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

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Form 10-Q for VSE CORP


1-Aug-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, ship and aircraft maintenance, 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 wholly owned subsidiary Wheeler Bros., Inc. ("WBI"). 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 commercial 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, Air Force, Department of Justice, Bureau of Alcohol, Tobacco, Firearms and Explosives ("ATF"), and other customers. Significant work efforts for this group include 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 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 six months ended June 30,
                       2014                      2013
Source of Revenue    Revenues          %       Revenues        %
USPS MIP            $    78,963         35     $  68,828        29
FMS Program              42,534         19        42,455        18
U.S. Army Reserve        29,330         13        39,032        16
Other                    76,544         33        87,904        37
 Total Revenues     $   227,371        100     $ 238,219       100

Management Outlook

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 extending these competencies to new markets, especially with respect to our supply chain services, has given us a clear direction for our future. Our initiatives for future growth are focused on extending our key sustainment and logistics competencies to these more promising markets, while we continue to defend and maintain our presence in our chosen legacy markets. We are committed to providing value to our clients by assisting them in extending the service life and enhancing the performance of their existing physical assets as an attractive alternative to costly replacement.

Our key 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 by USPS business operations. This is our largest revenue source and we have seen growth in this program. Additionally, WBI's managed inventory competency is being successfully marketed to commercial clients operating large vehicle fleets. 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.

We have experienced declines in our DoD and other federal civilian agency revenues due to a curtailment of government spending for certain programs and services, changes in government spending priorities and increased competition for fewer opportunities. In response to uncertainty in our legacy business environment, we have aggressively balanced our cost structure with our workload. We will continue cost balancing efforts to remain competitive and profitable as we go forward. Despite these challenges to our revenue base, we have key programs in our legacy markets continuing 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 impeded by protracted delays in passing the legislation required for the transfer of naval vessels to allied navies. Historically, supporting the U.S. Navy in reactivating, transferring and providing the follow-on technical support to receiving navies constituted the majority of our FMS business. Our current 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 a large backlog of U.S. Navy ships for transfer to foreign government clients, presents us with an opportunity to return to prior FMS revenue levels 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 our revenue from this support under these circumstances is 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 than our previous staffing levels. Our Egyptian Navy support services generated approximately $18 million of revenue for the first half 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. Our long-term relationship with the Egyptian Navy remains strong and will only grow stronger as U.S. and Egyptian relations improve. 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 contract for this work 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 those task orders have resulted in lower profit margins for us on this program compared to our previous contractual arrangements. This program generated approximately $29 million of revenue for the first half of 2014 and approximately $60 million of revenue for a full year in 2013. The U.S. Army Reserve is not insulated from DoD and Department of the Army budget reductions. Currently, it remains uncertain how much of this work will be re-competed, continued or extended upon expiration of our current task orders.

Our work as the prime contractor for the U.S. Department of Treasury Executive Office for Asset Forfeiture general property program came to an end in 2014, and substantially all of our work on this program was completed as of March 2014. This program generated approximately $9 million of revenue for the first half of 2014 and approximately $36 million of revenue for a full year in 2013.

We have consistently reduced our bank debt and that positions us to consider a variety of options to increase stockholder value.

Bookings and Funded Backlog

Much of our revenues depends 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.

A summary of our bookings and revenues for the six months ended June 30, 2014 and 2013, and funded contract backlog as of June 30, 2014 and 2013 is as follows:

                             (in millions)
                            2014        2013
 Bookings                  $   173      $ 248
 Revenues                  $   227      $ 238
 Funded Contract Backlog   $   178      $ 238

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The ASU is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. The ASU will become effective for us on January 1, 2017. We currently are assessing the impact that this standard will have on its consolidated financial statements.

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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 2013 Form 10-K for a full discussion of our critical accounting policies.

Revenue by Contract Type

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

                              Six months ended June 30,
Contract Type          2014          %         2013          %
Fixed-price (1)      $ 131,064        58     $ 116,810        49
Cost-type               75,751        33        50,965        21
Time and materials      20,556         9        70,444        30
                     $ 227,371       100     $ 238,219       100

(1) WBI's revenue is classified as fixed-price revenue.

