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VSEC > SEC Filings for VSEC > Form 10-Q on 1-May-2014All Recent SEC Filings

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Form 10-Q for VSE CORP


1-May-2014

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Executive Overview

We provide sustainment services for legacy systems and equipment and professional and technical services to the United States Government (the "government"), including the United States Department of Defense ("DoD"), the United States Postal Service ("USPS"), and federal civilian agencies, and to other customers. Our largest customers are the DoD and the USPS. Our operations consist primarily of vehicle fleet parts, supply chain management, vehicle and equipment maintenance and refurbishment, logistics, engineering, energy and environmental, IT solutions, health care IT, and consulting services performed on a contract basis.

Organization and Reporting Segments

Our operations are conducted within four reportable segments aligned with our management groups: 1) Supply Chain Management; 2) International; 3) Federal; and
4) IT, Energy and Management Consulting.

Supply Chain Management Group - Our Supply Chain Management Group provides sourcing, acquisition, scheduling, transportation, shipping, logistics, data management, and other services to assist our clients with supply chain management efforts. This group consists of our Wheeler Bros., Inc. ("WBI") subsidiary. Significant current work efforts for this group include WBI's ongoing Managed Inventory Program ("MIP") that supplies vehicle parts for the USPS truck fleet and other clients.

International Group - Our International Group provides engineering, industrial, logistics, maintenance, information technology, fleet-wide ship and aircraft support, aircraft sustainment and maintenance, facility operations, storage and disposal support for seized and forfeited general property programs, and foreign military sales services to the U.S. military branches, government agencies, and other customers. This group provides its services to the U.S. Navy, Department of Treasury, Air Force, Department of Justice, Bureau of Alcohol, Tobacco, Firearms and Explosives ("ATF"), and other customers. Significant work efforts for this group include ongoing assistance to the U.S. Navy in executing its Foreign Military Sales ("FMS") Program for surface ships sold, leased or granted to foreign countries, various task orders under the U.S. Air Force Contract Field Teams ("CFT") Program, and management of Department of Treasury, Department of Justice, and ATF seized and forfeited general property programs ("Seized Asset Programs").

Federal Group - Our Federal Group provides engineering, technical, management, and integrated logistics support services to U.S. military branches, government agencies and other customers. These services include full life cycle engineering, logistics, maintenance, field support, and refurbishment services to extend and enhance the life of existing vehicles and equipment; comprehensive systems and software engineering, systems technical support, configuration management, obsolescence management, prototyping services, technology insertion programs, and technical documentation and data packages; and management and execution of government programs under large multiple award contracts. This group provides its services to the U.S. Army, Army Reserve, Marine Corps, and other customers. Significant current work efforts for this group include our ongoing U. S. Army Reserve vehicle refurbishment program and various vehicle and equipment maintenance and sustainment programs for U. S. Army commands.

IT, Energy and Management Consulting Group - Our IT, Energy and Management Consulting Group consists of our wholly owned subsidiaries Energetics Incorporated ("Energetics") and Akimeka, LLC ("Akimeka"). This group provides technical and consulting services primarily to various DoD and federal civilian agencies, including the United States Departments of Energy, Homeland Security, Commerce, Interior, Labor, Agriculture and Housing and Urban Development; the Social Security Administration; the Pension Benefit Guaranty Corporation; the National Institutes of Health; customers in the military health system; and other government agencies and commercial clients. Energetics provides technical, policy, business, and management support in areas of energy modernization, clean and efficient energy, climate change mitigation, infrastructure protection, and measurement technology. Akimeka offers solutions in fields that include medical logistics, medical command and control, e-health, information assurance, public safety, enterprise architecture development, information assurance/business continuity, program and portfolio management, network IT services, systems design and integration, quality assurance services, and product and process improvement services.


