UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the Quarterly Period Ended September 29, 2006
--------------------------
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _______ to _______
Commission File Number 1-9309
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VersarInc.
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(Exact name of registrant as specified in its charter)
DELAWARE 54-0852979
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
6850 Versar Center
Springfield, Virginia 22151
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(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code (703) 750-3000
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Not Applicable
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(Former name, former address and former fiscal year, if changed since
last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by 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.
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Class of Common Stock Outstanding at November 1, 2006
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$.01 par value 8,146,364
VERSAR, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
PAGE
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PART I - FINANCIAL INFORMATION
ITEM 1 - Financial Statements
Consolidated Balance Sheets as of
September 29, 2006 and June 30, 2006 3
Consolidated Statements of Operations for the
Three-Month Periods Ended September 29, 2006
and September 30, 2005 4
Consolidated Statements of Cash Flows
for the Three-Month Periods Ended September 29, 2006
and September 30, 2005 5
Notes to Consolidated Financial Statements 6-11
ITEM 2 - Management's Discussion and Analysis
of Financial Condition and Results of Operations 12-17
ITEM 3 - Quantitative and Qualitative Disclosures About
Market Risk 17
ITEM 4 - Controls and Procedures 17
PART II - OTHER INFORMATION
ITEM 1 - Legal Proceedings 17-18
ITEM 6 - Exhibits 18
SIGNATURES 19
EXHIBITS 20-23
2
VERSAR, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In Thousands)
September 29, June 30,
2006 2006
------------- -------------
ASSETS (Unaudited)
Current assets
Cash and cash equivalents $ 2,935 $ 140
Accounts receivable, net 14,853 16,227
Prepaid expenses and other current assets 1,576 1,430
Deferred income taxes 566 566
------------- -------------
Total current assets 19,930 18,363
Property and equipment, net 1,670 1,744
Deferred income taxes 1,144 1,144
Goodwill 776 776
Other assets 770 775
------------- -------------
Total assets $ 24,290 $ 22,802
============= =============
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities
Accounts payable $ 5,407 $ 4,691
Billings in excess of revenue 33 209
Accrued salaries and vacation 1,836 1,474
Other liabilities 2,677 2,585
Liabilities of discontinued operations, net 213 285
------------- -------------
Total current liabilities 10,166 9,244
Other long-term liabilities 928 986
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Total liabilities 11,094 10,230
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Commitments and contingencies
Stockholders' equity
Common stock, $.01 par value; 30,000,000
shares authorized; 8,148,192 shares and
8,144,692 shares issued; 8,132,687 and
8,129,187 shares outstanding at September
29, 2006 and June 30, 2006, respectively 81 81
Capital in excess of par value 22,808 22,790
Accumulated deficit (9,621) (10,227)
Treasury stock (72) (72)
------------- -------------
Total stockholders' equity 13,196 12,572
------------- -------------
Total liabilities and stockholders'
equity $ 24,290 $ 22,802
============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
3
VERSAR, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited - in thousands, except per share amounts)
For the Three-Month
Periods Ended
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September 29, September 30,
2006 2005
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GROSS REVENUE $ 22,285 $ 13,502
Purchased services and materials, at cost 13,671 5,040
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NET SERVICE REVENUE 8,614 8,462
Direct costs of services and overhead 6,466 6,875
Selling, general and administrative expenses 1,497 1,451
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OPERATING INCOME 651 136
OTHER EXPENSE
Interest expense, net 11 20
Income tax expense 34 ---
------------- -------------
NET INCOME $ 606 $ 116
============= =============
NET INCOME PER SHARE - BASIC AND DILUTED $ 0.07 $ 0.01
============= =============
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING - BASIC 8,148 7,988
============= =============
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING - DILUTED 8,429 8,412
============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
4
VERSAR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited - in thousands)
For the Three-Month
Periods Ended
------------- -------------
September 29, September 30,
2006 2005
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Cash flows from operating activities
Net income $ 606 $ 116
Adjustments to reconcile net income
to net cash provided by operating
activities
Depreciation and amortization 179 192
Provision for doubtful accounts
receivable 25 ---
Share based compensation 8 4
Changes in assets and liabilities
Decrease in accounts receivable 1,349 2,725
(Increase) decrease in prepaids
and other assets (135) 583
Increase (decrease) in accounts payable 716 (449)
Increase in accrued salaries and vacation 362 338
Decrease in other liabilities (142) (1,112)
------------- -------------
Net cash provided by continuing
operating activities 2,968 2,397
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Changes in net liabilities of
discontinued operations (72) (130)
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Net cash provided by operating
activities 2,896 2,267
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Cash flows used in investing activities
Purchase of property and equipment (85) (107)
Increase in life insurance policies
cash surrender value (26) (35)
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Net cash used in investing
activities (111) (142)
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Cash flows from financing activities
Net payments on bank line of credit --- (777)
Proceeds from issuance of common stock 10 285
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Net cash provided by (used in)
financing activities 10 (492)
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Net increase in cash and cash equivalents 2,795 1,633
Cash and cash equivalents at the beginning
of the period 140 132
------------- -------------
Cash and cash equivalents at the end of
the period $ 2,935 $ 1,765
============= =============
Supplementary disclosure of cash flow
information:
Cash paid during the period for
Interest $ 9 $ 23
Income taxes 7 10
The accompanying notes are an integral part of these
consolidated financial statements.
