SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended March 31, 2006 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 www.vsecorp.com
(Address of Principal Executive Offices) (Zip Code) (Webpage)
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 require-
ments for the past 90 days. Yes [x] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [x]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
Number of shares of Common Stock outstanding as of April 27, 2006: 2,364,111.
VSE Corporation and Subsidiaries
________________________________________________________________________________
Forward Looking Statements
This filing contains statements which, to the extent they are not recitations of
historical fact, constitute "forward looking statements" under federal
securities laws. All such statements are intended to be subject to the safe
harbor protection provided by applicable securities laws. For discussions
identifying some important factors that could cause actual VSE Corporation
("VSE" or the "Company") results to differ materially from those anticipated in
the forward looking statements contained in this filing, see VSE's discussions
captioned "Business," "Risk Factors"," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Notes to Consolidated
Financial Statements" contained in VSE's Annual Report on Form 10-K for the
fiscal year ended December 31, 2005 filed with the Securities and Exchange
Commission (the "SEC"), together with the Annual Report on Form 10-K/A filed
with the SEC on March 31, 2006 (collectively, "Form 10-K").
Readers are cautioned not to place undue reliance on these forward looking
statements, which reflect management's analysis only as of the date hereof.
The Company undertakes no obligation to publicly revise these forward looking
statements to reflect events or circumstances that arise after the date hereof.
Readers should carefully review the risk factors described in other documents
the Company files from time to time with the SEC, including this and other
Quarterly Reports on Form 10-Q to be filed by the Company subsequent to its
Annual Report on Form 10-K and any Current Reports on Form 8-K filed by the
Company.
-2-
PART I. Financial Information
Item 1. Financial Statements
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Balance Sheets
- --------------------------------------------------------------------------------
(in thousands except share and per share amounts)
March 31, December 31,
2006 2005
---- ----
(Unaudited)
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . . $ 7,972 $ 12,717
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . . 43,998 43,926
Contract inventories . . . . . . . . . . . . . . . 4,657 4,273
Deferred tax assets . . . . . . . . . . . . . . . 1,200 1,033
Other current assets . . . . . . . . . . . . . . . 3,494 2,205
-------- --------
Total current assets . . . . . . . . . . . . . . 61,321 64,154
Property and equipment, net . . . . . . . . . . . . 5,130 4,583
Deferred tax assets . . . . . . . . . . . . . . . . 823 682
Goodwill . . . . . . . . . . . . . . . . . . . . . . 1,054 1,054
Other assets . . . . . . . . . . . . . . . . . . . . 3,975 3,393
-------- --------
Total assets . . . . . . . . . . . . . . . . . . $ 72,303 $ 73,866
======== ========
Liabilities and Stockholders' Investment
Current liabilities:
Bank notes payable . . . . . . . . . . . . . . . . $ - $ -
Accounts payable . . . . . . . . . . . . . . . . . 29,398 29,752
Accrued expenses . . . . . . . . . . . . . . . . 8,929 12,178
Dividends payable . . . . . . . . . . . . . . . . 142 141
-------- --------
Total current liabilities . . . . . . . . . . . 38,469 42,071
Deferred compensation . . . . . . . . . . . . . . . 2,071 1,589
Other liabilities . . . . . . . . . . . . . . . . . 95 55
-------- --------
Total liabilities . . . . . . . . . . . . . . . 40,635 43,715
======== ========
Commitments and contingencies
Stockholders' investment:
Common stock, par value $.05 per share, authorized
5,000,000 shares; issued and outstanding 2,364,111
in 2006 and 2,359,611 shares in 2005 . . . . . . 118 118
Paid-in capital . . . . . . . . . . . . . . . . . 6,521 6,348
Deferred stock-based compensation . . . . . . . . - (1)
Retained earnings . . . . . . . . . . . . . . . . 25,029 23,686
-------- --------
Total stockholders' investment . . . . . . . . . 31,668 30,151
-------- --------
Total liabilities and stockholders' investment . $ 72,303 $ 73,866
======== ========
The accompanying notes are an integral part of these balance sheets.
-3-
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Income (Unaudited)
- -------------------------------------------------------------------------------
(in thousands except share and per share amounts)
For the three months
ended March 31,
2006 2005
---- ----
Revenues, principally from contracts . . . . . . . . $ 63,300 $ 65,919
Costs and expenses of contracts . . . . . . . . . . 60,912 63,755
--------- ---------
Gross profit . . . . . . . . . . . . . . . . . . . . 2,388 2,164
Selling, general and administrative expenses . . . . 123 56
Interest income, net . . . . . . . . . . . . . . . . (137) (19)
--------- ---------
Income before income taxes . . . . . . . . . . . . . 2,402 2,127
Provision for income taxes . . . . . . . . . . . . . 917 823
--------- ---------
Net income . . . . . . . . . . . . . . . . . . . . . $ 1,485 $ 1,304
========= =========
Basic earnings per share:
Net income . . . . . . . . . . . . . . . . . . . . . $ 0.63 $ 0.57
========= =========
Basic weighted average shares outstanding 2,361,261 2,279,326
========= =========
Diluted earnings per share:
Net income . . . . . . . . . . . . . . . . . . . . . $ 0.61 $ 0.55
========= =========
Diluted weighted average shares outstanding 2,433,317 2,353,954
========= =========
Dividends declared per share $ 0.06 $ 0.05
========= =========
The accompanying notes are an integral part of these financial statements.
-4-
VSE Corporation and Subsidiaries
Consolidated Financial Statements
Consolidated Statements of Stockholders' Investment (Unaudited)
- --------------------------------------------------------------------------------------------
(in thousands except per share data)
Deferred Total
Common Stock Paid-In Stock-Based Retained Stockholders'
Shares Amount Capital Compensation Earnings Investment
------ ------ ------- ------------ -------- ----------
Balance at
December 31, 2005 . . . . . 2,360 $ 118 $ 6,348 $ (1) $ 23,686 $ 30,151
Net income for the period . . - - - - 1,485 1,485
Stock-based compensation . . - - 63 - - 63
Exercised stock options . . . 4 - 73 - - 73
Excess tax benefits from
share-based payment
arrangements. . . . . . . . - - 37 - - 37
Deferred stock-based
compensation . . . . . . . - - - 1 - 1
Dividends declared ($.06) . . - - - - (142) (142)
----- ----- ------- ----- -------- --------
Balance at
March 31, 2006 . . . . . . 2,364 $ 118 $ 6,521 $ - $ 25,029 $ 31,668
===== ===== ======= ===== ======== ========
The accompanying notes are an integral part of these financial statements.
