UNITED STATES
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, 2007 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:
Name of each exchange
Title of each class on which registered
------------------- -------------------
Common Stock, par value $.05 per share The NASDAQ Stock Market LLC
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [x]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x]
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing require-
ments for the past 90 days. Yes [x] No [ ]
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. [ ]
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 [x] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [x]
The aggregate market value of outstanding voting stock held by nonaffiliates of
the Registrant as of June 30, 2007, was approximately $119.1 million based on
the last reported sales price of the Registrant's common stock on the Nasdaq
National Market as of that date.
Number of shares of Common Stock outstanding as of March 7, 2008: 5,057,012.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders expected to be held on May 6, 2008, are incorporated by reference
into Part III of this report.
TABLE OF CONTENTS
Page
PART I ----
ITEM 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 1A. Risk Factors . . . . . . . . . . . . . . . . . . . . . . . 7
ITEM 1B. Unresolved Staff Comments . . . . . . . . . . . . . . . . 10
ITEM 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . 10
ITEM 3. Legal Proceedings . . . . . . . . . . . . . . . . . 11
ITEM 4. Submission of Matters to a Vote of Security Holders . . . 11
Executive Officers of the Registrant . . . . . . . . . . . 12
PART II
ITEM 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities. . . . . 13
ITEM 6. Selected Financial Data . . . . . . . . . . . . . . . . . 16
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . 17
ITEM 7A. Quantitative and Qualitative Disclosures About
Market Risks . . . . . . . . . . . . . . . . . . . . . . . 35
ITEM 8. Financial Statements and Supplementary Data . . . . . . . 36
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure . . . . . . . . . . . 60
ITEM 9A. Controls and Procedures . . . . . . . . . . . . . . . . . 60
ITEM 9B. Other Information . . . . . . . . . . . . . . . . . . . . 63
PART III
ITEM 10. Directors, Executive Officers and Corporate Governance . . 63
ITEM 11. Executive Compensation . . . . . . . . . . . . . . . . . . 63
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters . . . . . . . . 63
ITEM 13. Certain Relationships and Related Transactions, and . . .
Director Independence . . . . . . . . . . . . . . . . . . 63
ITEM 14. Principal Accountant Fees and Services . . . . . . . . . . 63
PART IV
ITEM 15. Exhibits, Financial Statements and Schedules . . . . . . . 63
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66-75
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" (Items 1, 1A, 2
and 3), and "Management's Discussion and Analysis." Readers are cautioned not
to place undue reliance on these forward looking statements, which reflect
management's analysis only as of the date hereof. The Company undertakes no
obligation to publicly revise these forward looking statements to reflect
events or circumstances that arise after the date hereof. Readers should
carefully review the risk factors described in other documents the Company
files from time to time with the Securities and Exchange Commission, including
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 Background
VSE was incorporated in Delaware in 1959. VSE serves as a centralized
management and consolidating entity for the business operations conducted by
the Company's divisions and wholly owned subsidiaries. Unincorporated
divisions include BAV Division ("BAV"), Communications and Engineering
Division ("CED"), Coast Guard Division ("VCG"), Engineering and Logistics
Division ("ELD") beginning in 2006, Field Support Services Division ("FSS")
beginning in 2007, Fleet Maintenance Division ("FMD"), Management Sciences
Division ("MSD"), and Systems Engineering Division ("SED"). Wholly owned
subsidiaries include Energetics Incorporated ("Energetics") and Integrated
Concepts and Resources Corporation ("ICRC"), which was purchased in June 2007.
The term "VSE" or "Company" means VSE and its subsidiaries and divisions
unless the context indicates operations of the parent company only.
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 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.
(b) Financial Information
Financial information for the three years ended December 31, 2007,
appears in the "Consolidated Statements of Income" contained in this Form 10-K.
VSE operations are conducted within four reporting segments, the Federal
Group, the International Group, the Energy and Environmental Group and the
Infrastructure and Information Technology Group. The Federal Group, consisting
of CED, ELD, FSS, MSD, and SED, generated approximately 55% of VSE's revenues
in 2007. The International Group, consisting of BAV, FMD, and VCG, generated
3
approximately 35% of VSE's revenues in 2007. The Energy and Environmental
Group, consisting of Energetics, generated approximately 2% of VSE's revenues
in 2007. The Infrastructure and Information Technology Group, consisting of
ICRC, was formed in June 2007 upon the purchase of ICRC by VSE and generated
approximately 8% of VSE's revenues in 2007. Additional financial information
for VSE's reportable segments appears in "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations" and in "Item 8.
Financial Statements and Supplementary Data" of this Form 10-K.
(c) Description of Business
Services and Products
VSE engineering, logistics, management, and technical services include a
broad array of capabilities and resources that support military and other
government systems, equipment, and processes. VSE services are focused on
creating, sustaining, and improving the systems, equipment, and processes of
government through core competencies in legacy systems sustainment,
obsolescence management, prototyping, reverse engineering, technology
insertion, supply chain management, foreign military sales, management
consulting, and process improvement.
Typical projects include sustaining engineering support for military
vehicles and combat trailers; military equipment refurbishment and
modification; military vehicle ballistic protection systems; 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; technical manual development and support; smart
vehicle development; and large-scale port engineering development and
security.
Contracts
Depending on solicitation requirements and other factors, VSE offers its
professional and technical services and products through various competitive
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.
Substantially all of the Company's revenues are derived from contract
services performed for the government. The U.S. Navy and U.S. Army are VSE's
largest customers. Other significant customers include the Department of
Treasury, the Department of Transportation, the Army Reserve, and the
Department of Energy. The Company's customers also include various other
government agencies, non-government organizations, and commercial entities.
4
VSE Revenues by Customer
(dollars in thousands)
2007 2006 2005
Customer Revenues % Revenues % Revenues %
-------- -------- - -------- - -------- -
U.S. Army/Army Reserve . $344,296 52.7 $174,473 48.0 $ 56,019 20.0
U.S. Navy . . . . . . . 189,534 29.0 164,788 45.3 196,363 70.1
U.S. Air Force . . . . . 4,627 0.7 4,579 1.3 5,431 1.9
-------- ----- -------- ----- -------- -----
Subtotal for
Department of Defense 538,457 82.4 343,840 94.6 257,813 92.0
U.S. Treasury . . . . . 55,020 8.4 2,392 0.7 1,121 0.4
Department of
Transportation . . . . 30,977 4.7 0 0.0 0 0.0
Department of Energy . . 10,537 1.6 9,420 2.6 9,734 3.5
All other government . . 12,481 2.0 5,683 1.5 9,682 3.5
Commercial and other . . 5,692 0.9 2,399 0.6 1,789 0.6
-------- ----- -------- ----- -------- -----
Total $653,164 100.0 $363,734 100.0 $280,139 100.0
======== ===== ======== ===== ======== =====
The government's procurement practices in recent years have tended
toward the bundling of various work efforts under large comprehensive
management contracts ("omnibus"). 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 may lower the Company's overall profit margins in some years.
Although the government's practice of using omnibus contracts is expected to
continue, the Company has opportunities to compete for smaller contracts
requiring specific areas of expertise. 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. Substantially all of BAV's work is performed on a program for the U.S.
Navy that accounted for approximately 17%, 29%, and 43% of consolidated
revenues in 2007, 2006, and 2005, respectively. This program has been
performed under two contracts. The original ten-year contract was awarded in
1995 with a total contract ceiling of over $1 billion and was extended to
continue work on a major delivery order effort through most of 2006. A follow-
on five-year contract with a total ceiling of approximately $544 million was
awarded in 2005.
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 are earned.
The BAV Division contracts have terms that specify award fee payments
that are determined by performance and level of contract activity. Award fees
under the BAV contracts 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 or 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 multiplied by the contract defined
billing rates, plus the cost of materials used in performance on the contract.
Profits or losses on time and material contracts result from the difference
5
between the cost of services performed and the contract defined billing rates
for these services.
Revenue recognition methods on fixed-price contracts will vary depending
on the nature of the work and the contract terms. On some fixed-price
contracts revenues are recorded as costs are incurred, using the percentage-
of-completion method of accounting. Revenues on fixed-price service contracts
are recorded as 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. 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 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, 2007, is approximately $408
million. Funded backlog as of December 31, 2006 and 2005 was approximately
$299 million and $276 million, respectively. The increases in funded backlog
during these years are due to increases in funding on the Company's existing
programs and the funding received on new programs. Changes in funded backlog
on contracts are sometimes unpredictable due to uncertainties associated with
changing program requirements and the ultimate availability of funds.
In addition to the funded backlog levels, VSE has significant total
contract ceiling amounts available for use by the Company on large multiple
award, indefinite delivery, indefinite quantity contracts with the U.S. Army
and U.S. Navy. While these contracts increase the opportunities available to
VSE to pursue future work, the amount of future work is not determinable until
delivery orders are placed on the contracts. Additionally, these delivery
orders must be funded by the procuring agencies before the Company can perform
work and begin earning revenues from them.
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 December 31, 2007, VSE had 1,223 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, (f) logisticians, and g) construction and
environmental specialists. 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.
Competition
The professional and technical services industry in which VSE is engaged
is very competitive. There are numerous other organizations, including large,
diversified firms with greater financial resources and larger technical
6
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 emphasized awarding contracts of the types
performed by VSE on a competitive basis as opposed to a sole source or other
non-competitive basis. Most 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 five 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.
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.
Available Information
Copies of VSE's Annual Report 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, as amended, 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 and Exchange Commission ("SEC").
ITEM 1A. Risk Factors
VSE's future results may differ materially from past results and from
those projected in the forward-looking statements contained in this Form 10-K
due to various uncertainties and risks, including but not limited to those set
forth below, one-time events and other important factors disclosed previously
and from time to time in other filings with the SEC.
VSE's work on large program efforts presents a risk to revenue and profit
growth and sustainability.
A large portion of VSE's revenues and profits are concentrated in a small
number of contracts, customers or major programs. The eventual expiration of
such programs, or the loss of or disruption of revenues on a single contract,
presents the potential for a sudden drop in revenues and profits. The loss of
these revenues could further erode profits on remaining VSE programs that
would have to absorb a larger portion of the fixed corporate costs previously
allocated to the expiring programs or discontinued contract work.
7
Federal procurement directives could result in a loss of work on current
programs to set-asides and omnibus contracts.
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 VSE's
revenue growth and profit margins.
Funding uncertainties for federal programs could adversely affect the
Company's ability to continue work on its government contracts.
Government contract business is subject to funding delays, terminations,
reductions, extensions, and moratoriums caused by political and administrative
disagreements within the government. 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.
Global economic conditions and political factors could adversely affect
revenues on current programs.
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, 2005 and 2006 also comprised a large percentage of total sales.
Revenues from the CED Army Equipment Support, BAV Ship Transfer, Tanker
Ballistic Protection System ("TBPS") and other programs for which work is
performed in foreign countries are subject to political risks posed by the
ongoing conflicts in the Middle East and potential terrorist activity. A
significant amount of VSE revenues in recent years has resulted from the U.S.
military involvement in Iraq and Afghanistan, and an end to such U.S. military
involvement in the future could potentially cause a decrease in VSE revenues.
Similarly, a change in the political landscape in Egypt or other client
countries served by BAV could potentially cause a decrease in VSE revenues.
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.
VSE is exposed to contractual and financial liabilities if its subcontractors
do not perform satisfactorily.
A large percentage of VSE's contract work is performed by
subcontractors, which raises certain government compliance, performance and
financial risks to VSE. While subcontractor terms generally specify the terms
and performance for which the subcontractor is liable to VSE, if any
unsatisfactory performance or compliance failure occurs on the part of
subcontractors, the Company still must bear the cost to ensure satisfactory
performance or compliance remedy on its prime contracts.
Investments in facilities could cause losses to VSE if certain work efforts
are disrupted or discontinued.
VSE has made investments in facilities and lease commitments to support
specific business programs, work requirements, or service offerings. A slowing
8
or disruption of these business programs, work requirements, or service
offerings that results in operating them at less than intended levels could
cause the company to suffer financial losses.
Environmental and pollution risks could potentially impact VSE financial
results.
VSE is exposed to certain environmental and pollution risks due to the
nature of some of the contract work the company performs. Costs associated
with pollution clean up efforts could potentially have an adverse impact on
financial results.
As a U.S. Government contractor, VSE is subject to a number of procurement
rules and regulations that could expose the Company to potential liabilities
or loss of work.
VSE must comply with and is affected by laws and regulations relating to
the award, administration and performance of U.S. Government contracts.
Additionally, VSE is responsible for subcontractor compliance with these laws
and regulations. Government contract laws and regulations affect how the
Company does business with its customers and, in some instances, impose added
costs on the business. A violation of specific laws and regulations could
result in the imposition of fines and penalties or the termination of
contracts or debarment from bidding on contracts.
In some instances, these laws and regulations impose terms or rights
that are more favorable to the government than those typically available to
commercial parties in negotiated transactions. For example, the U.S.
Government may terminate any government contract or subcontract at their
convenience, as well as for default based on performance. Upon termination for
convenience of a fixed-price type contract, the Company would normally be
entitled to receive the purchase price for delivered items, reimbursement for
allowable costs for work-in-process and an allowance for profit on the
contract or adjustment for loss if completion of performance would have
resulted in a loss. Upon termination for convenience of a cost-type contract,
the Company would normally be entitled to reimbursement of allowable costs
plus a portion of the fee. Such allowable costs would include the cost to
terminate agreements with suppliers and subcontractors. The amount of the fee
recovered, if any, is related to the portion of the work accomplished prior to
termination and is determined by negotiation.
A termination for default could expose the Company to liability and have
a material adverse effect on its ability to compete for future contracts and
orders. In addition, the U.S. Government could terminate a prime contract
under which the Company is a subcontractor, irrespective of the quality of
services provided by VSE as a subcontractor.
VSE's business could be adversely affected by a negative audit by the U.S.
Government.
U.S. Government agencies, including the Defense Contract Audit Agency
and the Department of Labor, routinely audit and investigate government
contractors. These agencies review a contractor's performance under its
contracts, cost structure and compliance with applicable laws, regulations and
standards. The U.S. Government also may review the adequacy of, and a
contractor's compliance with, its internal control systems and policies,
including the contractor's purchasing, property, estimating, compensation and
management information systems. Any costs found to be improperly allocated to
a specific contract will not be reimbursed, while such costs already
reimbursed must be refunded. If an audit uncovers improper or illegal
activities, the Company may be subject to civil and criminal penalties and
administrative sanctions, including termination of contracts, forfeiture of
profits, suspension of payments, fines and suspension or prohibition from
doing business with the U.S. Government. In addition, the Company could suffer
serious harm to its reputation if allegations of impropriety were made.
9
VSE's earnings and margins may vary based on the mix of contracts and
programs.
The Company's business includes both cost-type and fixed-price
contracts. Cost-type contracts generally have lower profit margins than fixed-
price 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 may lower the Company's overall profit margins in
some years.
VSE uses estimates in accounting for its programs. Changes in estimates could
affect future financial results.
The Company uses 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.
New accounting standards could result in changes to VSE's methods of
quantifying and recording accounting transactions, and could affect financial
results and financial position.
Changes to Generally Accepted Accounting Principles in the United States
("GAAP") arise from new and revised standards, interpretations and other
guidance issued by the Financial Accounting Standards Board, the SEC, and
others. The effects of such changes may include prescribing an accounting
method where none had been previously specified, prescribing a single
acceptable method of accounting from among several acceptable methods that
currently exist, or revoking the acceptability of a current method and
replacing it with an entirely different method, among others. Such changes
could result in unanticipated effects on results of operations, financial
position and other financial measures.
The nature of VSE's operations and significant increases in revenues in recent
years present certain challenges related to work force management.