5
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(A) Basis of Presentation
The accompanying consolidated financial statements are presented in
accordance with the requirements of Form 10-Q and consequently do not
include all of the disclosures normally required by generally accepted
accounting principles or those normally made in Versar, Inc.'s Annual
Report on Form 10-K filed with the United States Securities and Exchange
Commission. These financial statements should be read in conjunction
with the Company's Annual Report filed on Form 10-K for the year ended
June 30, 2006 for additional information.
The accompanying consolidated financial statements include the
accounts of Versar, Inc. and its wholly-owned subsidiaries ("Versar" or
the "Company"). All significant intercompany balances and transactions
have been eliminated in consolidation. The financial information has been
prepared in accordance with the Company's customary accounting practices.
In the opinion of management, the information reflects all adjustments
necessary for a fair presentation of the Company's consolidated financial
position as of September 29, 2006, and the results of operations for the
three-month periods ended September 29, 2006 and September 30, 2005.
The results of operations for such periods, however, are not necessarily
indicative of the results to be expected for a full fiscal year.
(B) Accounting Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results may differ from those estimates.
(C) Contract Accounting
Contracts in process are stated at the lower of actual cost incurred
plus accrued profits or net estimated realizable value of incurred costs,
reduced by progress billings. The Company records income from major
fixed-price contracts, extending over more than one accounting period,
using the percentage-of-completion method. During performance of such
contracts, estimated final contract prices and costs are periodically
reviewed and revisions are made as required. The effects of these
revisions are included in the periods in which the revisions are made.
On cost-plus-fee contracts, revenue is recognized to the extent of costs
incurred plus a proportionate amount of fee earned, and on time-and-material
contracts, revenue is recognized to the extent of billable rates times hours
delivered plus material and other reimbursable costs incurred. Losses on
contracts are recognized when they become known. Disputes arise in the
normal course of the Company's business on projects where the Company is
contesting with customers for collection of funds because of events such as
delays, changes in contract specifications and questions of cost allowability
or collectibility. Such disputes, whether claims or unapproved change orders
in the process of negotiation, are recorded at the lesser of their estimated
net realizable value or actual costs incurred and only when realization is
probable and can be reliably estimated. Claims against the Company are
recognized where loss is considered probable and reasonably determinable in
amount. Management reviews outstanding receivables on a regular basis and
assesses the need for reserves taking into consideration past collection
history and other events that bear on the collectibility of such receivables.
(D) Income Taxes
At September 29, 2006, the Company had approximately $4.6 million in
deferred tax assets which primarily relate to net operating loss and tax
credit carryforwards. Since the Company had experienced losses in previous
years, management recorded a valuation allowance of approximately $2.8
million against the net deferred tax asset. The valuation allowance is
adjusted periodically based upon management's assessment of the Company's
ability to derive benefit from the deferred tax assets.
6
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(E) Debt
The Company has a line of credit facility with United Bank (the Bank)
that provides for advances up to $5,000,000 based upon qualifying
receivables. Interest on borrowings is based on the prime rate of interest
(8.25% as of September 29, 2006). As of September 29, 2006, there were no
borrowings outstanding under the line of credit. Obligations under the
credit facility are guaranteed by the Company and each subsidiary
individually and collectively secured by accounts receivable, equipment and
intangibles, plus all insurance policies on property constituting collateral.
The credit facility matures in November 2007. The line of credit is subject
to certain covenants related to the maintenance of financial ratios. These
covenants require a minimum tangible net worth of $8,500,000, a maximum
total liabilities to tangible net worth ratio not to exceed 2.5 to 1; and
a minimum current ratio of at least 1.25 to 1. Failure to meet the covenant
requirements gives the Bank the right to demand outstanding amounts due
under the line of credit, which may impact the Company's ability to finance
its working capital requirements. At September 29, 2006, the Company was
in compliance with the financial covenants.
The Company believes that the borrowing capacity under the line of
credit, together with anticipated cash flows from operations, is sufficient
to meet the Company's liquidity needs. There can be no assurance, however,
that amounts available in the future from existing sources of liquidity
will be sufficient to meet future capital needs.
(F) Discontinued Operations and Restructuring Charges
In fiscal year 1998, the Company discontinued a significant portion
of the operations of Science Management Corporation (SMC). Since 1998,
the Company has disposed of substantially all of the remaining assets and
liabilities of SMC with the exception of certain defined benefit obligations.
In the second quarter of fiscal year 2006, the Company recorded an additional
$205,000 liability based on a revised actuarial calculation of the remaining
SMC pension plan obligation. In the fourth quarter of fiscal year 2006, an
additional $85,000 accrual was deemed necessary to cover the under funding
and plan termination costs. At September 29, 2006, there was an accrual of
approximately $213,000 to cover the cost to terminate the SMC pension plan in
accordance with the Pension Guaranty Corporation Benefit (PBGC) requirements.
The Company has received Internal Revenue Service (IRS) and PBGC plan
termination approval and is in the process of locating eligible participants
in the pension plan and intends to make a final distribution as early as
administratively practical.
(G) Contingencies
Versar and its subsidiaries are parties to various legal actions
arising in the normal course of business. The Company believes that the
ultimate resolution of these legal actions will not have a material adverse
effect on its consolidated financial position and results of operations.
(See Part II, Item 1 - Legal Proceedings).