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                   Concentration of Revenues
                        (in thousands)
             For the three months ended March 31,

                     2014                    2013
Source of Revenue  Revenues        %       Revenues        %
USPS MIP            $  38,611        32     $  34,083        29
FMS Program            21,466        18        19,590        16
US Army Reserve        14,494        12        20,622        17
Other                  44,838        38        44,862        38
  Total Revenues    $ 119,409       100     $ 119,157       100

Management Outlook

Our history and heritage of assisting our clients in optimizing the use of their existing physical assets as an attractive alternative to costly replacement has long provided value. As challenges in our legacy markets continue to adversely impact our revenues, we are responding by adapting our vehicle, ship, and aircraft sustainment, service life extension, and logistics competencies to the needs of adjacent markets. Our success in these markets, including supply chain, has given us a clear direction for our future. Going forward, our growth initiatives will focus on these more promising markets while we continue to defend and maintain our presence in key legacy markets in anticipation of a future rebound.

Our adjacent markets and new service offerings include managed inventory services centered on vehicle fleet sustainment offered by our Supply Chain Management Group. WBI's USPS MIP provides ongoing mission-critical supply chain support to the USPS, which provides us with a steady revenue and earnings source. This program does not rely on appropriated government spending, as it is primarily self-funded through revenues generated through USPS business operations. This is our largest revenue source and we have seen growth in this program. Additionally, WBI's supply chain and inventory management competencies provide us opportunities to further expand our customer base to new commercial client markets. We are actively marketing these service offerings to commercial clients, and are currently beginning to service large commercial vehicle fleets thereby broadening our addressable markets. Success in WBI's offerings to both traditional and commercial markets has encouraged us to focus our strategic direction on this part of our business and direct financial and management resources toward such efforts.

The challenges we have faced in our legacy markets in recent years have resulted in declining revenues in these markets. We have seen declines in our DoD and IT revenues due to a curtailment of government spending for certain programs and services, changes in government spending priorities, delays in government contract awards and funding, and the expiration of programs without follow-on contract awards. In response to our uncertain legacy business environment, we have aggressively managed our cost structure to retain balance with our workload. We will continue cost balancing efforts wherever feasible to remain competitive and profitable as we go forward.

Despite the challenges, we have key programs in our legacy markets that continue to provide a substantial portion of our business. These programs include our International Group's U.S. Navy FMS Program, and our Federal Group's military vehicle and equipment refurbishment work.

Our International Group's U.S. Navy FMS Program is our second largest source of revenue. This program does not rely on appropriated government spending as it is largely funded by foreign government clients. FMS Program revenues for the past few years have been generated primarily from follow on technical services work with very little ship reactivation and transfer work. Due to extended legislation delays in the U.S. Congress, our traditional mainstay of ship reactivation and transfer work continues to be deferred. Our contract supporting this work gives us potential contract coverage of up to $1.5 billion over a five-year period that began in January 2012. This level of contract coverage, combined with the eligibility, upon approval, of multiple U.S. Navy ships for transfer to foreign government clients, presents us with an opportunity for revenue growth from this program if and when a Naval Vessel Transfer Act is passed by Congress.

Follow on technical support work under our FMS Program has generated relatively consistent revenues. These services are provided to a number of foreign client countries, the largest of which is the Egyptian Navy. In July 2013, we evacuated our workforce from Egypt due to significant domestic and political unrest in that country. We continued performing support services for the Egyptian Navy at other locations, but revenue levels associated with this support under these circumstances are lower than when our workforce is located in Egypt. In March and April 2014 we began reinstating some of our workforce in Egypt at lower staffing levels than previously. Our Egyptian Navy support services generated approximately $10 million of revenue for the first quarter of 2014 and approximately $48 million of revenue for a full year in 2013. Operating profit margin on this work is consistent with the reported profit margin of our International Group. We cannot predict the longer range impact that the political situation in Egypt will have on our Egyptian Navy support program.