The Company's financial performance is heavily dependent on the
abilities of its administrative and operating staffs with respect to technical
skills, operating performance, pricing, cost management, and administrative
and compliance efforts. A wider diversity of contract types, nature of work,
work locations, and increased legal and regulatory complexities means that the
staff and skill sets are spread much thinner than in years prior to the rapid
growth. Failure to attract or retain an adequately skilled workforce, lack of
knowledge or training in critical functions, or inadequate staffing levels can
lead to lost work, reduced profit margins, and losses from cost overruns or
performance deficiencies.
ITEM 1B. Unresolved Staff Comments
None
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,
2013. This building contains approximately 127,000 square feet of engineering,
shop, and administrative space. VSE also provides services and products from
approximately 30 other 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
10
aggregate of approximately 900,000 square feet of office and warehouse space.
VSE employees often provide services at customer facilities, limiting VSE's
requirement for additional space. BAV, CED, and SED provide services from
several locations outside of the United States, generally at foreign shipyards
or U.S. military installations.
VSE owns and operates two facilities in Ladysmith, Virginia. One of
these properties consists of approximately 45 acres of land and multiple
storage and vehicle maintenance buildings totaling approximately 17,000 square
feet of space and additional space of approximately 40,000 currently under
construction. The other property, purchased in October 2006 for approximately
$1.5 million, consists of 30 acres of land and buildings totaling
approximately 13,500 square feet of space. These properties are used by VSE to
test military equipment for which VSE provides system technical support or
other engineering services; to provide storage, 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. However, the results of
any legal proceedings cannot be predicted with certainty.
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, 2007.
11
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information concerning the executive
officers of the Registrant as of March 7, 2008. 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 Messrs. Lexo, Reed and
Williams.
Mr. Lexo joined VSE in 2007 as Executive Vice President of Strategic
Initiatives and Business Development, as well as Chief Executive Officer and
Vice Chairman of the Board of Directors of VSE's wholly owned subsidiary ICRC.
Mr. Lexo has served as Chief Executive Officer of ICRC since 1996.
Mr. Reed joined VSE in 2005 as Chief Operating Officer of VSE's wholly
owned subsidiary Energetics, and effective April 1, 2005, he was appointed
Energetics' President. Mr. Reed was a founder of Energetics in 1979 and served
as an officer of Energetics from 1979 to 2001. He provided senior-level
consulting services to government and private clients as a sole proprietor
during the period 2001 through 2004. He is a Registered Professional Engineer
in Maryland.
Mr. Williams joined VSE in 2007 as President and Chief Operating Officer
of ICRC. Mr. Williams completed 23 years of service in the U.S. Navy,
retiring as Commander. He joined ICRC as its Executive Vice President of
Operations in 2000 and has served as Chief Operating Officer of ICRC since
2003.
The executive officers are appointed annually to serve until the first
meeting of VSE's Board of Directors (the "Board") 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 . . . . . . . . 62 Executive Vice President and President,
Federal Group
Donald M. Ervine . . . . . . . 71 Chairman and Chief Executive Officer,
President and Chief Operating Officer
Michael E. Hamerly . . . . . . 62 Executive Vice President,
International Group
James E. Reed . . . . . . . . . 59 President, Energetics Incorporated and
Energy and Environment Group
James M. Knowlton . . . . . . . 65 Executive Vice President and
President, International Group
James W. Lexo, Jr. . . . . . . 59 Executive Vice President, Strategic
Initiatives and Business Development;
Chief Executive Officer and Vice
Chairman of the Board of Directors,
ICRC
Thomas R. Loftus . . . . . . . 52 Executive Vice President and Chief
Financial Officer
Craig S. Weber . . . . . . . . 63 Executive Vice President, Chief
Administrative Officer and Secretary
Carl E. Williams . . . . . . . 55 President, ICRC and Infrastructure
and Information Technology Group
12
PART II
ITEM 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
(a) Market Information
The Company's common stock (par value $.05 per share) is traded on the
Nasdaq Global Select Market, trading symbol, "VSEC," Newspaper listing, "VSE."
On May 1, 2007, VSE announced a two for one stock split in the form of a
100% stock dividend payable to stockholders of record as of June 11, 2007.
The stock dividend was made on June 28, 2007. All share and per share amounts
have been adjusted to give retroactive effect to the increased number of
common shares outstanding due to the stock split.
The following table sets forth the range of high and low sales price
(based on information reported by the Nasdaq Global Select Market) and cash
dividend per share information for VSE common stock for each quarter and
annually during the last two years. Sales prices and cash dividend per share
information have been adjusted for the two for one stock split effective June
28, 2007.
Quarter Ended High Low Dividends
------------- ---- --- ---------
2006:
March 31 . . . . . . . $25.98 $19.08 $.030
June 30 . . . . . . . 20.75 9.99 .035
September 30 . . . . . 17.00 14.77 .035
December 31 . . . . . 18.75 14.33 .035
For the Year $25.98 $ 9.99 $.135
2007:
March 31 . . . . . . . $46.81 $33.31 $.035
June 30 . . . . . . . 68.00 33.67 .040
September 30 . . . . . 56.77 33.48 .040
December 31 . . . . . 63.00 45.54 .040
For the Year $68.00 $33.31 $.155
(b) Holders
As of February 6, 2008, VSE's common stock, par value $.05 per share,
was held by approximately 213 shareholders of record. The number of
shareholders of record is not representative of the number of beneficial
holders because many of the shares are held by depositories, brokers, or
nominees.
(c) Dividends
In 2006 cash dividends were declared quarterly at the annual rate of
$.12 per share through March 31, 2006, and at the annual rate of $.14 per
share commencing June 6, 2006.
In 2007 cash dividends were declared quarterly at the annual rate of
$.14 per share through March 31, 2007, and at the annual rate of $.16 per
share commencing June 11, 2007.
Pursuant to VSE's bank loan agreement (see Note 7 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.
13
(d) Equity Compensation Plan Information
Compensation Plans
The Company has four compensation plans approved by VSE's stockholders
under which the Company's equity securities are authorized for issuance to
employees and directors: The VSE Corporation 2004 Stock Option Plan, the
predecessor 1998 Stock Option Plan, the VSE Corporation 2004 Non-employee
Directors Stock Plan and the VSE Corporation 2006 Restricted Stock Plan.
On December 30, 2005, the Board of Directors directed VSE to
discontinue, until and unless the Board determined otherwise, awarding
options, both discretionary and nondiscretionary, to purchase VSE common
stock, par value $.05 per share ("VSE Stock"), under VSE's 2004 Stock Option
Plan (the "2004 Plan"). The options outstanding under the 2004 Plan and
predecessor 1998 Stock Option Plan were not affected by this Board action.
The following table provides information about the Company's equity
compensation plans as of December 31, 2007:
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))(2)
Plan Category (a) (b) (c)
------------- ------------ ----------- ------------------
Equity compensation
plans approved by
stockholders . . . . . 73,500 $11.53 904,760
Equity compensation
plan not approved
by stockholders . . . . - - -
------ ------ -------
Total 73,500 $11.53 904,760
====== ====== =======
(1) Excludes 446,978 shares of issued and outstanding VSE Stock held by the
VSE Corporation Employee ESOP/401(k) Plan; these shares may be transferred to
Plan participants on retirement, termination of VSE employment, or pursuant to
ESOP diversification.
(2) At December 31, 2007, 575,000, 88,460, and 241,300 shares of VSE Stock
were available under the 2004 Stock Option Plan and predecessor 1998 Stock
Option Plan, the 2004 Non-employee Directors Stock Plan and the 2006
Restricted Stock Plan, respectively.
14
Performance Graph
Set forth below is a line graph comparing the cumulative total return of
VSE Stock with (a) a performance index for the broad market (NASDAQ Global
Select Market) in which VSE Stock is traded and (b) a published industry
index. VSE Stock is traded on the NASDAQ Global Select Market, and VSE's
industry group is engineering and technical services (formerly SIC Code 8711).
Accordingly, the performance graph compares the cumulative total return for
VSE Stock with (a) an index for the NASDAQ Global Select Market (U.S.
companies) ("NASDAQ Index") and (b) a published industry index for SIC Code
8711 ("Industry Index").
[insert graph]
* Total return assumes reinvestment of dividends and assumes $100 invested
on December 31, 2002, in VSE Stock, the NASDAQ Index, and the Industry
Index.
Performance Graph Table
2002 2003 2004 2005 2006 2007
---- ---- ---- ---- ---- ----
VSE Stock 100 125 239 403 327 948
NASDAQ Index 100 150 165 169 188 205
Industry Index 100 151 171 252 313 646
15
ITEM 6. Selected Financial Data
---------------------------------------------------------------------------------------------------
(In thousands, except per share data)
2007 2006 2005 2004 2003
---- ---- ---- ---- ----
Contract revenues . . . . . . . . . . . . . $653,164 $363,734 $280,139 $216,011 $133,059
======== ======== ======== ======== ========
Income from continuing operations . . . . . $ 14,102 $ 7,789 $ 6,169 $ 3,445 $ 2,090
Loss from discontinued operations . . . . . - - - (1) (79)
-------- -------- -------- -------- --------
Net income . . . . . . . . . . . . . . . $ 14,102 $ 7,789 $ 6,169 $ 3,444 $ 2,011
======== ======== ======== ======== ========
Basic earnings per common share:
Income from continuing operations . . . . $ 2.85 $ 1.64 $ 1.33 $ .77 $ .48
Loss from discontinued operations . . . . - - - - (.02)
-------- -------- -------- -------- --------
Net income per common share. . . . . . . $ 2.85 $ 1.64 $ 1.33 $ .77 $ .46
======== ======== ======== ======== ========
Diluted earnings per common share:
Income from continuing operations . . . . $ 2.82 $ 1.61 $ 1.29 $ .75 $ .47
Loss from discontinued operations . . . . - - - - (.02)
-------- -------- -------- -------- --------
Net income per common share - diluted. . $ 2.82 $ 1.61 $ 1.29 $ .75 $ .45
======== ======== ======== ======== ========
Working Capital . . . . . . . . . . . . . . $ 24,756 $ 25,646 $ 22,028 $ 15,748 $ 13,394
======== ======== ======== ======== ========
Total assets . . . . . . . . . . . . . . . . $171,771 $ 98,535 $ 73,866 $ 60,352 $ 30,776
======== ======== ======== ======== ========
Stockholders' equity . . . . . . . . . . . . $ 56,376 $ 38,236 $ 30,151 $ 23,043 $ 19,058
======== ======== ======== ======== ========
Cash dividends per common share . . . . . . $ .16 $ .14 $ .12 $ .10 $ .08
======== ======== ======== ======== ========
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.
16
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 unincorporated divisions and wholly owned subsidiaries. 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"), Engineering and
Logistics Division ("ELD") beginning in 2006, Field Support Services Division
("FSS") beginning in June 2007, Fleet Maintenance Division ("FMD"), Management
Sciences Division ("MSD"), and Systems Engineering Division ("SED"). Energetics
Incorporated ("Energetics") and Integrated Concepts and Research Corporation
("ICRC"), acquired in June 2007, are VSE's currently active subsidiaries.
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
("DoD"), including agencies of the U.S. Navy, Army, and Air Force.
VSE Revenues by Customer
(dollars in thousands)
2007 2006 2005
Source of Revenue Revenues % Revenues % Revenues %
----------------- -------- - -------- - -------- -
Army/Army Reserve $344,296 52.7 $174,473 48.0 $ 56,019 20.0
Navy 189,534 29.0 164,788 45.3 196,363 70.1
Other 119,334 18.3 24,473 6.7 27,757 9.9
-------- ----- -------- ----- -------- -----
Total Revenues $653,164 100.0 $363,734 100.0 $280,139 100.0
======== ===== ======== ===== ======== =====
VSE Operating Segments
Management of VSE's business operations is conducted under four
reportable operating segments: the Federal Group, the International Group, the
Energy and Environmental Group, and the Infrastructure and Information
Technology Group.
Federal Group - VSE's Federal Group provides engineering, technical,
management, integrated logistics support, and information technology services
to all U.S. military services and other government agencies. It consists of
five divisions:
CED is dedicated to supporting the Army's Communications and Electronics
Command ("CECOM") in the management and execution of the Rapid Response ("R2")
Program, which supports clients across DoD and the Federal Government. CED
manages execution of tasks involving research and development, technology
insertion, systems integration and engineering, hardware/software fabrication
and installation, testing and evaluation, studies and analysis, technical data
management, logistics support, training, and acquisition support. A large
portion of CED's current work on this program is related to the U.S. military
17
involvement in Iraq and Afghanistan, including the Army Equipment Support
Program and the Assured Mobility Systems Program.
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. A large majority of the services on this program
are provided by CED's subcontractor. Profit margins on subcontract work such
as this are lower than on work performed by Company personnel. CED provides
certain program management services and is accountable for contract
performance and compliance as the prime contractor. Work on this program began
in 2006. The original contract task order for this program, including
modifications made subsequent to award, had a ceiling value of approximately
$446 million. This task order expired in February 2008 and a follow on task
order with a ceiling value of approximately $282 million was awarded to
continue the program work for an additional twelve months. This program
contributed significantly in 2007 and 2006 with revenues of approximately $219
million and $106 million, respectively.
CED Assured Mobility Systems Program - In December 2006, VSE's CED
Division was awarded a task order on its Rapid Response support contract to
provide technical support services including program management, integrated
logistics, repairing, and sustaining route and area clearance
countermine/counter Improvised Explosive Device ("IED") system in support of
U.S. Army PM Assured Mobility Systems and TACOM. The original award was for a
16-month task order representing potential VSE revenues of about $164.8
million if all options are exercised. The task order was modified in 2007 to
increase the ceiling value to approximately $271 million and extend the period
of performance to August 2008.
ELD provides full lifecycle engineering, logistics, maintenance, and
refurbishment services to extend and enhance the life of existing equipment.
ELD principally supports the U.S. Army Reserve, U.S. Army, and Army National
Guard with core competencies in combat and combat service support system
conversions, technical research, sustainment and re-engineering, system
integration, and configuration management.
FSS was formed in June 2007 to provide worldwide field maintenance and
logistics support services for a wide variety of military vehicles and
equipment, including performance of organizational, intermediate and
specialized depot-level maintenance. FSS principally supports the U.S. Army
and Marine Corps by providing specialized Field Service Representatives
("FSR") and Field Support Teams ("FST") in areas of combat operations and
austere environments. In June 2007, FSS began providing some field service
support on the CED Army Equipment Support program.
MSD provides nationally and internationally recognized experts in
product and process improvement, supporting a variety of government and
commercial clients. MSD provides training, consulting, and implementation
support in the areas of: Enterprise Excellence, Lean Six Sigma, process and
product optimization, project management, leadership quality engineering,
Integrated Product and Process Development ("IPPD"), and reliability
engineering. MSD's services range from individual improvement projects to
global organizational change programs.
SED provides comprehensive systems and software engineering, logistics,
and prototyping services to DoD. SED principally supports U.S. Army, Air
Force, and Marine Corps combat and combat support systems. SED's core
competencies include: systems technical support, configuration management, and
lifecycle support for wheeled and tracked vehicles and ground support
equipment; obsolescence management, service life extension, and technology
insertion programs; and technical documentation and data packages. A large
portion of SED's current work is related to the war effort in Iraq and
18
Afghanistan, including the TBPS Program and a task order to provide
installation and follow-on support services to the U.S. Army for vehicular
remote detection devices.
TBPS Program - VSE's SED Division performs work on a program providing 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
polyurethane based ballistic coating system and necessary Add-on Armor Panels
for Army Fuel Transportation and Dispensing Tankers as protection from hostile
fire. Delivery of completed vehicle protection systems began in January 2005.
SED has performed on the TBPS program under multiple firm fixed price
per unit contracts. Subsequent to program implementation, VSE has received
modifications to consolidate contracting activity into fewer contracts and to
adjust the number of tankers based on Army tanker availability and needs, and
the possibility remains that there may be future contract modifications as the
Army's needs change. The total contract ceiling value on the TBPS Program
contracts as of December 31, 2007 was approximately $93.6 million, and the
remaining available contract ceiling as of December 31, 2007 was approximately
$10.4 million. These contract ceiling amounts are fully funded. Contractual
coverage on the program runs through July 2008.