(H) Goodwill and Other Intangible Assets
On January 30, 1998, Versar completed the acquisition of The Greenwood
Partnership, P.C. subsequently renamed (Versar Global Solutions, Inc. or
VGSI). The transaction was accounted for as a purchase. Goodwill resulting
from this transaction was approximately $1.1 million. In fiscal year 2003,
the Company adopted the Statement of Financial Accounting Standards (SFAS)
No. 142, "Goodwill and Other Intangible Assets" which eliminated the
amortization of goodwill, but requires the Company to test such goodwill
for impairment annually. The carrying value of goodwill of approximately
$776,000 relating to the acquisition of VGSI, is included in the
Infrastructure and Management Services (IMS) reporting unit. Such a
combination provided a more efficient use of resources and more effective
management of the business operations. In performing its goodwill impairment
analysis, management has utilized a market-based valuation approach to
determine the estimated fair value of the
7
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
IMS reporting unit. Management engages outside professionals and
valuation experts, as necessary, to assist in performing this analysis.
An analysis was performed on public companies and company transactions to
prepare a market-based valuation. Based upon the analysis, the estimated
fair value of the IMS reporting unit was $25 million which exceeds the
carrying value of its net assets by a substantial margin. Should the IMS
reporting unit financial performance not meet estimates, then impairment
of goodwill would have to be further assessed to determine whether a
write down of goodwill value would be warranted. If such a write down
were to occur, it would negatively impact the Company(s financial position
and results of operations. However, it would not impact the Company's
cash flow or financial debt covenants.
On April 15, 2005, the Company acquired the Cultural Resources Group
from Parsons Infrastructure & Technology Group, Inc., a subsidiary of
Parsons Corporation for a purchase price of approximately $260,000 in cash.
The Cultural Resources Group, based in Fairfax County, Virginia provides
archaeological, cultural and historical services to federal, state and
municipal clients across the country. The acquisition expanded the
Company's existing and future capabilities in cultural resources work
enhancing and complimenting Versar's environmental core business.
The Cultural Resources Group was incorporated into the Company's IMS
segment. As part of the acquisition, the Company executed a two year
marketing agreement with Parsons which gives Versar the first right
of refusal to certain Parsons cultural resources work from existing
Parsons' clients. Thereafter, this agreement is annually renewable
should both parties agree. Substantially all of the purchase price was
allocated to contract rights and is being amortized over a three-year
period.
(I) Net Income Per Share
Basic net income per common share is computed by dividing net
income by the weighted average number of common shares outstanding
during the period. Diluted net income per common share also includes
common stock equivalents outstanding during the period if dilutive.
The Company's common stock equivalents shares consist of stock
options and restricted stock.
For the Three-Month Periods Ended
---------------------------------
September 29, September 30,
2006 2005
-------------- --------------
Weighted average common shares
outstanding - basic 8,147,879 7,987,872
Effect of assumed exercise of
options 281,251 423,716
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Weighted average common shares
outstanding - diluted 8,429,130 8,411,588
============== ==============
(J) Common Stock
The Company issued 3,500 shares of common stock upon the exercise
of stock options during the first three months of fiscal year 2007.
Total proceeds from the exercise of such stock options were approximately
$10,000.
Effective January 1, 2005, the Company implemented an Employee Stock
Purchase Plan (ESPP) to allow eligible employees of Versar the opportunity
to acquire an ownership interest in the Company's common stock. As amended,
the Plan permits employees to purchase shares of Versar common stock from
the open market at 95% of its fair market value. The Plan qualifies as an
"employee stock purchase plan" under Section 423 of the Internal Revenue
Code.
8
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(K) Stock-Based Compensation
Effective July 1, 2005, the Company adopted the Financial Accounting
Standards Board (FASB) SFAS No. 123 (Revised 2004), "Accounting for
Stock-Based Compensation" (SFAS 123(R)). This Statement revises SFAS No.
123 by eliminating the option to account for employee stock options under
APB No. 25 and generally requires companies to recognize the cost of
employee services received in exchange for awards of equity instruments
based on the grant-date fair value of those awards (the "fair-value-based"
method). The compensation expense of $7,000 for the first quarter of
fiscal year 2007 was included in the Consolidated Statements of Operations.
On June 21, 2005, the Board of Directors of the Company accelerated
the vesting of certain unvested "out-of-the-money" employee options that
had exercise prices of $3.00 or more per share. The awards subject to
acceleration were made under the Versar, Inc. 1996 Stock Option Plan and
2002 Stock Incentive Plan. As a result, options to purchase 306,010 shares
of the Company's common stock became exercisable immediately. All other
terms and conditions applicable to the outstanding stock option grants
remained in effect. The acceleration of the out-of-the-money stock
options was done in order to avoid the impact of adopting SFAS 123(R).
Based on the potential for these options to have value over their
expected term, the Company estimated stock-based compensation of expense
it otherwise would have been required to recognize in its consolidated
statements of income by approximately $124,000.
In November 2005, the stockholders approved the Versar, Inc. 2005
Stock Incentive Plan (the 2005 Plan). The 2005 Plan provides for grants
of incentive awards, including stock options, SARS, restricted stock,
restricted stock units and performance based awards, to directors,
officers and employees of the Company and its affiliates as approved
from time to time by the Company's Compensation Committee. Only employees
may receive stock options classified as "incentive stock options", also
known as "ISO's". The per share exercise price for options and SARS
granted under the 2005 Plan shall not be less than the fair market value
of the common stock on the date of grant. A maximum of 400,000 shares of
Common Stock may be awarded under the 2005 Plan. No single director,
officer, or employee may receive awards as to more than 100,000 shares
of Common Stock during the term of the 2005 Plan. The ability to make
awards under the 2005 Plan will terminate in November 2015.
