Under the terms of the ICRC and G&B acquisitions, additional consideration is due to the sellers if certain financial performance targets are achieved. G&B achieved certain financial performance targets for the second earn-out period ended on March 31, 2010. This resulted in a $1.4 million earn-out, which was recorded as goodwill during the first quarter of 2010 and paid to the sellersellers in May 2010. ICRC achieved certain financial performance targets for the third earn-out period ended on December 31, 2009. Additional goodwill of approximately $445 thousand was recorded as of December 31, 2009 and paid to the sellersellers in March 2010.
The accounting standard for fair value measurements defines fair value, and establishes a market-based framework or hierarchy for measuring fair value. The standard is applicable whenever assets and liabilities are measured at fair value. The unaudited consolidated balance sheets include various financial instruments (primarily cash and cash equivalents, receivables, accounts payable, deferred supplemental compensation plan, deferred compensation and contingent consideration under the Akimeka acquisition).
The fair value hierarchy established in the standard prioritizes the inputs used in valuation techniques into three levels as follows:
Level 1 – Observable inputs – quoted prices in active markets for identical assets and liabilities;
Level 2 – Observable inputs other than the quoted prices in active markets for identical assets and liabilities – includes quoted prices for similar instruments, quoted prices for identical or similar instruments in inactive markets, and amounts derived from valuation models where all significant inputs are observable in active markets; and
Level 3 – Unobservable inputs – includes amounts derived from valuation models where one or more significant inputs are unobservable and require us to develop relevant assumptions.
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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Executive Overview
Organization
Our business is focused on providing sustainment services for U.S. Department of Defense ("DoD") legacy systems and equipment and professional services to DoD and Federal Civilian agencies. Our operations consist primarily of logistics, engineering, equipment refurbishment, IT, construction management and consulting services performed on a contract basis. Substantially all of our contracts are with United States Government (“government”) agencies and other government prime contractors.
Our business is managed under operating groups. Our Federal Group operations are conducted by our Communications and Engineering Division ("CED"), Engineering and Logistics Division ("ELD"), Field Support Services Division (“FSS”), and Systems Engineering Division ("SED"). Our International Group operations are conducted by our GLOBAL Division ("GLOBAL") and Fleet Maintenance Division ("FMD"). Our IT, Energy and Management Consulting Group operations are conducted by our wholly owned subsidiaries Energetics Incorporated ("Energetics") and, G&B Solutions, Inc. (“G&B”), and, beginning August 19, 2010, our newly acquired wholly owned subsidiary Akimeka, LLC (“Akimeka”). Our Infrastructure Group operations are conducted by our wholly owned subsidiary Integrated Concepts and Research Corporation (“(R 20;ICRC”).
Segments
Our operations are conducted within four reportable segments aligned with our management groups: 1) Federal; 2) International; 3) IT, Energy and Management Consulting; and 4) Infrastructure.
Federal Group - Our Federal Group provides engineering, technical, management, and integrated logistics support services to U.S. military branches and other government agencies.
CED - CED is dedicated to the management and execution of the U.S. Army CECOM's Rapid Response (“R2”) Program, which supports clients across DoD and the government. CED manages execution of tasks involving research and development, technology insertion, systems integration and engineering, hardware/software fabrication and installation, testing and evaluation, studies and analysis, technical data management, logistics support, training and acquisition support. A large portion of our current work on this program is related to the U.S. military involvement in the Middle East and Asia. A substantial portion of our revenue on the R2 contract results from the pass through of subcontractor support services that have a low profit margin. The contract supporting the R2 Program is scheduled to expire in January 2011. In July 2010, we received one of several new multiple award omnibus contracts to continue work under the R2 replacement program known as Rapid Response-Third Generation (“R2-3G”)over a five-year period of performance, which is anticipated to include an undetermined amount of follow-on work from the original R2 contract in addition to potential new requirements.
RCV Modernization Program – We perform work on our R2 support contract for a program to provide maintenance work on U.S. Army Route Clearing Vehicles (“RCV”) in Kuwait. Discussions are ongoing to utilize the RCV facility and personnel to execute Mine Resistance Ambush Protected (“MRAP”) and other vehicle related maintenance efforts, but if we are unable to do so, the RCV program will end when the R2 contract expires in January 2011.
ELD - ELD provides full life cycle engineering, logistics, maintenance and refurbishment services to extend and enhance the life of existing equipment. ELD supports the U.S. Army Army Reserve and Army National GuardReserve with core competencies in combat and combat service support system conversions, technical research, sustainment and re-engineering, system integration and configuration management.
FSS - FSS provides worldwide field maintenance and logistics support services for a wide variety of military vehicles and equipment, including performance of organizational, intermediate and specialized depot-level maintenance. FSS principally supports the U.S. Army and Marine Corps by providing specialized Field Service Representatives (“FSR”) and Field Support Teams (“FST”) in areas of combat operations and austere environments.
SED - SED provides comprehensive systems and software engineering, logistics, and prototyping services to DoD. SED principally supports the U.S. Army, Air Force, and Marine Corps combat and combat support systems. SED’s core competencies include: systems technical support, configuration management and life cycle support for wheeled and tracked vehicles and ground support equipment; obsolescence management, service life extension, and technology insertion programs; and technical documentation and data packages.
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International Group - Our International Group provides engineering, industrial, logistics and foreign military sales services to the U.S. military and other government agencies.