-5-
VSE Corporation and Subsidiaries
Consolidated Financial Statements (Unaudited)
Consolidated Statements of Cash Flows
- ------------------------------------------------------------------------------
(in thousands)
For the three months
ended March 31,
2006 2005
---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . $ 1,485 $ 1,304
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . 391 326
Loss on sale of property and equipment . . . . . . . 1 2
Deferred taxes . . . . . . . . . . . . . . . . . . . (308) (141)
Stock-based compensation . . . . . . . . . . . . . . 63 -
Tax benefit of options exercised . . . . . . . . . . - 15
Amortization of deferred stock-based compensation . . - (1)
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable, net. . . . . . . . . . . . . . . (72) (9,579)
Contract inventories . . . . . . . . . . . . . . . . (384) 4,130
Other current assets and noncurrent assets . . . . . (1,896) (243)
Increase (decrease) in:
Accounts payable and deferred compensation . . . . . 128 5,668
Accrued expenses . . . . . . . . . . . . . . . . . . (3,249) 541
Other liabilities . . . . . . . . . . . . . . . . . . 40 14
------- -------
Net cash (used in) provided by operating activities (3,801) 2,036
------- -------
Cash flows from investing activities:
Purchase of property and equipment . . . . . . . . . . . (914) (456)
------- -------
Net cash used in investing activities (914) (456)
------- -------
Cash flows from financing activities:
Net repayment of bank loans . . . . . . . . . . . . . . - (1,578)
Dividends paid . . . . . . . . . . . . . . . . . . . . . (141) (114)
Excess tax benefits from share-based
payment arrangements . . . . . . . . . . . . . . . . . 37 -
Proceeds from the exercise of options of common stock . 74 26
------- -------
Net cash used in financing activities (30) (1,666)
------- -------
Net decrease in cash and cash equivalents . . . . . . . . (4,745) (86)
Cash and cash equivalents at beginning of period . . . . 12,717 130
------- -------
Cash and cash equivalents at end of period . . . . . . . $ 7,972 $ 44
======= =======
The accompanying notes are an integral part of these financial statements.
-6-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three months ended March 31, 2006 are not necessarily indicative
of the results that may be expected for the year ending December 31, 2006. For
further information refer to the consolidated financial statements and footnotes
thereto included in the VSE Corporation Annual Report on Form 10-K for the year
ended December 31, 2005. The Company operates within one reportable segment.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Significant
estimates affecting the financial statements include the allowance for doubtful
accounts, accruals for loss contracts, contract disallowance reserves, self
insured health claims and estimated cost to complete on firm fixed-price
contracts.
Contract Inventories
The components of contract inventories as of March 31, 2006 and December 31,
2005 were as follows (in thousands):
2006 2005
---- ----
Raw material . . . . . . . . . . . . . . . . . . . . . . $ - $ -
Work in process . . . . . . . . . . . . . . . . . . . . 10,078 9,965
------- ------
$10,078 $9,965
Less: Progress payments and customer
advances received . . . . . . . . . . . . . . . . (5,421) (5,692)
------- ------
Total contract inventories $ 4,657 $4,273
======= ======
Contract inventories consist of materials purchased, advances to suppliers, and
other expenditures for use in a contract to modify and apply a protective
system, the Tanker Ballistic Protection System ("TBPS"), to military vehicles
for the U.S. Army.
Although these costs are classified as inventories for accounting purposes, they
are similar in nature to materials and direct supplies purchased for use in
performance on the Company's other contracts in that they are solely and
directly attributable to the contract and will be billed to the customer within
a relatively short time. These materials and direct supplies will not be
restocked to maintain any permanent inventory levels. Contract inventories are
relieved when units are delivered and revenue is recognized.
-7-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Raw materials inventories consist of advances to suppliers for materials for use
on this contract but on which work has not yet begun. Work in process
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 inventories at March 31, 2006 and
December 31, 2005 included applicable indirect cost burdens, including general
and administrative costs totaling approximately $1.4 million and $1.3 million,
respectively. Indirect cost burdens, including general and administrative costs
charged to cost of sales from inventories for the periods ended March 31, 2006
and December 31, 2005 totaled $4.1 million and $3.4 million, respectively.
Debt
VSE has a loan agreement with a bank under which credit is made available to the
Company in the form of revolving loan amounts or letters of credit. The amount
of credit available to the Company is $15 million, subject to certain
conditions, including a borrowing formula based on billed receivables. The
expiration date of the loan agreement is May 31, 2007. From time to time the
bank and the Company may negotiate an amendment to the loan to increase or
decrease the amount of available credit or to change the expiration date to a
later date.
The loan agreement contains terms whereby the Company may borrow against the
revolving 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. There are
collateral requirements by which Company assets secure amounts outstanding,
restrictive covenants that include minimum tangible net worth and profitability
requirements, a limit on annual dividends, and other affirmative and negative
covenants. As of March 31, 2006 the Company has not been notified by the bank,
nor is the Company aware of any non-compliance with any of the bank loan
covenants.
The Company pays a fixed annual commitment fee of $20 thousand, interest on any
revolving loan borrowings at a prime-based rate or an optional LIBOR-based rate,
and fees on any letters of credit that are issued. As of March 31, 2006 and
December 31, 2005, there were no revolving loan amounts outstanding and one
letter of credit for approximately $192 thousand. Interest expense incurred on
the loan for the three months ending March 31, 2006 and 2005 was approximately
$0 and $1 thousand, respectively.
