred and fees earned. Profits on cost-type contracts are equal to the
fees that are earned. The BAV contract terms specify award fee payments that are
determined by performance and level of contract activity. Award fees are made
three times during the year and a contract modification authorizing the award
fee payment is issued subsequent to the period in which the work is performed.
The Company does not recognize award fee income until the contract modification
authorizing the award fee is certain. Due to such timing, and to fluctuations in
the level of revenues, profits as a percentage of revenues on this contract will
fluctuate from period to period.
Revenues for time and materials contracts are recorded on the basis of
contract allowable labor hours worked times the contract defined billing rates,
plus the cost of materials used in performance on the contract. Profits on time
and material contracts result from the difference between the cost of services
performed and the contract defined billing rates for these services.
21
Revenue recognition methods on fixed-price contracts will vary depending
on the nature of the work and the contract terms. On certain fixed-price
contracts revenues are recorded as costs are incurred, using the percentage-of-
completion method of accounting, since these contracts require design,
engineering, or manufacturing services performed to the customer's
specifications. Revenues on fixed-price service contracts are recorded as
services are provided. Revenues on fixed-price contracts that require delivery
of specific items may be recorded based on a price per unit as units are
delivered. Profits on fixed-price contracts result from the difference between
the incurred costs and the revenue earned.
The Company will occasionally perform work at risk, which is work that is
performed prior to the government formalizing funding for such work. Revenue
related to work performed at risk is not recognized until it can be reliably
estimated and its realization is probable. VSE recognizes this "risk funding" as
revenue when the associated costs are incurred or the work is performed. VSE is
at risk of loss for any risk funding not received. The Company provides for
anticipated losses on contracts by a charge to income during the period in which
losses are first identified. Revenues recognized in 2004 include approximately
$133 thousand for which the Company had not received formalized funding as of
December 31, 2004. The Company received funding modifications for approximately
$77 thousand of this amount in February 2005, leaving approximately $56 thousand
of 2004 revenues classified as risk funding. VSE believes that it will receive
funding for this remaining risk funding revenue.
Revenues by contract type for the three years ended December 31, 2004
were as follows (in thousands):
2004 2003 2002
Contract Type Revenues % Revenues % Revenues %
- ------------- -------- - -------- - -------- -
Cost-type . . . . . $148,043 68.5 $ 93,552 70.3 $106,235 82.7
Time and materials. 31,928 14.8 24,362 18.3 14,482 11.3
Fixed-price . . . . 36,040 16.7 15,145 11.4 7,700 6.0
-------- ----- -------- ----- -------- -----
$216,011 100.0 $133,059 100.0 $128,417 100.0
======== ===== ======== ===== ======== =====
Long-Lived Assets
In assessing the recoverability of long-lived assets, including goodwill
and other intangibles, VSE must make assumptions regarding estimated future
cash flows and other factors to determine the fair value of the respective
assets. If these estimates or their related assumptions change in the future,
VSE may be required to record impairment charges for these assets not previously
recorded.
Goodwill
Goodwill and intangible assets with indefinite lives are subject to a
review for impairment at least annually. The Company performs its annual
impairment test on September 30. As of December 31, 2004, the Company had
approximately $1.1 million of goodwill associated with its acquisition of
Energetics in 1995. The Company has not recognized any reduction to the goodwill
due to the impairment rules. If at some time in the future it is determined that
impairment has occurred, such impairment could potentially have a material
22
adverse impact on the Company's results of operations or financial condition.
Contingencies
From time to time VSE is subject to proceedings, lawsuits and other
claims related to environmental, labor and other matters. VSE is required to
assess the likelihood of any adverse judgments or outcomes to these
contingencies as well as potential ranges of probable losses and establish
reserves accordingly. The amount of reserves required may change in future
periods due to new developments in each matter or changes in approach to a
matter such as a change in settlement strategy.
Income Taxes
The carrying value of VSE net deferred tax assets is based on assumptions
regarding VSE's ability to generate sufficient future taxable income to utilize
these deferred tax assets. If the estimates and related assumptions regarding
VSE's future taxable income change in the future, VSE may be required to record
valuation allowances against its deferred tax assets, resulting in additional
income tax expense.
Results of Operations
Revenues
The following table shows the revenues from operations of VSE, its
subsidiaries and divisions, and such revenues as a percent of total revenues:
Revenues from Operations
(dollars in thousands)
2004 2003 2002
Company or Business Unit Revenues % Revenues % Revenues %
- ------------------------ -------- - -------- - -------- -
VSE (parent company). . . . . $ 12 0.0 $ 1,720 1.3 $ 14,796 11.5
BAV . . . . . . . . . . . . . 112,963 52.3 63,817 48.0 72,072 56.1
FMD . . . . . . . . . . . . . 41,711 19.3 24,406 18.4 9,602 7.5
CED . . . . . . . . . . . . . 24,615 11.4 11,743 8.8 - 0.0
SED . . . . . . . . . . . . . 12,762 5.9 9,750 7.3 7,287 5.7
Energetics . . . . . . . . . 11,693 5.4 11,982 9.0 12,171 9.5
VCG . . . . . . . . . . . . . 7,314 3.4 4,946 3.7 1,895 1.5
MSD . . . . . . . . . . . . . 3,300 1.5 2,261 1.7 1,440 1.1
VSS . . . . . . . . . . . . . 1,631 0.8 2,292 1.7 8,156 6.4
Ordnance . . . . . . . . . . 10 0.0 - 0.0 244 0.2
HRSI . . . . . . . . . . . . - 0.0 142 0.1 703 0.5
SRR . . . . . . . . . . . . . - 0.0 - 0.0 46 0.0
VSI . . . . . . . . . . . . . - 0.0 - 0.0 5 0.0
-------- ----- -------- ----- -------- -----
$216,011 100.0 $133,059 100.0 $128,417 100.0
======== ===== ======== ===== ======== =====
Revenues increased by approximately 62% and 4% for the years ended
December 31, 2004 and December 31, 2003, as compared to each of the respective
prior years. The primary reasons for the increase in revenues in 2004 were
1) an increase in work performed under the BAV contract, including increased
revenues associated with the Taiwan ship transfer; 2) the CED Rapid Response
contract received work orders that generated revenues throughout the full year
23
in 2004, as compared to the prior year when the contract was awarded in February
of 2003 and did not begin to receive any significant amount of work until
September; and 3) increased levels of work performed by FMD due in part to the
Navy's elevated readiness requirements. Work requirements and revenues also
increased in SED, MSD and VCG.
During 2003, the Company had decreased revenues in some of its divisions
and subsidiaries which were offset by increases in the revenues of others. The
most notable area of decline in revenue was in BAV, which was due to work
ordered by certain client countries in 2002 that was not repeated in 2003.
Revenues also declined slightly for Energetics, HRSI and VSS. The declines in
revenues of these divisions were offset by the revenues generated by the start
up of CED and an increase in the revenues of the Company's other active
divisions compared to the prior year. While the increased revenues in SED,
MSD, and VCG were not significant in proportion to total Company revenues,
the increases were significant in proportion to the prior years' revenues of
each of these divisions.
Income from Continuing Operations Before Income Taxes
The following table shows consolidated revenues and income from
operations before income taxes, other items of income and expense, and such
amounts as a percent of revenues.
Income from Continuing Operations Before Income Taxes
(dollars in thousands)
Description 2004 % 2003 % 2002 %
- ----------- ---- - ---- - ---- -
Revenues . . . . . . . . . $216,011 100.0 $133,059 100.0 $128,417 100.0
Costs and expenses . . . . 209,841 97.1 129,372 97.2 125,467 97.7
-------- ----- -------- ----- -------- -----
Gross profit . . . . . . . 6,170 2.9 3,687 2.8 2,950 2.3
Selling, general and
administrative expenses. 636 0.3 351 0.3 281 0.2
Interest(income)expense . (102) 0.0 (69) (0.1) 24 0.0
-------- ----- -------- ----- -------- -----
Income from continuing
operations before
income taxes . . . . . . $ 5,636 2.6 $ 3,405 2.6 $ 2,645 2.1
======== ===== ======== ===== ======== =====
VSE's gross profit margin on continuing operations remained substantially
unchanged during 2004 as compared to 2003 and increased in 2003 as compared to
2002. Due to a large amount of material and travel activity, the BAV contract
tends to have lower gross margins than other VSE contracts. Accordingly,
increases in BAV contract work as a percentage of total company revenues tend
to decrease companywide gross margins, and decreases in BAV contract work as a
percentage of total company revenues tend to increase companywide gross margins.
Additionally, companywide revenue increases tend to increase the gross margins
realized on the Company's fixed price and T&M contracts due to the ability to
spread corporate costs over a larger revenue base. Changes in the amount of
revenues for each of VSE's operating divisions as a percentage of total company
revenues and the increases in total company revenues are the primary reasons for
changes in the gross profit margins during 2004, 2003, and 2002. Another factor
that has affected gross margins is the operational losses associated with CED in
2004 and 2003, and to a lesser extent by start up costs associated with CED in
24
2003. Other factors that affect the Company's gross margins include the timing
of contract award fees, effective project and cost management, and competitive
factors.