GLOBAL - Through GLOBAL, we provide assistance to the U.S. Navy in executing its Foreign Military Sales (“FMS”) Program for surface ships sold, leased or granted to foreign countries. GlobalGLOBAL provides program management, engineering, technical support, logistics services for ship reactivations and transfers and follow-on technical support. The level of revenues and associated profits resulting from fee income generated by this program varies depending on a number of factors, including the timing of ship transfers and associated support services ordered by foreign governments and economic conditions of potential customers worldwide. Changes in the level of activity associated with the Navy’s ship transfer program have historically caused quarterly and annual revenuerevenu e fluctuations.
FMD - FMD provides field engineering, logistics, maintenance, and information technology services to the U.S. Navy and Air Force, including fleet-wide ship and aircraft support programs. FMD’s expertise includes ship repair and modernization, ship systems installations, ordnance engineering and logistics, facility operations, war reserve materials management, and IT systems integration. FMD also provides aircraft sustainment and maintenance services to the United States Air Force under the Contract Field Teams (“CFT”) Program.
Treasury Seized Asset Program – FMD also provides management, maintenance, storage and disposal support for the U.S. Department of Treasury’s seized and forfeited general property program. Our contract with the Department of Treasury to supportWe have performed this program isunder a cost plus incentive fee contract that contains certain conditions under which the incentive fee revenue is earned. The amount of incentive fee earned depends on our costs incurred on the contract compared to certain target cost levels specified in the contract. An assessment of actual costs compared to target costs is made annually pursuant to the contract. We recognize incentive fee when the amount is fixed or determinable and collectability is reasonably assured. DueWe recognize a minimum incentive fee each quarter, and the remaining incentive fee after an assessment of actual costs compared to target costs is made annual ly pursuant to the conditionscontract. This assessment is performed after September 30 of each year, and we recognize the majority of incentive fee in the third quarter of each year. The amount recorded in September 2010 was approximately $3.2 million as compared to approximately $3.3 million recorded in September 2009. The recognition of this majority of the annual incentive fee in the third quarter of 2010 and 2009 has resulted in higher income levels for the third quarter as compared to other quarters during the year.
Our cost plus incentive fee contract to support this program ended September 30, 2010 and the Department of Treasury awarded us a seven-month interim contract for approximately $25.9 million to continue providing services under whichthe program. The interim contract will allow the customer additional time to make an award decision on a successor contract. Additionally, we were awarded through our GLOBAL division a 10-year IDIQ contract in September 2010 with the Department of Justice, Bureau of Alcohol, Tobacco, Firearms, and Explosives (ATF) to provide similar services. The ATF contract represents a recompete win under a separate competition of the ATF portion of the Treasury Seized Asset Program. The interim contract and the ATF contract do not have the incentive fee forterms that have resulted in earnings fluctuations on this contract is awarded, and to the potential for changesprogram in the cost targets as work requirements vary, the full amountpast and we do not expect such fluctuations associated with this program in future periods.
IT, Energy and Management Consulting Group – The IT, Energy and Management Consulting Group provides technical and consulting services primarily to various DoD and civilian government agencies.
Energetics - Energetics provides technical, policy, business, and management support in areas of clean and efficient energy, climate change mitigation, infrastructure protection, measurement technology, and global health. Energetics’ expertise lies in managing collaborative processes to bring together diverse stakeholders in decision making, R&D program planning and evaluation metrics, state-of-the-art technology assessments, technical and economic feasibility analysis, and technical communications. Customers include the U.S. Department of Energy, the U.S. Department of Homeland Security, U.S. Department of Commerce, and other government agencies and commercial clients.
G&B – G&B is an established information technology provider to many government agencies, including the Departments of Homeland Security, Interior, Labor, Agriculture, Housing and Urban Development, and Defense; the Social Security Administration; the Pension Benefit Guaranty Corporation; and the National Institutes of Health. G&B’s core expertise lies in 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.
Akimeka - We acquired Akimeka in August 2010 for an initial cash purchase price of approximately $32.3 million plus potential additional payments in future years if specified financial targets are achieved. For the year ended December 31, 2009, Akimeka had revenues of approximately $38 million and pretax income of approximately $6.5 million. Akimeka provides the Department of Defense’s health services and logistics sector with innovative IT solutions that meet high-priority challenges. The company has a technical team skilled at developing creative information technology (IT) health care solutions within government systems and protocols. Akimeka offers solutions in fields that include Medical Logistics, Medical Command and Control, E-health, Information Assurance, and Public Safety. Most of Akimeka’s customers are in the Military Health System.
Infrastructure Group – ICRC is engaged principally in providing engineering and transportation infrastructure services and construction management services primarily to Federal Civilian agencies. ICRC’s largest contract is with the U.S. Department of Transportation Maritime Administration for services performed on the Port of Anchorage Intermodal Expansion Project in Alaska (the "PIEP"). The seasonal variability in Anchorage, Alaska and the work constraints imposed by the intermittent presence of endangered species result in fluctuations in revenues from the PIEP.
