United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2010
 
Commission file number 0-3676
 
VSE CORPORATION
(Exact name of registrant as specified in its charter)
 
     
 
Delaware
 
 
54-0649263
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
2550 Huntington Avenue, Alexandria, VA 22303-1499 (703/960-4600)
(Address and telephone number of principal executive offices)
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
 
Title of Each Class
 
 
 
Name of each exchange on which registered
 
Common Stock, $0.05 par value
 
The NASDAQ Global Select Market
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨     No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨    No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes x    No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ¨    No ¨
 
Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act (check one).
Large accelerated filer ¨        Accelerated filer x         Non-accelerated filer ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b2 of the Exchange Act).    Yes    ¨  No    x
 
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second quarter.
 
Approximately $130.9 million as of June 30, 2010.
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. Common Stock, $.05 par value, 5,203,691 shares outstanding as of March 2, 2011.
 

 
 

 



DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for the Annual Meeting of Stockholders expected to be held on May 3, 2011, are incorporated by reference into Part III of this report.

 
2

 

TABLE OF CONTENTS


   
Page
   
     
ITEM 1.
5
ITEM 1A
9
ITEM 1B.
11
ITEM 2.
11
ITEM 3.
12
ITEM 4.
12
 
13
     
   
     
ITEM 5.
16
ITEM 6.
19
ITEM 7.
20
ITEM 7A.
38
ITEM 8.
39
ITEM 9.
61
ITEM 9A.
61
ITEM 9B.
64
     
     
   
     
ITEM 10.
64
ITEM 11.
64
ITEM 12.
64
ITEM 13.
64
ITEM 14.
64
     
     
   
     
ITEM 15.
64
     
 
66
     
 
67-76




 
3

 

Forward Looking Statements

This filing contains statements that, to the extent they are not recitations of historical fact, constitute "forward looking statements" under federal securities laws.  All such statements are intended to be subject to the safe harbor protection provided by applicable securities laws. For discussions identifying some important factors that could cause actual VSE Corporation (“VSE,” the “Company,” “us,” “our,” or “we”) results to differ materially from those anticipated in the forward looking statements contained in this filing, see VSE's “Narrative Description of Business” (Items 1, 1A, 2 and 3), and “Management’s Discussion and Analysis.” Readers are cautioned not to place undue reliance on these forward looking statements, which reflect management’s analysis only as of the date hereof. The Company undertakes no obligation to publicly revise these forward looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q filed by the Company subsequent to this Annual Report on Form 10-K and any Current Reports on Form 8-K filed by the Company.

 




 
4

 
 
PART I
ITEM 1. Business

 
(a)  
   General Background

VSE was incorporated in Delaware in 1959 and serves as a centralized management and consolidating entity for our business operations. Our business operations are managed under groups that perform our services. Our Federal Group consists of our Communications and Engineering Division ("CED"), Engineering and Logistics Division ("ELD"), Field Support Services Division (“FSS”), and Systems Engineering Division ("SED"). Our International Group consists of our GLOBAL Division ("GLOBAL") and Fleet Maintenance Division ("FMD"). Our IT, Energy and Management Consulting Group consists of our wholly owned subsidiaries Energetics Incorporated ("Energetics"), G&B Solutions, Inc. (“G&B") and, beginning August 19, 2010, our newly acquired wholly owned subsidiary Akimeka, LLC (“Akimeka”). Our Infrastructure Group consists of our wholly owned subsidiary Integrated Concepts and Research Corporation (“ICRC”). The term "VSE" or "Company" means VSE and its subsidiaries and divisions unless the context indicates operations of the parent company only.

Our business operations consist primarily of diversified logistics, engineering, IT, construction management and consulting services performed on a contract basis. Almost all of our contracts are with agencies of the United States Government (the "government") and other government prime contractors.

We seek to provide our customers with competitive, cost-effective solutions to specific problems. These problems generally require a detailed technical knowledge of materials, processes, functional characteristics, information systems, technology and products and an in-depth understanding of the basic requirements for effective systems and equipment.

 
(b)   Financial Information

Our operations are conducted within four reportable segments aligned with our management groups: 1) Federal, which generated approximately 53% of our revenues in 2010; 2) International, which generated approximately 30% of our revenues in 2010; 3) IT, Energy and Management Consulting, which generated approximately 11% of our revenues in 2010; and 4) Infrastructure, which generated approximately 6% of our revenues in 2010. Additional financial information for our reportable segments appears in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.

 
(c)  Description of Business

Services and Products

Our services include a broad array of capabilities and resources that support military, federal civil, and other government systems, equipment and processes. We are focused on creating, sustaining and improving the systems, equipment and processes of government through core offerings in logistics, engineering, IT, construction management and consulting services.

Typical projects include sustaining engineering support for military vehicles and combat trailers; military equipment refurbishment and modification; ship maintenance, repair, overhaul planning and follow-on technical support; logistics management support; machinery condition analysis; specification preparation for ship alterations and repairs; ship force crew training; life cycle support for ships; ship communication systems; energy conservation and advanced technology demonstration projects; technical data package preparation; multimedia, computer local area network (“LAN”), and telecommunications systems; cross-platform technical data; product data; technical manual development and support; information technology management consulting, services, and solutions; and large-scale port engineering development and construction management. See Item 7 “Management’s Discussion and Analysis of Financial Information and Results of Operations” for more information regarding our business.

 
5

Contracts

Depending on solicitation requirements and other factors, we offer our professional and technical services and products through various competitive contract arrangements and business units that are responsive to customer requirements and may also provide an opportunity for diversification. Some of the contracts permit the contracting agency to issue delivery orders or task orders in an expeditious manner to satisfy relatively short-term requirements for engineering and technical services.  

Almost all of our revenues are derived from contract services performed for Department of Defense (“DoD”) agencies or for Federal Civil agencies. The U.S. Army, Army Reserve and U.S. Navy are our largest customers. Other significant customers include the Department of Treasury, the Department of Transportation, the Department of Energy and the Department of Interior. To a lesser degree, our customers also include various other government agencies and commercial entities.