The TBPS Program has contributed to increases in VSE financial results
in 2005, 2006 and 2007. The work performed on this program 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
presents VSE's business with the potential for both increased profit margins
and increased risks of incurring a loss.
International Group - VSE's International Group provides engineering,
industrial, logistics, and foreign military sales services to the U.S.
military and other government agencies. It consists of three divisions - BAV,
FMD, and VCG.
BAV provides assistance to the U.S. Navy in executing its Foreign
Military Sales ("FMS") Program for surface ships sold, leased or granted to
foreign countries by providing program management, engineering, technical
support, and logistics services for ship reactivations and transfers, as well
as follow-on support. BAV's expertise includes: ship reactivation/transfer,
overhaul and maintenance, follow-on technical support, FMS integrated
logistics support, engineering and industrial services, training, and spare
and repair parts support.
BAV Ship Transfer Program - BAV provides its ship transfer services to
the Navy under large comprehensive ("omnibus") management contracts. During
its life, this program has been a significant revenue producer for the
Company. 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 was a major contributor to
the Company's revenues in 2005 and 2006, and the transfer of a ship to India
was a major contributor in 2007.
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
continued work associated with the transfer of four ships to Taiwan under
19
delivery orders issued on the original contract until the work was
substantially completed in 2006.
Contract terms under both the original and new contract 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 or 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. In
2005, 2006 and 2007, each of the three month periods ended March 31, June 30
and December 31 includes BAV award fee income. The three month periods ended
September 30, 2005, 2006 and 2007 do not include BAV award fee income.
FMD provides global field engineering, logistics, maintenance, and
information technology services to the U.S. Navy and Air Force, including
fleet-wide ship and aircraft support programs. FMD's expertise includes ship
repair and modernization, ship systems installations, ordnance engineering and
logistics, facility operations, war reserve materials management, aircraft
sustainment and maintenance automation, and IT systems integration. FMD also
provides management, maintenance, storage, and disposal support for the U.S.
Department of Treasury's seized and forfeited general property program.
Treasury Seized Asset Program - In August 2006, FMD was awarded a
contract to support the U.S Department of the Treasury seized and forfeited
general property program. VSE assembled a team of experts to support all
phases of the contract. Such support includes: 1) consolidating general
personal property into Regional Property Management Centers, 2) optimizing
vehicle sales at facilities nationwide, 3) providing field representatives
nationwide to support local seizures, 4) utilizing the services of recognized
sales and marketing organizations to increase the sales of general property
and vehicles and 5) providing the Government with visibility, accountability,
and controls. This is a single award, cost-plus-incentive-fee contract that
includes a base period of performance, four option periods, and award term
provisions. Phase in work on the contract began in 2006 to transition the
program from a predecessor contractor. This program has the potential to be a
significant contributor to VSE's financial results during the term of the
contract. If all option and award term periods are exercised, contract
performance is expected to continue through September 30, 2014. While the
contract award specified an amount of approximately $113 million under the
base and option periods, actual revenues are dependent on service
requirements.
Contract terms specify incentive fee payments to VSE, with the incentive
fee amount ranging between a minimum percentage of 2% of cost incurred and a
maximum percentage of 12% of cost incurred. Incentive fee amounts above the
minimum are awarded once annually and are determined based on an evaluation by
the customer following the government's September 30 fiscal year end. The
Company does not know the amount of incentive fee income above the minimum
until after notification of the results of this evaluation. The Company does
not recognize fee income until the fees are fixed or determinable.
Accordingly, the Company will not recognize incentive fee income above the
minimum until after notification of the results of the evaluation. Due to such
timing, and to fluctuations in the level of revenues, profits as a percentage
of revenues will vary from period to period. The Company recognized the
minimum incentive fee income on this contract for the twelve months ended
December 31, 2007. For the contract base period of performance which ended
October 31, 2006, the Company was notified by the customer of an incentive fee
payment above the minimum and this incentive fee was recognized during the
fourth quarter of 2007. For the contract option year one period of performance
which ended September 30, 2007, initial notification from the customer
20
indicated that the incentive fee payment would be limited to the minimum
incentive fee amount unless the Company could provide documentation to support
a higher fee amount. The Company is in the process of documenting results to
the customer to support an incentive fee above the minimum.
VCG provides the U.S. Coast Guard with FMS support and lifecycle support
for vessels transferred to foreign governments. VCG's core competencies
include pre-transfer joint vessel inspections, reactivations, crew training,
transit assistance, heavy-lift contracting, logistics support, technical
support, and overseas husbandry.
Energy and Environmental Group - VSE's Energy and Environmental Group
provides high-level consulting services in the field of energy and
environmental management. The Energy and Environmental Group includes VSE's
wholly owned subsidiary, Energetics, Inc.
Energetics, Inc. is a full-service energy and environmental consulting
company providing technical and management support in all aspects of technology
research, development, and demonstration. The company's expertise lies in
state-of-the-art and advanced technology assessment, technical and economic
feasibility analysis, technology transfer, R&D program planning, engineering
studies, market assessment, strategic resource management, regulatory analysis,
environmental compliance, and risk management. Founded in 1979 and acquired by
VSE in 1995, Energetics has enjoyed solid financial results as a result of its
dedication to providing superior products and services to our clients in both
the public and private sectors.
Infrastructure and Information Technology Group - VSE's Infrastructure
and Information Technology Group, a newly created segment in the second quarter
of 2007, consists of its subsidiary, ICRC. VSE purchased ICRC in June 2007 for
an initial cash purchase price of approximately $11.8 million plus potential
additional payments in future years (see Note 6 in the Financial Statements and
Supplementary Data). VSE's consolidated statement of income for the year ended
December 31, 2007 includes ICRC operations from the June 4, 2007 date of
acquisition through December 31, 2007.
ICRC is engaged principally in providing diversified technical and
management services to the U.S. Government, including information technology,
advanced vehicle technology, aerospace services, and engineering and
transportation infrastructure services. The acquisition of ICRC provides VSE
with an opportunity to expand VSE's presence in the markets it serves; opens or
expands markets in smart vehicles, alternate fuels, large-scale port
engineering development and security, and information technology services; adds
approximately 200 technical and professional employees to VSE's staff; and adds
several long-term contracts to VSE's business base.
Port of Anchorage Contract - A significant amount of ICRC's revenue and
net income comes from a ten-year U.S. Department of Transportation ("DOT")
contract awarded in 2003 under the Section 8(a) Program of the United States
Small Business Administration ("SBA") for the provision of infrastructure
services for the Port of Anchorage in Alaska (the "POA Contract"). ICRC's
revenues from the POA Contract were approximately $30 million during the
period from June 4, 2007 (when VSE acquired ICRC) to December 31, 2007. While
the SBA has not granted DOT's request for a waiver required to permit the
continuation of the POA Contract under Federal Acquisition Regulations, on
February 26, 2008, DOT announced its intention to award a contract to ICRC for
the continued project management service of the Port of Anchorage expansion
project. There is no assurance that the proposed one year contract, with four
one-year options, will be awarded to ICRC. Payment of the above-referenced
potential additional purchase price amounts of up to approximately $5.8
million is contingent on ICRC realizing certain revenues from the POA Contract
during the six-year period following VSE's June 2007 acquisition of ICRC.
VSE's management does not believe that the outcome of this matter will have a
material adverse effect on VSE's financial condition or operations.
21
Concentration of Revenues From Continuing Operations
(in thousands)
2007 2006 2005
Source of Revenue Revenues % Revenues % Revenues %
----------------- -------- - -------- - -------- -
CED Army Equipment Support $218,615 33.5 $106,209 29.2 $ - -
BAV Egypt 51,295 7.9 51,446 14.1 52,926 18.9
BAV India 38,337 5.9 971 0.3 - -
BAV Greece 11,312 1.7 5 - - -
BAV Taiwan 6,348 1.0 45,729 12.6 63,058 22.5
BAV Other 6,432 1.0 8,673 2.4 5,024 1.8
-------- ----- -------- ----- -------- -----
Total BAV 113,724 17.5 106,824 29.4 121,008 43.2
Treasury Seized Asset Program 53,690 8.2 1,345 0.4 - -
Port of Anchorage Contract 30,674 4.7 - - - -
CED Assured Mobility Systems 27,547 4.2 - - - -
TBPS Program 23,712 3.6 29,770 8.2 29,533 10.5
VSE Other 185,202 28.3 119,586 32.8 129,598 46.3
-------- ----- -------- ----- -------- -----
Total Revenues $653,164 100.0 $363,734 100.0 $280,139 100.0
======== ===== ======== ===== ======== =====
Management Outlook
------------------
Growth Continued in 2007
Continuing the trend in revenue and profit growth in recent years, VSE
experienced an extremely high growth rate and record levels of revenues and
profits in 2007. Major contributors to 2007 results were work performed on the
CED Army Equipment Support Program, the BAV Ship Transfer program, the
acquisition of ICRC, the CED Assured Mobility Systems Program, the Treasury
Seized Asset Program, growth in ELD's Equipment Refurbishment Services provided
to the U.S. Army Reserve, performance on the TBPS Program, and additional work
provided by significant Indefinite Delivery Indefinite Quantity ("IDIQ")
contracts. See "Results of Operations" below for a more detailed discussion of
2007 results.
More Moderate Growth in 2008
VSE believes it has the potential to continue to increase revenues and
profits in 2008; however, it may be difficult to sustain the very high growth
level experienced in 2007. Discussion of some of the events and circumstances
that will impact the Company's growth follows below.
CED Army Equipment Support Program
CED began work on this program in 2006 and revenues from this program in
2007 were approximately $219 million. This program has the potential to
continue to be VSE's largest revenue producer in 2008. A follow on contract
task order was awarded in February 2008 to continue work on the program for an
additional twelve months. The contract task orders for this program are
incrementally funded, with funded backlog of approximately $117 million as of
December 31, 2007. Additional funding of approximately $76 million has been
received as of February 2008. While profit margins on this program are
expected to be low, the Company expects to benefit from the revenue base that
this program provides.
22
BAV Ship Transfer Program
During 2007, BAV supported the transfer of five excess U.S. Navy ships
to ship transfer FMS clients. A large amphibious ship was transferred to India
and four mine hunter ships, two each, were transferred to Egypt and Greece. This
marks the first opportunity BAV has had to work with India and a resumption of
support for Greece after several years of inactivity. It is also a significant
increase in ship transfer activity in Egypt. These efforts, as well as the
integration of four ex-U.S. Navy ships into the fleet operations of the Taiwan
Navy under this program, provide BAV with some solid prospects for follow-on
technical support and training services in these countries. The Company expects
the BAV Ship Transfer Program, including follow-on technical support provided
to countries with transferred U.S. ships and systems, to continue to be a major
provider of revenues in 2008 and future years. Funded backlog on the BAV Ship
Transfer Program was approximately $83.7 million as of December 31, 2007.
ICRC Acquisition
The acquisition of ICRC contributed to VSE's revenues and profits in
2007 and is expected to contribute to revenues and profits in 2008. ICRC
revenues in 2007 since the acquisition date were approximately $50 million.
CED Assured Mobility Systems Program
CED began work on this program in 2007 and revenues in 2007 were
approximately $28 million. Work on this program is expected to increase in
2008. The contract task order for the work performed by VSE expires in August
2008. The contract task orders are incrementally funded, with funded backlog of
approximately $33 million as of December 31, 2007. While profit margins on this
program are expected to be low, the Company expects to benefit from the
increased revenue base that this program provides.
Treasury Seized Asset Program
Phase in work on this contract began in 2006 to transition the program
from a predecessor contractor and contract activity increased significantly in
2007. This program was a significant contributor to VSE's financial results in
2007 and is expected to contribute in future years. Funded backlog on this
program was approximately $8 million as of December 31, 2007, and additional
funding of approximately $15 million was received in January 2008. If all
option and award term periods are exercised, contract performance is expected
to continue through September 30, 2014 with revenue amounts that are dependant
on service requirements.
ELD Equipment Refurbishment Services
VSE has provided the U.S. Army Reserve with military vehicle and
equipment refurbishment services for several years. Beginning in 2006, VSE
formed ELD to continue the performance of these services. ELD has expanded its
workforce, facilities, capacity to perform work, contractual coverage and
funding since its inception, resulting in increases in revenues from these
services in 2006 and 2007. The Company expects further increases in 2008 and
future years. Funded backlog for ELD was approximately $13 million as of
December 31, 2007.
TBPS Program
In 2007, the U.S. Army identified additional work to continue the TBPS
program, added funding, and extended contractual coverage on the program
through July 2008. Revenues from this program were approximately $24 million
in 2007 and approximately $30 million in both 2006 and 2005. The TBPS program
is expected to continue to be a strong contributor to VSE financial results in
2008, but probably at lower revenue levels than in 2007. Funded backlog
remaining on the program was approximately $10.4 million as of December 31,
2007.
23
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 could contribute to future revenue
growth, including new work in 2008. These three contracts are described below.
VSE's CED Division has a multiyear Rapid Response support contract
awarded by the U.S. Army Communications-Electronics Command ("CECOM") 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
the amount of this ceiling that will eventually be realized cannot be
determined with certainty, the Company has received over $1.8 billion in task
order awards and over $985 million of funding since inception of the contract.
This contract has generated revenues for all of VSE of approximately $362
million, $143 million and $37 million during 2007, 2006 and 2005,
respectively, including revenues of approximately $219 million on the CED Army
Equipment Support Program in 2007. VSE continues to pursue new orders on this
contract that present potential revenue opportunities for the future.
VSE's FMD Division has a SeaPort Enhanced contract with the U.S. Navy,
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.
ELD has a contract, the Field and Installation Readiness Support Team
("FIRST") Contract, awarded in November 2006, with the U.S. Army to provide a
broad range of logistics and engineering and technical services for Army
activities in the continental United States and overseas locations. The
contract has a five-year base period and three five-year option periods. VSE
is one of several awardees eligible to share in the potential total contract
ceiling amount, which is expected to be several billion dollars. The award of
this contract provides VSE with the opportunity to compete for work which may
contribute to future revenue growth.
Increases in Bookings and Funded Backlog
Revenues in government contracting businesses are dependent upon
contract funding ("Bookings") and funded contract backlog is an indicator of
potential future revenues. A summary of VSE's bookings and revenues for the
years ended December 31, 2007, 2006 and 2005, and funded contract backlog as
of December 31, 2007, 2006 and 2005 is as follows.
(in millions)
2007 2006 2005
---- ---- ----
Bookings . . . . . . . . . . . . . . . . $736 $388 $390
Revenues . . . . . . . . . . . . . . . . $653 $364 $280
Funded Backlog . . . . . . . . . . . . . $408 $299 $276
ICRC was acquired in June 2007 and is included in the table above.
Funded backlog as of December 31, 2007 includes approximately $32 million from
ICRC.
24
Longer Term
The growth in VSE revenues and profits during 2007, 2006, and 2005
presents the Company with both challenges and opportunities for future years.
Certain work efforts that have supported VSE's growth in recent years have
begun to wind down, have expired, or are due to expire. A large majority of
the originally proposed work on the TBPS Program has been delivered and
current contractual coverage is scheduled to expire in July 2008. Large task
order awards under the Rapid Response support contract, including the CED Army
Equipment Support Program, typically are made for shorter time periods than
most of the Company's other contracts. The potential expiration of these
programs may reduce VSE annual revenues if the expiring work is not replaced
by new or follow-on work.
The Company believes it is well prepared to meet the challenge of
replacing the expiring work. Progress has already been made toward this end
with the start up of the Treasury Seized Asset Program in 2007, continued
increases in ELD's equipment refurbishment services, and the acquisition of
ICRC. The Company has also continued to receive new task order awards and
funding and is pursuing additional opportunities under the Rapid Response
support contract.