Concentration of Revenues (in thousands) For the six months ended June 30, | | |
Concentration of Revenues (in thousands) For the Nine months ended September 30, | | Concentration of Revenues (in thousands) For the Nine months ended September 30, | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Source of Revenue | | 2010 | | | % | | | 2009 | | | % | | | 2010 | | | % | | | 2009 | | | % | |
| | | | | | | | | | | | | | | | | |
CED Army Equipment Support | | $ | 49 | | | | - | | | $ | 52,229 | | | | 11 | | |
CED Assured Mobility Systems | | | 92,759 | | | | 21 | | | | 65,783 | | | | 13 | | | $ | 129,105 | | | | 20 | | | $ | 102,844 | | | | 14 | |
GLOBAL FMS | | | | 95,432 | | | | 14 | | | | 72,043 | | | | 9 | |
RCV Modernization | | | 36,784 | | | | 8 | | | | 37,256 | | | | 8 | | | | 50,030 | | | | 8 | | | | 62,751 | | | | 8 | |
CED Other | | | 57,937 | | | | 13 | | | | 91,290 | | | | 18 | | |
Total CED | | | 187,529 | | | | 42 | | | | 246,558 | | | | 50 | | |
| | | | | | | | | | | | | | | | | |
GLOBAL FMS | | | 57,915 | | | | 13 | | | | 45,632 | | | | 9 | | |
| | | | | | | | | | | | | | | | | |
ELD US Army Reserve | | | | 45,394 | | | | 7 | | | | 54,647 | | | | 7 | |
Treasury Seized Asset Program | | | 22,859 | | | | 5 | | | | 20,655 | | | | 4 | | | | 37,790 | | | | 6 | | | | 34,988 | | | | 5 | |
| | | | | | | | | | | | | | | | | |
PIEP Contract | | | 16,533 | | | | 4 | | | | 15,224 | | | | 3 | | | | 34,869 | | | | 5 | | | | 26,607 | | | | 4 | |
| | | | | | | | | | | | | | | | | |
Other | | | 155,813 | | | | 36 | | | | 167,495 | | | | 34 | | | | 260,972 | | | | 40 | | | | 404,752 | | | | 53 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total Revenues | | $ | 440,649 | | | | 100 | | | $ | 495,564 | | | | 100 | | | $ | 653,592 | | | | 100 | | | $ | 758,632 | | | | 100 | |
The decline in the “Other” linecategory in the table above include: 1) revenuesis primarily attributable to a decline in our Federal Group from legacy sustainment equipment refurbishment services performed by our ELD divisionsubcontractor work on CED task orders and from work performed by our FSS and SED divisions on programs other than the RCV Modernization Program; 2) revenues in our FMD division from services provided on engineering and technical services task orders and from work performed on the CFT Program; and 3) revenues from various contracts performed in our IT, Energy and Management Consulting Group.orders.
Management Outlook
We believe that our near term outlook has not changed appreciably from our recent prior filings withWhile market conditions and certain contract activity are causing us to experience a decline in revenue in the SEC. Wecurrent year, we continue to sharpen our focus on strategic efforts to improve our profit margins at a time when we are experiencing an anticipatedprofitability. A decline in our revenues. Our over-arching strategy of transitioning from low-to-no profit margin subcontract work while also moving to more promising Federal markets is having the desired effect of increasing profit margins. The intended result is an increased percentage of work performed by our employees while performing a larger percentagesubcontractors that generated much of our revenue growth in prior years is the primary reason for the decrease in revenue. During the time that subcontractor work in growing Federal markets. These efforts have resulted in improved profit margins in each of the first two quarters of 2010.
Our strategic efforts to improve our profit margins include increasinghas declined, our direct labor revenueservices have increased and diversifying our service offerings and customer base.we are pursuing markets that offer potential for additional direct labor revenues with higher margins. Revenue from work performed by our employees, or direct labor revenue, typically has a higher profit margin than revenue generated by our subcontractor work,from subcontractors, which generally has little or no associated profit. Our current mix of subcontract and direct labor work, and our move toward more profitable markets has increased our profit margins in 2010.
The acquisition of Akimeka represents a key initiative in our efforts to improve profitability. Almost all of Akimeka’s revenues are derived from services performed by their employees, with very little revenue derived from subcontractor services. The DoD health-related information technology services performed by Akimeka provide us with access to an expanding DoD market. Akimeka’s IT competencies are also needed in the federal civil health related agencies served by G&B. We continue to specialize in markets that position us as providers of in-demand services to our existing customers.
We began the year 2010 with 614 more employees than we began 2009, and2009. Including the addition of Akimeka employees that joined us in August 2010, we have added 78another 275 employees induring the first twothree quarters of 2010. We had 2,612 employeesOur total employee count was 2,809 as of JuneSeptember 30, 2010 and 2,534 employees as of December 31, 2009. As a result,2010. These increases in employee count are supporting our targeted direct labor revenue increases and the associated revenues are up in 2010 and we expect to realize the benefits of this higher labor base as we go forward. The largest portion of ourprofit margin improvements.
Our new employees are primarily engaged in information technology, energy and management consulting, and work on DoD legacy systems sustainment services, an area on which weservices. We believe DoDthe government will continue to be focusedfocus on these areas in the near future. Work performed by our subcontractors that generated much of our revenue growth in prior years continues to decline and is the primary reason for the decrease in revenue.
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There are indications of a shift in government spending to more services for energy, IT infrastructure, physical infrastructure, and health care IT, and we have had an increase inbelieve the numbercomposition of our employees performingworkforce and the services for Federal Civilian agencies in these strategic areas. Accordingly, we continue to emphasize growth in these services. These efforts include: 1) an emphasis on marketing our Energetics subsidiary services that has shown favorable results, including an increase in the number of Energetics employees and new contracts that will be performed during the next three to five years; 2) an emphasis on increasing G&B services offered by its employees; 3) an emphasis on marketing ICRC infrastructure services to a wider range of clients; and 4) our continued commitment to grow through strategic acquisitions of companies that perform services in these areas for Federal Civilianoffer are well aligned with near term future government agencies as well as for DoD.spending priorities. We expect these efforts directed toward the growth of our work in these service areas will help offset declines in revenue from DoD-related subcontractor work.