In November 2002, the stockholders approved the Versar, Inc. 2002
Stock Incentive Plan (the 2002 Plan). The 2002 Plan provides for the grant
of options, restricted stock and other types of stock-based awards to any
employee, service provider or director to whom a grant is approved from
time to time by the Company's Compensation Committee. A "service provider"
is defined for purposes of the 2002 Plan as an individual who is neither
an employee nor a director of the Company or any of its affiliates but
who provides the Company or one of its affiliates substantial and
important services. The aggregate number of shares of the Company's Common
Stock that may be issued upon exercise of options or granted as restricted
stock or other stock-based awards under the 2002 Plan is 700,000. Grants
of restricted stock, performance equity awards, options and stock
appreciation rights in any one fiscal year to any one participant may not
exceed 250,000 shares. The maximum amount of compensation that may be
received by any one employee with respect to performance unit grants in
any one fiscal year may not exceed $250,000.
In November 1996, the stockholders approved the Versar 1996 Stock
Option Plan (the 1996 Plan) to provide employees and directors of the
Company and certain other persons an incentive to remain as employees of
the Company and to encourage superior performance. The Company also
maintains the Versar 1992 Stock Option Plan (the "1992 Plan"). Options
have been granted under these plans to purchase the Company's common stock.
Under the 1996 Plan, through September 2006, options were granted to
key employees, directors and service providers at the fair market value on
the date of grant. The vesting of each option was determined by the
Administrator of the Plan. Each option expires on the earlier of the last
day of the tenth year after the date of grant or after expiration of a
period designated in the option agreement. The 1996 Plan has expired and
no additional options may be granted under this plan. The Company will
continue to maintain the plan until all previously granted options have
been exercised, forfeited or expire.
9
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Under the 1992 Plan, through November 2002, options were generally
granted to key employees at the fair market value on the date of grant and
became exercisable during the five-year period from the date of the grant
at 20% per year. Options were granted with a ten year term and expire
if not exercised by the tenth anniversary of the grant date. The 1992
plan has expired and no additional options may be granted under this plan.
The Company will continue to maintain the plan until all previously
granted options have been exercised, forfeited or expire.
As a result of adopting SFAS 123(R) on July 1, 2005, the Company's
income before income taxes for the first quarter ended September 29, 2006
and September 30, 2005 was reduced by stock-based compensation expense of
$7,000 and $4,000, respectively. Basic and diluted earnings per share for
the first quarter ended September 29, 2006 remained the same at $0.07.
A summary of the Company's stock option plans as of September 29,
2006, and changes during the first quarter of fiscal year 2007 is
presented below:
Weighted-
Weighted- Average Aggregate
Options Average Remaining Intrinsic
Shares Exercise Contractual Value
(000) Price Term ($000)
------------------- ------------ -------------- ------------- ----------
Outstanding at
July 1, 2006 1,230 $ 3.15
Exercised (3) $ 2.92
Forfeited or expired (17) $ 3.46
------------ --------------
Outstanding at
September 29, 2006 1,210 $ 3.14 5.75 $ 2,120
============ ============== ============= ==========
Exercisable at
September 29, 2006 1,071 $ 3.12 5.96 $ 1,884
============ ============== ============= ==========
As of September 29, 2006, there were unvested options to purchase
approximately 108,000 shares outstanding under the plans. Estimated
compensation costs of $34,000 are expected to be recognized over a
weighted-average period of 4.2 years. The total fair value of these
unvested options is approximately $161,000 as of September 29, 2006.
(L) Business Segments
The Company's business segments are Infrastructure and Management
Services and National Security. The Infrastructure and Management Services
segment provides a full range of services including remediation/corrective
actions, site investigations, remedial designs, and construction, operation
and maintenance of remedial systems, engineering, design and construction
management to industrial, commercial and government facilities. The
National Security segment provides expertise in developing, testing and
providing personal protection equipment.
10
VERSAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
The Company evaluates and measures the performance of its business
segments based on net service revenue and operating income. As such,
selling, general and administrative expenses, interest and income taxes
have not been allocated to the Company's business segments.
Summary financial information for each of the Company's segments
follows:
For the Three-Month Periods Ended
--------------- ---------------
September 29, September 30,
2006 2005
--------------- ---------------
NET SERVICE REVENUE (In thousands)
-------------------
Infrastructure and Management
Services $ 7,367 $ 7,052
National Security 1,247 1,410
--------------- ---------------
$ 8,614 $ 8,462
=============== ===============
OPERATING INCOME(A)
-------------------
Infrastructure and Management
Services $ 2,124 $ 1,326
National Security 24 261
--------------- ---------------
$ 2,148 $ 1,587
Selling, general and
administrative expenses (1,497) (1,451)
--------------- ---------------
OPERATING INCOME $ 651 $ 136
=============== ===============
(A)Operating income is defined as net service revenue less direct costs of
services and overhead.