Stock-based Compensation
On December 30, 2005, the board of directors of VSE Corporation (the "Board")
directed VSE to discontinue, until and unless the Board determined otherwise,
awarding options, both discretionary and nondiscretionary, to purchase VSE
common stock ("VSE Stock") under VSE's 2004 Stock Option Plan approved by VSE's
stockholders on May 3, 2005 (the "2004 Plan"). The options outstanding under
the 2004 Plan, as of December 30, 2005, were not affected by this Board action.
In addition, the options to purchase shares of VSE Stock under VSE's 1998 Stock
Option Plan (the "1998 Plan") were not affected by this Board action.
-8-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The primary reason for the Board's suspension of option awards under the 2004
Plan was the potential impact on VSE's results of operations from the
application of SFAS 123 (R) to share-based payments to employees, including
stock option awards.
2004 Stock Option Plan
As of March 31, 2006 options issued under the 2004 Plan for up to 66,750 shares
of VSE Common Stock, par value $.05 per share ("shares" or "VSE Stock") remain
outstanding. Each option granted under the 2004 Plan was issued at the fair
market value of VSE shares on the date of grant. Each option vests 25% on date
of award and 25% on each anniversary date thereafter, becoming 100% vested as of
the third anniversary date of award. 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 March 31, 2006, options issued under the 1998 Plan for up to 126,313
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.
Accounting for Stock-based Compensation
Prior to January 1, 2006, the Company had followed the 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 accounted 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. Effective January 1, 2006,
the Company adopted the fair value recognition provisions of FASB Statement
No. 123(R), "Share-Based Payment", using the modified-prospective-transition
method. Under that transition method, compensation cost recognized as of
March 31, 2006 includes compensation cost for all share-based payments granted
prior to, but not yet vested as of January 1, 2006, based on the grant date fair
value estimated in accordance with the original provisions of Statement 123.
Results for prior periods have not been restated.
As a result of adopting SFAS 123(R) on January 1, 2006, the Company's income
before income taxes and net income for the period ended March 31, 2006, are
approximately $63 thousand and $39 thousand lower, respectively, than if it had
continued to account for share-based compensation under Opinion 25. Basic and
diluted earnings per share for the period ended March 31, 2006 would have been
$.65 and $.63, respectively, if the company had not adopted SFAS 123(R),
compared to reported basic and diluted earnings per share of $.63 and $.61,
respectively. The total compensation cost not yet recognized in the Company's
income before income taxes as of March 31, 2006 is approximately $370 thousand,
to be recognized over approximately 1.75 years.
Prior to the adoption of SFAS 123(R), the Company presented all tax benefits of
deductions resulting from the exercise of stock options as operating cash flows
in the Statement of Cash Flows. SFAS 123(R) requires the cash flows resulting
from the tax benefits resulting from tax deductions in excess of the
compensation cost recognized for those options (excess tax benefits) to be
classified as financing cash flows. Approximately $37 thousand in excess tax
benefits classified as cash provided by financing activities for the quarter
ended March 31, 2006 would have been classified as cash provided by operating
activities if the company had not adopted SFAS 123(R).
-9-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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(R)
to options granted under the Company's stock option plans for the period ending
March 31, 2005. For purposes of this pro forma disclosure, the value of the
options is estimated using a Black-Scholes-Merton option-pricing formula and
amortized to expense over the options' vesting periods.
Three Months
Ended March 31,
2005
----
Net income, as reported $1,304
Add: Total stock-based employee
compensation expense as reported
under intrinsic value method
(APB No. 25) for all awards, net
of related tax effects -
Deduct: Total stock-based
compensation expense
determined under fair value based
method (SFAS No. 123) for all
awards, net of related tax effects (62)
------
Pro forma net income $1,242
======
Earnings per share:
Basic - as reported $0.57
Diluted - as reported $0.55
Basic - pro forma $0.54
Diluted - pro forma $0.53
The fair value of the options was estimated on the date of grant using the
Black-Scholes option pricing model. The following assumptions were used in
the pricing calculations for 2005. In 2006, no such assumptions were made as
no options were granted:
2005
----
Risk free interest rate 3.28%
Dividend yield 0.79%
Expected life 3 years
Expected volatility 60.50%
A summary of the Company's stock option activity for the three months ended
March 31, 2006 and 2005 are as follows:
Weighted Weighted
Average Average
Exercise Exercise
2006 Price 2005 Price
---- ----- ---- -----
Number of shares under
stock options:
Outstanding at beginning of period 197,563 $15.83 211,625 $ 9.51
Granted . . . . . . . . - - 70,000 25.17
Exercised . . . . . . . (4,500) 16.36 (2,937) 8.87
Forfeited . . . . . . - - (4,250) 12.03
------- ------ ------- ------
Outstanding at end of period 193,063 $15.82 274,438 $13.44
======= ====== ======= ======
Exercisable at end of period 141,938 $13.85 174,626 $13.50
======= ====== ======= ======
-10-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2006 2005
---- ----
Weighted average remaining
contractual life 2 Years 3 Years
Weighted average fair
value of options granted - $4.70
The aggregate intrinsic values of outstanding, exercisable and exercised shares
as of March 31, 2006 and 2005 are as follows (in thousands):
2006 2005
---- ----
Outstanding shares $4,958 $3,331
Exercisable shares $3,924 $2,671
Exercised shares $ 115 $ 41
The total fair value of shares vested during the first quarter of 2006 and 2005
was $0 and approximately $181 thousand, respectively.
A summary of the Company's nonvested stock option activity for the three months
ended March 31, 2006 and 2005 are as follows:
Weighted Weighted
Average Average
Grant Date Grant Date
2006 Fair Value 2005 Fair Value
---- ---------- ---- ----------
Nonvested stock at beginning
of period 51,125 $ 8.41 49,687 $ 3.66
Granted - - 70,000 10.37
Vested - - (17,500) 10.37
Forfeited - - (2,375) 3.28
------ ------ ------- ------
Nonvested stock at end
of period 51,125 $ 8.41 99,812 $ 7.20
====== ====== ======= ======
-11-
VSE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Earnings Per Share
Basic earnings per share have been computed by dividing net income by the
weighted average number of shares of common stock outstanding during each
period. Shares issued during the period and shares reacquired during the period
are weighted for the portion of the period that they were outstanding. Diluted
earnings per share have been computed in a manner consistent with that of basic
earnings per share while giving effect to all potentially dilutive common
shares that were outstanding during each period. Potentially dilutive common
shares include incremental common shares issuable upon exercise of stock
options.