   
Revenues by Customer
 
   
(Dollars in Thousands)
 
   
Years ended December 31,
 
Customer
 
2010
   
%
   
2009
   
%
   
2008
   
%
 
U.S. Army/Army Reserve
  $ 463,305       53.5     $ 555,238       54.7     $ 625,237       59.9  
U.S. Navy
    198,833       23.0       271,189       26.7       195,792       18.8  
U.S. Air Force
    13,303       1.5       13,839       1.4       10,720       1.0  
Total - DoD
    675,441       78.0       840,266       82.8       831,749       79.7  
                                                 
Department of
                                               
  Transportation
    51,497       6.0       35,722       3.5       89,873       8.6  
Department of
                                               
  U.S. Treasury
    49,332       5.7       47,676       4.7       57,021       5.5  
Department of Interior
    29,810       3.4       29,275       2.9       19,156       1.8  
Department of Energy
    21,890       2.5       16,111       1.6       12,812       1.2  
Other government
    33,055       3.8       42,670       4.2       29,748       2.9  
Total – Federal Civil Agencies
    185,584       21.4       171,454       16.9       208,610       20.0  
                                                 
Commercial
    5,011       0.6       2,919       0.3       3,376       0.3  
                                                 
Total
  $ 866,036       100.0     $ 1,014,639       100.0     $ 1,043,735       100.0  



The government’s procurement practices sometimes include the bundling of various work efforts under large comprehensive management contracts (“omnibus”). As a result, the growth opportunities available to us can occur in significant, unpredictable increments. We have pursued these larger opportunities by assembling teams of subcontractors to offer the range of technical competencies required by these omnibus contracts. Typically the use of subcontractors and large material purchases on government contracts provides lower profit margins than work performed by our own personnel. As a result, the use of such teaming arrangements may lower our overall profit margins in some years. Although the government’s practice of using omnibus multiple award contracts is expected to continue, we also have opportunities to compete for other contracts requiring our specific areas of expertise. We are positioned to pursue these opportunities while continuing to use subcontractor teams to compete for the omnibus contracts.
 
6

Our contracts with the government are typically cost plus fee, time and materials, or fixed-price contracts. Revenues result from work performed on these contracts by our own employees, from pass-through of costs for work performed by our subcontractors, and for materials. Revenues on cost-type contracts are recorded as allowable costs are incurred and fees are earned.

Revenues for time and materials contracts are recorded on the basis of allowable labor hours worked multiplied by the contract defined billing rates, plus the cost of materials used in performance on the contract. Profits or losses on time and material contracts result from the difference between the cost of services performed and the contract defined billing rates for these services.

Revenue recognition methods on fixed-price contracts vary depending on the nature of the work and the contract terms. Revenues on fixed-price service contracts are recorded as work is performed, typically ratably over the service period. Revenues on fixed-price contracts that require delivery of specific items may be recorded based on a price per unit as units are delivered.

Backlog  

Funded backlog for government contracts represents a measure of our potential future revenues. Funded backlog is defined as the total value of contracts that has been appropriated and funded by the procuring agencies, less the amount of revenues that have already been recognized on such contracts. Our funded backlog as of December 31, 2010, is approximately $407 million. Funded backlog as of December 31, 2009 and 2008 was approximately $476 million and $567 million, respectively. Changes in funded backlog on contracts are sometimes unpredictable due to uncertainties associated with changing government program priorities and availability of funds, which is heavily dependent upon the congressional authorization and appropriation process.  Delays in this process, such as those experienced in 2010 and 2009, may temporarily diminish the availability of funds for ongoing and planned work.

In addition to the funded backlog levels, we have contract ceiling amounts available for use on multiple award, indefinite delivery, indefinite quantity contracts with DoD and Federal Civil agencies. While these contracts increase the opportunities available for us to pursue future work, the amount of future work is not determinable until delivery orders are placed on the contracts.  Frequently, these delivery orders are competitively awarded. Additionally, these delivery orders must be funded by the procuring agencies before we can perform work and begin generating revenues.

Marketing  

Our marketing activities are conducted at the operating group level by our business development staff and our professional staff of engineers, program managers, and other personnel. These activities are centrally coordinated through our Corporate Sales and Marketing Department. Information concerning new programs and requirements becomes available in the course of contract performance, through formal and informal briefings, from participation in professional organizations, and from literature published by the government, trade associations, professional organizations and commercial entities.

Personnel  

Services are provided by our staff of professional and technical personnel having high levels of education, experience, training and skills. As of December 31, 2010, we had 2,897 employees, an increase from 2,534 as compared to December 31, 2009. Principal categories include (a) mechanics and vehicle and equipment technicians, (b) information technology professionals in computer systems, applications and products, configuration, change and data management disciplines, (c) engineers and technicians in mechanical, electronic, industrial, energy and environmental services, (d) logisticians, and (e) construction and environmental specialists. The expertise required by our customers also frequently includes knowledge of government administrative procedures. Many of our employees have previously served as government employees or members of the U.S. Armed Forces.

 
7

Competition  

The professional and technical services industry in which we are engaged is very competitive. Numerous other organizations, including large, diversified firms, have greater financial resources and larger technical staffs that are capable of providing the same services offered by us. Our lean operating model provides the agility and value necessary to remain competitive in our chosen markets.

Government agencies emphasize awarding contracts on a competitive basis as opposed to a sole source or other noncompetitive basis. Most of the significant contracts that we currently perform were either initially awarded on a competitive basis or have been renewed at least once on a competitive basis. Government agencies also order work through contracts awarded by General Services Administration (“GSA”). GSA provides a schedule of services at fixed prices that may be ordered outside of the solicitation process. We have nine GSA schedule contracts for different classes of services. There is no assurance regarding the level of work we may obtain under these contracts. Government budgets, and in particular the budgets of certain government agencies, can also affect competition in our business. A reallocation of government spending priorities or a general decline in government budgets can result in lower levels of potential business, thereby intensifying competition.