IDENTIFIABLE ASSETS September 29, June 30,
------------------- 2006 2006
--------------- ---------------
Infrastructure and Management
Services $ 15,215 $ 16,456
National Security 1,590 1,777
Corporate and Other 7,485 4,569
--------------- ---------------
Total Assets $ 24,290 $ 22,802
=============== ===============
11
ITEM 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations
Financial trends
----------------
In fiscal year 2006, the Company's gross revenues continued to decline
primarily due to the continuation of federal government delays in funding,
which in certain instances, spanned as much as nine months and the
continued diversion of funding to the war in Iraq. The Company adapted to
the funding shifts by expanding its services in Iraq under existing
contracts and seeking new contract work in Iraq. By the end of fiscal
year 2006, the project funding began to return to normal levels and the
Company's funded backlog increased by 55% to $48 million. For the first
quarter of fiscal year 2007, the Company was able to further increase its
funded backlog, to $65 million at September 29, 2006, an increase of 35%
over that reported at June 30, 2006. The increase was primarily
attributable to increased funding of construction work as a result of the
U.S. government's year end funding of project work. Management continues
to pursue many business opportunities to continue such growth.
There are a number of risk factors or uncertainties that could
significantly impact our financial performance including the following:
. General economic or political conditions;
. Threatened or pending litigation;
. The timing of expenses incurred for corporate initiatives;
. Employee hiring, utilization, and turnover rates;
. The seasonality of spending in the federal government and for
commercial clients;
. Delays in project contracted engagements;
. Unanticipated contract changes impacting profitability;
. Reductions in prices by our competitors;
. The ability to obtain follow-on project work;
. Failure to properly manage projects resulting in additional costs;
. The cost of compliance for the Company(s laboratories;
. The impact of a negative government audit potentially impacting our
costs, reputation and ability to work with the federal government;
. Loss of key personnel;
. The ability to compete in a highly competitive environment;
. Federal funding delays due to war in Iraq, and funding of Iraq
support; and
. Changes in political parties and the impact to funding of
priorities.
12
ITEM 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Results of Operations
---------------------
First Quarter Comparison of Fiscal Year 2007 and 2006
-----------------------------------------------------
This report contains certain forward-looking statements which are
based on current expectations. Actual results may differ materially. The
forward-looking statements include those regarding the continued award of
future work or task orders from government and private clients, cost
controls and reductions, the expected resolution of delays in billing of
certain projects, and the possible impact of current and future claims
against the Company based upon negligence and other theories of liability.
Forward-looking statements involve numerous risks and uncertainties that
could cause actual results to differ materially, including, but not
limited to, the possibilities that the demand for the Company's services
may decline as a result of changes in general and industry specific
economic conditions and the effects of competitive services and pricing;
the possibility the Company will not be able to perform work within budget
or contractual limitations; one or more current or future claims made
against the Company may result in substantial liabilities; the possibility
the Company will not be able to attract and retain key professional
employees; changes to or failure of the Federal government to fund certain
programs in which the Company participates; and such other risks and
uncertainties as are described in reports and other documents filed by the
Company from time to time with the Securities and Exchange Commission.
Gross revenue for the first quarter of fiscal year 2007 was
$22,285,000, an $8,783,000 (65%) increase over that reported in the first
quarter of fiscal year 2006. Approximately sixty-six percent of the
increase is due to growth in construction work in support of the
Air Force and the State Department. The remaining amount of the increase
is due to additional work in Iraq to provide personnel services for the
Army, which was awarded to the Company in fiscal year 2006.
Purchased services and materials increased by $8,631,000 (171%)
in the first quarter of fiscal year 2007 compared to that reported in the
first quarter of fiscal year 2006. The increase was the result of the
increased gross revenues as mentioned above.
Net service revenue is derived by deducting the costs of purchased
services and materials from gross revenue. Versar considers it
appropriate to analyze operating margins and other ratios in relation
to net service revenue, because such revenues reflect the actual work
performed by the Company's labor force. Net service revenues increased
by 2% in the first quarter of fiscal year 2007 compared to that reported
in the first quarter of fiscal year 2006. The increase was primarily due
to the markup on the increased purchased services and materials.
Direct costs of services and overhead include the cost to Versar of
direct and overhead staff, including recoverable and unallowable costs that
are directly attributable to contracts. The percentage of these costs to
net service revenue decreased to 75.1% in the first quarter of fiscal year
2007 compared to 81.2% in the first quarter of fiscal year 2006. The
decrease was primarily due to increased labor utilization and reduced
facility costs over that reported in the prior fiscal year reporting period.
Selling, general and administrative expenses approximated 17.4% of net
service revenue in the first quarter of fiscal year 2007, compared to 17.1%
in the first quarter of fiscal year 2006. The slight increase is primarily
due to costs associated with the Company's reinstitution of its in-house
corporate proposal development capacity in the first quarter of fiscal year
2007 to address the Company's business growth and future business
opportunities.
Operating income for the first quarter of fiscal year 2007 was
$651,000, a $515,000 increase over that reported in the prior fiscal year.
The increase is primarily due to the increased gross revenues and the
decreased direct costs of services and overhead as discussed above.
13
ITEM 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Interest expense for the first quarter of fiscal year 2007 was
$11,000, a decrease of $9,000 (45%) over that reported in the prior
fiscal year. The decrease was due to reduced usage of the Company's line
of credit and the effect of interest income earned during the quarter on
cash balances invested with the United Bank.
In the first quarter of fiscal year 2007, the company recorded $34,000
of tax expenses associated with the various annual minimum tax filing
requirements for the Company.
Versar's net income for the first quarter of fiscal year 2007 was
$606,000 compared to $116,000 in the first quarter of fiscal year 2006.