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. The larger revenue
level and capital base built up in recent years improves the Company's ability
to pursue larger programs and potential acquisition opportunities.
Recent Accounting Pronouncements
--------------------------------
In December 2007, the Financial Accounting Standards Board ("FASB")
issued Statment of Financial Accounting Standards ("SFAS") No. 141(R),
"Business Combinations; a replacement of FASB Statement No. 141," which will
become effective January 1, 2009. The new standard will replace existing
guidance and significantly change accounting and reporting relative to
business combinations in consolidated financial statements, including
requirements to recognize acquisition-related transaction and post acquisition
restructuring costs in results of operations as incurred. SFAS No. 141(R)
will be effective for businesses acquired after the effective date.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements," which is effective January 1, 2008. SFAS No. 157 defines fair
value, establishes a market-based framework or hierarchy for measuring fair
value and expands disclosures about fair value measurements. The new standard
generally is applicable whenever another accounting pronouncement requires or
permits assets and liabilities to be measured at fair value. On February 12,
2008, the FASB issued FASB Staff Position No. 157-2, "Effective Date of FASB
Statement No. 157," to delay the effective date of SFAS No. 157 for
nonfinancial assets and nonfinancial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a
recurring basis (that is, at least annually). For items with its scope, the
FSP defers the effective date of SFAS No. 157 to fiscal years beginning after
November 15, 2008, and interim periods within those fiscal years. Management
is continuing to evaluate the requirements of SFAS No. 157, but currently do
not expect that it will have a material impact on the Company's results of
operations, financial position or cash flows.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities - Including an Amendment of
FASB Statement No. 115," which also becomes effective January 1, 2008. Under
SFAS No. 159, a company may choose to measure certain financial instruments
(e.g., assets and liabilities) and certain other items not currently subject
to fair value measurement at fair value. If so elected, any unrealized gains
and losses from marking those items to market will be included in earnings in
25
each subsequent reporting period. The fair value option may be elected on an
instrument-by-instrument basis, with few exceptions. The Company does not
plan to elect the fair value option.
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 the more significant accounts, particularly
those that involve 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
time and materials contracts, cost-type 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 for time and materials contracts are recorded on the basis of
contract allowable labor hours worked multiplied by the contract defined
billing rates, plus the direct costs and indirect cost burdens associated with
materials and subcontract work used in performance on the contract. Generally,
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.
Revenues on cost-type contracts are recorded as contract allowable costs
are incurred and fees 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 or 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.
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, and development 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. Profits on
fixed-price contracts result from the difference between the incurred costs
and the revenue earned.
Revenues by contract type for the three years ended December 31, 2007
were as follows (in thousands):
2007 2006 2005
Contract Type Revenues % Revenues % Revenues %
------------- -------- - -------- - -------- -
Time and materials. $388,564 59.5 $172,766 47.5 $ 60,618 21.6
Cost-type . . . . . 220,782 33.8 147,733 40.6 177,567 63.4
Fixed-price . . . . 43,818 6.7 43,235 11.9 41,954 15.0
-------- ----- -------- ----- -------- -----
$653,164 100.0 $363,734 100.0 $280,139 100.0
======== ===== ======== ===== ======== =====
The increases in time and materials revenues in 2007 and 2006 shown in
the table above is primarily attributable to revenues from the CED Army
26
Equipment Support contract that started in 2006. Substantially all of the
revenues on this contract result from the pass through of subcontractor
support services that have a very low profit margin for VSE.
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
2007 include approximately $357 thousand for which the Company had not
received formalized funding as of December 31, 2007. The Company received
funding modifications for approximately $103 thousand of this amount as of
March 2008, leaving approximately $254 thousand of 2007 revenues classified as
risk funding. VSE believes that it is entitled to reimbursement and will
receive funding for this remaining 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 and Intangible Assets
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, 2007, the Company had
approximately $1.1 million of goodwill associated with its acquisition of
Energetics in 1995 and approximately $5.7 million of goodwill and intangible
assets with indefinite lives associated with its acquisition of ICRC in 2007.
The Company has not recognized any reduction to the goodwill or intangibles 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.
Recoverability of Deferred Tax Assets
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.
27
Results of Operations
---------------------
Revenues
The following table shows the revenues of VSE, its subsidiaries and
divisions, and such revenues as a percentage of total revenues:
Revenues from Operations
(dollars in thousands)
2007 2006 2005
Company or Business Unit Revenues % Revenues % Revenues %
------------------------ -------- - -------- - -------- -
CED . . . . . . . . . . . . . $293,644 45.0 $128,658 35.4 $ 28,564 10.2
BAV . . . . . . . . . . . . . 113,724 17.4 106,824 29.4 121,008 43.2
FMD . . . . . . . . . . . . . 112,805 17.3 50,480 13.9 59,800 21.3
ICRC . . . . . . . . . . . . 49,918 7.7 - - - -
SED . . . . . . . . . . . . . 36,854 5.6 42,016 11.5 49,001 17.5
ELD . . . . . . . . . . . . . 26,158 4.0 16,771 4.6 - -
Energetics . . . . . . . . . 14,522 2.2 14,269 3.9 12,694 4.5
MSD . . . . . . . . . . . . . 2,700 0.4 3,511 1.0 4,063 1.5
VCG . . . . . . . . . . . . . 1,472 0.2 1,148 0.3 4,975 1.8
FSS . . . . . . . . . . . . . 1,335 0.2 - - - -
Other . . . . . . . . . . . . 32 0.0 57 0.0 34 0.0
-------- ----- -------- ----- -------- -----
$653,164 100.0 $363,734 100.0 $280,139 100.0
======== ===== ======== ===== ======== =====
Revenues increased by approximately 80% and 30% for the years ended
December 31, 2007 and 2006, as compared to the respective prior years. A
substantial portion of the increases in revenues for 2007 and 2006 was
attributable to revenues associated with the CED Army Equipment Support
Program work, which started in January 2006.
Additional significant reasons for the increases in revenues in 2007
were 1) revenues associated with other CED task orders, including CED's U.S.
Army PM Assured Mobility Systems and TACOM support; 2) revenues from the start
of FMD's Treasury Seized Property Management Program and increases in other
FMD services; 3) revenues from newly acquired ICRC; 4) revenues associated
with BAV's ship transfer to India; and 5) an increase in ELD equipment
refurbishment services.
Additional reasons for the increases in revenues in 2006 were increased
revenues from ELD equipment refurbishment services (revenues from these
services were included in SED's results in 2005 and 2004) and increased
revenues from SED and Energetics contract services. The increases in revenues
in 2006 were partially offset by decreases in the level of work performed
under the BAV Ship Transfer Program, on FMD's Navy contracts, and on VCG's
contract with the U.S. Coast Guard.
Income 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 percentage of revenues.
Income Before Income Taxes
(dollars in thousands)
Description 2007 % 2006 % 2005 %
----------- ---- - ---- - ---- -
Contract revenues . . . . $653,164 100.0 $363,734 100.0 $280,139 100.0
Contract costs . . . . . . 629,351 96.4 350,978 96.5 269,780 96.3
-------- ----- -------- ----- -------- -----
Gross profit . . . . . . . 23,813 3.6 12,756 3.5 10,359 3.7
Selling, general and
administrative expenses. 1,505 0.2 694 0.2 580 0.2
Interest(income)expense . (699) (0.1) (427) (0.1) (210) (0.1)
-------- ----- -------- ----- -------- -----
Income before income taxes $ 23,007 3.5 $ 12,489 3.4 $ 9,989 3.6
======== ===== ======== ===== ======== =====
28
VSE's gross profits as a percentage of revenues have remained relatively
stable during the three year period from 2005 through 2007.
VSE's gross profit dollars increased in 2007 as compared to 2006. The
increase was primarily due to revenues from recently acquired ICRC, the
increase in revenues on the CED Army Equipment Support program and on other
Rapid Response support contract task orders, revenue and margin increases on
ELD's equipment refurbishment services, increased profitability of SED
services performed, increased BAV fee income, and profits associated with the
increase in FMD revenues.
VSE's gross profit dollars increased in 2006 as compared to 2005.
Programs that contributed to gross profit increases, in part due to improved
gross margins resulting from higher revenue levels, included the TBPS Program
and services provide by FMD and Energetics. Additionally, BAV Ship Transfer
Program services experienced improved profitability in 2006. 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. As a percentage of revenues, these expenses varied
little in 2007 and 2006 as compared to the respective prior years. The
increase in these expenses in 2007 as compared to 2006 is primarily due to the
amortization of intangible assets attributable to the ICRC acquisition and the
inclusion of ICRC's selling, general and administrative expenses in VSE
results in 2007 but not included in 2006.
VSE did not have significant borrowing requirements or interest expense
in 2007, 2006 or 2005. The Company's interest income increased in 2007 as
compared to 2006 and increased in 2006 as compared to 2005 as profits from
operations and resulting cash surpluses were invested.
Provision for Income Taxes
VSE's effective tax rates were 38.7% for 2007, 37.6% for 2006, and 38.2%
for 2005. The taxable income for 2007 reached a level that resulted in income
taxed at a 35% federal tax rate as compared to the prior years tax rate of
34%, resulting in an increased effective rate for 2007 as compared to 2006.
The effective tax rate for 2006 was lower than the 2005 rate primarily due to
a decrease in the effective state tax rate.
Segment Operating Results
Federal Group
-------------
The following table shows consolidated revenues, costs and expenses, and
gross profit from operations for the Federal Group (in thousands).
Description 2007 % 2006 % 2005 %
----------- ---- - ---- - ---- -
Contract revenues . . . . . $360,690 100.0 $190,956 100.0 $ 81,628 100.0
Contract costs . . . . . . . 348,794 96.7 185,077 96.9 76,192 93.3
-------- ----- -------- ----- -------- -----
Gross profit . . . . . . . . $ 11,896 3.3 $ 5,879 3.1 $ 5,436 6.7
Selling, general and
administrative expenses . 73 0.0 24 0.0 52 0.1
Interest (income) expense . (252) 0.0 423 0.2 266 0.3
-------- ----- -------- ----- -------- -----
Income before income taxes . $ 12,075 3.3 $ 5,432 2.9 $ 5,118 6.3
======== ===== ======== ===== ======== =====
Revenues in the Federal Group increased by approximately 89% and 134%
for the years ended December 31, 2007 and 2006, as compared to the respective
prior years. A substantial portion of the increase in revenues for 2007 and
2006 was attributable to revenues associated with the CED Army Equipment
29
Support Program work, which started in January 2006. Other reasons for the
increases in 2007 revenues included: 1) work on additional CED task orders,
including CED's U.S. Army PM Assured Mobility Systems and TACOM support; 2)
increased revenues from ELD's equipment refurbishment services for the
U.S. Army Reserve; and 3) increases in SED contract services performed other
than the TBPS Program. The increases in revenues of this segment were offset
partially by a decrease in TBPS Program revenues and a decline in MSD
revenues. Other reasons for the increases in 2006 revenues included increased
revenues from ELD's equipment refurbishment services and SED contract
services.
Gross profits in the Federal Group increased by approximately 102% and
8% for the years ended December 31, 2007 and 2006, as compared to the
respective prior years. The increases in gross profits were primarily due to
the increase in revenues on the CED Army Equipment Support Program work and
other CED task orders; profits associated with the increased military
equipment refurbishment services performed by ELD for the U.S. Army Reserve;
and increased profitability of SED services performed on the TBPS Program and
other SED services. Profits on work performed by FSS contributed to the
increase in segment gross profits and a decline in MSD profits offset slightly
the increases in gross profits of this segment.
While the CED Army Equipment Support Program work was the largest
contributor to the Federal Group's revenue increases in 2007 and 2006,
approximately $112 million and $106 million, respectively, substantially all
of the work on this program is performed by a subcontractor and these costs
are passed on to the government essentially at cost. Accordingly, gross profit
as a percentage of revenues was lower in 2007 and 2006 as compared to the
gross profit as a percentage of revenues in 2005. Production efficiency
improvements on the TBPS Program contributed to an increase in gross profit
dollars in both 2007 and 2006.
Selling, general and administrative expenses consist primarily of costs
and expenses that are not chargeable or reimbursable on the Federal Group's
contracts. As a percentage of revenues, these expenses varied little in 2007
and 2006 as compared to the respective prior years and have not been
significant in relation to revenue levels.
The Federal Group incurred net interest expense in 2006 and 2005 to
finance the investment in SED's TBPS Program and the start up of ELD. This
segment realized interest income in 2007 as 1) the cash investments in these
programs in prior years were returned as the programs matured; 2) cash from
profits was used to pay down borrowings; and 3) the Company benefited from
efficient cash flow cycles on certain CED task order work.
International Group
-------------------
The following table shows consolidated revenues, costs and expenses, and
gross profit from operations for the International Group (in thousands).
Description 2007 % 2006 % 2005 %
----------- ---- - ---- - ---- -
Contract revenues . . . . . $228,002 100.0 $158,452 100.0 $185,784 100.0
Contract costs . . . . . . . 220,624 96.8 153,130 96.6 182,068 98.0
-------- ----- -------- ----- -------- -----
Gross profit . . . . . . . . $ 7,378 3.2 $ 5,322 3.4 $ 3,716 2.0
Selling, general and
administrative expenses . 67 0.0 93 0.1 46 0.0
Interest (income) expense . (124) (0.1) (258) (0.2) (30) 0.0
-------- ----- -------- ----- -------- -----
Income before income taxes . $ 7,435 3.3 $ 5,487 3.5 $ 3,700 2.0
======== ===== ======== ===== ======== =====
Revenues in the International Group increased by approximately 44% and
decreased by approximately 15% for the years ended December 31, 2007 and 2006,
as compared to the respective prior years. The increases in 2007 revenues were
primarily due to revenues provided by the start of FMD's Treasury Seized
Property Management Program and to revenues associated with BAV's ship
30
transfer to India. These additional revenues were partially offset by the
substantial completion of BAV's work associated with the transfer of U.S. Navy
ships to Taiwan in 2006. The increases in 2007 revenues of this segment were
partially attributable to an increase in VCG revenues.
The decrease in revenues in 2006 was primarily due to the completion of
BAV's work associated with the transfer of U.S. Navy ships to Taiwan and to a
reduction in the amount of subcontractor pass-through ordered through FMD's
Navy contracts. A reduction in the amount of services ordered on VCG's
contract with the U.S. Coast Guard also contributed to the decrease in
revenues in 2006.
Gross Profits in the International Group increased by approximately 39%
and 43% for the years ended December 31, 2007 and 2006, as compared to the
respective prior years. The increase was primarily due to increased BAV fee
income and to profits from higher revenue levels in FMD attributable to FMD's
Treasury Seized Property Management Program. The increases in 2007 gross
profits of this segment were helped slightly by an increase in profits of VCG.
The increase in 2006 gross profits of this segment was primarily due to
increased BAV fee income and to an increase in labor driven revenues on FMD's
Navy contracts.
Selling, general and administrative expenses consist primarily of costs
and expenses that are not chargeable or reimbursable on the International
Group's contracts. As a percentage of revenues, these expenses varied little
in 2007 and 2006 as compared to the respective prior years and have not been
significant in relation to revenue levels.
Interest income for the International Group decreased in 2007 as
compared to 2006 due to investment in the start up of FMD's Treasury Seized
Asset Program. Interest income in this segment increased in 2006 as compared
to 2005 due to earnings from the investment of cash from profits.
Energy and Environmental Group
------------------------------
The following table shows consolidated revenues, costs and expenses, and
gross profit from operations for the Energy and Environmental Group (in
thousands).