Results of Operations

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

                             Three months                 Six months                     Change
                            ended June 30,              ended June 30,            Three           Six
                          2014          2013          2014          2013          Months         Months
Revenues                $ 107,962     $ 119,062     $ 227,371     $ 238,219     $  (11,100 )   $  (10,848 )
Contract costs             96,481       105,555       204,092       214,338         (9,074 )      (10,246 )
Selling, general and
 administrative
expenses                      778           806         1,219         1,238            (28 )          (19 )
Operating Income           10,703        12,701        22,060        22,643         (1,998 )         (583 )
Interest expense, net       1,090         1,481         2,287         3,058           (391 )         (771 )
Income before income
taxes                       9,613        11,220        19,773        19,585         (1,607 )         (188 )
Provision for income
taxes                       3,669         4,257         7,560         7,351           (588 )          209
Income from
continuing operations       5,944         6,963        12,213        12,234         (1,019 )          (21 )
Loss from
discontinued
operations                   (279 )        (101 )        (894 )        (114 )         (178 )         (780 )
Net Income              $   5,665     $   6,862     $  11,319     $  12,120     $   (1,197 )   $     (801 )

Our revenues decreased approximately $11 million, or 9%, for the second quarter of 2014, and approximately $11 million, or 5%, for the first six months of 2014, as compared to the same periods of 2013. Revenues of our Supply Chain Management Group increased and revenues of our International, Federal, and IT, Energy and Management Consulting Groups decreased 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 $9 million, or 9%, for the second quarter of 2014, and approximately $10 million, or 5%, for the first six months of 2014, as compared to the same periods 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 Group increased and contract costs from our International, Federal, and IT, Energy and Management Consulting Groups decreased compared to the prior year.

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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 decreased approximately $2 million, or 16% for the quarter ended June 30, 2014, and approximately $583 thousand, or 3%, for the first six months of 2014, as compared to the same periods of 2013. Operating income from our Supply Chain Management Group increased and operating income from our International, Federal and IT, Energy and Management Consulting Groups 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.

Interest expense decreased approximately $391 thousand, or 26%, for the quarter ended June 30, 2014, and approximately $771 thousand, or 25%, for the first six months of 2014, as compared to the same periods 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 six months of 2014 was approximately $841 thousand, as compared to $865 thousand for the same period of 2013.

Our effective income tax rate was 38.2% for the first six months of 2014 as compared to 37.5% 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                 Six months                    Change
                            ended June 30,              ended June 30,            Three          Six
                          2014          2013          2014          2013         Months        Months
Revenues                $  42,313     $  36,891     $  82,936     $  74,594     $   5,422     $   8,342
Contract costs             34,579        29,897        67,382        61,398         4,682         5,984
Selling, general and
administrative
expenses                       37            20            36            67            17           (31 )
Operating Income        $   7,697     $   6,974     $  15,518     $  13,129     $     723     $   2,389
Profit percentage            18.2 %        18.9 %        18.7 %        17.6 %

Revenues for our Supply Chain Management Group increased approximately $5.4 million, or 15%, for the second quarter of 2014 as compared to the same period for the prior year. Revenues increased approximately $8.3 million, or 11%, for the six months ended June 30, 2014 as compared to the same period for the prior year. The increases resulted primarily from an increase in WBI's USPS MIP revenue of approximately $5.6 million for the quarter and approximately $10.1 million for the six months. The increases were partially offset by declines in sales of parts to DoD clients. Contract costs increased approximately $4.7 million, or 16%, for the quarter and approximately $6 million, or 10%, for the six months.