The increased earnings were primarily due to increased gross revenues and
reduced direct costs of services and overhead as discussed above.
Liquidity and Capital Resources
-------------------------------
The Company's working capital as of September 29, 2006 approximated
$9,764,000, an increase of $645,000 (7%). In addition, the Company's
current ratio was 1.96, which was slightly less than June 30, 2006.
The reduction was primarily due to the increased business growth of the
Company increasing both accounts receivables and accounts payables in the
first quarter of fiscal year 2007.
The Company has a line of credit facility with United Bank (the Bank)
that provides for advances up to $5,000,000 based upon qualifying
receivables. Interest on borrowings is based on the prime rate of interest
(8.25% as of September 29, 2006). As of September 29, 2006, there were no
borrowings outstanding under the line of credit. Obligations under the
credit facility are guaranteed by the Company and each subsidiary
individually and collectively secured by accounts receivable, equipment and
intangibles, plus all insurance policies on property constituting collateral.
The credit facility matures in November 2007. The line of credit is subject
to certain covenants related to the maintenance of financial ratios. These
covenants require a minimum tangible net worth of $8,500,000, a maximum total
liabilities to tangible net worth ratio not to exceed 2.5 to 1; and a minimum
current ratio of at least 1.25 to 1. Failure to meet the covenant
requirements gives the Bank the right to demand outstanding amounts due under
the line of credit, which may impact the Company's ability to finance its
working capital requirements. At September 29, 2006, the Company was in
compliance with the financial covenants.
We believe that with our current cash position along with anticipated
cash flows will be sufficient to meet the Company?s liquidity needs within
the next year. Expected capital requirements for fiscal year 2007 are
approximately $400,000 primarily to maintain our existing information
technology systems. Such capital requirements will either be funded through
existing working capital or will be financed through third party sources.
Critical Accounting Policies and Related Estimates That Have a Material
-----------------------------------------------------------------------
Effect on Versar's Consolidated Financial Statements
----------------------------------------------------
Below is a discussion of the accounting policies and related estimates
that we believe are the most critical to understanding the Company's
consolidated, financial position, and results of operations which require
management judgments and estimates, or involve uncertainties. Information
regarding our other accounting policies is included in the notes to our
consolidated financial statements included elsewhere in this report on
Form 10-Q and our annual report on Form 10-K filed for our 2006 fiscal year.
Revenue recognition: Contracts in process are stated at the lower of
actual costs incurred plus accrued profits or net estimated realizable value
of costs, reduced by progress billings. On cost-plus fee contracts, revenue
is recognized to the extent of costs incurred plus a proportionate amount of
fee earned, and on time-and material contracts, revenue is recognized to the
extent of billable rates times hours delivered plus material and other
reimbursable costs incurred. The Company records income from major
fixed-price contracts, extending over more than one accounting period, using
the percentage-of-completion method. During the performance of such
contracts, estimated final contract prices and costs are periodically
reviewed and revisions are made as required. Fixed price contracts can be
significantly impacted by changes in contract performance, contract delays,
liquidated damages and
14
ITEM 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
penalty provisions, and contract change orders, which may affect the
revenue recognition on a project. Losses on contracts are recognized in the
period when they become known.
There is the possibility that there will be future and currently
unforeseeable significant adjustments to our estimated contract revenues,
costs and margins for fixed price contracts, particularly in the later
stages of these contracts. It is likely that such adjustments could occur
with our larger fixed priced projects. Such adjustments are common in the
construction industry given the nature of the contracts. These adjustments
could either positively or negatively impact our estimates due to the
circumstances surrounding the negotiations of change orders, the impact of
schedule slippage, subcontractor claims and contract disputes which are
normally resolved at the end of the contract. Adjustments to the financial
statements are made when they are known.
Allowance for doubtful accounts: Disputes arise in the normal course
of the Company's business on projects where the Company is contesting with
customers for collection of funds because of events such as delays, changes
in contract specifications and questions of cost allowability or
collectibility. Such disputes, whether claims or unapproved change orders
in process of negotiation, are recorded at the lesser of their estimated
net realizable value or actual costs incurred and only when realization is
probable and can be reliably estimated. Claims against the Company are
recognized where loss is considered probable and reasonably determinable
in amount. Management reviews outstanding receivables on a regular basis
and assesses the need for reserves, taking into consideration past
collection history and other events that bear on the collectibility of such
receivables.
Deferred tax valuation allowance: The Company has approximately
$4.6 million in deferred tax assets of which a $2.8 million valuation
allowance has been established against such assets. Management provides
for a valuation allowance until such time as it can conclude more likely
than not that the Company will derive a benefit from such assets. The
valuation allowance is adjusted as necessary based upon the Company's
ability to generate taxable income, including management's ability to
implement tax strategies that will enable the Company to benefit from
such deferred tax assets.
Goodwill and other intangible assets: On January 30, 1998, Versar
completed the acquisition of The Greenwood Partnership, P.C. subsequently
renamed (Versar Global Solutions, Inc. or VGSI). The transaction was
accounted for as a purchase. Goodwill resulting from this transaction was
approximately $1.1 million. In fiscal year 2003, the Company adopted the
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets" which eliminated the amortization of goodwill,
but requires the Company to test such goodwill for impairment annually.