Selling, general and administrative expenses consist primarily of costs
and expenses that are not chargeable or reimbursable on the Company's operating
unit contracts. These costs increased in 2004 as compared to 2003 due to the
cost associated with vacant facilities in 2004. Other expenses of this type
remained substantially unchanged in 2004. As a percentage of revenues, these
expenses did not vary much in 2004 and 2003 as compared to the respective prior
years.
VSE did not have significant borrowing requirements or interest expense
in 2004, 2003, and 2002. The Company's interest income increased in 2004 as
compared to 2003 and the Company had interest income in 2003 as compared to
interest expense in 2002 as profits from operations and resulting cash surpluses
were invested.
Discontinued Operations
In July 2004, all business operations associated with the Company's TTD
division ceased. Accordingly, prior period consolidated financial statements
have been restated to reflect the financial results of TTD as discontinued
operations. The revenues, costs and expenses of TTD have been excluded from the
respective captions in the Consolidated Statement of Operations. The loss from
discontinued operations associated with TTD, net of tax, in the years ended
December 31, 2004, 2003, and 2002 was approximately $1 thousand, $79 thousand
and, $933 thousand, respectively.
Financial Condition
The Company's largest asset is its accounts receivable and its largest
liabilities are its accounts payable and accrued expenses. Accounts receivable
increased approximately $18.4 million, and accounts payable and accrued expenses
increased approximately $13.9 million in 2004 as compared to 2003 due primarily
to the increase in the level of business activity and the associated billings to
customers and subcontractor payments required to perform this work. The increase
in total stockholder's investment in 2004 resulted primarily from earnings and
dividend activity and from the exercise of stock options.
Liquidity and Capital Resources
Cash Flows
The Company's cash and cash equivalents decreased by approximately $9.7
million during 2004. Approximately $8.7 million in net cash was used in
operating activities, investing activities used approximately $2.7 million,
and financing activities provided approximately $1.7 million. The difference
between cash used in operating activities of approximately $8.7 million in 2004
as compared to cash provided by operating activities of approximately $6.4
million in 2003 is primarily due to increases in accounts receivable and
contract inventories associated with contract requirements for significant
material and subcontractor usage for which the billing and collections cycle had
25
not been completed. The accounts receivable and contract inventories increases
were partially offset by increases in net income and accounts payable and
accrued expenses. Investing activities consisted of the purchase of property
and equipment. Financing activities consisted of $1.6 million provided by bank
loan proceeds, $518 thousand provided by the issuance of common stock associated
with the exercise of stock options, and $401 thousand used to pay dividends.
The Company's cash and cash equivalents increased by approximately $5.6
million during 2003. Approximately $6.4 million in net cash was provided by
operating activities, investing activities used approximately $720 thousand,
and financing activities used approximately $34 thousand. Investing activities
consisted of the purchase of property and equipment. Financing activities
consisted of $349 thousand used to pay dividends and $315 thousand provided by
the issuance of common stock associated with the exercise of stock options. Cash
flows provided by operating activities increased in 2003 as compared to 2002 due
primarily to increases in net income and accounts payable, which was partially
offset by an increase in accounts receivable.
The Company's cash and cash equivalents increased by approximately $4.0
million during 2002. Approximately $5.0 million in net cash was provided by
operating activities, investing activities used approximately $521 thousand, and
financing activities used approximately $456 thousand. Investing activities
consisted of the purchase of property and equipment. Financing activities
consisted of the repayment of $351 thousand of bank loan borrowings, $349
thousand used to pay dividends, and $244 thousand provided by the issuance of
common stock associated with the exercise of stock options.
Cash dividends were declared at the rate of $.04 per share for the
quarter ending March 31, 2004 and $.05 per share for the quarters ending
June 30, 2004, September 30, 2004 and December 31, 2004. Pursuant to its bank
loan agreement (see Note 8 of "Notes to Consolidated Financial Statements"), the
payment of cash dividends by VSE is subject to annual rate restrictions. VSE has
paid cash dividends each year since 1973.
Liquidity
The Company's internal sources of liquidity result primarily from
operating activities, specifically from changes in the level of revenues and
associated accounts receivable and accounts payable from period to period, and
from profitability. Significant increases or decreases in revenue and accounts
receivable and accounts payable can cause significant increases or decreases in
internal liquidity.
Accounts receivable arise primarily from billings made by the Company to
the government or other government prime contractors for services rendered and
payments received on accounts receivable represent the principal source of cash
for the Company. Accounts receivable levels can be affected by contract
retainages, differences between the provisional billing rates authorized by the
government compared to the costs actually incurred by the Company, government
delays in processing administrative paperwork for contract funding, and the
timing of large materials purchases and subcontractor efforts used in
performance on Company's contracts.
26
The Company acquired contract inventories of approximately $8.5 million
as of December 31, 2004, due to work performed by SED on the TBPS contract.
Contract inventories consisted of materials, supplies and other expenditures for
which the end unit has not yet been completed and accepted. Although these costs
are classified as contract inventories for accounting purposes, they are similar
in nature to materials and direct supplies purchased for use in performance on
the Company's other contracts in that they are solely and directly attributable
to the contract and will be billed to the customer within a relatively short
time. All of the $8.5 million of contract inventories is expected to be
liquidated, billed, and collected in 2005. These materials and direct supplies
will not be restocked to maintain any permanent contract inventory levels.
Accounts payable arise primarily from purchases of subcontractor services
and materials used by the Company in the performance of its contract work.
Payments made on accounts payable, along with payments made to satisfy employee
payroll and payroll associated expenses, make up the principal cash requirements
of the Company. Accounts payable levels can be affected by changes in the level
of contract work performed by the Company and by the timing of large materials
purchases and subcontractor efforts used in performance on the Company's
contracts.
Other cash requirements include the acquisition of capital assets for
office and computer support, facilities maintenance, and the payment of cash
dividends. The Company invested approximately $1.1 million related to expansion
and improvement of facilities at two locations during 2004 and has commitments
to complete this work for an additional amount of approximately $164 thousand
in 2005. These investments were for the expansion of its facility in Ladysmith,
Virginia in support of growth in SED and improvements at its primary office
facility in Alexandria, Virginia.
VSE's external sources of liquidity consist of a revolving bank loan
agreement that provides loan financing based on the Company's accounts
receivable (See Note 8 of "Notes to Consolidated Financial Statements"). The
bank financing complements the internal sources of liquidity by providing
increasing levels of borrowing capacity as accounts receivable levels increase.
The bank loan agreement provided loan financing up to a maximum commitment of
$15 million as of December 31, 2004. The Company has determined that the
$15 million commitment is adequate to cover current and future liquidity
requirements. The expiration date of the revolving loan is May 31, 2006.
Performance of work under the BAV contract and other contracts that
require significant amounts of subcontractor or material purchases have the
potential to cause substantial requirements for working capital; however,
management believes that cash flows from operations and the bank loan commitment
are adequate to meet current operating cash requirements.
27
Contractual Obligations
The following table shows the consolidated contractual obligations as of
December 31, 2004 (in thousands):
Payments Due by Period
----------------------
Less than 1-3 4-5 After 5
Contractual Obligations Total 1 year years years years
- ----------------------- ----- ------ ----- ----- -----
Bank notes payable . . . $1,578 $1,578 $ - $ - $ -
Operating leases, net of
non-cancelable sublease
income . . . . . . . . 8,167 2,356 5,425 386 -
Purchase obligations . . 226 226 - - -
------ ------ ------ ------ ------
Total $9,971 $4,160 $5,425 $ 386 $ -
====== ====== ====== ====== ======
Bank notes payable consists of a revolving loan agreement that contains
collateral requirements by which Company assets secure amounts outstanding,
restrictive covenants that include minimum tangible net worth and profitability
requirements, a limit on annual dividends, and other affirmative and negative
covenants. This loan balance was paid in full when accounts receivable were
collected in January, 2005.
Operating lease commitments are primarily for VSE's principal executive
and administrative offices and leased facilities for office, shop, and warehouse
space located near customer sites. The Company also has some equipment and
software leases that are included in these amounts.
Purchase obligations consist primarily of contractual commitments
associated with construction, improvements and maintenance on VSE facilities,
and for the acquisition of office, shop, and computer equipment. Generally,
contracts with commercial customers for purchases of materials or services that
are not associated with performance on the Company's prime contracts with the
U.S. Government are included in the above table. The table excludes contractual
commitments for materials or subcontractor work purchased to perform on our
U.S. Government contracts. Such commitments for materials and subcontractors are
reimbursable to the Company when used on the contracts, and generally are also
reimbursable to the Company by the U.S. Government in the event a contract is
"terminated for convenience" pursuant to federal contracting regulations.
Inflation and Pricing
Most of the contracts performed by VSE provide for estimates of future
labor costs to be escalated for any option periods provided by the contracts,
while the non-labor costs included in such contracts are normally considered
reimbursable at cost. VSE property and equipment consists principally of
computer systems equipment and furniture and fixtures. The overall impact of
inflation on replacement costs of such property and equipment is not expected
to be significant.
28
Disclosures About Market Risk
Interest Rates
VSE's bank loan financing provides available borrowing to the Company at
variable interest rates. The Company has not borrowed significant amounts on the
loan in recent years. Accordingly, the Company does not believe that any
movement in interest rates would have a material impact on future earnings or
cash flows. If VSE were to significantly increase borrowings on the current loan
arrangement, future interest rate changes could potentially have a material
impact.