We also know there are risks and uncertainties related to our business. Government spending priorities may continue to change significantly.and there is significant pressure on government budgets. The current administration is redefining “inherently governmental work.” As a consequence, the governmentwork” and is implementing a strategy of “in-sourcing” to move work from federal contractors into the government. Accordingly, the flow of work to federal contractors may be significantly impacted. We believe that most of our service offerings are not targeted by these federal cutbacks. Federal budget reductions will be aimed more towards large capital expenditure projects that may present additional opportunities related to our legacy sustainment offerings. The government is also striving for budget efficiencies from better IT infrastructure and information management , another area for which we are well positioned.
Bookings and Funded Backlog
Revenues in our industry depend on contract funding (“bookings”) and funded contract backlog is an indicator of potential future revenues. A summary of our bookings and revenues for the sixnine months ended JuneSeptember 30, 2010 and 2009, and funded contract backlog as of JuneSeptember 30, 2010 and 2009 is as follows:
| | (in millions) | |
| | 2010 | | | 2009 | |
Bookings | | $ | 673 | | | $ | 789 | |
Revenues | | $ | 654 | | | $ | 759 | |
Funded Contract Backlog | | $ | 493 | | | $ | 597 | |
| (in millions) |
| 2010 | | 2009 |
Bookings | $458 | | $464 |
Revenues | $441 | | $496 |
Funded Contract Backlog | $491 | | $536 |
| | | |
Our declineContinuing from last year and into this year, we have experienced a general delay in funded contract backlog resulted from a declinethe funding and awarding of approximately $121 million in funded contract backlog on task orders that consist primarily of low margin subcontractor work, which was partially offset by increases in funded contract backlog on other task orders andfederal contracts.
Recent Accounting Pronouncements
In October 2009, the FASB revised its accounting guidance related to revenue arrangements with multiple deliverables. The guidance relates to the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting and modifies the manner in which the transaction consideration is allocated across the individual deliverables. Also, the guidance expands the disclosure requirements for revenue arrangements with multiple deliverables. The guidance will be effective for us beginning on January 1, 2011, and may be applied retrospectively for all periods presented or prospectively to arrangements entered into or materially modified after the adoption date. Early adoption is permitted provided that the guidance is retroactively applied to the beginning of the year of adoption. The guidance will be effective for us beginning on January 1, 2011, and will apply prospectively to multiple-element arrangements entered into or materially modified after the adoption date. We are currently assessing the potential effecthave determined the adoption of this new guidance will not have if any,a material impact on our consolidated financial statements.
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, 2009. Please refer to our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on March 4, 2010 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):
| | Six months ended June 30, | | | Nine months ended September 30, | |
Contract Type | | 2010 | | | % | | | 2009 | | | % | | | 2010 | | | % | | | 2009 | | | % | |
| | | | | | | | | | | | | |
Cost-type | | $ | 109,203 | | | | 25 | | | $ | 94,833 | | | | 19 | | | $ | 182,754 | | | | 28 | | | $ | 151,598 | | | | 20 | |
Time and materials | | | 305,326 | | | | 69 | | | | 382,265 | | | | 77 | | | | 430,067 | | | | 66 | | | | 576,333 | | | | 76 | |
Fixed-price | | | 26,120 | | | | 6 | | | | 18,466 | | | | 4 | | | | 40,771 | | | | 6 | | | | 30,701 | | | | 4 | |
| | $ | 440,649 | | | | 100 | | | $ | 495,564 | | | | 100 | | | $ | 653,592 | | | | 100 | | | $ | 758,632 | | | | 100 | |
A significant portion of our time and materials revenues are from CED R2 Program task orders under which revenues result primarily from the pass through of subcontractor support services. These revenues have a lower profit margin than revenues generated by work performed by our employees.
Results of Operations
TheOur results of operations are as follows (in thousands):
| | Three months | | | Six months | | | Change | | |
| | ended June 30, | | | ended June 30, | | | Three | | | Six | | | Three months | | | Nine months | | | Change | |
| | 2010 | | | 2009 | | | 2010 | | | 2009 | | | Months | | | Months | | | ended September 30, | | | ended September 30, | | | Three | | | Nine | |
| | | | | | | | | | | | | | | | | | | | 2010 | | | 2009 | | | 2010 | | | 2009 | | | Months | | | Months | |
Revenues | | $ | 212,473 | | | $ | 255,109 | | | $ | 440,649 | | | $ | 495,564 | | | $ | (42,636 | ) | | $ | (54,915 | ) | | $ | 212,943 | | | $ | 263,068 | | | $ | 653,592 | | | $ | 758,632 | | | $ | (50,125 | ) | | $ | (105,040 | ) |
Contract costs | | | 202,063 | | | | 244,440 | | | | 421,290 | | | | 477,249 | | | | (42,377 | ) | | | (55,959 | ) | | | 200,248 | | | | 250,144 | | | | 621,538 | | | | 727,393 | | | | (49,896 | ) | | | (105,855 | ) |
Selling, general and administrative expenses | | | 457 | | | | 180 | | | | 755 | | | | 382 | | | | 277 | | | | 373 | | | | 850 | | | | 422 | | | | 1,605 | | | | 804 | | | | 428 | | | | 801 | |
Operating Income | | | 9,953 | | | | 10,489 | | | | 18,604 | | | | 17,933 | | | | (536 | ) | | | 671 | | |
Operating income | | | | 11,845 | | | | 12,502 | | | | 30,449 | | | | 30,435 | | | | (657 | ) | | | 14 | |
Interest expense (income), net | | | 19 | | | | (60 | ) | | | 14 | | | | (119 | ) | | | 79 | | | | 133 | | | | 61 | | | | 3 | | | | 75 | | | | (116 | ) | | | 58 | | | | 191 | |
Income before income taxes | | | 9,934 | | | | 10,549 | | | | 18,590 | | | | 18,052 | | | | (615 | ) | | | 538 | | | | 11,784 | | | | 12,499 | | | | 30,374 | | | | 30,551 | | | | (715 | ) | | | (177 | ) |
Provision for income taxes | | | 3,831 | | | | 4,107 | | | | 7,089 | | | | 6,970 | | | | (276 | ) | | | 119 | | | | 4,566 | | | | 4,773 | | | | 11,655 | | | | 11,743 | | | | (207 | ) | | | (88 | ) |
Net Income | | $ | 6,103 | | | $ | 6,442 | | | $ | 11,501 | | | $ | 11,082 | | | $ | (339 | ) | | $ | 419 | | |
Net profit margin | | | 2.9 | % | | | 2.5 | % | | | 2.6 | % | | | 2.2 | % | | | | | | | | | |
Net income | | | $ | 7,218 | | | $ | 7,726 | | | $ | 18,719 | | | $ | 18,808 | | | $ | (508 | ) | | $ | (89 | ) |
Our revenues decreased approximately $43$50 million, or 17%19%, for the three months ended JuneSeptember 30, 2010, as compared to the same period of 2009. Revenues decreased approximately $55$105 million, or 11%14%, for the sixnine months ended JuneSeptember 30, 2010, as compared to the same period of 2009. Revenues in our Federal International, and InfrastructureInternational Groups declined while revenues increased in our IT, Energy and Management Consulting Groupand Infrastructure Groups increased during these periods.