Description 2007 % 2006 % 2005 %
----------- ---- - ---- - ---- -
Contract revenues . . . . . $14,522 100.0 $14,269 100.0 $12,693 100.0
Contract costs . . . . . . . 13,139 90.5 12,665 88.8 11,332 89.3
------- ----- ------- ----- ------- -----
Gross profit . . . . . . . . $ 1,383 9.5 1,604 11.2 1,361 10.7
Selling, general and
administrative expenses . 41 0.3 27 0.2 124 1.0
Interest (income) expense . (272) (1.9) (218) (1.5) (116) (0.9)
------- ----- ------- ----- ------- -----
Income before income taxes . $ 1,614 11.1 $ 1,795 12.5 $ 1,353 10.6
======= ===== ======= ===== ======= =====
Revenues in the Energy and Environmental Group increased by
approximately 2% and 12% for the years ended December 31, 2007 and 2006, as
compared to the respective prior years. The increases in revenues for both
years was due primarily to increases in the energy and environmental
consulting services performed as a result of increased emphasis on marketing
efforts.
Gross profits in the Energy and Environmental Group decreased by
approximately 14% for the year December 31, 2007 and increased by
approximately 18% for the year ended December 31, 2006, as compared to the
respective prior years. The decrease in 2007 was primarily due to job costs
incurred on certain contract task orders in excess of authorized ceilings. The
increase in 2006 was primarily due to the growth in revenues over 2005.
31
Selling, general and administrative expenses consist primarily of costs
and expenses that are not chargeable or reimbursable on the Energy and
Environmental Group's contracts. As a percentage of revenues, these expenses
varied little in 2007 and 2006 as compared to the respective prior years and
have not been significant in relation to revenue levels.
Interest income for the Energy and Environmental Group increased in 2007
and 2006 as compared to the respective prior years due to earnings from the
investment of cash from profits.
Infrastructure and Information Technology Group
-----------------------------------------------
The following table shows consolidated revenues, costs and expenses, and
gross profit from operations for the Infrastructure and Information Technology
Group (in thousands).
Description 2007 %
----------- ---- -
Contract revenues . . . . . . . . . . . . . . . $49,918 100.0
Contract costs . . . . . . . . . . . . . . . . . 46,844 93.8
------- -----
Gross profit . . . . . . . . . . . . . . . . . . $ 3,074 6.2
Selling, general and administrative expenses . . 310 0.6
Interest (income) expense . . . . . . . . . . . (44) 0.0
------- -----
Income before income taxes . . . . . . . . . . . $ 2,808 5.6
======= =====
Included in the contract costs of the Infrastructure and Information
Technology Group is the amortization of the ICRC contract related intangible
assets of approximately $600 thousand for the period ended December 31, 2007.
Financial Condition
-------------------
VSE's financial condition did not change materially during 2007. The
Company's largest assets are its accounts receivable. The largest liabilities
are its accounts payable and accrued expenses. Accounts receivable increased
approximately $66 million, accounts payable increased approximately $45
million, and accrued expenses increased by approximately $9 million during
2007. These increases and changes to other asset and liability accounts were
due primarily to the increase in the level of business activity, contract
delivery schedules, subcontractor and vendor payments required to perform this
work, and the timing of associated billings to customers and collections. The
acquisition of ICRC also caused increases in accounts receivable, accounts
payable, and accrued expenses; and additionally resulted in a decrease in cash
and cash equivalents and increases in intangible assets.
The increase in total stockholders' equity in 2007 resulted from
earnings and dividend activity and from the exercise of stock options. In June
2006, the Board authorized the Company to repurchase up to 50,000 shares of
VSE Stock from time to time on the open market, subject to corporate
objectives. As of December 31, 2007, the Company had not purchased any of
these shares.
Liquidity and Capital Resources
-------------------------------
Cash Flows
The Company's cash and cash equivalents decreased by approximately $8.6
million during 2007. Approximately $20.5 million in net cash was used in
investing activities, approximately $8.3 million was provided by operating
activities, and approximately $3.6 million was provided by financing
activities. The difference between cash provided by operating activities of
approximately $8.3 million in 2007 as compared to cash provided by operating
activities of approximately $1.6 million in 2006 is primarily due to
differences in the levels of accounts receivable, contract inventories,
accounts payable and accrued expenses associated with contract requirements
32
and the associated billing and collections cycle, and to the Company's
increase in profits. Investing activities included costs associated with the
acquisition of ICRC of approximately $11.8 million, the expansion and
improvement of facilities of approximately $5.7 million and purchases of other
property and equipment, net of dispositions, of approximately $3 million.
Financing activities included approximately $4.3 million provided by stock
purchase transactions by directors and officers and associated excess tax
benefits related to the exercise of stock options, and approximately $741
thousand used to pay dividends.
The Company's cash and cash equivalents decreased by approximately $4.0
million during 2006. Approximately $1.6 million in net cash was provided by
operating activities, approximately $5.6 million was used in investing
activities, and approximately $15 thousand was provided by financing
activities. The difference between cash provided by operating activities of
approximately $1.6 million in 2006 as compared to cash provided by operating
activities of approximately $15.6 million in 2005 is primarily due to
differences in the levels of accounts receivable, contract inventories,
accounts payable and accrued expenses associated with contract requirements
and the associated billing and collections cycle, and to the Company's
increase in profits. Investing activities consisted of the purchase of
property and equipment. Financing activities consisted of $630 thousand
provided by stock purchase transactions by directors and officers associated
with the exercise of stock options and directors' fees, and $615 thousand used
to pay dividends.
Quarterly cash dividends were paid at the annual rate of $.15 per share
during 2007, stated on a post-split basis to reflect the two-for-one stock
split paid on June 28, 2007. 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 revenues and
accounts receivable and accounts payable can cause significant increases or
decreases in internal liquidity.
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, contract funding delays
arising from job performance issues, 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
33
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.
From time to time, the Company may also invest in the acquisition of
another company. The acquisition of ICRC in 2007 represented the use of
approximately $11.8 million of cash. The Company continues to pursue other
potential acquisitions.
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 acquisition,
expansion, improvement, and maintenance of its operational and administrative
facilities. The growth in the level of equipment refurbishment services
provided by ELD has required an increased level of investment in operational
facilities in 2006 and 2007, including construction of an additional 40,000
square feet of warehouse and shop space at its Ladysmith, Virginia facility.
Construction of this additional space began in July 2007 and is expected to be
completed in May 2008, with a budgeted cost of approximately $6.1 million. The
Company could possibly make additional investments in operational or
administrative facilities in 2008 or in future years.
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 7 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 $25 million as of December 31, 2007. The amount of this
commitment is negotiable between the Company and the bank. The Company has
determined that the current $25 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
The following table shows the consolidated contractual obligations for
VSE as of December 31, 2007 (in thousands):
Payments Due by Period
----------------------
Less than 1-3 4-5 After 5
Contractual Obligations Total 1 year years years years
----------------------- ----- ------ ----- ----- -----
Operating leases, net of
non-cancelable sublease
income . . . . . . . . $28,731 $6,810 $10,601 $7,737 $3,583
Purchase obligations . . 1,871 1,871 - - -
------- ------ ------- ------ ------
Total $30,602 $8,681 $10,601 $7,737 $3,583
======= ====== ======= ====== ======
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 or to serve customer needs. 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.
The table excludes contractual commitments for materials or subcontractor work
purchased to perform U.S. Government contracts. Such commitments for materials
and subcontractors are reimbursable when used on the contracts, and generally
are also reimbursable if a contract is "terminated for convenience" by the
U.S. Government pursuant to federal contracting regulations.
34
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.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risks
Interest Rates
VSE's bank loan financing provides available borrowing to the Company at
variable interest rates. The Company used a significant amount of its cash to
pay for the ICRC acquisition in June 2007, giving rise to a situation where
the Company may borrow on its bank loan from time to time in the near term.
VSE does not anticipate that such amounts borrowed will be significant, and
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, 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 very limited. Accordingly, the Company does not
believe that it is exposed to any material foreign currency risk.
35
ITEM 8. Financial Statements and Supplementary Data
Index To Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm . . . . 37
Consolidated Balance Sheets as of December 31, 2007 and 2006 . . 38
Consolidated Statements of Income for the years ended
December 31, 2007, 2006, and 2005 . . . . . . . . . . . 39
Consolidated Statements of Stockholders' Equity
for the years ended December 31, 2007, 2006, and 2005 . 40
Consolidated Statements of Cash Flows for the years ended
December 31, 2007, 2006, and 2005 . . . . . . . . . . . 41
Notes to Consolidated Financial Statements . . . . . . . . . . . 42
36
Report of Independent Registered Public Accounting Firm
The 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, 2007 and 2006, and the related
consolidated statements of income, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2007. 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
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
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, 2007 and 2006, and the consolidated results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2007, in conformity with U.S. generally accepted
accounting principles.
As discussed in Note 1 of the Notes to Consolidated Financial Statements, the
Company adopted Statement of Financial Accounting Standards No. 123(R), Share-
Based Payments, on January 1, 2006.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), VSE Corporation's internal control
over financial reporting as of December 31, 2007, based on criteria
established in Internal Control-Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission and our report dated
March 5, 2008 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean, VA
March 5, 2008
37
VSE Corporation and Subsidiaries
Consolidated Balance Sheets
-------------------------------------------------------------------------------
(in thousands, except per share amounts)
As of December 31,
2007 2006
---- ----
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . $ 109 $ 8,745
Accounts receivable, principally
U.S. Government, net . . . . . . . . . . . . . . . . . 132,389 66,730
Contract inventories . . . . . . . . . . . . . . . . . . - 4,459
Deferred tax assets . . . . . . . . . . . . . . . . . . 1,246 1,196
Other current assets . . . . . . . . . . . . . . . . . . 2,755 2,472
-------- -------
Total current assets . . . . . . . . . . . . . . . . 136,499 83,602
Property and equipment, net . . . . . . . . . . . . . . . 14,920 8,409
Deferred tax assets . . . . . . . . . . . . . . . . . . . 1,888 1,133
Intangible assets . . . . . . . . . . . . . . . . . . . . 8,034 -
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . 5,228 1,054
Other assets . . . . . . . . . . . . . . . . . . . . . . . 5,202 4,337
-------- -------
Total assets . . . . . . . . . . . . . . . . . . . . $171,771 $98,535
======== =======
Liabilities and Stockholders' Equity
Current liabilities:
Bank notes payable . . . . . . . . . . . . . . . . . . . $ 81 $ -
Accounts payable . . . . . . . . . . . . . . . . . . . . 88,565 44,302
Accrued expenses . . . . . . . . . . . . . . . . . . . . 22,895 13,486
Dividends payable . . . . . . . . . . . . . . . . . . . 202 168
-------- -------
Total current liabilities . . . . . . . . . . . . . 111,743 57,956
Deferred compensation . . . . . . . . . . . . . . . . . . 3,257 2,183
Other liabilities . . . . . . . . . . . . . . . . . . . . 395 160
-------- -------
Total liabilities . . . . . . . . . . . . . . . . . 115,395 60,299
-------- -------
Commitments and contingencies
Stockholders' equity:
Common stock, par value $.05 per share, authorized
15,000,000 shares; issued and outstanding 5,052,512
and 4,788,162, respectively . . . . . . . . . . . . . 253 240
Additional paid-in capital . . . . . . . . . . . . . . . 11,963 7,163
Retained earnings . . . . . . . . . . . . . . . . . . . 44,160 30,833
-------- -------
Total stockholders' equity . . . . . . . . . . . . . 56,376 38,236
-------- -------
Total liabilities and stockholders' equity . . . . . $171,771 $98,535
======== =======
The accompanying notes are an integral part of these balance sheets.
38
VSE Corporation and Subsidiaries
Consolidated Statements of Operations
--------------------------------------------------------------------------------
(in thousands, except share and per share amounts)
For the years ended December 31,
2007 2006 2005
---- ---- ----
Contract revenues . . . . . . . . . . . . . $ 653,164 $ 363,734 $ 280,139
Contract costs . . . . . . . . . . . . . . . 629,351 350,978 269,780
--------- --------- ---------
Gross profit . . . . . . . . . . . . . . . . 23,813 12,756 10,359
Selling, general and administrative expenses 1,505 694 580
Interest (income) expense, net . . . . . . . (699) (427) (210)
--------- --------- ---------
Income before income taxes . . . . . . . . . 23,007 12,489 9,989
Provision for income taxes . . . . . . . . . 8,905 4,700 3,820
--------- --------- ---------
Net income . . . . . . . . . . . . . . . . . $ 14,102 $ 7,789 $ 6,169
========= ========= =========
Basic earnings per share: $ 2.85 $ 1.64 $ 1.33
========= ========= =========
Basic weighted average shares outstanding 4,953,289 4,737,450 4,645,472
========= ========= =========
Diluted earnings per share: $ 2.82 $ 1.61 $ 1.29
========= ========= =========
Diluted weighted average shares
outstanding . . . . . . . . . . . . . . . . 5,003,675 4,848,884 4,784,054
========= ========= =========
The accompanying notes are an integral part of these statements.
39
VSE Corporation and Subsidiaries
Consolidated Statements of Stockholders' Equity
-----------------------------------------------------------------------------------------------
(in thousands except per share data)
Additional Deferred Total
Common Stock Paid-In Stock-based Retained Stockholders'
Shares Amount Capital Compensation Earnings Equity
------ ------ ------- ------------ -------- ------
Balance at
December 31, 2004 4,554 $ 228 $ 4,765 $ (4) $ 18,054 $23,043
Net income for the year . . - - - - 6,169 6,169
Exercised stock options . . 158 8 583 - - 591
Tax benefit of options
exercised . . . . . . . - - 761 - - 761
Deferred stock-based
compensation . . . . . . - - (3) - - (3)
Amortization of deferred
stock-based compensation. - - - 3 - 3
Issuance of stock . . . . . 8 - 124 - - 124
Dividends declared ($.12) . - - - - (537) (537)
----- ----- ------- ---- -------- -------
Balance at
December 31, 2005 4,720 236 6,230 (1) 23,686 30,151
Net income for the year . . - - - - 7,789 7,789
Stock-based compensation . 4 - 308 - - 308
Exercised stock options . . 62 4 253 - - 257
Excess tax benefits from
share-based payment
arrangements. . . . . . . - - 312 - - 312
Deferred stock-based
compensation . . . . . . - - - 1 - 1
Issuance of stock . . . . . 2 - 60 - - 60
Dividends declared ($.14) . - - - - (642) (642)
----- ----- ------- ---- -------- -------
Balance at
December 31, 2006 4,788 240 7,163 - 30,833 38,236
Net income for the year . . - - - - 14,102 14,102
Stock-based compensation . 5 - 551 - - 551
Exercised stock options . . 260 13 2,004 - - 2,017
Excess tax benefits from
share-based payment
arrangements. . . . . . . - - 2,245 - - 2,245
Dividends declared ($.16) . - - - - (775) (775)
----- ----- ------- ----- -------- -------
Balance at
December 31, 2007 5,053 $ 253 $11,963 $ - $ 44,160 $56,376
===== ===== ======= ===== ======== =======
The accompanying notes are an integral part of these statements.