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Our Federal Group's vehicle and equipment refurbishment work for the U.S. Army Reserve is our third largest source of revenue. Our U.S. Army Reserve contract was re-competed in July 2013 to transition the work from a General Services Administration ("GSA") contract to multiple Army contracts. In August and September 2013, we were awarded three new task orders on our existing Army contracts to continue work on this program for another year. Contractual terms under the new task orders have resulted in lower profit margins for us on this program compared to previous contractual arrangements. This program generated approximately $60 million of revenue in 2013. The U.S. Army Reserve is unlikely to be insulated from DoD and Department of the Army realignment of funding priorities in reaction to large budget reductions. It is uncertain how much of this work will be re-competed, continued or extended upon expiration of our current task orders.

VSE has been the prime contractor for the U.S. Department of Treasury Executive Office for Asset Forfeiture general property program since 2006. The follow-on contract for this work was awarded to a competitor, and substantially all of our work on this program was completed as of March 2014. This program generated approximately $8 million of revenue for the first quarter of 2014 and approximately $36 million of revenue for a full year in 2013.

We have used our positive cash flow to reduce our bank debt at a rate that will position us to consider a variety of options to increase stockholder value.

Bookings and Funded Backlog

Our revenues depend on contract funding ("bookings"), and bookings generally occur when contract funding documentation is received. For our revenues that depend on bookings arising from the receipt of contract funding documentation, funded contract backlog is an indicator of potential future revenues. While bookings and funded contract backlog generally result in revenues, occasionally we will have funded contract backlog that expires or is de-obligated upon contract completion and does not generate revenue.

WBI's revenues are driven by maintenance schedules and the rate and timing of parts failure on customer vehicles, and WBI bookings occur at the time of sale instead of the receipt of contract funding documentation. Accordingly, WBI does not generally have funded contract backlog and it is not an indicator of potential future revenues for WBI. Therefore, total funded contract backlog is less of an indicator of our overall potential future revenue than in years prior to our acquisition of WBI.

A summary of our bookings and revenues for the three months ended March 31, 2014 and 2013, and funded contract backlog as of March 31, 2014 and 2013 is as follows:

                            (in millions)
                           2014       2013
 Bookings                   $   89     $ 154
 Revenues                   $  119     $ 119
 Funded Contract Backlog    $  205     $ 264

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and assumptions. There have been no changes in our critical accounting policies since December 31, 2013. Please refer to our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC on March 7, 2014 for a full discussion of our critical accounting policies.


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Revenue by Contract Type

Our revenues by contract type were as follows (in thousands):

                            Three Months ended March 31,
Contract Type          2014          %         2013          %
Fixed-price          $  67,752        57     $  57,999        49
Cost-type               42,319        35        25,081        21
Time and materials       9,338         8        36,077        30
                     $ 119,409       100     $ 119,157       100

WBI revenues are classified as fixed-price revenue.

Results of Operations

Our results of operations are as follows (in thousands):

                                                   Three months ended March 31,
                                                  2014          2013         Change
Revenues                                       $  119,409     $ 119,157     $    252
Contract costs                                    107,611       108,783       (1,172 )
Selling, general and administrative expenses          441           432            9
Operating Income                                   11,357         9,942        1,415
Interest expense, net                               1,197         1,577         (380 )
Income before income taxes                         10,160         8,365        1,795
Provision for income taxes                          3,891         3,094          797
Income from continuing operations                   6,269         5,271          998
Loss from discontinued operations                    (615 )         (13 )       (602 )
Net Income                                     $    5,654     $   5,258     $    396

Our revenues were substantially unchanged for the first quarter of March 31, 2014, as compared to the same period of 2013. Revenues from our Supply Chain Management and Federal Groups increased, while revenues from our International and IT, Energy and Management Consulting Groups declined compared to the prior year.

Contract costs consist primarily of direct costs including labor, inventory, material, and supplies used in the performance of our work and delivery of our products, and indirect costs associated with these direct costs. These costs will generally increase or decrease in conjunction with our level of work or products sold and associated revenues.