Our operating income decreased approximately $536$657 thousand, or approximately 5% for the three months ended JuneSeptember 30, 2010, as compared to the same period of 2009. Operating income increased approximately $671$14 thousand or approximately 4% for the sixnine months ended JuneSeptember 30, 2010, as compared to the same period of 2009. Operating income in our FederalIT, Energy and Management Consulting Group declinedincreased while operating income increased in each of our other operating groups declined during these periods.
Changes in revenues and income are further discussed in the summaries of our group results that follow.
Selling, general and administrative expenses consist primarily of costs and expenses that are not chargeable or reimbursable on our operating unit contracts. These expenses increased for the three- six-monthand nine-month periods ended JuneSeptember 30, 2010 as compared to the same periods of 2009 due primarily to strategic planning costs corporate consulting costs and professional services fees.associated with our acquisition of Akimeka.
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Our effective income tax ratesrate for the sixnine months ended JuneSeptember 30, 2010 and 2009 were 38.1% and 38.6%, respectively. The decrease in the effective tax rate is the result of the reversal of a valuation allowance of approximately $51 thousand during the first quarter of 2010.was 38.4%.
Federal Group Results
The results of operations for our Federal Group are as follows (in thousands):
| | Three months | | | Six months | | | Change | | | Three months | | | Nine months | | | Change | |
| | ended June 30, | | | ended June 30, | | | Three | | | Six | | | ended September 30, | | | ended September 30, | | | Three | | | Nine | |
| | 2010 | | | 2009 | | | 2010 | | | 2009 | | | Months | | | Months | | | 2010 | | | 2009 | | | 2010 | | | 2009 | | | Months | | | Months | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Revenues | | $ | 128,755 | | | $ | 151,302 | | | $ | 258,521 | | | $ | 304,259 | | | $ | (22,547 | ) | | $ | (45,738 | ) | | $ | 103,274 | | | $ | 142,332 | | | $ | 361,795 | | | $ | 446,591 | | | $ | (39,058 | ) | | $ | (84,796 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Operating Income | | $ | 6,059 | | | $ | 6,422 | | | $ | 10,843 | | | $ | 10,920 | | | $ | (363 | ) | | $ | (77 | ) | |
Operating income | | | $ | 5,593 | | | $ | 6,046 | | | $ | 16,436 | | | $ | 16,966 | | | $ | (453 | ) | | $ | (530 | ) |
Profit percentage | | | 4.7 | % | | | 4.2 | % | | | 4.2 | % | | | 3.6 | % | | | | | | | | | | | 5.4 | % | | | 4.2 | % | | | 4.5 | % | | | 3.8 | % | | | | | | | | |
Revenues for our Federal Group decreased approximately $23$39 million and $46$85 million, or 15%27% and 19%, for the three- and six-monthnine-month periods ended JuneSeptember 30, 2010 as compared to the same periods for the prior year. The decreases in revenues for this segment resulted primarily from a decrease in CED revenues associated with work performed under our R2 contract of approximately $27$42 million and $59$101 million, for the three- and six-monthnine-month periods, respectively. Revenues associated with our ELD division equipment refurbishment services also declined approximately $5$6 million and $7$13 million for the three- and six-monthnine-month periods, respectively. The declines in revenues in this group were partially offset by revenue increases of approximately $6$5 million and $13$19 million for the three- and six-monthnine-month periods, respectively, associated with our FSS Division work on vehicles and equipment overseas and by revenue increases of approximately $4 million and $7$11 million for the three- and six-monthnine- month periods, respectively, associated with our SED Division engineering and design work.
Operating income for our Federal Group decreased approximately $363$453 thousand and $77$530 thousand, or 6%7% and %1,3%, respectively, for the three- six-monthand nine-month periods ended JuneSeptember 30, 2010, as compared to the same periods for the prior year. The decreaseschanges in operating income for these periods are primarily due to: decreases in profits of approximately $632 thousand$3.5 million and $582 thousand$4.3 million, respectively, associated with the decline in CED revenues from our R2 Program; decreases in profits of approximately $1.5$2.2 million and $2.8$5.0 million, respectively, associated with the decline in revenues on our ELD equipment refurbishment services; increases in profits of approximately $900$989 thousand and $2.1$3.1 million, respectively, on our FSS division work attributable to the increased revenues in this division; and increases in profits of approximately $900 thousand$1.2 millio n and $1.3$2.4 million, respectively, on our SED division work. Profit margins in this group are increasing as revenues from our low margin subcontractor work on the R2 Program decline and revenues generated by our direct labor become a larger percentage of our overall revenues.