Foreign Currency
While a significant amount of the Company's business results from the
services provided by BAV related to the transfer of ships to foreign
governments, the BAV contract payments are made by the U.S. Government in
U.S. dollars. Additionally, most funding requirements to support work performed
or services purchased in foreign countries are made in U.S. dollars, and the
infrequent disbursements that are made in foreign currencies are reimbursable to
BAV in post conversion dollars. Foreign currency transactions of other VSE
divisions or subsidiaries are virtually non-existent. Accordingly, the Company
does not believe that it is exposed to any material foreign currency risk.
29
ITEM 8. Financial Statements and Supplementary Data
Index To Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm . . . . . 31
Consolidated Balance Sheets as of December 31, 2004 and 2003 . . . 32
Consolidated Statements of Operations for the years ended
December 31, 2004, 2003, and 2002 . . . . . . . . . . . . 33
Consolidated Statements of Stockholders' Investment
for the years ended December 31, 2004, 2003, and 2002 . . 34
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003, and 2002 . . . . . . . . . . . . 35
Notes to Consolidated Financial Statements . . . . . . . . . . . . 36
30
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders of VSE Corporation:
We have audited the accompanying consolidated balance sheets of VSE Corporation
and subsidiaries as of December 31, 2004 and 2003, and the related consolidated
statements of operations, stockholders' investment and cash flows for each of
the three years in the period ended December 31, 2004. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration
of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose
of expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit
also includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of VSE Corporation
and subsidiaries at December 31, 2004 and 2003, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2004, in conformity with U.S. generally accepted accounting
principles.
/s/ Ernst & Young LLP
McLean, Virginia
February 18, 2005
31
VSE Corporation and Subsidiaries
Consolidated Balance Sheets
- --------------------------------------------------------------------------------
(in thousands, except share amounts)
As of December 31,
2004 2003
---- ----
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . $ 130 $ 9,843
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . . . . . 40,274 21,835
Contract inventories . . . . . . . . . . . . . . . . . . 8,504 -
Deferred tax assets . . . . . . . . . . . . . . . . . . 1,077 819
Other current assets . . . . . . . . . . . . . . . . . . 1,595 1,379
------- -------
Total current assets . . . . . . . . . . . . . . . . 51,580 33,876
Property and equipment, net . . . . . . . . . . . . . . . 4,435 3,038
Deferred tax assets . . . . . . . . . . . . . . . . . . . 312 297
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . . . . . 2,971 2,511
------- -------
Total assets . . . . . . . . . . . . . . . . . . . . $60,352 $40,776
======= =======
Liabilities and Stockholders' Investment
Current liabilities:
Bank notes payable . . . . . . . . . . . . . . . . . . . $ 1,578 $ -
Accounts payable . . . . . . . . . . . . . . . . . . . . 26,853 14,634
Accrued expenses . . . . . . . . . . . . . . . . . . . . 7,452 5,760
Dividends payable . . . . . . . . . . . . . . . . . . . 114 88
------- -------
Total current liabilities . . . . . . . . . . . . . 35,997 20,482
Deferred compensation . . . . . . . . . . . . . . . . . . 1,312 1,236
------- -------
Total liabilities . . . . . . . . . . . . . . . . . 37,309 21,718
------- -------
Commitments and contingencies
Stockholders' investment:
Common stock, par value $.05 per share, authorized
5,000,000 shares; issued 2,276,688 in 2004 and
2,214,136 in 2003 . . . . . . . . . . . . . . . . . . 114 110
Paid-in surplus . . . . . . . . . . . . . . . . . . . . 4,879 3,928
Deferred stock-based compensation . . . . . . . . . . . (4) (17)
Retained earnings . . . . . . . . . . . . . . . . . . . 18,054 15,037
------- -------
Total stockholders' investment . . . . . . . . . . . 23,043 19,058
------- -------
Total liabilities and stockholders' investment . . . $60,352 $40,776
======= =======
The accompanying notes are an integral part of these balance sheets.
32
VSE Corporation and Subsidiaries
Consolidated Statements of Operations
- --------------------------------------------------------------------------------
(in thousands, except share and per share amounts)
For the years ended December 31,
2004 2003 2002
---- ---- ----
Revenues, principally from contracts . . . . $ 216,011 $ 133,059 $ 128,417
Costs and expenses of contracts . . . . . . 209,841 129,372 125,467
--------- --------- ---------
Gross profit . . . . . . . . . . . . . . . . 6,170 3,687 2,950
Selling, general and administrative expenses 636 351 281
Interest (income) expense, net . . . . . . . (102) (69) 24
--------- --------- ---------
Income before income taxes . . . . . . . . . 5,636 3,405 2,645
Provision for income taxes . . . . . . . . . 2,191 1,315 1,060
--------- --------- ---------
Income from continuing operations . . . . . 3,445 2,090 1,585
Discontinued operations:
Loss from operations before income taxes . (2) (127) (1,500)
Benefit for income taxes . . . . . . . . . (1) (48) (567)
--------- --------- ---------
Loss from discontinued operations . . . . . (1) (79) (933)
--------- --------- ---------
Net income . . . . . . . . . . . . . . . . . $ 3,444 $ 2,011 $ 652
========= ========= =========
Basic earnings per share:
Income from continuing operations $ 1.54 $ 0.96 $ 0.73
Loss from discontinued operations 0.00 (0.04) (.43)
--------- --------- ---------
Net income . . . . . . . . . . . . . . . . . $ 1.54 $ 0.92 $ 0.30
========= ========= =========
Basic weighted average shares outstanding 2,231,848 2,189,197 2,172,384
========= ========= =========
Diluted earnings per share:
Income from continuing operations $ 1.49 $ 0.94 $ 0.72
Loss from discontinued operations 0.00 (0.04) (0.42)
--------- --------- ---------
Net income . . . . . . . . . . . . . . . . . $ 1.49 $ 0.90 $ 0.30
========= ========= =========
Diluted weighted average shares
outstanding . . . . . . . . . . . . . . . . 2,309,932 2,230,226 2,196,390
========= ========= =========
The accompanying notes are an integral part of these statements.
33
VSE Corporation and Subsidiaries
Consolidated Statements of Stockholders' Investment
- -----------------------------------------------------------------------------------------------
(in thousands except per share data)
Deferred Total
Common Stock Paid-In Stock-based Retained Stockholders'
Shares Amount Surplus Compensation Earnings Investment
------ ------ ------- ------------ -------- ----------
Balance at
December 31, 2001 . . . . 2,150 $ 107 $ 3,294 - $ 13,074 $16,475
Net income for the year . . - - - - 652 652
Exercised stock options . . 33 2 213 - - 215
Tax benefit of options
exercised . . . . . . . . - - 22 - - 22
Issuance of stock . . . . . 3 - 29 - - 29
Dividends declared ($.16) . - - - - (350) (350)
----- ----- ------- ----- -------- -------
Balance at
December 31, 2002 2,186 $ 109 $ 3,558 - $ 13,376 $17,043
Net income for the year . . - - - - 2,011 2,011
Exercised stock options . . 25 1 270 - - 271
Tax benefit of options
exercised . . . . . . . - - 14 - - 14
Deferred stock-based
compensation . . . . . . - - 42 (42) - -
Amortization of deferred
stock-based compensation. - - - 25 - 25
Issuance of stock . . . . . 3 - 44 - - 44
Dividends declared ($.16) . - - - - (350) (350)
----- ----- ------- ----- -------- -------
Balance at
December 31, 2003 2,214 110 3,928 (17) 15,037 19,058
Net income for the year . . - - - - 3,444 3,444
Exercised stock options . . 62 4 505 - - 509
Tax benefit of options
exercised . . . . . . . - - 433 - - 433
Deferred stock-based
compensation . . . . . . - - 4 (4) - -
Amortization of deferred
stock-based compensation. - - - 17 - 17
Issuance of stock . . . . . 1 - 9 - - 9
Dividends declared ($.19) . - - - - (427) (427)
----- ----- ------- ----- -------- -------
Balance at
December 31, 2004 2,277 $ 114 $ 4,879 $ (4) $ 18,054 $23,043
===== ===== ======= ===== ======== =======
The accompanying notes are an integral part of these statements.