The extent and range of competition that we will encounter as a result of changing economic or competitive conditions, customer requirements or technological developments is unpredictable. We believe the principal competitive factors for our business are technical and financial qualifications, past performance and price.

Government acquisition policies and procedures often emphasize factors that present challenges to our efforts to win new business, and may make it difficult for us to qualify as a potential bidder. For example, past performance may be used to exclude entrance into new government markets, and multiple-award schedules may result in unequal contract awards between successful contractors.

Available Information

Copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports are filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. They are available free of charge through our website www.vsecorp.com as soon as reasonably practicable after the reports are electronically filed with the Securities and Exchange Commission (“SEC”).  



 
8



ITEM 1A.  Risk Factors

Our future results may differ materially from past results and from those projected in the forward-looking statements contained in this Form 10-K due to various uncertainties and risks, including but not limited to those set forth below, one-time events and other important factors disclosed previously and from time to time in our other filings with the SEC.


Our work on large program efforts presents a risk to revenue and profit growth and sustainability.

The eventual expiration of large programs, or the loss of or disruption of revenues on a single contract, presents the potential for reduced revenues and profits. Such revenue losses could also erode profits on our remaining programs that would have to absorb a larger portion of the fixed corporate costs previously allocated to the expiring programs or discontinued contract work. Our largest contract, the Rapid Response (“R2”) Program, expired in January 2011, adversely impacting our 2010 revenues as specific task orders under the R2 contract expired intermittently prior to the expiration date of the contract. Our mitigation efforts include moving some of the work previously performed under the R2 contract to other existing contracts and pursuing other contracts under which the work can be performed. We were also awarded a follow-on R2-3G contract; however, government administrative and funding issues have delayed awards under this program.

Uncertain and shifting federal government priorities could delay contract awards and funding and adversely affect our ability to continue work on our government contracts.

Our business is subject to funding delays, terminations, reductions, extensions, and moratoriums caused by political and administrative disagreements and inefficiencies within the government. The current federal procurement environment is unpredictable and could adversely affect our ability to perform work on new and existing contracts. Contract award and funding delays extend across the federal technical services industry. We experienced delays in contract awards and funding on our contracts during 2009 and 2010 that have impacted our ability to continue existing work and to replace expiring work.

The nature of our operations and significant increases in work performed by our employees in recent years present certain challenges related to work force management.

Our financial performance is heavily dependent on the abilities of our operating and administrative staffs with respect to technical skills, operating performance, pricing, cost management, safety, and administrative and compliance efforts. A wider diversity of contract types, nature of work, work locations, and increased legal and regulatory complexities challenges our administrative staff and skill sets more than in prior years. Also, the recent increases and geographical expansion in our operating workforce presents challenges for our quality of workforce, quality of work, safety, and labor relations compliance. The scale of our current and projected work in foreign countries is exposing us to new challenges associated with export compliance, local laws and customs, workforce issues, extended supply chain, and war zone threats. Failure to attract or retain an adequately skilled workforce, lack of knowledge or training in critical functions, or inadequate staffing levels can result in lost work, reduced profit margins, losses from cost overruns, performance deficiencies, workplace accidents, and regulatory non-compliance.

Global economic conditions and political factors could adversely affect revenues on current programs.

Revenues from our programs for which work is performed in foreign countries are subject to political risks posed by the ongoing conflicts in the Middle East and potential terrorist activity. A significant amount of our revenues in recent years has resulted from the U.S. military involvement in Iraq and Afghanistan, and an end to or substantial reduction of such U.S. military involvement could cause a decrease in our revenues. Similarly, the current political unrest in Egypt or potential changes in the political landscapes in other countries could cause a decrease in our revenues. International tensions can also affect our work by FMD on U.S. Navy ships when they are deployed outside of U.S. Navy facilities and are unavailable for maintenance work during those times. Adverse results arising from these global economic and political risks could have a material adverse impact on our results of operations.

 
9

Increased market competition resulting from decreases in government spending for contract services could affect our ability to sustain our revenue levels.

Continuing pressure on government budgets may significantly impact the flow of work to federal contractors, particularly new programs. Accordingly, competitor contractors that experience a loss of government work may tend to redirect their marketing efforts toward the types of work performed by us. This increase in competition for our service offerings could potentially affect our ability to win new work or to win successor contracts to continue work that is currently performed by us under expiring contracts.

Investments in facilities could cause losses if certain work is disrupted or discontinued.

We have made investments in facilities and lease commitments to support specific business programs, work requirements, and service offerings. A slowing or disruption of these business programs, work requirements, or service offerings that results in operating below intended levels could cause us to suffer financial losses.

As a government contractor, we are subject to a number of procurement rules and regulations that could expose us to potential liabilities or loss of work.

We must comply with and are affected by laws and regulations relating to the award, administration and performance of government contracts. Additionally, we are responsible for subcontractor compliance with these laws and regulations. Government contract laws and regulations affect how we conduct business with our customers and, in some instances, impose added costs to us. A violation of specific laws and regulations could result in the imposition of fines and penalties or the termination of contracts or debarment from bidding on contracts.

In some instances, these laws and regulations impose terms or rights that are significantly more favorable to the government than those typically available to commercial parties in negotiated transactions. For example, the government may terminate any government contract or subcontract at its convenience, as well as for performance default.

A termination for default could expose us to liability and have a material adverse effect on our ability to compete for future contracts and orders. In addition, the government could terminate a prime contract under which we are a subcontractor, irrespective of the quality of services provided by us as a subcontractor.

We are exposed to contractual and financial liabilities if our subcontractors do not perform satisfactorily.