The carrying value of goodwill of approximately $776,000 relating to the
acquisition of VGSI, is included in the Infrastructure and Management
Services (IMS) reporting unit. Such a combination provided a more
efficient use of resources and more effective management of the business
operations. In performing its goodwill impairment analysis, management
has utilized a market-based valuation approach to determine the estimated
fair value of the IMS reporting unit. Management engages outside
professionals and valuation experts, as necessary, to assist in performing
this analysis. An analysis was performed on public companies and company
transactions to prepare a market-based valuation. Based upon the analysis,
the estimated fair value of the IMS reporting unit was $25 million which
exceeds the carrying value of its net assets by a substantial margin.
Should the IMS reporting unit financial performance not meet estimates,
then impairment of goodwill would have to be further assessed to determine
whether a write down of goodwill value would be warranted. If such a write
down were to occur, it would negatively impact the Company's financial
position and results of operations. However, it would not impact the
Company's cash flow or financial debt covenants.
On April 15, 2005, the Company acquired the Cultural Resources Group
from Parsons Infrastructure & Technology Group, Inc., a subsidiary of
Parsons Corporation for a purchase price of approximately $260,000 in cash.
The Cultural Resources Group, based in Fairfax County, Virginia provides
archaeological, cultural and historical services to federal, state and
municipal clients across the country. The acquisition expanded the
Company's existing and future capabilities in cultural resources work
enhancing and complimenting Versar's environmental core business. The
Cultural Resources Group was incorporated into the Company's IMS segment.
15
ITEM 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
As part of the acquisition, the Company executed a two year marketing
agreement with Parsons which gives Versar the first right of refusal to
certain Parsons cultural resources work from existing Parsons' clients.
Thereafter, this agreement is annually renewable should both parties agree.
Substantially all of the purchase price was allocated to contract rights and
is being amortized over a three-year period.
Stock-based compensation: Effective July 1, 2005, the Company
adopted the Financial Accounting Standards Board (FASB) SFAS No. 123
(Revised 2004), "Share-Based Payment" (SFAS 123(R)). This Statement
revised SFAS No. 123 by eliminating the option to account for employee
stock options under APB No. 25 and related interpretations and generally
requires companies to recognize the cost of employee services received in
exchange for awards of equity instruments based on the grant-date fair value
of those awards (the "fair-value-based" method).
On June 21, 2005, the Board of Directors of the Company accelerated
the vesting of certain unvested "out-of-the-money" employee options that
had exercise prices of $3.00 or more per share. The awards acceleration
were made under the Versar, Inc. 1996 Stock Option Plan and 2002 Stock
Incentive Plan. As a result, options to purchase 306,010 shares of the
Company's common stock became exercisable immediately. All other terms
and conditions applicable to the outstanding stock option grants remained
in effect. The acceleration of the out-of-the-money stock options was
done in order to avoid the impact of adopting SFAS 123(R). Based on the
potential for these options to have value over their expected term, the
Company estimated stock-based compensation of expense it otherwise would
have been required to recognize in its consolidated statements of income by
approximately $124,000.
New accounting pronouncements: On July 13, 2006, the Financial
Accounting Standards Board (FASB) issued FIN No. 48, Accounting for
Uncertainty of Income Taxes, which is an interpretation of FAS 109,
Accounting for Income Taxes. The FASB issued FIN No. 48 to address
concerns about the diversity in financial reporting of tax positions
with uncertainty. The regulation prevents the recording of tax benefits
of a transaction unless it is more-likely-than-not that the benefits
from a tax position will be realized in the financial statements.
FIN No. 48 becomes effective as of July 1, 2007. The Company is
currently evaluating the impact of the adoption of this standard to
determine any potential impact to the consolidated financial results
of the Company.
In September 2006, the Financial Accounting Standard Board
issued a Statement of Financial Accounting Standards (SFAS) No. 157.
The Statement defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles (GAAP), and
expands disclosures about fair value measurements. This Statement is
effective for financial statements issued for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal years.
Management believes that the adoption of SFAS 157 will not have a material
impact on the consolidated financial results of the Company.
In September 2006, the Securities and Exchange Commission (SEC)
released Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 expresses
the SEC staff's views regarding the process of quantifying financial
statement misstatements. These interpretations were issued to address
diversity in practice and the potential under current practice for the
build up of improper amounts on the balance sheet. SAB 108 expresses
the SEC staff's view that a registrant's materiality evaluation of an
identified unadjusted error should quantify the effects of the error on
each financial statement and related financial statement disclosures and
that prior year misstatements should be considered in quantifying
misstatements in current year financial statements. SAB 108 also states
that correcting prior year financial statements for immaterial errors
would not require previously filed reports to be amended. Such correction
may be made the next time the registrant files the prior year financial
statements. Registrants electing not to restate prior periods should
reflect the effects of initially applying the guidance in SAB 108 in their
annual financial statements covering the first fiscal year ending after
November 15, 2006. The cumulative effect of the initial application
should be reported in the carrying amounts of assets and liabilities as of
the beginning of that fiscal year and the offsetting adjustment should be
made to the opening balance of retained earnings for that year. Registrants
should disclose the nature and amount of each individual error being
corrected in the cumulative adjustment. The disclosure should also include
when and how each error arose and the fact that the errors had
16
previously been considered immaterial. The SEC staff encourages early
application of the guidance in SAB 108 for interim periods of the first
fiscal year ending after November 15, 2006.
Impact of Inflation
-------------------
Versar seeks to protect itself from the effects of inflation. The
majority of contracts the Company performs are for a period of a year or
less or are cost plus fixed-fee type contracts and, accordingly, are less
susceptible to the effects of inflation. Multi-year contracts provide
for projected increases in labor and other costs.