34
VSE Corporation and Subsidiaries
Consolidated Statements of Cash Flows
- ------------------------------------------------------------------------------------------------
(in thousands)
For the years ended December 31,
2004 2003 2002
---- ---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,444 $ 2,011 $ 652
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization . . . . . . . . . . . . . . 1,304 1,158 1,414
Loss on impairment of intangible assets . . . . . . . . . . - - 576
Loss on sale of property and equipment . . . . . . . . . . - 7 27
Deferred taxes . . . . . . . . . . . . . . . . . . . . . . (273) 646 (274)
Tax benefit of options exercised . . . . . . . . . . . . . 433 14 22
Amortization of deferred stock-based compensation . . . . . 17 25 -
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable . . . . . . . . . . . . . . . . . . . (18,439) (3,913) 2,927
Contract inventories . . . . . . . . . . . . . . . . . . . (8,504) - -
Other current assets and noncurrent assets . . . . . . . . (676) (246) 769
Increase (decrease) in:
Accounts payable and deferred compensation. . . . . . . . . 12,295 5,977 (1,952)
Accrued expenses . . . . . . . . . . . . . . . . . . . . . 1,692 708 817
------- ------- -------
Net cash (used in) provided by operating activities (8,707) 6,387 4,978
------- ------- -------
Cash flows from investing activities:
Purchase of property and equipment. . . . . . . . . . . . . . . (2,701) (720) (521)
------- ------- -------
Net cash used in investing activities (2,701) (720) (521)
------- ------- -------
Cash flows from financing activities:
Net proceeds from (payments on) bank loans . . . . . . . . . . 1,578 - (351)
Dividends paid . . . . . . . . . . . . . . . . . . . . . . . (401) (349) (349)
Proceeds from issuance of common stock . . . . . . . . . . . 518 315 244
------- ------- -------
Net cash provided by (used in) financing activities 1,695 (34) (456)
------- ------- -------
Net (decrease) increase in cash and cash equivalents . . . . . . (9,713) 5,633 4,001
Cash and cash equivalents at beginning of year . . . . . . . . 9,843 4,210 209
------- ------- -------
Cash and cash equivalents at end of year . . . . . . . . . . . $ 130 $ 9,843 $ 4,210
======= ======= =======
Supplemental cash flow disclosures (in thousands):
2004 2003 2002
---- ---- ----
Cash paid during the year for:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ - $ 61
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,292 $ 616 $ 205
The accompanying notes are an integral part of these statements.
35
VSE Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements consist of the operations of the
parent company, operations of the Company's wholly owned subsidiaries, and
operations of the Company's divisions. In 2004, Energetics Incorporated
("Energetics") is VSE's only active subsidiary. Active divisions include BAV
Division ("BAV"), Coast Guard Division ("VCG") beginning in February 2002,
Communications and Engineering Division ("CED") beginning in February 2003,
Fleet Maintenance Division ("FMD"), Management Sciences Division ("MSD"),
Systems Engineering Division ("SED," formerly Land Systems Division),
Telecommunications Technologies Division ("TTD"), and Value Systems Services
Division ("VSS"). In February 2003, VSE decided to terminate operations of TTD
due to declining revenues and significant losses sustained by this division. TTD
continued work on uncompleted contracts during 2003 and 2004 to satisfy its
contractual obligations and upon finishing work in July 2004 TTD was classified
as a discontinued operation. Some of TTD's technical capabilities have been
transferred to other VSE divisions.
The term "VSE" or "Company" means VSE and its subsidiaries and divisions
unless the context indicates operations of the parent company only.
Intercompany sales are principally at cost. All intercompany transactions have
been eliminated in consolidation. Certain prior year balances have been
reclassified for comparative purposes.
The Company's business operations consist primarily of diversified
engineering, logistics, management, and technical services performed on a
contract basis. Substantially all of the Company's contracts are with agencies
of the United States Government (the "government") and other federal government
prime contractors. The Company's customers also include non-government
organizations and commercial entities.
VSE operations are conducted within a single reporting segment and
financial information is presented on a company-wide basis. The Company's
segment includes all of the operations of the Company's subsidiaries and
divisions as they have similar operations servicing a similar customer base.
The Company manages these services as a single segment that is divided into
profit centers that are focused on contracts.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Significant estimates affecting the financial statements include the allowance
for doubtful accounts and accruals for loss contracts, contract disallowance and
self insured health claims, and estimated cost to complete on certain fixed-
price contracts.
36
Accounting for Stock-based Compensation
The Company has adopted the disclosure-only provisions of SFAS 123,
"Accounting for Stock-Based Compensation," as amended by SFAS 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure." Accordingly, the
Company accounts for stock-based compensation under Accounting Principles Board
(APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations, using the intrinsic value method. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS 123 to all stock-based
employee compensation (in thousands, except per share amounts):
Year Ended December 31
---------------------------
2004 2003 2002
---- ---- ----
Net income, as reported . . . . . . . . $3,444 $2,011 $ 652
Add: Total stock-based employee
compensation expense as reported
under intrinsic value method
(APB No. 25) for all awards, net
of related tax effects . . . . . . . . 9 15 --
Deduct: Total stock-based
compensation expense
determined under fair value based
method (SFAS No. 123) for all
awards, net of related tax effects . . (119) (83) (111)
------ ------ -----
Pro forma net income . . . . . . . . . $3,334 $1,943 $ 541
====== ====== =====
Earnings per share:
Basic - as reported . . . . . . . . . $1.54 $0.92 $0.30
Diluted - as reported . . . . . . . . $1.49 $0.90 $0.30
Basic - pro forma . . . . . . . . . . $1.49 $0.89 $0.25
Diluted - pro forma . . . . . . . . . $1.44 $0.87 $0.25
The fair value of the options is estimated on the date of grant using the
Black-Scholes option pricing model. The following assumptions were used in the
pricing calculations for 2004, 2003, and 2002:
2004 2003 2002
---- ---- ----
Risk free interest rate . . . . . . . . 2.47% 2.18% 3.50%
Dividend yield . . . . . . . . . . . . 1.30% 1.48% 2.16%
Expected life . . . . . . . . . . . . . 3 years 3 years 3 years
Expected volatility . . . . . . . . . . 48.30% 37.30% 32.90%
In December 2004, the Financial Accounting Standards Board issued
SFAS 123(R), "Share-Based Payment," which is a revision to SFAS 123. SFAS 123(R)
supersedes APB Opinion No. 25 and amends SFAS 95, "Statement of Cash Flows."
Generally, the approach in SFAS 123(R) is similar to the approach described in
37
SFAS 123. However, SFAS 123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure is no longer an
alternative. The Company can adopt SFAS 123(R) in one of two ways - the
modified prospective method or the modified retrospective method. The Company
will adopt SFAS 123(R) on July 1, 2005 and is currently evaluating the
alternative methods.
The impact of adoption of SFAS 123(R) cannot be predicted at this time
because it will depend on levels of share-based payments granted in the future.
However, had we adopted SFAS 123(R) in prior periods, the impact of that
standard would have approximated the impact of SFAS 123 as described in the
disclosure of pro forma net income and earnings per share above. SFAS 123(R)
also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will
reduce net operating cash flows and increase net financing cash flows in periods
after adoption. While the Company cannot estimate what those amounts will be in
the future (because they depend on, among other things, when employees exercise
stock options), the amount of operating cash flows recognized for each of the
last three years of the period ending December 31, 2004 for such excess tax
deductions were approximately $433 thousand, $14 thousand, and $22 thousand for
2004, 2003 and 2002, respectively.
Earnings Per Share
Basic earnings per share have been computed by dividing net income by the
weighted average number of shares of common stock outstanding during each
period. Shares issued during the period and shares reacquired during the period
are weighted for the portion of the period that they were outstanding. Diluted
earnings per share have been computed in a manner consistent with that of basic
earnings per share while giving effect to all potentially dilutive common shares
that were outstanding during each period. Potentially dilutive common shares
include incremental common shares issuable upon exercise of stock options.
Years Ended December 31,
2004 2003 2002
---- ---- ----
Basic weighted average
common shares outstanding . . 2,231,848 2,189,197 2,172,384
Diluted effect of options . . . 78,084 41,029 24,006
--------- --------- ---------
Diluted weighted average
common shares outstanding . . 2,309,932 2,230,226 2,196,390
========= ========= =========
Cash and Cash Equivalents
Cash and cash equivalents reported by the Company consist of cash
balances in the Company's bank accounts and short term temporary invested
balances connected to the bank accounts with sweep arrangements, netted by
checks issued on the Company's bank accounts that have not yet been presented to
the bank for collection. The Company considers all highly liquid investments
38
with an original maturity of three months or less to be cash equivalents.
Contract Inventories
Contract inventories consist of materials purchased, advances to
suppliers, and other expenditures arising from and solely and directly
attributable to contract requirements. The cost of such contract inventories is
expected to be billed to the customer within a relatively short time. These
materials and direct supplies are purchased to satisfy contract requirements and
are not restocked to maintain any permanent contract inventory levels.
Raw material contract inventories consist of advances to suppliers for
materials for use in contract requirements for which work has not yet begun and
are stated at cost. Work in process contract inventories consist of amounts for
materials, supplies and other expenditures for which work has been performed but
for which the end unit has not yet been completed and accepted. Work in process
contract inventory is stated at cost plus applicable indirect cost burdens,
including general and administrative costs.
Property and Equipment
Property and equipment are stated at cost. Depreciation of computer
systems equipment is provided principally by the double-declining method over
periods of two to four years. Depreciation of furniture and fixtures is provided
principally by the straight-line method over approximately nine years.
Depreciation of other equipment is provided principally by the double-declining
method over periods of three to ten years. Depreciation of buildings and land
improvements is provided principally by the straight-line method over periods of
approximately twenty to thirty years. Amortization of leasehold improvements is
provided by the straight-line method over the lesser of their useful life or the
remaining term of the lease.