Three Months Ended March 31,
2006 2005
---- ----
Basic weighted average
common shares outstanding 2,361,261 2,279,326
Diluted effect of options 72,056 74,628
--------- ---------
Diluted weighted average
common shares outstanding 2,433,317 2,353,954
========= =========
Litigation
The Company is a party to or has property subject to litigation during the
normal course of business. In the opinion of management, the resolution of any
such litigation will not have a material adverse effect on the Company's results
of operations or financial position. However, the results of any legal
proceedings cannot be predicted with certainty.
-12-
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Executive Overview
VSE Organization
VSE's business operations consist primarily of services performed by the
Company's unincorporated divisions and wholly owned subsidiary. 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 divisions and subsidiaries
unless the context indicates operations of the parent company only.
Unincorporated divisions include BAV Division ("BAV"), Communications and
Engineering Division ("CED"), Coast Guard Division ("VCG"), Fleet Maintenance
Division ("FMD"), Management Sciences Division ("MSD"), Systems Engineering
Division ("SED"), and Engineering and Logistics Division ("ELD") beginning in
2006. Energetics Incorporated ("Energetics") is currently VSE's only active
subsidiary.
VSE also has several other subsidiaries and divisions that were inactive as of
March 31, 2006, including Information Assurance Division ("IAD", formerly Value
Systems Services Division or "VSS"), which became inactive as of May 2005.
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 Company's services is the U.S. Department of Defense
("Defense"), including agencies of the U.S. Navy, Army, and Air Force.
Navy - 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 Foreign Military Sales ("FMS") ship transfer program. FMD supports the
Navy by providing a variety of services including ship systems installation
efforts, combat systems inspections, ship repair and overhaul availability
planning, weapons management, ordnance alterations, and air combat logistics.
VCG provides services to the U.S. Coast Guard that are similar to the work
performed by BAV for the U.S. Navy and its FMS customers.
Army/Army Reserve - VSE also performs a significant amount of its work for the
U.S. Army and U.S. Army Reserve. VSE, through SED and ELD, provides these
customers 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 training services in quality systems and 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.
Other - Energetics provides the Department of Energy and other government and
industry customers with expert consulting services that typically include
program planning and analysis, R&D management services, technology assessment
and performance metrics, communications and outreach, and conference planning.
The Company provides base support and other services to the U.S. Air Force and
has also provided support services to the U.S. Postal Service and U.S.
Department of Treasury.
-13-
BAV Ship Transfer Program
VSE's BAV Division provides the U.S. Navy with engineering, technical and
logistical support services associated with the sale, lease, or transfer of
Navy ships to foreign governments. During its life, this program has been
the Company's single largest revenue producer. Revenues generated by this
program have typically accounted for approximately 40% to 50% of consolidated
VSE revenues, and revenues generated by this program accounted for approximately
44% and 45% of consolidated revenues during the three-month periods ended
March 31, 2006 and 2005, respectively. The level of revenues and associated
profits resulting from fee income generated by this program varies depending on
a number of factors, including the timing of ship transfers and associated
support services ordered by foreign governments and economic conditions of
potential customers worldwide. The Company has experienced significant quarterly
and annual revenue fluctuations and anticipates that future quarterly and annual
revenues will be subject to variation due to changes in the level of activity
associated with the Navy's ship transfer program. The transfer of four U.S. Navy
ships to Taiwan conducted under this program has been a major contributor to the
Company's revenues in 2005 and 2004, and is expected to continue contributing to
the Company's revenues in 2006.
The original contract associated with this program was a ten-year cost-plus
award fee contract awarded in 1995 with a total ceiling value of more than
$1 billion. BAV was awarded a second contract in April 2005 to continue work on
this program. The new contract is a five-year cost-plus award fee contract with
a total ceiling value of approximately $544 million. The Navy began issuing
orders on the new contract in the second quarter of 2005 and ceased issuing
orders for new work on the original contract at that time. BAV will continue
work associated with the transfer of four ships to Taiwan under delivery orders
previously issued on the original contract until the work is completed and all
four ships are delivered to Taiwan.
Contract terms under both the original and new contracts specify base fee
payments and award fee payments to BAV. Base fee payments are determined by
level of contract activity and base fee income is recognized each month. Award
fee payments 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 fees are fixed and determinable, generally upon contract
notification confirming the award fee. Award fees are made three times during
the year. Accordingly, the Company typically has three quarterly reporting
periods per year that include the recognition of BAV award fee income and one
quarterly reporting period that does not include BAV award fee income. Due to
such timing, and to fluctuations in the level of revenues, profits as a
percentage of revenues will fluctuate from period to period. The Company
recognized BAV award fee income in the three-month period ended March 31, 2006.
In 2005, the Company recognized BAV award fee income in each of the three-month
periods ended December 31, June 30, and March 31, and did not recognized any BAV
award fee income in the three-month period ended September 30.
TBPS Program
VSE's SED Division performs work on a program to provide a protection system,
the Tanker Ballistic Protection System ("TBPS"), for vehicles deployed by the
U.S. Army in Iraq. Under this program, SED applies 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. Delivery of completed
vehicle protection systems began in January 2005.
SED has multiple firm fixed price per unit contracts under which it is
performing the TBPS Program. Subsequent to award, VSE has received modifications
to the contracts to adjust the number of tankers based on Army tanker
availability and needs, and the possibility remains that there may be future
modifications to these contracts as the Army's needs change. The total contract
ceiling value on the TBPS Program contracts is approximately $77 million, and
the remaining available contract ceiling on the TBPS Program contracts is
-14-
approximately $44 million as of March 31, 2006. Contract value on the TBPS
contracts is fully funded at the time of award or modification.