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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 | | | Three months | | | Nine months | | | Change | |
| | ended June 30, | | | ended June 30, | | | Three | | | Six | | | ended September 30, | | | ended September 30, | | | Three | | | Nine | |
| | 2010 | | | 2009 | | | 2010 | | | 2009 | | | Months | | | Months | | | 2010 | | | 2009 | | | 2010 | | | 2009 | | | Months | | | Months | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Revenues | | $ | 52,939 | | | $ | 73,267 | | | $ | 122,187 | | | $ | 137,423 | | | $ | (20,328 | ) | | $ | (15,236 | ) | | $ | 64,686 | | | $ | 88,675 | | | $ | 186,873 | | | $ | 226,098 | | | $ | (23,989 | ) | | $ | (39,225 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Operating Income | | $ | 1,841 | | | $ | 1,755 | | | $ | 3,883 | | | $ | 3,593 | | | $ | 86 | | | $ | 290 | | |
Operating income | | | $ | 3,688 | | | $ | 4,074 | | | $ | 7,571 | | | $ | 7,667 | | | $ | (386 | ) | | $ | (96 | ) |
Profit percentage | | | 3.5 | % | | | 2.4 | % | | | 3.2 | % | | | 2.6 | % | | | | | | | | | | | 5.7 | % | | | 4.6 | % | | | 4.1 | % | | | 3.4 | % | | | | | | | | |
Revenues for our International Group decreased approximately $20$24 million and $15$39 million, respectively, or 28%27% and 11%17%, for the three- and six-monthnine-month periods ended JuneSeptember 30, 2010, as compared to the same periods for the prior year. The decrease in revenues resulted primarily from a decline of approximately $22$36 million and $35$71 million, respectively, in revenues for these periods primarily from FMD servicespass-through work provided on engineering and technical services task orders.orders under the R2 contract. The revenue declines were partially offset by revenue increases on our GLOBAL Division services of approximately $9.5 million and $23.4 million, for the three- and nine-month periods, respectively; revenue increases on the CFT Program of approximately $1.4$1.7 million and $3.7$5.4 million for the three- and six-monthnine-month periods, respectively,respectively; and revenue increasesincrea ses on the Treasury Seized Asset Program of approximately $247$599 thousand and $2.2$2.8 million for the three- and six-monthnine-month periods, respectively, and revenue increases on our GLOBAL Division services of approximately $13 million.respectively.
Operating income for our International Group increaseddecreased approximately $86$386 thousand and $290$96 thousand, respectively, or 5%9% and 8%1%, for the three- and six-monthnine-month periods ended JuneSeptember 30, 2010, as compared to the same periods for the prior year. The increaseschanges in operating income are primarily due to: a change in the profitability of the Treasury Seized Asset Program of approximately $480 thousand and $805 thousand for these periods; an increase in profits of approximately $370 thousand and $783 thousand for these periods from our GLOBAL Division work; a decline in profits of approximately $495 $366
thousand and $690 thousand$1 million, respectively, for these periods from the CFT Program; and to a decline in profits of approximately $221$187 thousand and $539$726 thousand, respectively, for these periods associated with the lower revenues from FMD services provided on engineering and technical services task orders.
orders; an increase in the profits of approximately $168 thousand and $972 thousand, respectively, for these periods on the Treasury Seized Asset Program; and an increase in profits of approximately $56 thousand and $839 thousand, respectively, for these periods from our GLOBAL Division 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 | | | Six months | | | Change | | | Three months | | | Nine months | | | Change | |
| | ended June 30, | | | ended June 30, | | | Three | | | Six | | | ended September 30, | | | ended September 30, | | | Three | | | Nine | |
| | 2010 | | | 2009 | | | 2010 | | | 2009 | | | Months | | | Months | | | 2010 | | | 2009 | | | 2010 | | | 2009 | | | Months | | | Months | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Revenues | | $ | 21,336 | | | $ | 18,620 | | | $ | 41,628 | | | $ | 35,325 | | | $ | 2,716 | | | $ | 6,303 | | | $ | 25,831 | | | $ | 19,377 | | | $ | 67,459 | | | $ | 54,702 | | | $ | 6,454 | | | $ | 12,757 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Operating Income | | $ | 2,450 | | | $ | 2,230 | | | $ | 4,434 | | | $ | 3,405 | | | $ | 220 | | | $ | 1,029 | | |
Operating income | | | $ | 3,534 | | | $ | 2,507 | | | $ | 7,968 | | | $ | 5,912 | | | $ | 1,027 | | | $ | 2,056 | |
Profit percentage | | | 11.5 | % | | | 12.0 | % | | | 10.7 | % | | | 9.6 | % | | | | | | | | | | | 13.7 | % | | | 12.9 | % | | | 11.8 | % | | | 10.8 | % | | | | | | | | |
Revenues for our IT, Energy and Management Consulting Group increased approximately $2.7$6.5 million and $6.3$12.8 million, respectively, or 15%33% and 18%23%, for the three- and six-monthnine-month periods ended JuneSeptember 30, 2010, as compared to the same periods for the prior year. The increase in revenues for these periods resulted from an increaseincreases in the revenues of our Energetics subsidiary revenues of approximately $1.6$2.1 million and $3.5$5.6 million, respectively, a decrease of approximately $155 thousand for the three-month period and an increase of approximately $2.7 million for the nine-month period in ourthe revenues of G&B, subsidiaryand the inclusion of revenues of recently acquired Akimeka of approximately $1.1 million and $2.8 million for these periods. Both of these subsidiaries$4.5 million. Revenue increases in this group have increased theirbeen driven by increases in the direct labor workforces as compared to the prior year, which has resulted in increased revenues.workforce.