Concentration of Credit Risk/Fair Value of Financial Instruments
Financial instruments that potentially subject the Company to
concentration of credit risk consist primarily of cash, cash equivalents and
trade accounts receivable. The Company believes that concentrations of credit
risk with respect to trade accounts receivable are limited as they are primarily
government receivables. The Company believes that the fair market value of all
financial instruments, including assets of the deferred compensation plan and
debt, approximate book value.
Contracts with the U.S. Government either as a prime or subcontractor,
primarily with the U.S. Department of Defense, accounted for approximately 99%
of revenues for each of the years ending December 31, 2004, 2003, and 2002.
The BAV contract accounted for approximately 52%, 48% and 56% of consolidated
revenues during 2004, 2003 and 2002, respectively.
Contract Revenues
Substantially all of the Company's revenues result from contract services
performed for the U.S. Government or for contractors engaged in work for the
government under a variety of contracts. Revenue is recognized when earned as
services are provided. Revenue is considered earned when persuasive evidence
39
of an arrangement exists, services have been rendered, the price is fixed and
determinable and collectibility is reasonably assured.
Revenues on cost-type contracts are recorded on the basis of recoverable
costs incurred and fees earned. The Company has a contract in its BAV division
for which contract terms specify award fee payments to BAV that are determined
by performance and level of contract activity. Award fees are made three times
during the year and a contract modification authorizing the award fee payment
is issued subsequent to the period in which the work is performed. The Company
does not recognize award fee income until the contract modification authorizing
the award fee is certain. Due to such timing, and to fluctuations in the level
of revenues, profits as a percentage of revenues on this contract will fluctuate
from period to period. Approximately $148.0 million, $93.6 million and $106.2
million of the Company's revenues were under cost reimbursable contracts for
the years ended December 31, 2004, 2003, and 2002, respectively.
Revenues on time and material contracts are recorded on the basis of
billable rates times allowable hours worked plus material and other reimbursable
costs incurred. Revenues on fixed-price service contracts are recorded as
services are provided. Revenues on certain fixed-price contracts are recorded
as costs are incurred, using the percentage-of-completion method of accounting,
since these contracts require design, engineering, or manufacturing services
performed to the customer's specifications. Revenues on fixed-price contracts
that require delivery of specific items may be recorded based on a price per
unit as units are delivered. Profits on fixed-price contracts result from the
difference between the incurred costs and the revenue earned.
Revenue related to work performed on contracts at risk, which is work
performed at the customer's request prior to the government formalizing funding,
is not recognized as income until it can be reliably estimated and its
realization is probable. The Company provides for anticipated losses on
contracts by a charge to income during the period in which losses are first
identified.
A substantial portion of contract and administrative costs is subject to
audit by the Defense Contract Audit Agency. The Company's indirect cost rates
have been audited and approved for 2002 and prior years and these completed
audits have not resulted in material adjustments to the Company's results of
operations or financial position. While the Company maintains reserves to cover
the risk of potential future audit adjustments based primarily on the results of
prior audits, there can be no assurances that the audits of the indirect cost
rates for 2004 and 2003 will not result in material adjustments to the Company's
results of operations or financial position.
The Company establishes allowances for collection of doubtful accounts.
The Company assesses the adequacy of these reserves by considering general
factors, such as the length of time individual receivables are past due and
historical collection experience. The Company believes that the established
valuation allowances are adequate.
40
Deferred Compensation Plans
Deferred compensation plan expense for the years ended December 31, 2004,
2003, and 2002 was $240 thousand, $0, and $7 thousand, respectively.
Included in other assets are assets of the deferred compensation plans
which include equity securities recorded at fair value. The fair value of the
deferred compensation plan assets was approximately $1.3 million and $1.2
million as of December 31, 2004, and 2003, respectively. Because plan
participants are at risk for market value changes in these assets, the liability
to plan participants fluctuates with the asset values.
Impairment of Long-Lived Assets
Long-lived assets includes property and equipment to be held and used.
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount should be addressed pursuant to
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
("SFAS No. 144"). The criteria for determining impairment for such long-lived
assets to be held and used is determined by comparing the carrying value of
these long-lived assets to management's best estimate of future undiscounted
cash flows expected to result from the use of the assets. The Company believes
that no impairment existed under SFAS No. 144 as of December 31, 2004.
Income Taxes
Income taxes are accounted for under the asset and liability method in
accordance with FASB Statement No. 109, "Accounting for Income Taxes." Under
the asset and liability method, deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. This method also requires the
recognition of future tax benefits such as net operating loss carryforwards, to
the extent that realization of such benefits is more likely than not. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.
The carrying value of VSE net deferred tax assets is based on assumptions
regarding VSE's ability to generate sufficient future taxable income to utilize
these deferred tax assets. If the estimates and related assumptions regarding
VSE's future taxable income change in the future, VSE may be required to record
valuation allowances against its deferred tax assets, resulting in additional
income tax expense. Management believes that it is more likely than not that
the deferred tax assets will be realized through future taxable income and,
therefore, no valuation allowance is required.
Discontinued Operations
In July 2004, all business operations associated with the Company's
TTD division ceased. Accordingly, prior period consolidated financial statements
have been restated to reflect the financial results of TTD as discontinued
41
operations. The revenues, costs and expenses of TTD have been excluded from the
respective captions in the Consolidated Statement of Operations. The revenues
from discontinued operations associated with TTD in the years ended December 31,
2004, 2003 and 2002 were approximately $9 thousand, $1.4 million, and $6
million, respectively. The loss from discontinued operations associated with
TTD, net of tax, in the years ended December 31, 2004, 2003, and 2002 was
approximately $1 thousand, $79 thousand and, $933 thousand, respectively.
Approximately $5 thousand net current assets related to TTD were included in the
December 31, 2004 balance sheet, comprised primarily of receivables.
Goodwill
The Company adopted SFAS No. 142 "Goodwill and Other Intangible Assets,"
effective January 1, 2002. SFAS No. 142 does not permit amortization of
goodwill, but requires a review for impairment at least annually, or more
frequently if an asset might be impaired, using a fair-value based approach.
See Note 7 of the Company's consolidated financial statements for further
discussion.
(2) Accounts Receivable
The components of accounts receivable as of December 31, 2004 and 2003,
were as follows (in thousands):
2004 2003
---- ----
Billed . . . . . . . . . . . . . . . . . . . . $15,777 $ 5,397
Unbilled:
Government retainage . . . . . . . . . . . . 35 8
Subcontract retainage . . . . . . . . . . . . 4,700 348
Other (principally December work billed in
January) . . . . . . . . . . . . . . . . 19,814 16,159
Less-Allowance for doubtful accounts . . . . . (52) (77)
------- -------
Total accounts receivable $40,274 $21,835
======= =======
Unbilled subcontract retainage includes amounts withheld from payments
to subcontractors.
The "Unbilled: Other" includes certain costs for work performed at risk
but which the Company believes will be funded by the government. Amounts not
presently funded included in "Unbilled: Other" were $56 thousand and $478
thousand as of December 31, 2004, and 2003, respectively.
The Company generally expects to collect all accounts receivable other
than retainages within one year.
42
The following table summarizes activity in the allowance for doubtful
accounts (in thousands):
Additions
Balance at Charged to Balance at
Beginning Costs and End of
Allowance for Doubtful Accounts of Period Deductions(1) Expenses Period
- ------------------------------- ---------- ------------- ---------- ----------
For the year ended
December 31, 2004 . . . . . . . . . $ 77 $ 35 $10 $ 52
For the year ended
December 31, 2003 . . . . . . . . . 99 87 65 77
For the year ended
December 31, 2002 . . . . . . . . . 300 270 69 99
(1) Write-offs and settlements
(3) Other Current Assets
Other current assets consisted of the following as of December 31, 2004
and 2003 (in thousands):
2004 2003
---- ----
Federal and state tax receivable . . . . . . . . . . $ 371 $ 129
Travel advances . . . . . . . . . . . . . . . . . . 271 443
Prepaid rent expense . . . . . . . . . . . . . . . . 208 243
Software licensing . . . . . . . . . . . . . . . . . 95 59
Prepaid materials . . . . . . . . . . . . . . . . . 88 39
Other prepaid expenses . . . . . . . . . . . . . . . 562 466
------ ------
Total other current assets $1,595 $1,379
====== ======
(4) Contract Inventories
The components of contract inventories as of December 31, 2004 and 2003
were as follows (in thousands):
2004 2003
---- ----
Raw material . . . . . . . . . . . . . . . . . . $4,783 $ 0
Work in process . . . . . . . . . . . . . . . . 3,721 0
------ -----
Total contract inventories $8,504 $ 0
====== =====
Contract inventories at December 31, 2004 consisted of materials
purchased, advances to suppliers, and other expenditures for use in a contract
to modify and apply a protective system, the Tanker Ballistic Protection System
("TBPS"), to military vehicles for the U.S. Army. This contract was awarded to
VSE in November 2004. VSE was not performing this type of effort, and did not
have any contract inventories, prior to November 2004.
Although these costs are classified as contract inventories for
accounting purposes, they are similar in nature to materials and direct supplies
purchased for use in performance on the Company's other contracts in that they
43
are solely and directly attributable to the contract and will be billed to the
customer within a relatively short time. All of the $8.5 million of contract
inventories is expected to be liquidated, billed, and collected in 2005. These
materials and direct supplies will not be restocked to maintain any permanent
contract inventory levels.