Currently, contractual coverage for work on the TBPS program runs through
January 2007 and the Company expects to most likely complete work in 2007.
The TBPS Program contributed significantly to VSE revenues in 2005 and is
expected to provide significant revenues in 2006. The work performed on this
program also significantly increases the amount of fixed price contract work
performed by the Company. In general, fixed price contract work carries a higher
level of risk and has higher profit margins than work on other contract types.
Accordingly, the TBPS program has presented, and is expected to continue to
present, VSE's business with the potential for both increased profit margins and
increased risks of incurring a loss.
CED Army Equipment Support Program
In December 2005, VSE's CED Division was awarded a task order on its Rapid
Response support contract to provide maintenance and logistics services in
support of U.S. Army equipment in Iraq and Afghanistan. Services provided under
this program include deployed sustainment management, deployed logistics and
repairs management, unique system training and curriculum support, resource
management, and acquisition and administrative support. Work on this program
began in 2006.
The task order for this program is time and materials, with substantially all
of the services provided by CED's subcontractor. CED will provide certain
program management services. The contract task order has a base year valued at
approximately $139 million and an additional one-year option period valued at
approximately $212 million. This program is expected to contribute significantly
to VSE's revenues in 2006 and 2007, however, profit margins on subcontract work
are generally lower than on work performed by Company personnel.
Government Procurement Policies and Practices
VSE's business is subject to the risks arising from economic conditions and
political factors that may impact the budgets and program funding of customers
served through VSE's contracts. VSE's revenues have historically been subject to
annual fluctuations resulting from changes in the level of Defense spending.
Future budgetary and funding decisions by government lawmakers or Defense
restructuring efforts could affect the types and level of services provided by
VSE to its government customers and could potentially have a material adverse
impact on the Company's results of operations or financial condition.
The revenues of the Company depend on its ability to win new contracts and on
the amount of work ordered by the government under the Company's existing
contracts. The Company's ability to win new contracts is affected by government
acquisition policies and procedures, including government procurement practices
that in some years have tended toward bundling work efforts under large
comprehensive ("omnibus") management contracts. This emphasis on large contracts
presents challenges to winning new contract work, including making it more
difficult for the Company to qualify as a bidder, increasing the level of
competition due to the award of fewer contracts, and forcing the Company into
competition with larger organizations that have greater financial resources and
larger technical staffs. Competing for these contracts requires the Company to
use teams of subcontractors to be able to offer the range of technical
competencies needed to do the work. While the use of subcontractors on a large
scale basis allows the Company to compete for this work, profit margins on
subcontract work are lower than on work performed by Company personnel, thereby
reducing the Company's overall profit margins.
The use of subcontractors on government contracts also raises certain
performance and financial risks to VSE because government prime contractors are
responsible for performing to the requirements of the contract and
-15-
ensuring compliance with U.S. Government regulations relative to the performance
by subcontractors.
Other government procurement practices that can affect the Company's revenues
are 1) the length of contracts issued, which may vary depending on changes in
contracting regulations and other factors; 2) the use of past performance
criteria that may preclude entrance into new government markets; and
3) government social programs that limit contract work to small, woman, or
minority owned businesses. Additional risk factors that could potentially affect
the Company's results of operations are the government's right to terminate
contracts for convenience, the government's right to not exercise all of the
option periods on a contract, and funding delays caused by government political
or administrative actions.
Global Economic Conditions and Political Factors
VSE's business is subject to the risks arising from global economic conditions
and political factors associated with current and potential customers served
through VSE's contracts with the U.S. Government. An economic slowdown in
countries served under the BAV Ship Transfer Program could potentially affect
sales. Failure by the government of a potential foreign customer to approve and
fund acquisition of U.S. Navy ships serviced under this program could affect
sales. In any one year, a significant amount of the Company's revenues may
result from sales on the BAV Ship Transfer Program to a single foreign
government. BAV sales to Egypt have historically comprised a large percentage of
the Company's total sales in any one year. Work associated with the transfer of
four ships to Taiwan under the BAV Ship Transfer Program during 2004 and 2005
comprised a large percentage of total revenues, and 2006 revenues under this
program are expected to be significant to the Company.
The current international situation posed by potential terrorist activity and
the continuing conflict in the Middle East could potentially increase the
political risks for revenues from the BAV Ship Transfer, TBPS, and CED Army
Equipment Support Programs. International tensions can also affect work by FMD
on U.S. Navy ships when they are deployed outside of U.S. Navy facilities and
are unavailable for maintenance work during this time period. Adverse results
arising from these global economic and political risks could potentially have a
material adverse impact on the Company's results of operations.
Concentration of Revenues From Continuing Operations
(in thousands)
For the three months ended March 31,
------------------------------------
2006 2005
Source of Revenue Revenues % Revenues %
----------------- -------- - -------- -
BAV Egypt $ 12,054 19 $ 13,009 20
BAV Taiwan 13,588 22 15,788 24
BAV Other 2,001 3 644 1
-------- --- -------- ---
Total BAV 27,643 44 $ 29,441 45
TBPS Program 4,133 7 6,164 9
-------- --- -------- ---
CED Army Equipment Support 5,233 8 - -
VSE Other 26,291 41 30,314 46
-------- --- -------- ---
Total Revenues $ 63,300 100 $ 65,919 100
======== === ======== ===
Management Outlook
The growth trend established by VSE's record high revenues and profits in 2004
and 2005 is expected to continue in 2006. The major contributors to 2006 results
are expected to be: 1) a continuation of the Taiwan Ship Transfer work performed
by BAV; 2) performance on the TBPS Program; 3) new work performed on
-16-
the CED Army Equipment Support Program; and 4) additional work provided by Other
Significant Contracts.
Taiwan Ship Transfer. The Taiwan ship transfer effort is expected to continue
through mid to late 2006, allowing BAV to maintain revenue levels in 2006
similar to 2005. Funded backlog on the BAV Ship Transfer Program was
approximately $97 million as of March 31, 2006.