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Operating income for this segment increased approximately $220 thousand and $1 million and $2.1 million, respectively, or 10%41% and 30%35%, for the three- and six-monthnine-month periods ended JuneSeptember 30, 2010, as compared to the same periods for the prior year. The increased profits are primarily attributable to revenue increases, including revenue increases associated with the increasesinclusion of Akimeka in revenues in both subsidiaries.our operating results.
Infrastructure Group Results
The results of operations for our Infrastructure Group are as follows (in thousands):
| | Three months | | | Six months | | | Change | | | Three months | | | Nine months | | | Change | |
| | ended June 30, | | | ended June 30, | | | Three | | | Six | | | ended September 30, | | | ended September 30, | | | Three | | | Nine | |
| | 2010 | | | 2009 | | | 2010 | | | 2009 | | | Months | | | Months | | | 2010 | | | 2009 | | | 2010 | | | 2009 | | | Months | | | Months | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Revenues | | $ | 9,443 | | | $ | 11,920 | | | $ | 18,313 | | | $ | 18,557 | | | $ | (2,477 | ) | | $ | (244 | ) | | $ | 19,152 | | | $ | 12,684 | | | $ | 37,465 | | | $ | 31,241 | | | $ | 6,468 | | | $ | 6,224 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Operating Income | | $ | 188 | | | $ | 302 | | | $ | 469 | | | $ | 341 | | | $ | (114 | ) | | $ | 128 | | |
Operating (loss) income | | | $ | (73 | ) | | $ | 294 | | | $ | 396 | | | $ | 635 | | | $ | (367 | ) | | $ | (239 | ) |
Profit percentage | | | 2.0 | % | | | 2.5 | % | | | 2.6 | % | | | 1.8 | % | | | | | | | | | | | (0.4 | )% | | | 2.3 | % | | | 1.1 | % | | | 2.0 | % | | | | | | | | |
This segment consists of our ICRC subsidiary. Revenues for this group decreasedincreased approximately $2.5$6.5 million and $244 thousand,$6.2 million, respectively or 21%51% and 1%20%, for the three- and six-monthnine-month periods ended JuneSeptember 30, 2010, as compared to the same periods for the prior year. Operating income for this segment decreased approximately $114$367 thousand and $239 thousand, respectively, or 38%,125% and increased approximately $128 thousand, or 38%, for the three- and six-monthnine-month periods ended JuneSeptember 30, 2010, as compared to the same periods for the prior year. Changes in revenues and operating income for this divisionsegment are primarily attributable to revenue and profit activity on the PIEP. During 2010, the customer has funded the cost of certain work
we have performed on this project, but has not funded any fees normally associated with this work pending resolution of environmental and technical issues impacting the work. Accordingly, we have not recognized fee for most of the work on this project performed in 2010 and this has caused the decreases in operating income for this segment. We received an awardare currently in discussions with our customer regarding resolution of the fee issue. If the fee on this work is funded for performance through September 30, 2010, the PIEP ofadditional revenue and operating income will be approximately $117 thousand in the first quarter of 2010.$1.0 million.
Financial Condition
Our financial condition did not change materially in the first sixnine months of 2010. 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.
Liquidity and Capital Resources
Cash Flows
Cash and cash equivalents decreased approximately $927 thousand$6 million during the first sixnine months of 2010.
Cash provided by operating activities in the first sixnine months of 2010 decreased by approximately $6.3$9.4 million as compared to the same period of 2009. This resulted primarily from an increase of approximately $7.8$10.4 million in cash used in operating activities due to changes in the levels of operating assets and liabilities, which was offset by increases of approximately $1 million in depreciation and amortization and other non-cash operating activities and approximately $419 thousand of net income.liabilities. Of the operating assets and liabilities, our largest asset is our accounts receivable and our largest liability is our accounts payable. 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 requirements. Accordingly, our levels of accounts receivable and
accounts payable may fluctuate significantly depending on the timing of the government services ordered, the timing of billings received from subcontractors and materials vendors to fulfill these services, and the timing of payments received from customers of the government in payment of these services. Such timing differences may cause significant increases and decreases in our accounts receivable and accounts payable in short time periods.
We used approximately $1.9$26.7 million lessmore cash in investing activities in the first sixnine months of 2010 as compared to the same period of 2009. InvestingWe used approximately $29.8 million of cash in 2010 related to our acquisition of Akimeka. Other investing activities consisted of purchases of property and equipment and earn-out payments associated with the acquisitions of ICRC and G&B when certain financial performance targets were achieved.
Cash provided by financing activities was approximately $19.2 million in the first nine months of 2010 compared to cash used for financing activities in the first six months of 2010 decreased by approximately $3.9$7.3 million as compared tofor the same period of 2009. This difference was primarily the result ofdue to borrowing requirements on our bank term loan to help finance our acquisition of Akimeka in 20092010 as compared to no borrowing requirements in 2010.2009 when we paid down borrowings on our bank loan.
We paid quarterly cash dividends of $0.05 per share in each of the first two quarters of 2010, and a quarterly dividend of $0.06 per share in the third quarter of 2010. Pursuant to our bank loan agreement, our payment of cash dividends is subject to annual rate restrictions. We have paid cash dividends each year since 1973.