40
VSE Corporation and Subsidiaries
Consolidated Statements of Cash Flows
------------------------------------------------------------------------------------------------
(in thousands)
For the years ended December 31,
2007 2006 2005
---- ---- ----
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . $14,102 $ 7,789 $ 6,169
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization . . . . . . . . . . . . . . 3,463 1,882 1,417
Loss on sale of property and equipment . . . . . . . . . . - 9 1
Deferred taxes . . . . . . . . . . . . . . . . . . . . . . (805) (614) (326)
Stock-based compensation . . . . . . . . . . . . . . . . . 551 308 -
Tax benefit of options exercised . . . . . . . . . . . . . - - 761
Changes in operating assets and liabilities,
net of impact of acquisition:
Accounts receivable, net . . . . . . . . . . . . . . . . . (59,141) (22,804) (3,652)
Contract inventories . . . . . . . . . . . . . . . . . . . 4,459 (186) 4,231
Other current assets and noncurrent assets . . . . . . . . (1,254) (1,310) (932)
Accounts payable and deferred compensation. . . . . . . . . 41,812 15,144 3,646
Accrued expenses . . . . . . . . . . . . . . . . . . . . . 4,826 1,308 4,256
Other liabilities . . . . . . . . . . . . . . . . . . . . . 235 105 55
------- ------- -------
Net cash provided by operating activities 8,248 1,631 15,626
------- ------- -------
Cash flows from investing activities:
Purchases of property and equipment . . . . . . . . . . . . . . (8,731) (5,618) (1,666)
Acquisition of ICRC, including acquisition costs . . . . . . . (11,755) - -
------- ------- -------
Net cash used in investing activities (20,486) (5,618) (1,666)
------- ------- -------
Cash flows from financing activities:
Borrowings on loan arrangement . . . . . . . . . . . . . . . . 9,589 - -
Repayments on loan arrangement . . . . . . . . . . . . . . . . (9,508) - (1,578)
Dividends paid . . . . . . . . . . . . . . . . . . . . . . . (741) (615) (510)
Excess tax benefits from share-based payment arrangements . . 2,245 312 -
Proceeds from the exercise of options of common stock . . . . 2,017 258 591
Proceeds from issuance of common stock . . . . . . . . . . . - 60 124
------- ------- -------
Net cash provided by (used in) financing activities 3,602 15 (1,373)
------- ------- -------
Net (decrease) increase in cash and cash equivalents . . . . . . (8,636) (3,972) 12,587
Cash and cash equivalents at beginning of year . . . . . . . . 8,745 12,717 130
------- ------- -------
Cash and cash equivalents at end of year . . . . . . . . . . . $ 109 $ 8,745 $12,717
======= ======= =======
Supplemental cash flow disclosures (in thousands):
2007 2006 2005
---- ---- ----
Cash paid during the year for:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6 $ - $ 2
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,139 $ 4,472 $ 3,153
The accompanying notes are an integral part of these statements.
41
VSE Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
(1) Nature of Business and Significant Accounting Policies
Nature of Business
The term "VSE" or "Company" means VSE and its subsidiaries and divisions
unless the context indicates operations of the parent company only.
VSE'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.
Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements consist of the operations of the
parent company, operations of the Company's unincorporated divisions and
wholly owned subsidiaries. The Company's subsidiaries include Energetics
Incorporated ("Energetics"), Integrated Concepts and Research Corporation
("ICRC") and VSE Services International, Incorporated, which is inactive.
Divisions include BAV Division ("BAV"), Coast Guard Division ("VCG"),
Communications and Engineering Division ("CED"), Engineering and Logistics
Division ("ELD"), Fleet Maintenance Division ("FMD"), Management Sciences
Division ("MSD"), Systems Engineering Division ("SED"), and Field Support
Services Division ("FSS") beginning in 2007. Intercompany sales are
principally at cost. All intercompany transactions have been eliminated in
consolidation.
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.
Stock-based Compensation
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS
No. 123R") using the modified prospective method. Under this method,
compensation costs for all awards granted after the date of adoption and the
unvested portion of previously granted awards outstanding at the date of
adoption are measured at estimated fair value. The compensation expense is
amortized on a straight-line basis over the requisite service period of the
grant and included in operating expenses over the vesting period during which
an employee provides service in exchange for the award. Accordingly, prior
period amounts presented herein have not been restated to reflect the adoption
of SFAS No. 123R.
42
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. The Statement of Cash
Flows has approximately $2.2 million and $312 thousand in excess tax benefits
classified as cash provided by financing activities for the years ended
December 31, 2007 and 2006, respectively. The amount of operating cash flows
recognized for such excess tax deductions for the year ended December 31, 2005
was approximately $761 thousand.
The following table illustrates the effect on net income and earnings
per share for the year ended December 31, 2005, if the Company had applied the
fair value recognition provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation," to all stock-
based employee compensation for the period prior to the adoption of SFAS No.
123(R)(in thousands, except per share amounts):
2005
----
Net income, as reported . . . . . . . . $6,169
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 . . (294)
------
Pro forma net income . . . . . . . . . $5,875
======
Earnings per share:
Basic - as reported . . . . . . . . . $1.33
Diluted - as reported . . . . . . . . $1.29
Basic - pro forma . . . . . . . . . . $1.27
Diluted - pro forma . . . . . . . . . $1.23
The weighted fair value of the stock 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:
Risk free interest rate . . . . . . . . 3.28%
Dividend yield . . . . . . . . . . . . 0.79%
Expected life . . . . . . . . . . . . . 3 years
Expected volatility . . . . . . . . . . 60.50%
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. All share amounts have been adjusted to give retroactive effect
to the increased number of common shares outstanding due to the June 2007
43
stock split. See Note 14 Capital Stock, for further discussion of the stock
split announced in May, 2007.
Years Ended December 31,
2007 2006 2005
---- ---- ----
Basic weighted average
common shares outstanding . . 4,953,289 4,737,450 4,645,472
Dilutive effect of options . . 50,386 111,434 138,582
--------- --------- ---------
Diluted weighted average
common shares outstanding . . 5,003,675 4,848,884 4,784,054
========= ========= =========
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Due to the short
maturity of these instruments, the carrying values on our consolidated balance
sheets approximate fair value.
Contract Inventories
Contract inventories consist of materials purchased and other
expenditures arising from contract requirements. Contract inventories are
stated at cost plus applicable indirect cost burdens, including general and
administrative costs. The cost of such contract inventories is expected to be
billed to the customer within a relatively short time.
Property and Equipment
Property and equipment is stated at cost. Depreciation of computer
systems equipment is provided principally by the double-declining method over
periods of three to five 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, 2007, 2006, and 2005.
The BAV contract accounted for approximately 17%, 29% and 43% of consolidated
revenues during 2007, 2006 and 2005, respectively. The CED Army Equipment
Support Programs started in 2006 and accounted for approximately 34% and 29% of
consolidated revenues during 2007 and 2006, 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 considered earned
when persuasive evidence of an arrangement exists, services have been
44
rendered, the price is fixed or determinable and collectibility is reasonably
assured.
Revenues on cost-type contracts are recorded as contract allowable costs
are incurred and fees 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 or 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 multiplied by the contract defined
billing rates, plus the direct costs and indirect cost burdens associated with
materials and subcontract work 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 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, and development 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. 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, based on total contract revenue compared to total contract costs,
by a charge to income during the period in which losses are first identified.
Contract costs include direct and indirect costs, including general and
administrative costs, which are considered costs and expenses of contracts.
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 2004 and prior years and partially audited
for 2005 with no 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 2007, 2006 and 2005 will not result in material adjustments to the
Company's results of operations or financial position.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivables are recorded at their face amount less an allowance
for doubtful accounts. VSE reviews its receivables regularly to determine if
there are any potential uncollectible accounts. The majority of VSE's
receivables are from agencies of the U.S. Government, where there is minimal
credit risk. The Company records allowances for bad debt as a reduction to
accounts receivable and an increase to bad debt expense. The Company assesses
the adequacy of these reserves by considering general factors, such as the
length of the time individual receivables are past due and historical
collection experience.
45
Deferred Compensation Plans
Deferred compensation plan expense for the years ended December 31,
2007, 2006, and 2005 was approximately $1.1 million, $769 thousand, and
$421 thousand, respectively.
Included in other assets are assets of the deferred compensation plans
which include debt and equity securities recorded at fair value. The fair
value of the deferred compensation plan assets was approximately $3.2 million
and $2.2 million as of December 31, 2007, and 2006, 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 include 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 Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets." The criteria for
determining impairment for such long-lived assets to be held and used are
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 as of December 31, 2007.
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 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 the
deferred tax assets will be realized through future taxable income and,
therefore, no valuation allowance is required.
The Company adopted the provisions of FIN 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,"
("FIN 48"), on January 1, 2007. As a result of the adoption of FIN 48, the
Company made a comprehensive review of its portfolio of uncertain tax
positions in accordance with recognition standards established by FIN 48. In
this regard, an uncertain tax position represents the Company's expected
treatment of a tax position taken in a filed tax return, or planned to be
taken in a future tax return, that has not been reflected in measuring income
tax expense for financial reporting purposes. As a result of this review and
subsequent reviews, the Company concluded that there are no uncertain tax
positions. As a result of applying the provisions of FIN 48, there was no
cumulative effect on retained earnings upon adoption. In addition, there were
no adjustments recorded during 2007 after the initial adoption of FIN 48.
46
Goodwill and Intangibles
The Company applies SFAS No. 141, "Business Combinations" ("SFAS No.
141") and No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142").
Under these rules, goodwill is not amortized but is subject to annual
impairment tests in accordance with SFAS No. 142. Annually, the Company
performs a fair value analysis of goodwill and indefinite-lived intangible
assets recorded with the acquisitions of Energetics and ICRC using valuation
techniques prescribed in SFAS No. 142. Based on the analysis performed as of
September 30, 2007, the Company determined that there had been no impairment
of goodwill.
Intangible assets consist of the value of contract related intangible
assets and the ICRC tradename acquired in the ICRC acquisition (see Note 6).
The contract related intangible assets are amortized on a straight line basis
over their estimated useful lives of approximately six to eight years with a
weighted average life of approximately 7.1 years as of December 31, 2007.
Recently Issued Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 141(R), "Business Combinations; a replacement of FASB
Statement No. 141," which will become effective January 1, 2009. The new
standard will replace existing guidance and significantly change accounting
and reporting relative to business combinations in consolidated financial
statements, including requirements to recognize acquisition-related
transaction and post acquisition restructuring costs in results of operations
as incurred. SFAS No. 141(R) will be effective for businesses acquired after
the effective date.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements," which is effective January 1, 2008. SFAS No. 157 defines fair
value, establishes a market-based framework or hierarchy for measuring fair
value and expands disclosures about fair value measurements. The new standard
generally is applicable whenever another accounting pronouncement requires or
permits assets and liabilities to be measured at fair value. On February 12,
2008, the FASB issued FASB Staff Position No. 157-2, "Effective Date of FASB
Statement No. 157," to delay the effective date of SFAS No. 157 for
nonfinancial assets and nonfinancial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a
recurring basis (that is, at least annually). For items with its scope, the
FSP defers the effective date of SFAS No. 157 to fiscal years beginning after
November 15, 2008, and interim periods within those fiscal years. Management
is continuing to evaluate the requirements of SFAS No. 157, but currently do
not expect that it will have a material impact on the Company's results of
operations, financial position or cash flows.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities - Including an Amendment of
FASB Statement No. 115," which also becomes effective January 1, 2008. Under
SFAS No. 159, a company may choose to measure certain financial instruments
(e.g., assets and liabilities) and certain other items not currently subject
to fair value measurement at fair value. If so elected, any unrealized gains
and losses from marking those items to market will be included in earnings in
each subsequent reporting period. The fair value option may be elected on an
instrument-by-instrument basis, with few exceptions. The Company does not
plan to elect the fair value option.
47
(2) Accounts Receivable
The components of accounts receivable as of December 31, 2007 and 2006,
were as follows (in thousands):
2007 2006
---- ----
Billed . . . . . . . . . . . . . . . . . . . . $ 45,045 $16,424
Unbilled:
Government retainage . . . . . . . . . . . . 179 28
Subcontract retainage . . . . . . . . . . . . 4,000 4,000
Other (principally December work billed in
January) . . . . . . . . . . . . . . . . . 83,176 46,292
Less-allowance for doubtful accounts . . . . . (11) (14)
-------- -------
Total accounts receivable, net $132,389 $66,730
======== =======
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 $357 thousand and $369
thousand as of December 31, 2007, and 2006, respectively.
Allowance for doubtful accounts are determined based on management's
best estimate of potentially uncollectible accounts receivable. The Company
writes off accounts receivable when such amounts are determined to be
uncollectible.
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, 2007 . . . . . . . . . $14 $ 3 $ - $11
For the year ended
December 31, 2006 . . . . . . . . . $56 $42 $ - $14
For the year ended
December 31, 2005 . . . . . . . . . $52 $22 $26 $56
(1) Write-offs and settlements
(3) Contract Inventories
Contract inventories consisted of work in process of approximately $0
and $4.4 million as of December 31, 2007 and 2006, respectively.
The Company has a contract to modify and apply a protective system, the
Tanker Ballistic Protection System ("TBPS"), to military vehicles for the U.S.
Army. Accounting convention requires that materials purchased and other
program expenditures for use on this contract be allocated ratably to the
vehicles to which the system is applied. Accordingly, materials purchased and
program expenditures made in advance of the delivery of vehicles with
completed TBPS systems to the customer are classified as contract inventories.
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.
48
As of December 31, 2007, the TBPS program had matured to the point where
enough vehicles had been delivered to the customer so that estimated materials
and program expenditures allocated to completed vehicles exceeded the amounts
purchased. Accordingly, the Company no longer has contract inventories
associated with the TBPS program and now has an amount included in accrued
expenses to reflect the estimated costs allocated to completed vehicles. The
amount of this liability is approximately $706 thousand as of December 31,
2007.
Contract inventories at December 31, 2006 included applicable indirect
cost burdens, including general and administrative costs totaling
approximately $608 thousand. Indirect cost burdens, including general and
administrative costs charged to contract costs for the years ended December
31, 2007 and 2006 totaled approximately $2.9 million and $3.9 million,
respectively.
(4) Other Assets
Other assets consisted of the following as of December 31, 2007 and 2006
(in thousands):
2007 2006
---- ----
Cash surrender value of life insurance policies . . $ 1,566 $ 1,516
Deferred compensation. . . . . . . . . . . . . . . . 3,212 2,183
Other assets . . . . . . . . . . . . . . . . . . . . 424 638
------- -------
Total other assets $ 5,202 $ 4,337
======= =======
(5) Property and Equipment
Property and equipment consisted of the following as of December 31,
2007 and 2006(in thousands):
2007 2006
---- ----
Computer systems equipment . . . . . . . . . . . . . $ 8,077 $ 6,064
Furniture, fixtures, equipment and other . . . . . . 5,845 4,945
Leasehold improvements . . . . . . . . . . . . . . . 3,541 3,256
Buildings and building improvements. . . . . . . . . 7,170 2,327
Land and land improvements . . . . . . . . . . . . . 1,805 1,175
------- -------
26,438 17,767
Less accumulated depreciation and amortization . . . (11,518) (9,358)
------- -------
Total property and equipment $14,920 $ 8,409
======= =======
Depreciation and amortization expense for property and equipment was
approximately $2.6 million for 2007, $1.8 million for 2006 and $1.4 million
for 2005.
(6) Acquisitions, Goodwill and Intangible Assets
On June 4, 2007, the Company acquired all of the common stock of ICRC of
Alexandria, Virginia. ICRC's core expertise lies in information technology,
advance vehicle technology, aerospace, engineering and transportation
infrastructure. Management believes that the addition of ICRC will provide the
Company with an opportunity to expand and diversify its business across a
number of project areas, including smart vehicles, alternate fuels, large-
scale port engineering development and security, and information technology
services. The results of ICRC's operations are included in the accompanying
consolidated financial statements beginning as of June 4, 2007.
The acquisition of ICRC in 2007 included initial cash payments of
approximately $11.8 million and potential additional cash payments of up to
approximately $5.8 million, contingent on meeting certain financial targets
during the next six years. Additionally, the Company has filed an election
under the Internal Revenue Code Section 338(h)(10) which treats the
transaction as a sale of assets for tax purposes. When this election is filed,
49
an additional payment will be made to the seller which represents the seller's
incremental tax liability as a result of the election. Tax advantages to the
Company that arise from filing the 338(h)(10) election will exceed the
additional payment that will be made to the seller of approximately $1.6
million which is included in goodwill and accrued expenses on the accompanying
December 31, 2007 balance sheet.