TBPS Program. SED began delivery of completed vehicle protection systems on
this program in 2005, and work on the program increased during the first three
quarters of 2005. Changes in production schedules can result from operating in
an uncertain and volatile environment in Iraq, changing Army needs, technical
specification issues, and facility location changes. Such changes caused work
on this program to level off during the fourth quarter of 2005 and the first
quarter of 2006. Production levels are expected to increase again beginning in
the second quarter of 2006 and the program is expected to generate increased
levels of revenue in 2006. Funded backlog on the TBPS program was approximately
$44 million as of March 31, 2006.
CED Army Equipment Support Program. During the first quarter of 2006, work on
this program was transitioned from a predecessor contract to CED's contract
task order, and CED revenue from this program is expected to accelerate rapidly
beginning in the second quarter of 2006. The program is new work and is expected
to increase Company revenues in 2006. The majority of the $139 million base year
task order is expected to be worked in 2006. The contract task order for this
program is incrementally funded, with funded backlog of approximately
$49 million as of March 31, 2006, and additional funding received in April 2006
of approximately $38 million.
Other Significant Contracts. VSE has three multiyear, multiple award, indefinite
delivery, indefinite quantity contracts that have large nominal ceiling amounts
with no funding committed at the time of award. VSE is one of several awardees
on each contract. While future VSE revenue from these contracts cannot be
predicted with certainty, the award of these contracts provides the Company with
the opportunity to compete for work that may contribute to future revenue
growth, including new work in 2006. These three contracts are described below.
VSE's CED Division has a multiyear Rapid Response support contract issued by the
U.S. Army Communications-Electronics Command (CECOM) that was awarded in January
2003. 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 nominal
ceiling of approximately $2.9 billion over an eight-year period. While it is
not likely that the full ceiling amount will be realized, this contract has
generated revenues for VSE of approximately $37 million and $27 million during
2005 and 2004, respectively. The CED Army Equipment Support Program is expected
to add significantly to this contract's and the Company's revenues in 2006. VSE
continues to pursue new orders on this contract that present potential revenue
opportunities for the future.
VSE's FMD Division has a contract with the U.S. Navy, SeaPort Enhanced, awarded
in April 2004, 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. To
date, FMD has generated only minor amounts of revenue from this contract.
FMD also has a contract, awarded in September 2004, with the U.S. Navy to
provide engineering and technical services to support Naval Sea Systems Command
maintenance, overhaul, repair, and alteration of systems aboard ships. This
contract has a total nominal contract ceiling amount of $1.022 billion over a
five-year period if all option periods are exercised. VSE is one of several
-17-
awardees eligible to share in the potential total contract ceiling amount. Since
the date of the contract award, FMD has been awarded delivery orders with
ceilings valued at approximately $44 million on this contract, of which
approximately $37 million has been funded. Although it is not likely that the
full $1.022 billion ceiling amount will be realized, this contract presents
potential future revenue opportunities.
Funded Backlog
Revenue increases in government contracting businesses are typically preceded
by increases in contract funding ("Bookings") and a build-up of funded contract
backlog. VSE's Bookings and funded backlog are continuing at levels that give
the Company a firm basis for continued revenue growth in 2006.
(in millions)
-------------
Bookings for the three months ended March 31, 2006 $ 51
Funded backlog as of March 31, 2006 $262
Revenues for the three months ended March 31, 2006 $ 63
Longer Term
The growth in VSE revenue and profits during 2004 and 2005, and the expected
continuation of this growth in 2006, will present the Company with both
challenges and opportunities for future years.
The biggest challenge that VSE faces in future years is the ability to sustain
its recent level of growth. Certain work efforts that have supported VSE's
growth in 2004 and 2005 and that are expected to support continued growth in
2006 are due to expire in the future. VSE has received significant contributions
to its revenue growth in 2004 from the Taiwan Ship Transfer work and in 2005
from both the Taiwan Ship Transfer work and the TBPS Program work. These two
programs and the CED Army Equipment Support Program are expected to be the
largest contributors to VSE revenue in 2006. The expiration of these programs at
various dates in 2006 and 2007 will reduce VSE annual revenues if the expiring
work is not replaced by new or follow-on work.
The opportunities associated with VSE's recent growth include a more competitive
price structure with which to bid on future work, a wider range of employee
skill sets, and a broader name recognition and past performance record for use
in expanding the Company's customer base. VSE is currently tracking multiple
bidding opportunities for new contract work. Additionally, the larger revenue
level and capital base improves the Company's ability to pursue larger programs
and 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. SFAS 123(R) supersedes
APB Opinion No. 25 and amends SFAS 95, "Statement of Cash Flows." Generally, the
approach in SFAS 123(R) is similar to the approach described in SFAS 123.
However, SFAS 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the income statement based
on their fair values. The Company adopted SFAS 123(R), using the modified
prospective method, on January 1, 2006.
The impact of adopting SFAS 123(R) is expected to decrease income before income
taxes by approximately $252 thousand in 2006. The amount of stock-based
compensation expense for the three months ended March 31, 2006 was $63 thousand.
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 the old method. The amount of financing
cash flows from benefits of tax deductions in excess of recognized compensation
cost for the three months ended March 31, 2006 was $37 thousand. The amount of
operating cash flows from benefits of tax deductions
-18-
in excess of recognized compensation cost for the three months ended March 31,
2005 was $15 thousand.
On December 30, 2005, VSE's board of directors (the "Board") directed VSE to
discontinue awarding options, both discretionary and nondiscretionary, to
purchase VSE common stock ("VSE Stock") under VSE's 2004 Stock Option Plan
approved by VSE's stockholders on May 3, 2005 (the "2004 Plan"). The options
outstanding under the 2004 Plan as of December 30, 2005, and the options to
purchase VSE Stock under VSE's 1998 Stock Option Plan (the "1998 Plan") are not
affected by this Board action. The primary reason for the Board's suspension of
option awards under the 2004 Plan was the potential impact on VSE's results of
operations from the application of SFAS 123 (R) to share-based payments to
employees, including stock option awards.