Raw material contract inventories consist of advances to suppliers for
materials for use on this contract but on which work has not yet begun. Work in
process contract inventories consist of amounts for materials, supplies and
other expenditures for which work has been performed but for which the end unit
has not yet been completed and accepted. Work in process contract inventory
includes applicable indirect cost burdens, including general and administrative
costs totaling approximately $442 thousand.
(5) Other Assets
Other assets consisted of the following as of December 31, 2004 and
2003 (in thousands):
2004 2003
---- ----
Cash surrender value of life insurance . . . . . . . $ 1,347 $ 1,269
Deferred compensation trust . . . . . . . . . . . . 1,312 1,236
Other assets . . . . . . . . . . . . . . . . . . . . 312 6
------- -------
Total other assets $ 2,971 $ 2,511
======= =======
(6) Property and Equipment
Property and equipment (recorded at cost) consisted of the following as
of December 31, 2004 and 2003(in thousands):
2004 2003
---- ----
Computer systems equipment . . . . . . . . . . . . . $ 4,485 $ 3,644
Furniture, fixtures, equipment and other . . . . . . 2,877 2,533
Leasehold improvements . . . . . . . . . . . . . . . 2,607 1,968
Buildings . . . . . . . . . . . . . . . . . . . . . 1,050 302
Land and land improvements . . . . . . . . . . . . . 385 385
------- -------
11,404 8,832
Less accumulated depreciation and amortization . . . (6,969) (5,794)
------- -------
Total property and equipment $ 4,435 $ 3,038
======= =======
Depreciation and amortization expense for property and equipment was
approximately $1.3 million for 2004 and approximately $1.2 million for 2003 and
2002.
(7) Goodwill and Intangible Assets
As part of the August 29, 1995, acquisition of Energetics, the Company
recorded approximately $1.7 million of goodwill. Between 1995 and 2001, VSE
amortized the goodwill by the straight-line method using a fifteen year life.
In accordance with SFAS No. 142, VSE stopped amortizing the goodwill in
January 2002, but continues to review it at least annually, or more frequently
if an asset might be impaired, to determine if an impairment has occurred.
44
Approximately $1.1 million of unamortized goodwill remains on the books as of
December 31, 2004.
On December 28, 2000, TTD invested $960 thousand in the acquisition of
certain contract and marketing rights. Between January 2001 and December 2002,
these intangible assets were amortized by the straight-line method using a life
of five years. During the fourth quarter of 2002, VSE determined that an
impairment of the intangible assets had occurred due to recurring losses and
reduced backlog. As a result, an impairment loss for the remaining unamortized
amount of $576 thousand was recorded and is included in the loss from
discontinued operations in VSE's statement of operations for 2002.
Total Company amortization expense for intangible assets was $0 for 2004
and 2003 and approximately $192 thousand for 2002, which is included in the loss
from discontinued operations.
(8) Debt
VSE has a revolving loan agreement with a bank in which the Company can
borrow up to $15 million, subject to a borrowing formula based on billed
receivables. The loan agreement contains collateral requirements by which
Company assets secure amounts outstanding, restrictive covenants that include
minimum tangible net worth and profitability requirements, a limit on annual
dividends, and other affirmative and negative covenants.
The expiration date of the revolving loan is May 31, 2006, and the
Company is obligated to repay outstanding borrowings against the loan on this
date. From time to time the bank and the Company may negotiate an amendment to
the loan to change this expiration date to a later date. The loan agreement
contains terms whereby the Company may borrow against the loan and has the
option at any time and from time to time to prepay such borrowings in whole or
in part without premium or penalty. In December 2004, the Company borrowed
against the loan and amounts outstanding under this loan agreement were
approximately $1.6 million as of December 31, 2004. The Company subsequently
exercised its prepayment option and the borrowings were paid in whole in
January 2005. There were no outstanding amounts borrowed as of December 31,
2003.
The Company pays a fixed annual commitment fee and interest on any
borrowings under the loan at a prime-based rate or an optional LIBOR-based rate.
Interest expense incurred on the loan for 2004, 2003 and 2002 was approximately
$1 thousand, $0, and $55 thousand, respectively.
45
(9) Accrued Expenses
The components of accrued expenses as of December 31, 2004 and 2003, were
as follows (in thousands):
2004 2003
---- ----
Accrued salaries . . . . . . . . . . . . . . . . $1,432 $1,267
Accrued vacation . . . . . . . . . . . . . . . . 1,661 1,332
Estimated future losses on contracts . . . . . . 480 516
Estimated contract disallowances . . . . . . . . 467 442
Accrued bonus . . . . . . . . . . . . . . . . . . 1,856 1,157
Accrued pension and 401(k) contributions . . . . 468 452
Other accrued expenses . . . . . . . . . . . . . 1,088 594
------ ------
Total accrued expenses $7,452 $5,760
====== ======
(10) ESOP/401(k) Plan and Profit Sharing Plan
VSE established an ESOP/401(k) plan in 1984. Under the provisions of the
ESOP, VSE and certain of its operating entities made contributions into a trust
which purchased VSE stock on behalf of employees who met certain age and service
requirements and were employed at the end of the plan year. Contributions at the
rate of up to 2% of eligible employee compensation were permitted at the
discretion of the VSE Board of Directors and were allocated, subject to a
vesting schedule, on a pro rata basis on eligible employee compensation. The
401(k) segment of the plan allows employees meeting certain age and service
requirements to contribute a portion of their salary to certain investment
trusts. As of April 1, 1999, the ESOP contributions were discontinued and
replaced by employer 401(k) contributions made on behalf of the eligible
employee participants based on the employees' 401(k) payroll deferrals. The
employer contribution is equal to 50% of the employee deferral on the first 6%
of the employee pay deferred. The Company expense associated with this plan for
2004, 2003, and 2002 was $415 thousand, $262 thousand, and $342 thousand,
respectively.
The ESOP/401(k) plan held 281,933 shares and 317,223 shares of VSE stock
as of December 31, 2004 and 2003, respectively. Such shares receive dividend
payments and are included in the weighted average shares for earnings per share
calculations.
Energetics maintains a profit sharing plan for employees. All employees
who have completed two years of service are members of the profit sharing plan.
At its discretion, Energetics may make contributions to the plan. The plan
expense for 2004, 2003, and 2002 was $443 thousand, $429 thousand, and $458
thousand, respectively.
(11) Stock Option Plans
2004 Stock Option Plan
In May 2004 shareholders approved the VSE Corporation 2004 Stock Option
Plan (the "2004 Plan"), which is substantially similar to the 1998 Stock
Option Plan (the "1998 Plan"). Under the 2004 Plan, the Company may grant
options for an aggregate of up to 350,000 shares of VSE Common Stock, par value
$.05 per share ("shares" or "VSE Stock"). Shares which are forfeited back to the
Company may be reissued. Of the shares available for grant, nondiscretionary
46
options for up to 30,000 shares may be granted to non-employee directors of VSE,
and discretionary options for up to 320,000 shares may be granted to executives
and other key employees. No discretionary grant may be made under the 2004 Plan
if the total number of shares underlying unexercised outstanding options granted
under the 2004 Plan and the 1998 Plan would exceed 15% of total issued and
outstanding VSE Stock if such discretionary grant was made. Each option granted
under the 2004 Plan will be issued at the fair market value of VSE shares on the
date of grant for a period of up to five years, subject to earlier termination
as provided by the 2004 Plan. Each option issued vests 25% on date of award and
25% on each anniversary date thereafter, becoming 100% vested as of the third
anniversary date of award. No options were granted under the 2004 Plan in 2004.
On January 1, 2005, the Company granted options for up to 70,000 shares,
including nondiscretionary options for up to 6,000 shares. The 2004 Plan will
terminate on the earliest of May 1, 2014, or the date on which all options
issued under the 2004 Plan have been exercised, expire, or have been terminated.
1998 Stock Option Plan
As of December 31, 2004, options issued under the 1998 Plan for up to
211,625 shares remain outstanding. The 1998 Plan will terminate on the earliest
of May 6, 2008, or the date on which all options issued under the 1998 Plan have
been exercised, expire, or have been terminated.