Our contract costs decreased approximately $1.2 million, or 1%, for the first quarter of March 31, 2014, as compared to the same period of 2013. Reductions to our indirect costs initiated in the second quarter of 2013 contributed to the decrease in contract costs in 2014 as compared to 2013. Contract costs from our Supply Chain Management and Federal Groups increased, while contract costs from our International, and IT, Energy and Management Consulting Groups decreased compared to the prior year.

Selling, general and administrative expenses consist primarily of costs and expenses that are not chargeable or reimbursable on our operating unit contracts. These expenses include legal costs associated with contract protests and other matters.

Our operating income increased approximately $1.4 million, or 14% for the first quarter of March 31, 2014, as compared to the same period of 2013. Operating income from our Supply Chain Management, International, and IT, Energy and Management Consulting Groups increased, while operating income from our Federal Group decreased compared to the same period of 2013.

Changes in revenues, costs and expenses, and income are further discussed in the summaries of our segment results that follow.


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Interest expense decreased approximately $380 thousand for the first quarter of March 31, 2014, as compared to the same period of 2013 due to reductions in our level of borrowing as we pay down our bank loan. Interest expense also includes interest associated with capitalized construction costs related to our executive and administrative headquarters facility lease. The amount of interest expense associated with this capital lease in the first quarter of 2014 was approximately $420 thousand, as compared to $432 thousand for the same period of 2013.

Our effective income tax rate was 38.3% for the first quarter of March 31, 2014 as compared to 37.0% for the same period of 2013. Our tax rate is affected by discrete items that may occur in any given year, but may not be consistent from year to year. In addition to state income taxes, certain tax credits and other items can impact the difference between our statutory tax rates and our effective tax rate. Federal tax credits that lowered our 2013 effective tax rates expired at the end of 2013 and did not benefit our 2014 effective tax rate.

Supply Chain Management Group Results

The results of operations for our Supply Chain Management Group are as follows
(in thousands):

                                                        Three Months ended March 31,
                                                          2014                 2013           Change
Revenues                                             $       40,623       $       37,703     $   2,920
Contract costs                                               32,803               31,501         1,302
Selling, general and administrative expenses                     (1 )                 47           (48 )
Operating income                                     $        7,821       $        6,155     $   1,666
Profit percentage                                              19.3 %               16.3 %

Revenues for our Supply Chain Management Group increased approximately $2.9 million or 8% for the first quarter of 2014, as compared to the same period of 2013. The revenue increase resulted primarily from an increase in WBI's USPS MIP revenues of approximately $4.5 million. Contract costs increased by approximately $1.3 million or 4% and operating income increased by approximately $1.7 million or 27%. Contract costs and operating income increases resulted primarily from the increase in USPS MIP revenues. The profit percentage increase resulted from the USPS MIP revenue increase and a decrease in lower margin sales to DoD. Operating income for this segment was reduced by approximately $174 thousand in the first quarter of 2014 and approximately $277 thousand in the first quarter of 2013 for an increase to our accrued earn-out obligations associated with our acquisition of WBI.

International Group Results

The results of operations for our International Group are as follows (in
thousands):

                                                        Three Months ended March 31,
                                                          2014                 2013           Change
Revenues                                             $       34,715       $       35,390     $    (675 )
Contract costs                                               32,281               33,634        (1,353 )
Selling, general and administrative expenses                     45                   63           (18 )
Operating income                                     $        2,389       $        1,693     $     696
Profit percentage                                               6.9 %                4.8 %

Revenues for our International Group decreased approximately $675 thousand or 2%, and contract costs decreased approximately $1.4 million or 4% for the first quarter of 2014, as compared to the same period of 2013. The revenue decrease resulted primarily from 1) a decrease in revenues from our Seized Assets Programs of approximately $1.4 million; 2) a decrease in revenues from our CFT Program of approximately $700 thousand; 3) a decrease in other work of approximately $400 thousand; and 4) and a partial offsetting increase in revenues from our FMS Program of approximately $1.9 million. The decrease in contract costs is attributable to the lower level of work associated with our revenue decline. Operating income increased by approximately $700 thousand or 41%. Operating income and profit percentage increases resulted primarily from the elimination of losses on our CFT Program work, a reduction in losses on other jobs, and an improvement in margin on our Seized Asset Program work. Profit margins in this group can vary due to fluctuations in contract activity and the timing of contract award fees associated with our FMS Program.