Of the initial $11.8 million purchase price, approximately $7.1 million
was recorded as contract related intangible assets to be amortized on a
straight line basis over six to eight years; approximately $1.5 million was
recorded as an intangible asset related to ICRC's tradename, which has an
indefinite life; and approximately $2 million was recorded as initial
goodwill. Additional goodwill and accrued expenses of approximately $557
thousand were recorded as of December 31, 2007 for the earn-out payment that
will be made to the seller as a result of the achievement of the specified
earnings target in 2007.
The Company is following the guidance of SFAS No. 141 to record the
purchase of ICRC. The Company has recognized the fair value of assets
acquired and liabilities assumed as follows (in thousands):
Description Fair Value
----------- ----------
Current assets $ 6,544
Property and equipment 429
Other assets 27
Intangibles - contract 7,134
Intangibles - tradename 1,500
Goodwill 4,174
-------
Total assets acquired 19,808
Liabilities assumed (5,880)
-------
Total purchase price $13,928
=======
The total purchase price includes additional purchase price
consideration related to the 2007 earn-out of approximately $557 thousand and
the 338(h)(10) election of approximately $1.6 million, as described above.
Changes in goodwill for the years ended December 31, 2007 and 2006 are
as follows (in thousands):
Infrastructure
and
Energy and Information
Environmental Technology Total
------------- ---------- -----
Balance as of December 31, 2005 $1,054 $ - $1,054
Additional goodwill upon acquisition - - -
------ ------ ------
Balance as of December 31, 2006 1,054 - 1,054
Additional goodwill upon acquisition - 4,174 4,174
------ ------ ------
Balance as of December 31, 2007 $1,054 $4,174 $5,228
====== ====== ======
The Company amortized approximately $600 thousand of intangible assets
during the year ended December 31, 2007 subsequent to the ICRC acquisition
date. Amortizable intangible assets as of December 31, 2007 were comprised of
the following (in thousands):
Gross Net
Carrying Accumulated Carrying
Value Amortization Value
----- ------------ -----
Contract related intangible
assets $7,134 $600 $6,534
====== ==== ======
50
Future expected amortization expense of the contract related intangible
asset is as follows (in thousands):
Amortization
Expense
-------
2008 $1,029
2009 1,029
2010 1,029
2011 1,029
2012 1,029
Thereafter 1,389
------
Total $6,534
======
(7) Debt
VSE has a loan agreement with a bank under which credit is made
available to the Company in the form of revolving loans or letters of credit.
The amount of credit available to the Company is $25 million, subject to
certain conditions, including a borrowing formula based on billed receivables.
The expiration date of the loan agreement is August 14, 2009. From time to
time the bank and the Company may amend the loan to increase or decrease the
amount of available credit, change the expiration date to a later date, or
make other changes in the terms of the agreement.
The loan agreement contains terms whereby the Company may borrow against
the revolving loan at any time and from time to time can 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 December 31, 2007 the Company has not been
notified by the bank, nor is the Company aware, of any default under the loan
agreement.
The Company pays a commitment fee, 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 December 31, 2007 and December
31, 2006, there were no letters of credit outstanding and revolving loan
amounts borrowed were approximately $81 thousand and $0, respectively.
Interest expense incurred on the loan was approximately $6 thousand for the
year ended December 31, 2007 and $0 for the years ended December 31, 2006 and
2005.
(8) Accrued Expenses
Accrued expenses consisted primarily of accrued compensation and
benefits of approximately $15 million and $10 million as of December 31, 2007
and 2006, respectively. The accrued compensation and benefits amounts include
bonus, salaries and related payroll taxes, vacation and deferred compensation.
(9) Stock-Based Benefit Plans
(a) Restricted Stock Plan
On January 2, 2006, the Company's stockholders approved the VSE
Corporation 2006 Restricted Stock Plan (the "2006 Plan") for its directors,
officers and other employees. Under the provisions of the 2006 Plan, the
Company is authorized to issue 250,000 shares of VSE common stock. The
Compensation Committee is responsible for the administration of the 2006 Plan.
The shares issued under the 2006 Plan may, at the Company's option, be either
shares held in treasury or shares originally issued. The Compensation
Committee shall determine each recipient of an award under the 2006 Plan, the
number of restricted shares of common stock subject to such award and the
51
period of continued employment required for the vesting of such award. These
terms will be included in award agreements between the Company and the
recipients of the award. As of December 31, 2007, 241,300 restricted shares
were available for grant under this plan.
During 2007 and 2006, the Company granted 5,100 shares and 3,600 shares,
respectively, of restricted VSE Stock to the Company's outside Directors
under the 2006 Restricted Stock Plan. The weighted-average grant-date fair
value of these restricted stock grants was approximately $18.02 and $15.75,
respectively. Compensation expense related to those grants was approximately
$92 thousand and $57 thousand for the years ended December 31, 2007 and 2006,
respectively. The shares issued vested immediately and cannot be sold,
transferred, pledged or assigned before the second anniversary of the grant
date.
On January 3, 2007, the Company notified certain employees that they
are eligible to receive awards under the 2006 Restricted Stock Plan for
calendar year 2007, based on financial performance for 2007. Vesting of each
award will occur one-third on the date of award and one-third on each of the
next two anniversaries of such date of award. The date of award determination
is expected to be on March 7, 2008, the approximate date when we plan to file
the 2007 Form 10-K with the SEC, in accordance with the 2006 Plan. On each
vesting date, 100% of the vested award will be paid in VSE shares. The number
of VSE shares issued is based on the fair market value of VSE stock on the
vesting date. The earned amount will be expensed ratably over the vesting
period of approximately three years, including the service period of one year
which begins on January 1, 2007, due to the Company concluding that certain of
the financial statement targets were achieved and the awards were earned.
As a result, the Company has recognized approximately $278 thousand in related
expense for the year ended December 31, 2007. At December 31, 2007, there was
approximately $602 thousand of unrecognized compensation costs related to
these restricted stock awards which the Company expects to recognize over the
next 26 months.
(b) Stock Option Plans
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 under
VSE's 1998 Stock Option Plan (the "1998 Plan") and VSE's 2004 Stock Option
Plan approved by VSE' stockholders on May 3, 2005 (the "2004 Plan"). All
options outstanding as of December 30, 2005, were not affected by this Board
action.
As of December 31, 2007, options issued under the 2004 Plan for up to
61,000 shares of common stock remain outstanding. Each option granted under
the 2004 Plan was issued at the fair market value of the common shares on the
date of grant. Each option vests 25% upon issuance and 25% on each
anniversary date thereafter, becoming 100% vested as of the third anniversary
date of the 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.
As of December 31, 2007, options issued under the 1998 Plan for up to
12,500 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.
52
Information with respect to the number of shares under stock options, as
adjusted for the June 28, 2007 stock split, is as follows:
Weighted
Average
Exercise
Shares Price
------ -----
Outstanding at January 1, 2007 333,250 $ 8.61
Granted . . . . . . . . - -
Exercised . . . . . . . (259,250) 7.78
Forfeited . . . . . . . (500) 12.59
Terminations . . . . . . - -
-------- ------
Outstanding at December 31, 2007 73,500 $11.53
======== ======
Exercisable at end
of year 73,500 $11.53
======== ======
Weighted average remaining
contractual life of options
outstanding and exercisable 1.8 years
The weighted-average grant-date fair value of options granted during
2005 was $12.59. No options were granted in 2006 or 2007. The assumptions
used to calculate the fair value of outstanding stock options are described in
Note 1, as there were no option grants in 2006 and 2007.
The total intrinsic value of options exercised during 2007, 2006 and
2005 was approximately $5.8 million, $827 thousand and $2.0 million,
respectively. The aggregate intrinsic value of options outstanding and
exercisable as of December 31, 2007 was approximately $2.7 million. The total
fair value of shares vested during the years ended December 31, 2007, 2006 and
2005 was approximately $1.7 million, $1.1 million and $2.0 million,
respectively. At December 31, 2007, there was no unrecognized compensation
cost related to nonvested stock options.
The following table summarizes the range of exercise prices for options
outstanding at December 31, 2007:
Outstanding Options and
Exercisable Options
--------------------------------
Weighted
Average Weighted
Contractual Average
Number of Life Exercise
Exercise Price Shares (in years) Price
-------------- ------ ---------- -----
$ 6.41 . . . . . . . . . 12,500 1.0 $ 6.41
$12.59 . . . . . . . . . 61,000 2.0 12.59
------ --- ------
Total 73,500 1.8 $11.53
====== === ======
53
(c) Stock Compensation Expense
Stock-based compensation, which includes compensation recognized on stock
option grants and restricted stock awards was included in the following line
items on the accompanying statement of operations for the years ended December
31, 2007 and 2006 (in thousands):
2007 2006
---- ----
Contract costs . . . . . . . . . . . . . . . . $370 $ 57
Selling, general and administrative expenses . 181 251
---- ----
Total pre-tax stock-based compensation
included in income before income taxes 551 308
Income tax benefit recognized for
stock-based compensation . . . . . . . . . . (212) (116)
---- ----
Total stock-based compensation expense,
net of tax $339 $192
==== ====
(10) Income Taxes
The Company adopted the provisions of FIN 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,"
("FIN 48"), on January 1, 2007. As a result of the adoption of FIN 48, the
Company made a comprehensive review of its portfolio of uncertain tax
positions in accordance with recognition standards established by FIN 48. In
this regard, an uncertain tax position represents the Company's expected
treatment of a tax position taken in a filed tax return, or planned to be
taken in a future tax return, that has not been reflected in measuring income
tax expense for financial reporting purposes. As a result of this review and
subsequent reviews, the Company concluded that there are no uncertain tax
positions, and as a result of applying the provisions of FIN 48, there was no
cumulative effect on retained earnings upon adoption. In addition, there were
no adjustments recorded during 2007 after the initial adoption of FIN 48.
The Company is subject to U.S. federal income tax as well as income tax
in multiple state and local jurisdictions. The Company has substantially
concluded all U.S. federal income tax matters for years through 2004.
Substantially all material state and local matters have been concluded for
years through 2003.
In the Consolidated Statements of Income, the Company classifies
interest expense related to unrecognized tax benefits as "Interest income,
net" and any penalties in "Selling, general and administrative expenses." No
interest or penalty expense related to unrecognized tax benefits was
recognized for the year ended December 31, 2007. As of December 31, 2007, no
interest or penalties related to unrecognized tax benefits were accrued.
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, 2007, 2006, and 2005
are as follows (in thousands):
2007 2006 2005
---- ---- ----
Current
Federal . . . . . . . . . . . . . . . . . . $8,326 $4,521 $3,475
State . . . . . . . . . . . . . . . . . . . 1,384 793 671
------ ------ ------
9,710 5,314 4,146
------ ------ ------
Deferred
Federal . . . . . . . . . . . . . . . . . . (702) (546) (288)
State . . . . . . . . . . . . . . . . . . (103) (68) (38)
------ ------ ------
(805) (614) (326)
------ ------ ------
Provision for income taxes $8,905 $4,700 $3,820
====== ====== ======
54
The differences between the amount of tax computed at the federal
statutory rate of 35% for 2007 and 34% for 2006 and 2005, and the provision
for income taxes for 2007, 2006, and 2005 are as follows (in thousands):
2007 2006 2005
---- ---- ----
Tax at statutory federal income
tax rate . . . . . . . . . . . . . . . . . $8,053 $4,246 $3,396
Increases (decreases) in tax resulting from:
State taxes, net of federal tax benefit . . 833 479 417
Permanent differences, net . . . . . . . . 19 15 6
Other, net . . . . . . . . . . . . . . . . - (40) 1
------ ------ ------
Provision for income taxes $8,905 $4,700 $3,820
====== ====== ======
The Company had no valuation allowances recorded for its deferred tax
assets as of December 31, 2007 and 2006. The Company's deferred tax assets
(liabilities) as of December 31, 2007 and 2006, 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):
2007 2006
---- ----
Current deferred tax assets . . . . . . . . . . . $1,494 $1,357
Current deferred tax liabilities . . . . . . . . . (248) (161)
------ ------
Net current deferred tax assets 1,246 1,196
------ ------
Noncurrent deferred tax assets . . . . . . . . . . 2,704 1,974
Noncurrent deferred tax liabilities . . . . . . . . (816) (841)
------ ------
Net noncurrent deferred tax assets . . . . . . 1,888 1,133
------ ------
Net deferred tax assets $3,134 $2,329
====== ======
The tax effect of temporary differences representing deferred tax assets
and liabilities as of December 31, 2007 and 2006, are as follows (in
thousands):
2007 2006
---- ----
Gross deferred tax assets
Deferred compensation and accrued paid leave . . . $2,658 $2,048
Depreciation . . . . . . . . . . . . . . . . . . . 870 758
Accrued expenses . . . . . . . . . . . . . . . . . 360 236
Reserve for contract and other disallowances . . . 199 153
Stock option expense . . . . . . . . . . . . . . . 73 96
Retainage . . . . . . . . . . . . . . . . . . . . 34 35
Reserve for doubtful accounts . . . . . . . . . . 4 5
------ ------
Total gross deferred tax assets 4,198 3,331
------ ------
Gross deferred tax liabilities
Depreciation . . . . . . . . . . . . . . . . . . . (610) (594)
Deferred revenues . . . . . . . . . . . . . . . . (210) (141)
Intangible assets . . . . . . . . . . . . . . . . (206) (230)
Retainage . . . . . . . . . . . . . . . . . . . . (27) (20)
Accrued expenses . . . . . . . . . . . . . . . . . (11) (17)
------ ------
Total gross deferred tax liabilities (1,064) (1,002)
------ ------
Net deferred tax assets $3,134 $2,329
====== ======
(11) Commitments and Contingencies
(a) 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. The terms of the facilities leases typically provide for certain
minimum payments as well as increases in lease payments based upon the
operating cost of the facility and the consumer price index. Rent expense is
55
recognized on a straight-line basis for rent agreements having escalating
rent. Payments on these leases for 2007, 2006, and 2005 were as follows (in
thousands):
Payments Sublease Net
on Leases Income Expense
--------- ------ -------
2007 . . . . . . . . . . . $7,180 $ 981 $6,199
2006 . . . . . . . . . . . 4,128 930 3,198
2005 . . . . . . . . . . . 3,733 922 2,811
Future minimum annual non-cancelable commitments as of December 31, 2007
are as follows (in thousands):
Lease Sublease Net
Commitments Income Commitments
----------- ------ -----------
2008 . . . . . . . . . . . $ 7,313 $ 503 $ 6,810
2009 . . . . . . . . . . . 5,957 294 5,663
2010 . . . . . . . . . . . 5,146 208 4,938
2011 . . . . . . . . . . . 4,539 216 4,323
2012 . . . . . . . . . . . 3,638 224 3,414
Thereafter . . . . . . . . 3,660 77 3,583
------- ------ -------
Total $30,253 $1,522 $28,731
======= ====== =======
(b) Contingencies
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. However, the results of
any legal proceedings cannot be predicted with certainty.
(12) Business Segments and Customer Information
Segment Information
Management of VSE's business operations is conducted under four
reportable operating segments, the Federal Group, the International Group, the
Energy and Environmental Group, and the Infrastructure and Information
Technology Group. These segments operate under separate management teams and
discrete financial information is produced for each segment. The divisions
within the Federal Group and the International Group are operating segments
under SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," ("SFAS No. 131"), and meet the aggregation of operating segments
criteria of SFAS No. 131. The Company evaluates segment performance based on
consolidated revenues and profits or losses from operations before income
taxes. The accounting policies of each segment are the same as the policies
described in Note 1.
Federal Group - VSE's Federal Group provides engineering, technical,
management, integrated logistics support, and information technology services
to all U.S. military services and other government agencies. It consists of
four divisions: CED, ELD, MSD and SED.
International Group - VSE's International Group provides engineering,
industrial, logistics, and foreign military sales services to the U.S.
military and other government agencies. It consists of three divisions: BAV,
VCG and FMD.
Energy and Environmental Group - VSE's Energy and Environmental Group
provides high-level consulting services in the field of energy and
environmental management. The Energy and Environmental Group includes VSE's
wholly owned subsidiary, Energetics, Inc.