Information with respect to stock options is as follows:
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
2004 Price 2003 Price 2002 Price
---- ----- ---- ----- ---- -----
Number of shares under
stock options:
Outstanding at beginning
of year . . . . . . . . 212,250 $ 8.07 185,000 $ 7.66 217,375 $10.28
Granted . . . . . . . . 65,500 12.82 68,750 10.85 69,750 5.77
Exercised . . . . . . . (62,125) 8.19 (24,875) 10.89 (32,500) 6.59
Forfeited . . . . . . . - - (4,625) 10.18 (39,000) 7.86
Terminations . . . . . . (4,000) 8.03 (12,000) 10.93 (30,625) 9.42
------- ------ ------- ------ ------- ------
Outstanding at end
of year 211,625 $ 9.51 212,250 $ 8.07 185,000 $ 7.66
======= ====== ======= ====== ======= ======
Exercisable at end
of year . . . . . . . . 161,938 $ 8.70 127,250 $ 7.45 111,063 $ 8.29
======= ====== ======= ====== ======= ======
Weighted average remaining
contractual life . . . 3 years 2 years 1 year
Weighted average fair
value of options granted $2.76 $2.80 $1.97
===== ===== =====
47
The following table summarizes the range of exercise prices for options
outstanding at December 31, 2004:
Outstanding Options
-------------------------------
Exercisable Options
Weighted -------------------
Average Weighted Weighted
Contractual Average Average
Number of Life Exercise Number of Exercise
Range of Exercise Prices Shares (in years) Price Shares Price
- ------------------------ ------ ---------- ----- ------ -----
$5.77 to $6.62 . . . . . 86,375 1 $ 6.12 86,375 $ 6.12
$10.73 to $12.32 . . . . 60,250 3 10.80 43,313 10.78
$12.82 . . . . . . . . . 65,000 4 12.82 32,250 12.82
------- - ------ ------- ------
Total 211,625 3 $ 9.51 161,938 $ 8.70
======= = ====== ======= ======
The Company accounts for stock-based employee compensation using the
intrinsic value method prescribed in APB Opinion No. 25 and related
interpretations. The total stock-based employee compensation expense, net of tax
effects, as of December 31, 2004 and 2003, was approximately $9 thousand and $15
thousand, respectively.
(12) Income Taxes
The Company files consolidated federal income tax returns with all of its
subsidiaries. The components of the provision for income taxes from continuing
operations for the years ended December 31, 2004, 2003, and 2002 are as follows
(in thousands):
2004 2003 2002
---- ---- ----
Current
Federal . . . . . . . . . . . . . . . . . . $1,989 $ 796 $ 834
State . . . . . . . . . . . . . . . . . . . 475 244 188
------ ------ ------
2,464 1,040 1,022
Deferred
Federal . . . . . . . . . . . . . . . . . . (202) 275 25
State . . . . . . . . . . . . . . . . . . (71) - 13
------ ------ ------
(273) 275 38
------ ------ ------
Provision for income taxes . . . . . . . . . . $2,191 $1,315 $1,060
====== ====== ======
The benefit for income taxes from discontinued operations for the years
ended December 31, 2004, 2003 and 2002 are as follows (in thousands):
2004 2003 2002
---- ---- ----
Current . . . . . . . . . . . . . . . . . . . $ (1) $ (419) $ (255)
Deferred . . . . . . . . . . . . . . . . . . . - 371 (312)
------ ------ ------
Total income tax benefit $ (1) $ (48) $ (567)
====== ====== ======
48
The differences between the amount of tax computed at the federal
statutory rate of 34% and the provision for income taxes for 2004, 2003, and
2002 are as follows (in thousands):
2004 2003 2002
---- ---- ----
Tax at statutory federal income
tax rate at 34% . . . . . . . . . . . . . . $1,916 $1,158 $ 899
Increases (decreases) in tax resulting from:
State taxes, net of federal tax benefit . . 266 160 126
Permanent differences, net . . . . . . . . 9 (6) 12
Other, net . . . . . . . . . . . . . . . . - 3 23
------ ------ ------
Provision for income taxes . . . . . . . . . . $2,191 $1,315 $1,060
====== ====== ======
The Company's deferred tax assets (liabilities) as of December 31, 2004
and 2003 which represent the tax effects of temporary differences between tax
and financial accounting bases of assets and liabilities and are measured using
presently enacted tax rates, are as follows (in thousands):
2004 2003
---- ----
Current deferred tax assets . . . . . . . . . . $1,173 $1,023
Current deferred tax liabilities . . . . . . . . (96) (204)
------ ------
Net current deferred tax assets . . . . . . . . 1,077 819
------ ------
Noncurrent deferred tax assets . . . . . . . . . 1,109 887
Noncurrent deferred tax liabilities . . . . . . . (797) (590)
------ ------
Net noncurrent deferred tax assets . . . . . . 312 297
------ ------
Net deferred tax assets . . . . . . . . . . . . . $1,389 $1,116
====== ======
The tax effect of temporary differences representing deferred tax assets
and liabilities as of December 31, 2004 and 2003, are as follows (in thousands):
2004 2003
---- ----
Deferred compensation and accrued paid leave . . $1,221 $1,025
Reserve for future losses . . . . . . . . . . . . 186 200
Reserve for contract and other disallowances . . 165 159
Accrued expenses . . . . . . . . . . . . . . . . 75 70
Reserve for doubtful accounts . . . . . . . . . . 32 36
Retainages not taxed until billed . . . . . . . (9) (5)
Deferred revenues . . . . . . . . . . . . . . . . (50) (165)
Accelerated depreciation . . . . . . . . . . . . (133) (138)
Intangible assets . . . . . . . . . . . . . . . . (139) (92)
Other . . . . . . . . . . . . . . . . . . . . . . 41 26
------ ------
Net deferred tax assets $1,389 $1,116
====== ======
49
(13) Commitments and Contingencies
Leases and other commitments
The Company and its subsidiaries have various non-cancelable operating
leases for facilities, equipment, and software with terms between two and ten
years. Payments on these leases for 2004, 2003, and 2002 were:
(in thousands)
------------------------------------------
Payments Sublease Net
on Leases Income Expense
--------- ------ -------
2004 . . . . . . . . . . . $3,692 $ 566 $3,126
2003 . . . . . . . . . . . 3,289 637 2,652
2002 . . . . . . . . . . . 2,630 869 1,761
Future minimum annual non-cancelable commitments are as follows:
(in thousands)
------------------------------------------
Payments Sublease Net
on Leases Income Expense
--------- ------ -------
2005 . . . . . . . . . . . $ 3,250 $ 894 $2,356
2006 . . . . . . . . . . . 3,014 777 2,237
2007 . . . . . . . . . . . 2,645 798 1,847
2008 . . . . . . . . . . . 1,615 274 1,341
2009 . . . . . . . . . . . 386 - 386
Thereafter . . . . . . . . - - -
------- ------ ------
Total $10,910 $2,743 $8,167
======= ====== ======
Contingencies
The Company and its subsidiaries have, in the normal course of business,
certain claims against them and against other parties. The Company is not aware
of any present claims which would have a material adverse effect on the
Company's financial position or results of operations.
50
(14) Selected Quarterly Data (Unaudited)
The following table shows selected quarterly data for 2004 and 2003, in
thousands, except earnings per share:
2004 Quarters
-------------
1st 2nd 3rd 4th
--- --- --- ---
Revenues . . . . . . . . . . . . . . . . $42,609 $54,037 $62,223 $57,142
======= ======= ======= =======
Gross profit . . . . . . . . . . . . . . $ 1,147 $ 1,613 $ 1,604 $ 1,806
======= ======= ======= =======
Income from continuing operations . . . $ 708 $ 855 $ 885 $ 997
Loss from discontinued operations . . . - (1) - -
------- ------- ------- -------
Net income . . . . . . . . . . . . . . . $ 708 $ 854 $ 885 $ 997
======= ======= ======= =======
Basic earnings per share:
Income from continuing operations . . . $ .32 $ .38 $ .40 $ .44
Loss from discontinued operations . . . - - - -
------- ------- ------- -------
Net income per share . . . . . . . . . . $ .32 $ .38 $ .40 $ .44
======= ======= ======= =======
Weighted average shares outstanding . . 2,216 2,222 2,225 2,264
======= ======= ======= =======
Diluted earnings per share:
Income from continuing operations . . . $ .31 $ .37 $ .38 $ .43
Loss from discontinued operations . . . - - - -
------- ------- ------- -------
Net income per share . . . . . . . . . . $ .31 $ .37 $ .38 $ .43
======= ======= ======= =======
Weighted average shares outstanding . . 2,287 2,306 2,301 2,346
======= ======= ======= =======
2003 Quarters
-------------
1st 2nd 3rd 4th
--- --- --- ---
Revenues . . . . . . . . . . . . . . . . $25,429 $29,106 $36,339 $42,185
======= ======= ======= =======
Gross profit . . . . . . . . . . . . . . $ 794 $ 760 $ 936 $ 1,197
======= ======= ======= =======
Income from continuing operations . . . $ 492 $ 447 $ 530 $ 621
Loss from discontinued operations . . . (60) (11) (7) (1)
------- ------- ------- -------
Net income . . . . . . . . . . . . . . . $ 432 $ 436 $ 523 $ 620
======= ======= ======= =======
Basic earnings per share:
Income from continuing operations . . . $ .23 $ .20 $ .24 $ .28
Loss from discontinued operations . . . (.03) - - -
------- ------- ------- -------
Net income per share . . . . . . . . . . $ .20 $ .20 $ .24 $ .28
======= ======= ======= =======
Weighted average shares outstanding . . 2,187 2,189 2,189 2,192
======= ======= ======= =======
Diluted earnings per share:
Income from continuing operations . . . $ .22 $ .20 $ .23 $ .28
Loss from discontinued operations . . . (.03) - - -
------- ------- ------- -------
Net income per share . . . . . . . . . . $ .19 $ .20 $ .23 $ .28
======= ======= ======= =======
Weighted average shares outstanding . . 2,225 2,220 2,236 2,240
======= ======= ======= =======
51
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
ITEM 9A. Controls and Procedures
Evaluation of disclosure controls and procedures
VSE's chief executive officer and chief financial officer, after
evaluating the effectiveness of our "disclosure controls and procedures" (as
defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c))
as of December 31, 2004 (the "Evaluation Date"), have concluded that, as of the
Evaluation Date, VSE's disclosure controls and procedures were adequate to
ensure that the information required to be disclosed in the reports filed or
submitted by the Company under the Securities Exchange Act of 1934 is recorded,
processed, summarized, and reported within the requisite time periods specified
in the SEC's rules and forms.