Liquidity
Our internal sources of liquidity are primarily from operating activities, specifically from changes in the level of revenues and associated accounts receivable and accounts payable, and from profitability. Significant increases or decreases in revenues and accounts receivable and accounts payable can cause significant increases or decreases in internal liquidity. Our accounts receivable and accounts payable levels can be affected by changes in the level of the work we perform and by the timing of large materials purchases and subcontractor efforts used in our contracts.
We also purchase property and equipment and invest in expansion, improvement, and maintenance of our operational and administrative facilities. From time to time, we may also invest in the acquisition of other companies as we continue to seek opportunities for growth. The recording of a construction asset and corresponding long-term liability of $16.4 million related to the lease agreement signed in November 2009 (see note 10 of our financial statements) will not have an impact on our cash flows.
Our external liquidityfinancing consists of a loan agreement with a group of banks that provides us withseveral types of financing. The loan agreement consists of a term loan, revolving loans, and letters of credit. credit and expires in August 2013.
The term loan has monthly installments payable on a straight-line amortization schedule, with final payment due in August 2013. The amount of the term loan outstanding as of September 30, 2010 is $20 million. We pay interest on the term loan borrowings at a prime-based rate or an optional LIBOR-based rate.
The maximum amount of credit available to us from the banking group for revolving loans and letters of credit as of JuneSeptember 30, 2010 was $50 million and under the loan agreement we may elect to increase thethis maximum credit availability up to $75 million. The maturity date of the loan agreement is August 26, 2011. TheThis amount of credit available to us under the loan agreement is subject to certain conditions, including a borrowing formula based on our billed receivables. Under the terms of the loan agreement, weWe may borrow against the revolving loan at any time and can repay the borrowings at any time without premium or penalty. We pay a commitment fee, interest on any revolving loan borrowings at a prime-based rate or an optional LIBOR-based rate, and fees on any letters of credit that are issued.
We were usinghad approximately $4.9$5.0 million of the loan agreement availability as of June 30, 2010, consisting of letters of credit. We hadcredit outstanding and no revolving loan amounts outstanding as of JuneSeptember 30, 2010. During the first sixnine months of 2010, the highest outstanding revolving loan amount was $16.5 million and the lowest was $0. The timing of certain payments made and collections received associated with our subcontractor and materials requirements and other operating expenses can cause temporary peaks in our outstanding revolving loan amounts.
The loan agreement contains collateral requirements that secure our assets, restrictive covenants, a limit on annual dividends, and other affirmative and negative covenants. Restrictive covenants include a maximum Leverage Ratio (Total Funded Debt/EBITDA), a minimum Fixed Charge Coverage Ratio, and a minimum Fixed ChargeAsset Coverage Ratio that we were in compliance with at JuneSeptember 30, 2010.
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| Maximum Ratio | Actual Ratio |
Leverage Ratio | 3.00 to 1 | 0.100.53 to 1 |
| Minimum Ratio | Actual Ratio |
Fixed Charge Coverage Ratio | 1.25 to 1 | 3.353.14 to 1 |
| | |
| Minimum Ratio | Actual Ratio |
Asset Coverage Ratio | 1.5 to 1 | 5.61 to 1 |
Our banks continue to maintain investment grade credit ratings from the ratings services and we believe that we are well positioned to obtain financing from other banks if the need should arise. Accordingly, we do not believe that turbulence in the financial markets will have a material adverse impact on our ability to finance our business, financial condition, or results of operations. We currently do not use public debt security financing.
Inflation and Pricing
Most of our contracts provide for estimates of future labor costs to be escalated for any option periods, while the non-labor costs in our contracts are normally considered reimbursable at cost. Our property and equipment consists principally of computer systems equipment, furniture and fixtures, shop equipment, and land and improvements. We do not expect the overall impact of inflation on replacement costs of our property and equipment to be material to our future results of operations or financial condition.
Disclosures About Market Risk
Interest Rates
Our bank loan providesloans provide available borrowing to us at variable interest rates. The amount borrowed is not large with respect to our cash flows and we believe that we will be able to pay down any bank loan borrowings in a relatively short time frame. Because of this, we do not believe that any adverse movement in interest rates would have a material impact on future earnings or cash flows. If we were to significantly increase our borrowings, future interest rate changes could potentially have a material impact on us.
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VSE CORPORATION AND SUBSIDIARIES
See “Disclosures“Disclosures About Market Risk” in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
As of the end of the period covered by this report, based on management's evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d - 15(e) under the Securities Exchange Act of 1934, as amended) our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in ensuring that information required to be disclosed by us in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated anda nd communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
There was no change in our internal control over financial reporting during our secondthird quarter of fiscal 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
VSE did not purchase any of its equity securities during the period covered by this report.
Under the Registrant's bank loan agreement dividends may be paid in an annual aggregate amount of $.60 per share, provided there is no default under the loan agreement.
(a) Exhibits.
Exhibit No.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has omitted all other items contained in "Part II. Other Information" because such other items are not applicable or are not required if the answer is negative or because the information required to be reported therein has been previously reported.
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VSE CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | VSE CORPORATION | |
| | | |
| | | |
Date: July 30,October 29, 2010 | By: | /s/ M. A. Gauthier | |
| | M. A. Gauthier | |
| | Director, Chief Executive Officer, | |
| | President and Chief Operating | |
| | Officer | |
Date: July 30,October 29, 2010 | By: | /s/ T. R. Loftus | |
| | T. R. Loftus | |
| | Executive Vice President and | |
| | Chief Financial Officer | |
| | (Principal Accounting Officer) | |