A significant percentage of our contract work is performed by subcontractors, which are subject to government compliance, performance and financial risks. If unsatisfactory performance or compliance failure occurs on the part of subcontractors, we must bear the cost to remedy these deficiencies on our prime contracts.

 
10

Our business could be adversely affected by a negative audit by the government.

Government agencies, including the Defense Contract Audit Agency and the Department of Labor, routinely audit and investigate government contractors. These agencies review a contractor’s performance under its contracts, cost structure and compliance with applicable laws, regulations and standards. The government also may review the adequacy of, and a contractor’s compliance with, its internal control systems and policies, including the contractor’s purchasing, property, estimating, compensation and management information systems. Any costs found to be improperly allocated to a specific contract will not be reimbursed, while such costs already reimbursed must be refunded. If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the government. In addition, we could suffer serious harm to our reputation if allegations of impropriety were made.

Federal procurement directives could result in a loss of work on current programs to set-asides and omnibus contracts.

Our government business is subject to the risk that one or more of our potential contracts or contract extensions may be awarded by the contracting agency to a small or disadvantaged or minority-owned business pursuant to set-aside programs administered by the Small Business Administration, or may be bundled into omnibus contracts for very large businesses. These risks can potentially have an adverse effect on our revenue growth and profit margins.

Environmental and pollution risks could potentially impact our financial results.

We are exposed to certain environmental and pollution risks due to the nature of some of the contract work we perform. Costs associated with pollution clean up efforts and environmental regulatory compliance have not yet had a material adverse impact on our capital expenditures, earnings, or competitive position. However, the occurrence of a future environmental or pollution event could potentially have an adverse impact.

New accounting standards could result in changes to our methods of quantifying and recording accounting transactions, and could affect financial results and financial position.

Changes to Generally Accepted Accounting Principles in the United States (“GAAP”) arise from new and revised guidance issued by the Financial Accounting Standards Board, the SEC, and others. The effects of such changes may include prescribing an accounting method where none had been previously specified, prescribing a single acceptable method of accounting from among several acceptable methods that currently exist, or revoking the acceptability of a current method and replacing it with an entirely different method, among others. These changes could result in unanticipated effects on results of operations, financial position and other financial measures.


ITEM 1B.  Unresolved Staff Comments

None


ITEM 2.    Properties

Our principal executive and administrative offices are located in a five-story building in Alexandria, Virginia, leased by us through April 30, 2013. This building contains approximately 127,000 square feet of engineering, shop, and administrative space. In November 2009, we signed an agreement to lease a new building with approximately 95,000 square feet of office space in Springfield, Virginia that will serve as our new executive and administrative headquarters. This agreement includes a 15-year lease commitment. We expect to take occupancy of the building in the Spring of 2012.

 
11

We also provide services and products from approximately 41 leased facilities located near customer sites to facilitate communications and enhance project performance. These facilities are generally occupied under short-term leases and currently include a total of approximately 1.6 million square feet of office and warehouse space. Our employees often provide services at customer facilities, limiting our requirement for additional space. We also provide services from several locations outside of the United States, generally at foreign shipyards or U.S. military installations.
 
We own and operate two facilities in Ladysmith, Virginia. One of these properties consists of approximately 44 acres of land and multiple storage and vehicle maintenance buildings totaling approximately 57,000 square feet of space. The other property consists of 30 acres of land and buildings totaling approximately 13,500 square feet of space. We use these properties primarily to provide refurbishment services for military equipment, storage and maintenance and to supplement our Alexandria, Virginia, office and shop facilities.


ITEM 3.    Legal Proceedings

We may have, in the normal course of business, certain claims, including legal proceedings, against us and against other parties. In our opinion, the resolution of these claims will not have a material adverse effect on our results of operations or financial position. However, the results of any legal proceedings cannot be predicted with certainty.

Further, from time-to-time, government agencies investigate whether our operations are being conducted in accordance with applicable regulatory requirements.  Government investigations of us, whether relating to government contracts or conducted for other reasons, could result in administrative, civil or criminal liabilities, including repayments, fines or penalties being imposed upon us, or could lead to suspension or debarment from future government contracting.  Government investigations often take years to complete and many result in no adverse action against us.  We believe, based upon current information, that the outcome of any such government disputes and investigations will not have a material adverse effect on our financial position.


ITEM 4.    Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of our stockholders, through the solicitation of proxies or otherwise, during the three-month period ended December 31, 2010.

 
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EXECUTIVE OFFICERS OF THE REGISTRANT

Our executive officers are listed below, as well as information concerning their age and positions held with VSE.  There were no family relationships among any of our executive officers.  For executive officers who have been with us less than five years, their principal occupations and business experience over the last five years are provided.  The executive officers are appointed annually to serve until the first meeting of VSE’s Board of Directors (the “Board”) following the next annual meeting of stockholders and until their successors are elected and have qualified, or until death, resignation or removal, whichever is sooner.


Name
Age
Position with Registrant
     
Tina B. Bailey
52
Vice President – Human Resources
     
Thomas G. Dacus
65
Executive Vice President and President, Federal Group
     
Maurice A. Gauthier
63
Director, Chief Executive Officer, President and Chief Operating Officer
                              
   
Michael E. Hamerly
65
Executive Vice President and President, International Group
     
Randy W. Hollstein
54
Vice President – Sales and Marketing
     
William J. Jonas
58
Vice President - Procurement
     
Thomas M. Kiernan
43
Vice President, General Counsel and Secretary
     
James W. Lexo, Jr.
62
Executive Vice President, Strategic Planning and Business Initiatives
     
Thomas R. Loftus
55
Executive Vice President and Chief Financial Officer
                              
   
Denise Manning
51  
President, G&B Solutions Inc.
     
Nancy Margolis
55
President, Energetics Inc.
     