Operating income increased approximately $723 thousand, or 10%, for the quarter and approximately $2.4 million, or 18%, for the six months. Contract costs and operating income increases resulted primarily from the increase in USPS MIP revenue. Operating income for this segment for 2014 and 2013 was impacted by fair value adjustments in the accrued earn-out obligation associated with our acquisition of WBI. The adjustment to the earn-out obligation decreased operating income approximately $613 thousand for the quarter ended June 30, 2014 and increased operating income approximately $219 thousand for the same period of the prior year. The adjustment to the earn-out obligation decreased operating income approximately $787 thousand for the six months ended June 30, 2014 and decreased operating income approximately $58 thousand for the same period of the prior year. The changes in profit percentage resulted from the USPS MIP revenue increase and a decrease in lower margin sales to DoD, and from differences in earn-out obligation adjustments.

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International Group Results

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

                             Three months                 Six months                     Change
                            ended June 30,              ended June 30,            Three           Six
                          2014          2013          2014          2013          Months         Months
Revenues                $  26,794     $  36,239     $  61,510     $  71,629     $   (9,445 )   $  (10,119 )
Contract costs             25,846        34,551        58,128        68,185         (8,705 )      (10,057 )
Selling, general and
administrative
expenses                      189           215           234           278            (26 )          (44 )
Operating Income        $     759     $   1,473     $   3,148     $   3,166     $     (714 )   $      (18 )
Profit percentage             2.8 %         4.1 %         5.1 %         4.4 %

Revenues for our International Group decreased approximately $9.4 million, or 26%, for the second quarter, and decreased approximately $10.1 million, or 14%, for the six months ended June 30, 2014, as compared to the same periods for the prior year. Contract costs decreased approximately $8.7 million, or 25%, for the second quarter, and decreased approximately $10 million, or 15%, for the six months ended June 30, 2014, as compared to the same periods for the prior year. The decreases in revenues resulted primarily from decreases of approximately $8.4 million for the quarter and approximately $9 million for the six months associated with the completion of our U.S. Treasury Seized Assets Program in March 2014. The decreases in contract costs are primarily attributable to the lower level of work associated with our decreases in revenues.

Operating income decreased by approximately $714 thousand, or 48%, for the second quarter, and decreased approximately $18 thousand, or 1%, for the six months ended June 30, 2014, as compared to the same periods for the prior year. Changes in operating income resulted primarily from decreases in profits of approximately $1.3 million for the quarter and approximately $840 thousand for the six months attributable to the revenue declines associated with the completion of our U.S. Treasury Seized Assets Program in March 2014, offset by an increase in award fee income associated with our FMS Program in the second quarter and from the elimination of losses on our CFT 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. Award fee evaluations on this program occur three times per year. We recognize award fee revenue and income in the period we receive contractual notification of the award, and we typically receive such notification in the first, second, and fourth quarters each year. Because we had not received contractual notification for the award fee that is typically recognized in the second quarter of 2013 until after June 30, 2013, this award fee revenue and income was recognized in the third quarter of 2013. In 2014, we received timely notification and award fee revenue and income was recognized in the second quarter of 2014.

Federal Group Results

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

                             Three months                 Six months                     Change
                            ended June 30,              ended June 30,            Three           Six
                          2014          2013          2014          2013          Months         Months
Revenues                $  23,137     $  26,817     $  51,692     $  54,388     $   (3,680 )   $   (2,696 )
Contract costs             22,194        24,301        50,409        50,728         (2,107 )         (319 )
Selling, general and
administrative
expenses                       56             6            67            19             50             48
Operating Income        $     887     $   2,510     $   1,216     $   3,641     $   (1,623 )   $   (2,425 )
Profit percentage             3.8 %         9.4 %         2.4 %         6.7 %

Revenues for our Federal Group decreased approximately $3.7 million, or 14%, for the second quarter, and decreased approximately $2.7 million, or 5%, for the six months ended June 30, 2014, as compared to the same periods for the prior year. Contract costs decreased approximately $2.1 million, or 9%, for the second quarter, and decreased approximately $319 thousand, or 1%, for the six months ended June 30, 2014, as compared to the same periods for the prior year. The decreases in revenues resulted primarily from decreases of approximately $3.6 million for the quarter and approximately $9.8 million for the six months . . .

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