Contingencies
-------------
Versar and its subsidiaries are parties to various legal actions
arising in the normal course of business. The Company believes that
the ultimate resolution of these legal actions will not have a material
adverse effect on its consolidated financial position and results of
operations. (See Part II, Item 1 - Legal Proceedings).
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes regarding the Company's market
risk position from the information provided on Form 10-K for the fiscal
year end June 30, 2006.
Item 4 - Procedures and Controls
As of the last day of the period covered by this report, the
Company carried out an evaluation, under the supervision of the Company's
Chief Executive Officer and Chief Financial Officer, of the effectiveness
of the design and operation of the Company's disclosure controls and
procedures pursuant to Exchange Act Rule 13a-15. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are
effective, as of such date, to ensure that required information will be
disclosed on a timely basis in its reports under the Exchange Act.
Further, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures have been designed
to ensure that information required to be disclosed in reports filed by us
under the Exchange Act is accumulated and communicated to our management,
including the Chief Executive Officer and Chief Financial Officer, in a
manner to allow timely decisions regarding the required disclosure.
There were no changes in the Company's internal control over
financial reporting during the last quarter that have materially affected,
or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
In August 1997, Versar entered into a contract with the Trustees for
the Enviro-Chem Superfund Site, which provided that, based upon an existing
performance specification, Versar would refine the design of, and construct
and operate a soil vapor extraction system. During the performance of the
contract, disputes arose between Versar and the Trustees regarding the scope
of work. Eventually, Versar was terminated by the Trustees for convenience.
The Trustees then failed to pay certain invoices and retainages due Versar.
On March 19, 2001, Versar instituted a lawsuit against the Trustees and
three environmental consulting companies in the U.S. District Court of the
Eastern District of Pennsylvania, entitled Versar, Inc. v. Roy O. Ball,
Trustee, URS Corporation, Environmental Resources Management and Environ
Corp., No. 01CV1302. Versar, in seeking to recover amounts due under the
remediation contract from the Trustees of the Superfund Site, claimed breach
of contract, interference with contractual relationships, negligent
misrepresentations, breach of good faith and fair dealing, unjust enrichment
and implied contract. Mr. Ball and several defendants moved to dismiss the
action or, in the alternative, transfer the action to the U.S. District
Court for the Southern District of Indiana, where,
17
on April 20, 2001, the two Trustees had filed suit against Versar in the
U.S. District Court for the Southern District of Indiana, entitled,
Roy O. Ball and Norman W. Bernstein, Trustees v. Versar, Inc., Case
No. IPO1-0531 C H/G. The Trustees alleged breach of contract and breach of
warranty with respect to the remediation contract and asked for a
declaratory judgment on a number of the previously stated claims.
On July 12, 2001, the Federal District Court in Pennsylvania granted
defendants' motion to transfer the Pennsylvania lawsuit and consolidate
the two legal actions in Indiana. The Company filed an answer and
counterclaim to the Indiana lawsuit. The plaintiffs and third-party
defendants filed Motions to Dismiss the Company(s counterclaim. The court
granted the motions in part and denied them in part. Versar amended its
answer and counterclaim. In the meantime, plaintiffs filed a Motion for
Partial Summary Judgment which the Judge granted in part and denied in part.
The Judge held that certain agreements entered into by the parties
prevented Versar from recovering certain amounts under its counterclaim
but that Versar could pursue its claim for fraud in other areas.
Written and oral discovery which has continued for several years is now
completed. The court granted Versar's demand that the Trustees supply
requested information and documents. Versar continues to seek additional
discovery compliance by the Trustees. Motions for summary judgment were
filed by both parties. On September 5, 2006, the court granted, in part
and denied in part, the Trustees' claim that Versar was obligated to achieve
certain clean up criteria and eliminated certain, but not all, defenses
raised by Versar in its counterclaims. The court also granted Versar
summary judgement on one of the Trustees' breach of contract claims.
The court also denied both parties motions to exclude certain expert
testimony. Preliminary settlement discussions have taken place under the
Court's auspices. Trial is presently scheduled for February 26, 2007.
The Company continues to evaluate the impact of the Trustees' claim and
Versar's defenses and other avenues of potential recoveries. Based upon
discussions with outside counsel and assuming expected defenses and
recoveries are available, management does not believe that the ultimate
resolution under the Trustees' lawsuit will have a materially adverse
effect on the Company's consolidated financial condition and results of
operations.
Versar and its subsidiaries are parties from time to time to various
other legal actions arising in the normal course of business. The Company
believes that any ultimate unfavorable resolution of these legal actions
will not have a material adverse effect on its consolidated financial
condition and results of operations.
Item 6 - Exhibits
(a) Exhibits
31.1 and 31.2 - Certification pursuant to Securities Exchange Act
Section 13a-14.
32.1 and 32.2 - Certification under Section 906 of the Sarbanes-Oxley
Act of 2002.
18
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERSAR, INC.
------------
(Registrant)
By: /S/ Theodore M. Prociv
------------------------
Theodore M. Prociv
Chief Executive Officer,
President, and Director
By: /S/ Lawrence W. Sinnott
------------------------
Lawrence W. Sinnott
Executive Vice President,
Chief Operating Officer,
Chief Financial Officer,
Treasurer, and Principal
Accounting Officer
Date: November 13, 2006
19