Carl E. Williams
58
President, Infrastructure Group
     
Crystal R. Williams  
46
Vice President – Contracts


Mr. Gauthier joined VSE in April 2008 as Chief Executive Officer, President and Chief Operating Officer. He was elected as a VSE director by the Board in February, 2009. Mr. Gauthier completed a military career of over 28 years of service, retiring in 1997 as a Navy Captain and board certified Department of Defense Major Program Manager.  Mr. Gauthier worked for VSE from October 1997 through February 1999 as Vice President and Chief Technology Officer, and as Director of Strategic Planning and Business Development, before joining the Nichols Research Corporation Navy Group as its President. With the acquisition of Nichols Research Corporation by Computer Sciences Corporation (“CSC”) in 1999, Mr. Gauthier served as Vice President of CSC’s Advanced Marine Center. His most recent assignment with CSC was as Vice President and General Manager of CSC’s Navy and Marine Corps Business Unit where he was responsible for the overall leadership and financial performance of a 2,500-employee organization providing systems engineering, technical, information technology and telecommunications support to U.S. Navy and Marine Corps customers. Mr. Gauthier earned a Bachelor of Science degree from the U.S. Naval Academy. He received a Master of Science degree in Systems Engineering from the U.S. Naval Postgraduate School, Monterey, CA. He is a graduate of the Defense Acquisition University’s Defense Systems Management College and of the Advanced Executive Program and the International Marketing Program offered by the Kellogg Graduate School of Management at Northwestern University.

 
13

In December 2009, Ms. Bailey was promoted to Vice President of Human Resources, after joining VSE as Assistant Vice President, Director of Human Resources for the Federal Group in October 2008. Prior to joining VSE, Ms. Bailey served as Vice President of Administration, Human Resources Director, at Science Applications International Corporation (“SAIC”). Ms. Bailey has over 20 years of experience as a human resources professional serving in a variety of increasingly responsible roles at several Fortune 500 companies, including Aetna Casualty and Surety Company, Travelers Group and Citigroup. Ms. Bailey joined SAIC in 1998 as a Senior Level Employee Relations Manager. Ms. Bailey earned a Bachelor of Arts degree from Virginia Commonwealth University and a Master of Arts degree in Human Resources Management from Marymount University.

Mr. Hollstein joined VSE in August 2008 as Vice President of Marketing. Mr. Hollstein has over 30 years of experience as a naval officer and defense industry professional. Mr. Hollstein served in the U.S. Navy as a surface warfare officer before leaving to join industry. He has worked in several leading companies at increasing levels of responsibility in program management, government relations and business development. Before joining VSE, Mr. Hollstein was Senior Director of Business Development for Maersk Line, Limited where he was responsible for business development activities related to maritime and maritime security opportunities. In prior assignments at other companies, he has been responsible for business development with Navy, Marine Corps, Coast Guard and Army clients and for developing new business with other government agencies. Mr. Hollstein earned his Bachelor of Science degree in Business Management from Babson College.

Mr. Jonas joined VSE in March of 2009 as Vice President of Procurement. He currently serves as Vice President of Supply Chain Management  Prior to joining VSE, Mr. Jonas served as co-founder and President of Comprehensive Contracting Services (“CCS”), which provides Program Management services to U.S. Government customers in the Intelligence community.  Prior to CCS, Mr. Jonas was Vice President, General Manager of the Health and Logistics division of IMC.  Mr. Jonas has also served as Vice President of Procurement with IAP Corporation and with Kellogg, Brown and Root, where he was responsible for the support of government support contracts.  He has held positions of responsibility with Raytheon Company as well as TRW Space and Electronics (now Northrop Grumman Corp.) where he spent 23 years in increasingly responsible roles.  Mr. Jonas earned a Juris Doctorate degree from Loyola Law School in Los Angeles and a Bachelor of Science degree in Business Administration from the University of Redlands. 

Mr. Kiernan joined VSE in November 2008 as Vice President, General Counsel, and Assistant Secretary. From 2003 to 2008, Mr. Kiernan served as Vice President, General Counsel and Secretary for Intelsat General Corporation, a subsidiary of Intelsat, Ltd. serving government and commercial customers. From 2000 to 2003, Mr. Kiernan served as a member of the Intelsat, Ltd., Office of General Counsel. From 1994 to 2000, Mr. Kiernan served as corporate counsel for SRA Life Sciences. Mr. Kiernan is a graduate of Virginia Tech University (B.A., Political Science) and George Mason University School of Law. He is a member of the Virginia State Bar.

Mr. Lexo joined VSE in 2007 as Executive Vice President of Strategic Planning and Business Initiatives and Vice Chairman of the Board of Directors of VSE’s wholly owned subsidiary ICRC.  Mr. Lexo was the founder of ICRC and served as chief executive officer until its acquisition by VSE.  Before his career in business, he served on Capitol Hill as the Administrative Aide to Congressman Don Young of Alaska for 12 years.  Mr. Lexo received a Bachelor of Arts Degree in Political Science from Westminster College in Pennsylvania, and participated in graduate studies in government contracting at the University of Virginia.

Ms. Denise Manning became President of our wholly owned subsidiary G&B Solutions Inc. in 2010.  She has served as the COO for G&B since 2008, initially joining the company in 2002 as a Director responsible for service delivery. Prior to joining G&B, Ms. Manning was at Northrop Grumman for 18 years as a Program Director in the Enterprise Solutions organization. She also served as a Program Manager for Fairfax Imaging, Inc. and the Director of Project Management for BIAP Systems.  Ms. Manning graduated with a Computer Science degree from State University of New York System and is a certified project management professional (PMP).

 
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Ms. Nancy Margolis became President of our wholly owned subsidiary Energetics Incorporated in May 2010. She joined Energetics Incorporated in 1984 and served as Vice President of the Science and Technology Division. Prior to joining Energetics, Ms. Margolis worked at ARINC Corporation from 1981-1984, focusing on power plant reliability.  She also worked as a chemist for Bethlehem Steel Corporation from 1977-1978. She holds a B.A. in Chemistry from Johns Hopkins University and an M.S. in Mechanical Engineering from the University of Maryland at College Park.  