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 fees are fixed and
determinable, generally upon contract notification confirming the award fee.
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, because these contracts require design, engineering, and
manufacturing performed to the customer's specifications. Revenues on
fixed-price service contracts are recorded as work is performed. Revenues on
fixed-price contracts that require delivery of specific items may be recorded
based on a price per unit as units are delivered.
Certain direct and incremental contract costs have been deferred and reported
as a current asset prior to the recognition of revenue. These costs are
realizable over the life of the contract. The amount of costs classified as a
current asset as of March 31, 2006 is approximately $417 thousand.
-19-
Revenues by contract type for the three months ended March 31, 2006 and 2005
were as follows (in thousands):
2006 2005
Contract Type Revenues % Revenues %
------------- -------- - -------- -
Cost-type $38,308 61 $42,903 65
Time and materials 18,583 29 12,516 19
Fixed-price 6,409 10 10,500 16
------- --- ------- ---
$63,300 100 $65,919 100
======= === ======= ===
The Company will occasionally perform work at risk, which is work that is
performed prior to the government formalizing funding for such work. Revenue
related to work performed at risk is not recognized until it can be reliably
estimated and its realization is probable. VSE recognizes this "risk funding"
as revenue when the associated costs are incurred or the work is performed. 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. As of March 31, 2006, VSE has recognized
approximately $250 thousand in risk funding. VSE believes that it will receive
funding for all or substantially all of this risk funding revenue.
Long-Lived Assets
In assessing the recoverability of long-lived assets, including goodwill and
other intangibles, VSE must make assumptions regarding estimated future cash
flows and other factors to determine the fair value of the respective assets.
If these estimates or their related assumptions change in the future, VSE may
be required to record impairment charges for these assets not previously
recorded.
Goodwill
Goodwill and intangible assets with indefinite lives are subject to a review
for impairment at least annually. The Company performs its annual impairment
test on September 30. As of March 31, 2006, the Company had approximately
$1.1 million of goodwill associated with its acquisition of Energetics in 1995.
The Company has not recognized any reduction to the goodwill due to the
impairment rules. If at some time in the future it is determined that impairment
has occurred, such impairment could potentially have a material adverse impact
on the Company's results of operations or financial condition.
Contingencies
From time to time VSE is subject to proceedings, lawsuits, and other claims
related to environmental, labor, and other matters. VSE is required to assess
the likelihood of any adverse judgments or outcomes to these contingencies as
well as potential ranges of probable losses and establish reserves accordingly.
The amount of reserves required may change in future periods due to new
developments in each matter or changes in approach to a matter such as a change
in settlement strategy.
Income Taxes
The carrying value of VSE net deferred tax assets is based on assumptions
regarding VSE's ability to generate sufficient future taxable income to utilize
these deferred tax assets. If the estimates and related assumptions regarding
VSE's future taxable income change, VSE may be required to record valuation
allowances against its deferred tax assets, resulting in additional income tax
expense.
-20-
Results of Operations
The following table sets forth certain items, including consolidated revenues,
pretax income and net income from continuing operations, and the changes in
these items for the three-month periods ended March 31, 2006 and 2005 (in
thousands):
2006
Compared
to
2006 2005 2005
---- ---- ----
Revenues . . . . . . . . . . . . . . . . . $63,300 $65,919 $(2,619)
======= ======= =======
Income before income taxes . . . . . . . . $ 2,402 $ 2,127 $ 275
Provision for income taxes . . . . . . . . 917 823 94
------- ------- -------
Net income . . . . . . . . . . . . . . . $ 1,485 $ 1,304 $ 181
======= ======= =======
Revenues decreased by approximately 4% for the three-month period ended
March 31, 2006, as compared to the same period of 2005. The primary reasons for
the decrease in revenues were 1) production delays on the TBPS program; 2) a
decrease in work performed under the BAV Ship Transfer Program; 3) a decrease in
the level of work on VCG's contract with the U.S. Coast Guard; and 4) decreased
levels of subcontractor work on FMD's U.S. Navy contracts. Increases in revenue
from the CED Army Equipment Support Program, ELD equipment refurbishment
services, and Energetics services helped to offset some of the decreases in
revenues.
Income before income taxes increased by approximately 13% for the three-month
period ended March 31, 2006, as compared to the same period of 2005. The
increase was primarily due to an increase in profits on the BAV Ship Transfer
Program work.
Financial Condition
VSE's financial condition did not change materially during the three months
ended March 31, 2006. The Company's largest assets are its accounts receivable
and cash and cash equivalents. The largest liabilities are its accounts payable
and accrued expenses. Accounts receivable and accounts payable remained
substantially unchanged during the three months ended March 31, 2006. Cash and
cash equivalents decreased approximately $4.7 million and accrued expenses
decreased approximately $3.2 million due primarily to cash payments made in 2006
for expenses accrued in 2005. The change in total stockholders' investment in
this period resulted from earnings and dividend activity and from the exercise
of stock options.
Liquidity and Capital Resources
Cash Flows
Cash and cash equivalents decreased by approximately $4.7 million during the
three months ended March 31, 2006. The decrease in cash and cash equivalents
during this period resulted from cash used in operating activities of
approximately $3.8 million, cash used in investing activities of approximately
$914 thousand, and cash used in financing activities of approximately $30
thousand. Investing activities consisted of expansion and improvement of
facilities of approximately $165 thousand and purchases of property and
equipment, net of dispositions, of approximately $749 thousand. Financing
activities consisted of dividend payments and proceeds received from the
issuance of common stock associated with stock incentive plans.