56
Infrastructure and Information Technology Group - VSE's Infrastructure
and Information Technology Group is a recent segment due to the acquisition on
June 4, 2007 of its wholly owned subsidiary, ICRC. ICRC is engaged principally
in providing diversified technical and management services to the U.S.
Government, including information technology, advanced vehicle technology,
aerospace services, and engineering and transportation infrastructure
services.
The Company's segment information is as follows (in thousands):
2007 2006 2005
---- ---- ----
Revenues:
Federal Group $360,690 $190,956 $ 81,628
International Group 228,002 158,452 185,784
Energy and Environmental Group 14,522 14,269 12,693
Infrastructure and Information
Technology Group 49,918 - -
Corporate 32 57 34
-------- -------- --------
Total revenues $653,164 $363,734 $280,139
======== ======== ========
Income before income taxes:
Federal Group $ 12,075 $ 5,432 $ 5,118
International Group 7,435 5,487 3,700
Energy and Environmental Group 1,614 1,795 1,353
Infrastructure and Information
Technology Group 2,808 - -
Corporate/unallocated expenses (925) (225) (182)
-------- -------- --------
Income before income taxes $ 23,007 $ 12,489 $ 9,989
======== ======== ========
Interest (income) expense:
Federal Group $ (252) $ 423 $ 266
International Group (124) (258) (30)
Energy and Environmental Group (272) (218) (116)
Infrastructure and Information
Technology Group (44) - -
Corporate (7) (374) (330)
-------- -------- --------
Total interest (income) expense $ (699) $ (427) $ (210)
======== ======== ========
Total assets:
Federal Group $ 74,204 $ 40,670 $ 15,649
International Group 49,438 33,541 33,373
Energy and Environmental Group 3,860 4,174 3,087
Infrastructure and Information
Technology Group 14,885 - -
Corporate 29,384 20,150 21,757
-------- -------- --------
Total assets $171,771 $ 98,535 $ 73,866
======== ======== ========
Depreciation and amortization expense:
Federal Group $ 1,514 $ 1,044 $ 487
International Group 890 655 764
Energy and Environmental Group 184 183 166
Infrastructure and Information
Technology Group 875 - -
-------- -------- --------
Total depreciation and amortization $ 3,463 $ 1,882 $ 1,417
======== ======== ========
Capital expenditures:
Federal Group $ 6,401 $ 2,258 $ 773
International Group 332 519 336
Energy and Environmental Group 75 99 72
Infrastructure and Information
Technology Group 34 - -
Corporate 1,889 2,742 485
-------- -------- --------
Total capital expenditures $ 8,731 $ 5,618 $ 1,666
======== ======== ========
57
Revenues are net of inter-segment eliminations. Corporate/unallocated
expenses are primarily selling, general and administrative expenses not
allocated to segments. Corporate assets are primarily cash and fixed assets.
Customer Information
The Company is engaged principally in providing engineering, design,
logistics, management and technical services to 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. The Company's revenue by
customer is as follows (in thousands):
VSE Revenues by Customer
(dollars in thousands)
2007 2006 2005
Source of Revenue Revenues % Revenues % Revenues %
----------------- -------- - -------- - -------- -
Army/Army Reserve $344,296 52.7 $174,473 48.0 $ 56,019 20.0
Navy 189,534 29.0 164,788 45.3 196,363 70.1
Other 119,334 18.3 24,473 6.7 27,757 9.9
-------- ----- -------- ----- -------- -----
Total Revenues $653,164 100.0 $363,734 100.0 $280,139 100.0
======== ===== ======== ===== ======== =====
VSE does not measure revenue or profit by product or service lines,
either for internal management or external financial reporting purposes,
because it would be impractical to do so. Products offered and services
performed are determined by contract requirements and the types of products
and services provided for one contract bear no relation to similar products
and services provided on another contract. Products and services provided vary
when new contracts begin or current contracts expire. In many cases, more than
one product or service is provided under a contract or contract task order.
Accordingly, cost and revenue tracking is designed to best serve contract
requirements and segregating costs and revenues by product or service lines in
situations for which it is not required would be difficult and costly to both
VSE and its customers.
(13) Capital Stock
Common Stock
The Company's common stock has a par value of $.05. Proceeds from the
issue of the common stock that is greater than $.05 per share is credited to
additional paid in capital. Holders of shares of common stock are entitled to
one vote per common share held on all matters voted on by the Company's
stockholders. Stockholders of record are entitled to the amount of dividend
declared per common share held.
Stock Split
In May, 2007, VSE announced a two for one stock split in the form of a
100% stock dividend payable to stockholders of record as of June 11, 2007.
The stock dividend became effective on June 28, 2007. All share and per share
amounts have been adjusted to give retroactive effect to the increased number
of common shares outstanding due to the stock split.
(14) ESOP/401(k) Plan and Profit Sharing Plan
VSE has an ESOP/401(k) plan that allows employees meeting certain age
and service requirements to contribute a portion of their salary to certain
investment trusts. Under the terms of the plan, employer 401(k) contributions
are made on behalf of the eligible employee participants based on the
employees' 401(k) payroll deferrals. Effective January 1, 2007, the plan was
amended to incorporate the Safe Harbor method of meeting nondiscrimination
requirements of the Internal Revenue Code. Beginning with the 2007 plan year,
the employer contribution is equal to 100% of the employee deferral on the
first 3% of the employee pay deferred and 50% of the employee deferral on the
58
next 2% of the employee pay deferred. The Company expense associated with this
plan for 2007, 2006, and 2005 was approximately $1.4 million, $584 thousand,
and $578 thousand, respectively. The increase in Company expense in 2007 as
compared to prior years was due to: (1) an increase in the number of employees
receiving an employer contribution as a result of new employees hired and the
eligibility of Energetics' employees to receive employer contributions; and
(2) the change in the rate of employer contributions associated with the use
of the Safe Harbor method of meeting nondiscrimination requirements in 2007.
Prior to April 1, 1999, the Company made contributions under this plan
into an ESOP 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. Subsequent to April 1, 1999, the ESOP contributions were discontinued
and replaced by employer 401(k) contributions. The ESOP/401(k) plan held
446,978 shares and 477,734 shares of VSE stock as of December 31, 2007 and
2006, 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 its 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 2007, 2006, and 2005 was $227 thousand, $412
thousand, and $420 thousand, respectively.
ICRC sponsors a 401(k) profit sharing plan covering all ICRC regular
status employees. To be eligible to participate in the plan, an employee must
have completed one month of service with ICRC. The discretionary employer
contributions are immediately vested. The amount charged to operations for
employer contributions during the post acquisition period of June 2007 through
December 31, 2007 was approximately $378 thousand.
(15) Selected Quarterly Data (Unaudited)
The following table shows selected quarterly data for 2007 and 2006, in
thousands, except earnings per share:
2007 Quarters
-------------
1st 2nd 3rd 4th
--- --- --- ---
Revenues . . . . . . . . . . . . . . . $120,689 $159,644 $174,692 $198,139
======== ======== ======== ========
Gross profit . . . . . . . . . . . . . $ 4,441 $ 5,740 $ 5,945 $ 7,687
======== ======== ======== ========
Net income . . . . . . . . . . . . . . $ 2,729 $ 3,547 $ 3,359 $ 4,467
======== ======== ======== ========
Basic earnings per share . . . . . . . $ .57 $ .72 $ .67 $ .89
======== ======== ======== ========
Weighted average shares outstanding . 4,807 4,932 5,024 5,046
======== ======== ======== ========
Diluted earnings per share . . . . . . $ .56 $ .71 $ .66 $ .88
======== ======== ======== ========
Weighted average shares outstanding . 4,890 4,977 5,063 5,082
======== ======== ======== ========
2006 Quarters
-------------
1st 2nd 3rd 4th
--- --- --- ---
Revenues . . . . . . . . . . . . . . . $63,300 $94,844 $103,630 $101,960
======= ======= ======== ========
Gross profit . . . . . . . . . . . . . $ 2,388 $ 3,490 $ 3,173 $ 3,705
======= ======= ======== ========
Net income . . . . . . . . . . . . . . $ 1,485 $ 2,027 $ 1,889 $ 2,388
======= ======= ======== ========
Basic earnings per share . . . . . . . $ .31 $ .43 $ .40 $ .50
======= ======= ======== ========
Weighted average shares outstanding . 4,722 4,734 4,742 4,752
======= ======= ======== ========
Diluted earnings per share . . . . . . $ .31 $ .42 $ .39 $ .49
======= ======= ======== ========
Weighted average shares outstanding . 4,866 4,840 4,842 4,846
======= ======= ======== ========
59
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
Our management has evaluated, with the participation of our Chief
Executive Officer and Chief Financial Officer, the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-
15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act).
Based on this evaluation, our Chief Executive Officer and Chief Financial
Officer have concluded that, as of such date, our disclosure controls and
procedures were effective to ensure that information we are required to
disclose in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms and that such information
is accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure.
Management's Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange
Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the
participation of our management, including our Chief Executive Officer and
Chief Financial Officer, we conducted an assessment of the effectiveness of
our internal control over financial reporting as of December 31, 2007 based on
the framework in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on our
assessment under the framework in Internal Control - Integrated Framework ,
our management concluded that our internal control over financial reporting
was effective as of December 31, 2007. Ernst & Young LLP, the Company's
independent registered public accounting firm, has issued an opinion on the
Company's internal control over financial reporting. This opinion appears in
the Report of Independent Registered Public Accounting Firm under Item 9(a) of
this Annual Report on Form 10-K.
Management's assessment of and conclusion on the effectiveness of
internal control over financial reporting did not include the internal
controls of Integrated Concepts and Research Corporation ("ICRC"), which was
acquired June 4, 2007. ICRC is included in the December 31, 2007 consolidated
financial statements, and constituted approximately $14.9 million and $1.2
million of total and net assets, respectively, as of December 31, 2007 and
approximately $49.9 million and $2.1 million of revenues and net income,
respectively, for the year then ended.
Change in Internal Controls
During the fourth quarter of fiscal year 2007, there were no changes in
our internal control over financial reporting (as defined in Rules 13a-15(f)
and 15d-15(f) under the Securities Exchange Act of 1934, as amended) that have
materially affected these controls, or are reasonably likely to materially
affect these controls subsequent to the evaluation of these controls.
60
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of VSE Corporation
We have audited VSE Corporation's internal control over financial reporting as
of December 31, 2007, based on criteria established in Internal Control-
Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (the COSO criteria). VSE Corporation's management is
responsible for maintaining effective internal control over financial
reporting, and for its assessment of the effectiveness of internal control
over financial reporting included in the accompanying Management's Report on
Internal Control over Financial Reporting. Our responsibility is to express an
opinion on the Company's internal control over financial reporting based on
our audit.
We conducted our audit 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
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk, and performing such other
procedures as we considered necessary in the circumstances. We believe that
our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets
of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts
and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Management's Report on Internal Control over
Financial Reporting, management's assessment of and conclusion on the
effectiveness of internal control over financial reporting did not include the
internal controls of Integrated Concepts & Research Corporation, which is
included in the 2007 consolidated financial statements of VSE Corporation and
constituted approximately $14.9 million and $1.2 million of total and net
assets, respectively, as of December 31, 2007 and approximately $49.9 million
and $2.1 million of revenues and net income, respectively, for the year then
ended. Our audit of internal control over financial reporting of VSE
Corporation also did not include an evaluation of the internal control over
financial reporting of Integrated Concepts & Research Corporation.
In our opinion, VSE Corporation maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2007,
based on the COSO criteria.
61
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
VSE Corporation and subsidiaries as of December 31, 2007 and 2006, and the
related consolidated statements of income, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2007 and
our report dated March 5, 2008 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean, VA
March 5, 2008
62
ITEM 9B. Other Information
None.
PART III
Except as otherwise indicated below, 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) to Form 10-K and is incorporated herein by reference
to the Company's definitive proxy statement relating to its Annual Meeting of
Stockholders scheduled for May 6, 2008 (the "Proxy Statement") to be filed
with the SEC.
ITEM 10. Directors, Executive Officers and Corporate Governance
The information required by this Item is incorporated by reference to
the Proxy Statement.
ITEM 11. Executive Compensation
The information required by this Item is incorporated by reference to
the Proxy Statement.
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
Except for the "Equity Compensation Plan Information" disclosed in Item
5(d) above, the information required by this Item is incorporated by reference
to the Proxy Statement.
ITEM 13. Certain Relationships and Related Transactions, and Director
Independence
The information required by this Item is incorporated by reference to
the Proxy Statement.
ITEM 14. Principal Accountant Fees and Services
The information required by this Item is incorporated by reference to
the Proxy Statement.
PART IV
ITEM 15. Exhibits, Financial Statement Schedules
1. Financial Statements
The consolidated financial statements are listed under Item 8 of
this report.
2. Supplemental Financial Statement Schedules
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, notes to the consolidated financial statements, or supplementary
financial information.
63
3. Exhibits
See "Exhibit Index" hereinafter contained and incorporated by
reference.
64
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 7, 2008 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/ D M. Ervine Chairman, President, March 7, 2008
---------------------------- Chief Executive Officer and
Donald M. Ervine Chief Operating Officer
/s/ T. R. Loftus Executive Vice President and March 7, 2008
---------------------------- Chief Financial Officer
Thomas R. Loftus (Principal Financial and
Accounting Officer)
/s/ C. M. Kendall Director March 7, 2008
----------------------------
Clifford M. Kendall
/s/ C. S. Koonce Director March 7, 2008
----------------------------
Calvin S. Koonce
/s/ J. F. Lafond Director March 7, 2008
----------------------------
James F. Lafond
/s/ D. M. Osnos Director March 7, 2008
----------------------------
David M. Osnos
Director March 7, 2008
----------------------------
Jimmy D. Ross
/s/ B. K. Wachtel Director March 7, 2008
----------------------------
Bonnie K. Wachtel
/s/ R. E. Eberhart Director March 7, 2008
----------------------------
Ralph E. Eberhart
65
EXHIBIT INDEX
Reference No. Exhibit No.
per Item 601 of in this
Regulation S-K Description of Exhibit Form 10-K
-------------- ---------------------- ---------
2.1 Plan of acquisition, reorganization, arrangement,
liquidation or succession
Share Purchase Agreement, dated as of June 4, 2007,
by and among VSE Corporation, Koniag, Inc.,
Koniag Development Corporation, Nancy Ellen Lexo
Living Trus, James W. Lexo, Jr., and Integrated
Concepts and Research Corporation (Exhibit 2.1 to
Form 8-K dated June 4, 2007) *
3.1 Articles of incorporation and by-laws
Restated Certificate of Incorporation of VSE
Corporation dated as of February 6, 1996 (Exhibit
3.2 to Form 10-K405 dated March 25, 1996) *
3.2 By-Laws of VSE Corporation as amended through
November 1, 2005 (Exhibit 3.1 to Form 8-K dated
November 1, 2005) *
3.3 By-Laws of VSE Corporation as amended through
October 4, 2007(Exhibit 3.1 to Form 8-K dated
October 4, 2007) *
4.1 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) * +
10.1 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) * +
10.2 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) * +
10.3 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) * +
10.4 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) * +
10.5 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) * +
10.6 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) * +
10.7 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) * +
10.8 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) * +
10.9 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) * +
10.10 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) * +
66
EXHIBIT INDEX
Reference No. Exhibit No.
per Item 601 of in this
Regulation S-K Description of Exhibit Form 10-K
-------------- ---------------------- ---------
13.1 Annual report to security holders, Form 10-Q
or selected quarterly data Exhibit 13
21.1 Subsidiaries of the Registrant Exhibit 21
23.1 Consent of Ernst & Young LLP, independent
registered public accounting firm Exhibit 23.1
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
99.1 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.
+Indicates management contract or compensatory plan or arrangement.
67