Mr. Carl Williams joined VSE in 2007 as President and Chief Operating Officer of ICRC. Mr. Williams completed 23 years of service in the U.S. Navy, retiring as Commander. He joined ICRC as its Executive Vice President of Operations in 2000 and has served as Chief Operating Officer of ICRC since 2003. Mr. Williams was appointed President of VSE’s Infrastructure Group in 2008.  Mr. Williams received a Bachelor of Science Degree in Mechanical Engineering from North Carolina State University.

Ms. Crystal Williams joined VSE in December 2008 as Vice President – Contracts. Prior to joining VSE, Ms. Williams was Contracts Director for the North American Public Sector at CSC. She began her CSC career in 1994.  Prior to joining CSC, Ms. Williams provided contract administration services at ICF Kaiser International and at Dynamic Concepts Inc. Ms. Williams is a graduate of George Mason University (B.S., Public Administration) and has earned continuing education credits in contracts and marketing at the American Graduate University and at George Mason University, Continuing Education. 

 
15


PART II


ITEM 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

(a)  
Market Information

VSE common stock, par value $0.05 per share, is traded on the Nasdaq Global Select Market, trading symbol, "VSEC," Newspaper listing, "VSE."

The following table sets forth the range of high and low sales price (based on information reported by the Nasdaq Global Select Market) and cash dividend per share information for our common stock for each quarter and annually during the last two years.  


Quarter Ended
 
High
   
Low
   
Dividends
 
                   
2009:
                 
March 31
  $ 48.44     $ 19.51     $ 0.045  
June 30    
    31.50       23.42       0.050  
September 30    
    41.52       24.53       0.050  
December 31   
    49.00       37.00       0.050  
       For the Year           
  $ 49.00     $ 19.51     $ 0.195  
                         
2010:
                       
March 31
  $ 53.71     $ 41.16     $ 0.050  
June 30    
    41.46       31.82       0.060  
September 30    
    37.57       26.65       0.060  
December 31   
    39.90       29.78       0.060  
       For the Year           
  $ 53.71     $ 26.65     $ 0.230  


(b)Holders

As of February 7, 2011, VSE common stock, par value $0.05 per share, was held by approximately 269 stockholders of record.  The number of stockholders of record is not representative of the number of beneficial holders because many of the shares are held by depositories, brokers or nominees.

(c)Dividends

In 2009 cash dividends were declared quarterly at the annual rate of $0.18 per share through March 31, 2009, and at the annual rate of $0.20 per share commencing June 2, 2009. 

In 2010 cash dividends were declared quarterly at the annual rate of $0.20 per share through March 31, 2010, and at the annual rate of $0.24 per share commencing June 1, 2010. 

Pursuant to our bank loan agreement (see Note 7 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K), the payment of cash dividends is subject to annual rate restrictions. We have paid cash dividends each year since 1973.

 
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(d)  
Equity Compensation Plan Information


Compensation Plans

We have two compensation plans approved by our stockholders under which our equity securities are authorized for issuance to employees and directors:  (i) the VSE Corporation 2004 Non-employee Directors Stock Plan (the “2004 Plan”) and (ii) the VSE Corporation 2006 Restricted Stock Plan (the “2006 Plan”).

As of December 31, 2010, 175,475 shares of VSE common stock were available for future issuance under the 2006 Plan.

In December 2005, the Board directed us to discontinue awarding options, both discretionary and nondiscretionary, under the 2004 Plan.  The options outstanding under the 2004 Plan and predecessor 1998 Stock Option Plan were not affected by this Board action.








 
17


Performance Graph

Set forth below is a line graph comparing the cumulative total return of VSE common stock with (a) a performance index for the broad market (NASDAQ Global Select Market) in which VSE common stock is traded and (b) a published industry index. VSE common stock is traded on the NASDAQ Global Select Market, and our industry group is engineering and technical services (formerly SIC Code 8711). Accordingly, the performance graph compares the cumulative total return for VSE common stock with (a) an index for the NASDAQ Global Select Market (U.S. companies) (“NASDAQ Index”) and (b) a published industry index for SIC Code 8711 (“Industry Index”).
 
 
 
 
 
 
 

Performance Graph Table

 
2005
2006
2007
2008
2009
2010
VSE
100
81
235
190
219
162
NASDAQ Composite
100
112
125
 74
107
126
Peer Group
100
110
176
129
132
154



 
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ITEM 6.    Selected Financial Data

(In thousands, except per share data)
 
 
   
Years ended December 31,
 
                               
   
2010
   
2009
   
2008
   
2007
   
2006
 
                               
Revenues
  $ 866,036     $ 1,014,639     $ 1,043,735     $ 653,164     $ 363,734  
                                         
Net income
  $ 23,687     $ 24,024     $ 19,040     $ 14,102     $ 7,789  
                                         
Basic earnings per share
  $ 4.56     $ 4.68     $ 3.75     $ 2.85     $ 1.64  
                                         
Diluted earnings per share
  $ 4.56     $ 4.67     $ 3.74     $ 2.82     $ 1.61  
                                         
Cash dividends per common share
  $ 0.23     $ 0.195     $ 0.175     $ 0.155     $ 0.14  

   
As of December 31,
 
                               
   
2010
   
2009
   
2008
   
2007
   
2006
 
                               
Working capital
  $ 54,569     $ 45,902     $ 24,179     $ 24,756     $ 25,646  
                                         
Total assets
  $ 288,426     $ 253,990     $ 275,966     $ 171,771     $ 98,535  
                                         
 Long-term debt   $ 11,111          $     $     $  
                                         
 Long-term lease obligations   $ 20,258      $ 1,100      $     $     $  
                                         
Stockholders' equity
  $ 123,776     $ 101,310     $ 76,123     $ 56,376     $ 38,236  


 
This consolidated summary of selected financial data should be read in conjunction with Management’s Discussion and Analysis of the Financial Condition and Results of Operations included in Item 7 of this Form 10-K and with the Consolidated Financial Statements and related Notes included in Item 8 of this Form 10-K. The historical results set forth in this Item 6 are not necessarily indicative of the results of operations to be expected in the future.