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Federal Group Results

The results of operations for our Federal Group are as follows (in thousands):


                                                        Three Months ended March 31,
                                                          2014                 2013           Change
Revenues                                             $       28,555       $       27,571     $     984
Contract costs                                               28,215               26,427         1,788
Selling, general and administrative expenses                     11                   13            (2 )
Operating income                                     $          329       $        1,131     $    (802 )
Profit percentage                                               1.2 %                4.1 %

Revenues for our Federal Group increased approximately $984 thousand or 4%, and contract costs increased approximately $1.8 million or 7% for the first quarter of 2014, as compared to the same period of 2013. The revenue and contract cost increases resulted primarily from a task order performed in 2014 that started after the first quarter of 2013. Revenue for this task order in 2014 was approximately $8 million. This task order has a completion date of October 31, 2016 with a funded backlog of approximately $8 million as of March 31, 2014. The increases from this task order were partially offset by a decline in our Army Reserve vehicle refurbishment work of approximately $6 million and declines in some smaller projects. Operating income decreased by approximately $800 thousand or 71%. Operating income and profit percentage decreases resulted primarily due to a decrease in profits associated with the decline in Army Reserve work.

IT, Energy and Management Consulting Group Results

The results of operations for our IT, Energy and Management Consulting Group are
as follows (in thousands):

                                                        Three Months ended March 31,
                                                          2014                 2013           Change
Revenues                                             $       15,516       $       18,493     $  (2,977 )
Contract costs                                               14,046               17,216        (3,170 )
Selling, general and administrative expenses                     17                   38           (21 )
Operating income                                     $        1,453       $        1,239     $     214
Profit percentage                                               9.4 %                6.7 %

Revenues for our IT, Energy and Management Consulting Group decreased approximately $3 million or 16%, and contract costs decreased approximately $3.2 million or 18% for the first quarter of 2014, as compared to the same period of 2013. The revenue and contract cost decreases resulted primarily from a reduction in services performed due to contract expirations and a decline in services ordered by clients on continuing contracts. Operating income increased by approximately $200 thousand or 17%. Operating income and profit percentage increases resulted primarily from indirect cost reductions and efficiencies associated with combining our Akimeka and G&B subsidiaries.

Financial Condition

Our financial condition did not change materially in the first quarter of 2014. Changes to asset and liability accounts were due primarily to our earnings, our level of business activity, contract delivery schedules, subcontractor and vendor payments required to perform our work, and the timing of associated billings to and collections from our customers.


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Liquidity and Capital Resources

Cash Flows

Cash and cash equivalents increased approximately $137 thousand during the first quarter of 2014.

Cash provided by operating activities decreased approximately $1.3 million in the first quarter of 2014 as compared to the first quarter of 2013. The change is primarily attributable to a decrease of approximately $2 million due to changes in the levels of operating assets and liabilities, an increase of approximately $396 thousand in cash provided by net income, and an increase of approximately $271 thousand in depreciation and amortization and other non-cash operating activities. Our largest assets are our accounts receivable and inventories. Our largest operating liabilities are our accounts payable and accrued expenses. A significant portion of our accounts receivable and accounts payable result from the use of subcontractors to perform work on our contracts and from the purchase of materials to fulfill our contract obligations. Accordingly, our levels of accounts receivable and accounts payable may fluctuate depending on the timing of services ordered, government funding delays, the timing of billings received from subcontractors and materials vendors, and the timing of payments received for services. Such timing differences have the potential to cause significant increases and decreases in our accounts receivable and accounts payable in short time periods. Our levels . . .

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