Cash and cash equivalents decreased by approximately $86 thousand during the
three months ended March 31, 2005. The decrease in cash and cash equivalents
during this period resulted from cash used in financing activities of
approximately $1.7 million, cash used in investing activities of approximately
$456 thousand, and cash provided by operating activities of approximately
-21-
$2 million. Financing activities consisted of repayment of amounts previously
borrowed on the Company's bank loan of approximately $1.6 million, dividend
payments, and proceeds received from the issuance of common stock due to the
exercise of stock options. Investing activities consisted of expansion and
improvement of facilities of approximately $172 thousand and purchases of
property and equipment, net of dispositions, of approximately $284 thousand.
The difference between cash used in operating activities of approximately
$3.8 million in 2006 as compared to cash provided by operating activities of
approximately $2 million in 2005 is primarily due to: 1) payments made in 2006
for expenses accrued in 2005; and 2) an increase in the levels of prepaid
expenses and deferred contract costs in 2006 as compared to 2005.
Quarterly cash dividends were paid at the rate of $.06 per share during the
three months ended March 31, 2006. Pursuant to its bank loan agreement, 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 significantly
by the timing of large materials purchases and subcontractor efforts used in
performance on the Company's contracts. Accounts receivable levels are also
affected by contract retainages, differences between the provisional billing
rates authorized by the government compared to the costs actually incurred by
the Company, differences between billable amounts authorized by contract terms
compared to costs actually incurred by the Company, and government delays in
processing administrative paperwork for contract funding.
Work on the TBPS program requires the Company to acquire inventories consisting
of materials, supplies, and other expenditures for which end units have not yet
been completed and accepted. Although these costs are classified as inventories
for accounting purposes, they are similar in nature to materials and direct
supplies purchased for use in performance on the Company's other contracts in
that they are solely and directly attributable to the contract and will be
billed to the customer within a relatively short time. All of the inventories
are expected to be liquidated, billed, and collected as vehicle protection
systems are completed and accepted by the government customer. These materials
and direct supplies will not be restocked to maintain any permanent inventory
levels.
Accounts payable arise primarily from purchases of subcontractor services and
materials used by the Company in the performance of its contract work. Payments
made on accounts payable, along with payments made to satisfy employee payroll
and payroll associated expenses, make up the principal cash requirements of the
Company. Accounts payable levels can be affected by changes in the level of
contract work performed by the Company and by the timing of large materials
purchases and subcontractor efforts used in performance on the Company's
contracts.
Other cash requirements include income tax payments, the acquisition of capital
assets for shop, office and computer support, and the payment of cash dividends.
From time to time, the Company also invests in the expansion, improvement, and
maintenance of its operational and administrative facilities.
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
-22-
"Notes to Consolidated Financial Statements"). The bank financing complements
the Company's internal sources of liquidity by providing increasing levels of
borrowing capacity as accounts receivable levels increase. The bank loan
agreement provided loan financing up to a maximum commitment of $15 million as
of March 31, 2006. The Company has determined that the current $15 million
commitment amount is adequate to cover known current and future liquidity
requirements.
Performance of work under the Company's larger 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.
Contractual Obligations
In January 2006, the Company signed a five-year facility lease for shop, office
and warehouse space to begin in April 2006 for an aggregate amount of $668
thousand. In April 2006, the Company signed an addendum to this lease to
increase the amount of space leased and to defer the start date to May 2006. The
revised aggregate amount of the lease is $1.116 million. [See "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
contained in VSE's Annual Report on Form 10-K for the fiscal year ended
December 31, 2005 for a summary of the Company's other contractual obligations.]
Inflation and Pricing
Most of the contracts performed by VSE provide for estimates of future labor
costs to be escalated for any option periods provided by the contracts, while
the non-labor costs included in such contracts are normally considered
reimbursable at cost. VSE property and equipment consists principally of
computer systems equipment, furniture and fixtures, and land and improvements.
The overall impact of inflation on replacement costs of such property and
equipment is not expected to be material to VSE's future results of operations
or financial condition.
Disclosures About Market Risk
Interest Rates
VSE's bank loan financing provides available borrowing to the Company at
variable interest rates. The Company has not borrowed significant amounts
on the loan in recent years. Accordingly, the Company does not believe that
any movement in interest rates would have a material impact on future earnings
or cash flows. If VSE were to significantly increase borrowings on the current
loan arrangement, future interest rate changes could potentially have a material
impact.
Foreign Currency
While a significant amount of the Company's business results from the services
provided by BAV related to the transfer of ships to foreign governments, the
BAV contract payments are made by the U.S. Government in U.S. dollars.
Additionally, most funding requirements to support work performed or services
purchased in foreign countries are made in U.S. dollars, and the infrequent
disbursements that are made in foreign currencies are reimbursable to BAV in
post conversion dollars. Foreign currency transactions of other VSE divisions
or subsidiaries are minimal. Accordingly, the Company does not believe that it
is exposed to any material foreign currency risk.
-23-
VSE CORPORATION AND SUBSIDIARIES
Item 3. Quantitative and Qualitative Disclosures About Market Risks
See "Disclosures About Market Risk" in Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Item 4. Controls and Procedures
As of the end of the period covered by this report, based on management's
evaluation, with the participation of VSE Corporation's Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the disclosure controls and
procedures (as defined in Rules 13a-15(e) or 15d - 15(e) under the Securities
Exchange Act of 1934, as amended) our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures
are effective in ensuring that information required to be disclosed by us in
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and regulations.
There was no change in our internal control over financial reporting during our
first quarter of fiscal 2006 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
PART II. Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The Registrant did not purchase any of its equity securities during the period
covered by this report.
Under the Registrant's bank loan agreement dividends may be paid in an annual
aggregate amount of $.60 per share, provided there is no default under the loan
agreement.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit No.
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31.1 Section 302 CEO Certification
31.2 Section 302 CFO and PAO Certification
32.1 Section 906 CEO Certification
32.2 Section 906 CFO and PAO Certification
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has omitted all other items contained in "Part II. Other Information"
because such other items are not applicable or are not required if the answer
is negative or because the information required to be reported therein has been
previously reported.
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VSE CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VSE CORPORATION
Date: April 28, 2006 /s/ D. M. Ervine
__________________________________
D. M. Ervine
Chairman, President,
Chief Executive Officer and
Chief Operating Officer
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