ITEM 7.    Management’s Discussion and Analysis of Financial Condition
     and Results of Operations

Executive Overview

Organization

Our business is focused on providing sustainment services for DoD legacy systems and equipment and professional services to DoD and Federal Civilian agencies. Our operations consist primarily of diversified logistics, engineering, IT, construction management and consulting services performed on a contract basis. Substantially all of our contracts are with government agencies and other government prime contractors.

Our business is managed under operating groups consisting of one or more divisions or wholly owned subsidiaries that perform our services. 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"), 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 (“ICRC”).

Customers and Services

We provide logistics, engineering, legacy equipment sustainment, IT, construction management and consulting services to the government, other government prime contractors, and commercial entities. Our largest customer is the DoD, including agencies of the U.S. Army, Navy and Air Force. We also provide services to civilian government customers. See Item 1 “Business – Contracts” on page 6 for revenues by customer.

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 substantial portion of our revenue on the R2 contract results from the pass through of subcontractor support services that have a low profit margin. A large portion of the work on this program is related to the U.S. military involvement in the Middle East and Asia. The contract supporting the R2 Program expired in January 2011. Significant revenue generating programs that we have performed under R2 Program delivery orders include: 1) the CED Army Equipment Support Program, expired in February 2009, under which we provided maintenance and logistics services in support of U.S. Army equipment in Iraq and Afghanistan; 2) the CED Assured Mobility Systems Program, expired in January 2011, under which we provided technical support services in support of U.S. Army PM Assured Mobility Systems and U.S. Army Tank-automotive and Armaments Command (“TACOM”); and 3) the RCV Modernization Program, expired in January 2011, under which we performed maintenance work on U.S. Army Route Clearance Vehicles in Kuwait. 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. While the R2-3G contract gives us the opportunity to pursue follow-on work from the original R2 contract and new work, future revenue levels from this contract cannot be determined with certainty.

 
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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 and Army Reserve 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. Our services offered through SED principally support 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.

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. Global 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 several 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 revenue 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 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 the program. The interim contract will allow the customer additional time to make an award decision on a successor contract.

 
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IT, Energy and Management Consulting Group - Our IT, Energy and Management Consulting Group provides technical and consulting services primarily to various 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 for 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 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 $33 million, which includes $725 thousand of prepaid retention bonuses that are being expensed in the post-acquisition period as the affected employees provide service. As such, the initial cash purchase price was $32.3 million. Additional cash consideration of approximately $363 thousand was paid in December 2010 to the sellers based on the final working capital adjustment. Potential additional payments may be payable 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. Akimeka 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 This group consists of our ICRC subsidiary, which 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"). Seasonal variability at this location and work constraints imposed by the intermittent presence of endangered species and environmental and other factors result in fluctuations in revenues from the PIEP.

 
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Concentration of Revenues
   
(in thousands)
   
Years ended December 31,
Source of Revenues     2010              2009              2008         
CED Assured Mobility Systems(R2)
  $ 167,748       19     $ 144,375       14     $ 92,669       9  
Global FMS
    141,418       16       105,464       10       81,731       8  
ELD US Army Reserve (R2)
    61,064       7       70,287       7       30,233       3  
FSS RCV Modernization (R2)
    58,954       7       82,734       8       3,565       -  
PIEP Contract
    51,497       6       35,699       4       89,722       9  
Treasury Seized Asset Program
    47,008       6       45,090       4       55,218       5  
CED Army Equipment Support
    -       -       55,381       6       319,933       31  
Other
    338,347       39       475,609       47       370,664       35  
                           
  Total Revenues
  $ 866,036       100     $ 1,014,639       100     $ 1,043,735       100  


Management Outlook

We have experienced challenges to our business operations during 2010 while achieving certain successes that offer promise for our future. Our most significant challenge has been the sustainment of revenue levels at a time when revenues of our R2 contract have declined. While this caused us to experience a decline in revenue in 2010, our successful efforts to improve our profit margins have helped us to defend our bottom line. We continue to sharpen our focus on strategic efforts to improve profitability by growing our core capabilities through increases in our direct labor workforce and  pursuing lines of business that are more profitable.

A decline in work performed by our subcontractors on the R2 program that generated much of our revenue growth in prior years is the primary reason for the decrease in revenue in 2010. During the time that subcontractor work has declined, our direct labor services have increased and 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 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 its 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 health-related 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 2010 with 614 more employees than we began 2009. Including the addition of 209 Akimeka employees that joined us in August 2010, we added another 363 employees in 2010.  Our total employee count was 2,897 as of December 31, 2010. These increases in employee count are supporting our targeted direct labor revenue increases and associated profit margin improvements.

Our new employees are primarily engaged in information technology, energy and management consulting, and work on DoD legacy systems sustainment services. We believe the government will continue to focus on these areas in the near future. There are indications of a shift in government spending to more services for energy, IT infrastructure, and health care IT, and we believe the composition of our workforce and the services we offer are well aligned with near term future government spending priorities. We expect efforts directed toward the growth of our work in these service areas to help us replace declines in our DoD-related subcontractor work and sustain future revenue levels.
 
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We also know there are risks and uncertainties related to our business. Government spending priorities may continue to change and there is significant pressure on government budgets. Accordingly, the flow of work to federal contractors may be significantly impacted. We believe that most of our service offerings are not targeted by any currently planned federal cutbacks. Federal budget reductions will likely 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. Nonetheless, Federal budget constraints are affecting the timeliness of awards in our markets.