PART III
The information required by Items 10, 11, 12, 13 and 14 of Part III of
Form 10-K has been omitted in reliance of General Instruction G(3) and is
incorporated herein by reference to the Company's proxy statement to be filed
with the SEC pursuant to Regulation 14A promulgated under the Securities
Exchange Act of 1934, as amended, except for the specific disclosures below:
ITEM 10. Directors and Executive Officers of the Registrant
Audit Committee and Financial Expert
The Board of Directors has determined that the Company has at least one
audit committee financial expert serving on its Audit Committee, Director
James F. Lafond. Mr. Lafond is "independent" as that term is used in Schedule
14A, Item 7(d)(3)(iv) under the Securities Exchange Act of 1934, as amended.
Code of Business Conduct and Ethics
The Company has adopted a Code of Business Ethics and Conduct that
applies to all of its directors, officers, including principal executive
officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions, and employees. The Code
is posted on the Company's Internet website www.vsecorp.com.
52
ITEM 11. Executive Compensation
The information required by this Item 11 is included in the text and
tables under the caption "Executive Officer Compensation," in the 2004 Proxy
Statement, which is required to be filed by April 30, 2005, and that information
is incorporated by reference in this Form 10-K.
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management
The information required by this Item 12 is included under the caption
"Security Ownership of Certain Beneficial Owners and Management," in the 2004
Proxy Statement, which is required to be filed by April 30, 2005, and that
information is incorporated by reference in this Form 10-K.
ITEM 13. Certain Relationships and Related Transactions
The information required by Item 404 of Regulation S-K concerning certain
relationships and related transactions is included under the caption
"Transactions with Management and Others; Other Information" in our 2004 Proxy
Statement, which is required to be filed by April 30, 2005, and that information
is incorporated by reference in this Form 10-K.
ITEM 14. Principal Accountant Fees and Services
The information required by Item 9(e) of Schedule 14A concerning
principal accounting fees and services is included under the caption
"Appointment of Independent Certified Public Accountants" in our 2004 Proxy
Statement, which is required to be filed by April 30, 2005, and that information
is incorporated by reference in this Form 10-K.
PART IV
ITEM 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K
1. Financial Statements
The consolidated financial statements are listed under Item 8 of this
report.
2. Supplemental Financial Statement Schedule
Schedules not included herein have been omitted because of
the absence of conditions under which they are required or because the required
information, where material, is shown in the consolidated financial statements,
financial notes, or supplementary financial information.
3. Exhibits
See "Exhibit Index" hereinafter contained and incorporated by
reference.
53
4. Reports on Form 8-K
On October 29, 2004, the Registrant filed a Current Report on Form
8-K to announce the financial results of the third quarter 2004.
54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
VSE CORPORATION
Date: March 9, 2005 By: /s/ D. M. Ervine
---------------------------
D. M. Ervine
Chairman, President,
Chief Executive Officer and
Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Name Title Date
- -------------------------------------------------------------------------------
/s/ Donald M. Ervine Chairman, President, March 8, 2005
- ---------------------------- Chief Executive Officer,
Donald M. Ervine Chief Operating Officer
/s/ Craig S. Weber Executive Vice President, March 8, 2005
- ---------------------------- Chief Administrative
Craig S. Weber Officer, Secretary
/s/ Thomas R. Loftus Senior Vice President and March 8, 2005
- ---------------------------- Chief Financial Officer
Thomas R. Loftus (Principal Financial and
Accounting Officer)
/s/ Robert J. Kelly Director March 8, 2005
- ----------------------------
Robert J. Kelly
/s/ Clifford M. Kendall Director March 8, 2005
- ----------------------------
Clifford M. Kendall
/s/ Calvin S. Koonce Director March 8, 2005
- ----------------------------
Calvin S. Koonce
/s/ James F. Lafond Director March 8, 2005
- ----------------------------
James F. Lafond
/s/ David M. Osnos Director March 8, 2005
- ----------------------------
David M. Osnos
/s/ Jimmy D. Ross Director March 8, 2005
- ----------------------------
Jimmy D. Ross
/s/ Bonnie K. Wachtel Director March 8, 2005
- ----------------------------
Bonnie K. Wachtel
55
EXHIBIT INDEX
Reference No. Exhibit No.
per Item 601 of in this
Regulation S-K Description of Exhibit Form 10-K
- -------------- ---------------------- ---------
2 Plan of acquisition, reorganization, arrangement,
liquidation or succession
Exchange Agreement dated as of March 25, 1992,
amended as of September 1, 1992, by and between VSE
Corporation and JBT Holding Corp., et al. (Exhibit A
to Exhibit 1, Proxy Statement, filed on
Form 8-K on November 2, 1992) *
3 Articles of incorporation and by-laws
Restated Certificate of Incorporation of VSE
Corporation dated as of February 6, 1996 *
By-Laws of VSE Corporation as amended through
March 9, 2004 Exhibit 3.2
4 Instruments defining the rights of security holders,
including indentures
Specimen Stock Certificate as of May 19, 1983
(Exhibit 4 to Registration Statement No. 2-83255
dated April 22, 1983 on Form S-2) *
9 Voting trust agreement Not Applicable
10 Material contracts
Employment Agreement entered into as of December 10,
1997, by and between VSE Corporation and
Craig S. Weber (Exhibit VIII to form 10-K dated
March 7, 2001) *
Employment Agreement entered into as of October 21,
1998, by and between VSE Corporation and
Donald M. Ervine (Exhibit VI to Form 10-K dated
March 18, 1999) *
Employment Agreement entered into as of January 15,
1999, by and between VSE Corporation and
Energetics Incorporated and Robert J. Kelly
(Exhibit VII to Form 10-K dated March 18, 1999) *
Employment Agreement entered into as of June 3,
1999, by and between VSE Corporation and
James M. Knowlton (Exhibit V to Form 10-K dated
March 15, 2000) *
Employment Agreement dated as of March 10, 2004,
By and between VSE Corporation and Thomas G. Dacus
(Exhibit 10.1 to form 10-Q dated April 28, 2004) *
Employment Agreement dated as of July 1, 2004,
By and between VSE Corporation and Thomas R. Loftus
(Exhibit 10.1 to form 10-Q dated July 30, 2004) *
VSE Corporation Deferred Supplemental Compensation
Plan effective January 1, 1994 as amended by the
Board through March 9, 2004 (Exhibit 10.2 to
Form 10-Q dated April 28, 2004) *
57
EXHIBIT INDEX
Reference No. Exhibit No.
per Item 601 of in this
Regulation S-K Description of Exhibit Form 10-K
- -------------- ---------------------- ---------
Stock Purchase Agreement dated August 29, 1995 by
and between VSE Corporation and the shareholders
of Energetics Incorporated (Exhibit 2 to Form 8-K
dated September 13, 1995 and Amendment 1 on Form
8-K/A dated November 9, 1995) *
VSE Corporation 1996 Stock Option Plan (Appendix A to
Registrant's definitive proxy statement dated
April 3, 1996) *
VSE Corporation 1998 Stock Option Plan (Appendix A to
Registrant's definitive proxy statement for the Annual
Meeting of Stockholders held on May 6, 1998) *
VSE Corporation 1998 Non-employee Directors Stock Plan
(Appendix B to Registrant's definitive proxy statement
for the Annual Meeting of Stockholders held on May 6,
1998) *
VSE Corporation 2004 Stock Option Plan (Appendix B to
Registrant's definitive proxy statement for the Annual
Meeting of Stockholders held on May 3, 2004) *
VSE Corporation 2004 Non-employee Directors Stock Plan
(Appendix C to Registrant's definitive proxy statement
for the Annual Meeting of Stockholders held on
May 3, 2004) *
12 Statements re computation of ratios Not Applicable
13 Annual report to security holders, Form 10-Q
or selected quarterly data Exhibit 13
16 Letter re change in certifying accountant Not Applicable
18 Letter re change in accounting principles Not Applicable
21 Subsidiaries of the Registrant Exhibit 21
22 Published report regarding matters submitted
to vote of security holders Not Applicable
23.1 Consent of independent registered public accounting
firm Exhibit 23.1
24 Power of attorney Not Applicable
31.1 Section 302 CEO Certification Exhibit 31.1
31.2 Section 302 CFO and PAO Certification Exhibit 31.2
32.1 Section 906 CEO Certification Exhibit 32.1
32.2 Section 906 CFO and PAO Certification Exhibit 32.2
99 Audit Committee Charter (as adopted by the Board
Of Directors of VSE Corporation on March 9, 2004
(Appendix A to Registrant's definitive proxy
Statement for the Annual Meeting of Stockholders
held on May 3, 2004 *
*Document has been filed as indicated and is incorporated by reference herein.
58