In addition to U.S. domestic budget uncertainties, our business is subject to the risks arising from global economic conditions and political factors associated with current and potential customers served through our contracts with the government. An economic slowdown in countries served under the GLOBAL FMS Program, failure by the government of a potential foreign customer to approve and fund acquisition of U.S. Navy ships serviced under this program, or political unrest in a country in which work is performed could potentially affect our revenues. In any one year, a significant amount of our revenues may result from work on the FMS Program for a single foreign government. FMS Program services provided to Egypt have typically accounted for approximately $50 million to $60 million in revenue annually. Due to the shutdown of certain government services and to living and working environment dangers associated with severe domestic and political unrest in Egypt, most of our work efforts performed in Egypt on the FMS Program were suspended in January 2011. While we expect to resume working at our previous levels in Egypt when conditions have stabilized, we cannot determine with certainty the duration of this suspension of work or estimate the impact it may have on our financial operations.

Bookings and Funded Backlog

Revenues in government contracting businesses are dependent upon contract funding (“Bookings”) and funded contract backlog is an indicator of potential future revenues. A summary of our bookings and revenues for the years ended December 31, 2010, 2009 and 2008, and funded contract backlog as of December 31, 2010, 2009 and 2008 is as follows.   
               
   
(in millions)
 
   
2010
   
2009
   
2008
 
                   
 Bookings
  $ 799     $ 939     $ 1,189  
 Revenues
  $ 866     $ 1,015     $ 1,044  
 Funded Backlog
  $ 407     $ 476     $ 567  

Rapid Response Program

Our R2 Program contract expired in January 2011. Most of the work on this contract, with the exception of some residual work effort remaining to be performed on previously issued delivery orders, has ended. We anticipate performing an undetermined amount of follow-on work from the original R2 contract and new work under our follow-on R2-3G contract. Given uncertain DoD work requirements and the potential to perform work under our other multiple award omnibus contracts, we cannot be certain of our level of participation on the R2-3G contract. We have not received any significant work orders on this contract to date. A substantial portion of revenues from our original R2 contract were from low profit margin subcontract work. We believe our efforts to replace subcontract work with direct labor will result in increases in our profit margins.

Other Programs and Contracts

FMS Program revenues in our GLOBAL division increased in both 2010 and 2009. While the current situation in Egypt presents a challenge to growth in this division for 2011, there is strong demand for FMS Program services to other client countries. The contract under which this work is performed is scheduled to expire in July 2011. We have submitted a bid on a successor contract to continue this program work.

 
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Our ELD division has expanded its workforce, facilities, capacity to provide services, contractual coverage and funding since its inception. ELD revenues are primarily generated from direct labor. Our investment in facilities and personnel to support this work enhances our ability to serve DoD’s need for our equipment refurbishment and sustainment services. Prior to January 2011, a significant amount of ELD’s services were performed under an R2 contract delivery order. In January 2011, ELD was awarded a task order on our LOGWORLD omnibus contract with a base year and four one-year options having a potential value of $410 million to continue providing support services to its customers.

The U.S. Department of Treasury has awarded us an interim contract to continue providing services under our Treasury Seized Asset Program through April 2011. The interim contract will allow the customer additional time to make an award decision on a successor contract. We have submitted a bid on a successor contract to continue this program work.

The CFT Program contract gives us the opportunity to increase our sustainment and legacy services performed for the Air Force. This program is contributing to direct labor revenue increases in our FMD division. Revenues on this program for 2010 were approximately $23 million.

Our SED division was awarded a subcontract in 2009 to provide Vehicle Integration Kits (“VIKs”), spare VIK components, and engineering and installation support on tactical wheeled vehicles and combat vehicles for the U.S. Army and U.S. Marine Corps through a multiple award indefinite delivery/indefinite quantity contract under the Driver’s Vision Enhancer-Family of Systems (“DVE-FOS”) program. The subcontract has an anticipated ceiling value of approximately $190 million over a five-year period. Revenues on the DVE-FOS program for 2010 were approximately $13 million.

Our G&B subsidiary received two major awards in 2010. One award is a subcontract to provide information technology, product and service solutions in support of the National Oceanic and Atmospheric Administration’s (NOAA) NOAALink Program. While future revenues from this award cannot be determined with certainty, the prime contract is a multiple award contract with a ceiling value of $2.5 billion over 10 years. G&B also received a subcontract to provide Information Technology Support Services (ITSS) to the Social Security Administration (SSA). The prime contract is a multiple award contract with a ceiling value of $2.8 billion with a base period of one year and six one-year options. Both of these awards give us the potential to enhance G&B’s growth prospects in 2011 and future years.

Our Energetics subsidiary was awarded a three-year $21.7 million contract to support the U.S. Department of Energy (DOE), Office of Electricity Delivery and Energy Reliability (OE) in September 2010. This represents new work to Energetics.

Our ICRC subsidiary’s work on the PIEP Project in Anchorage, Alaska has continued to present challenges for us in 2010. Revenues increased significantly on this project in 2010. However, our customer has funded the cost of certain work we have performed, but has not funded fees normally associated with this work pending resolution of environmental and technical issues impacting the work, resulting in significantly lower profits on this program in 2010. Fees for this work performed in 2010 may be funded in 2011, which could result in increased profits in 2011. The amount of such fees is uncertain, but could potentially be up to $1.5 million.

We were awarded a GSA Logistics Worldwide (“LOGWORLD”) contract in 2009. This contract is available to all government agencies with an original five year base period, and options to extend the period of performance for up to 10 additional years. We have been awarded several task orders on this contract, including the $410 million task order awarded to ELD in January 2011. This contract is available to help support growth of our existing services.
 
 
25

We have several GSA work schedules and multiyear, multiple award, indefinite delivery, indefinite quantity (“omnibus”) contracts that have large nominal ceiling amounts. These contracts include the Field and Installation Readiness Support Team (“FIRST”) contract with the U.S. Army, the SeaPort Enhanced contract with the U.S. Navy, and the U.S. Army PEO CS & CSS Omnibus III contract. We are one of several awardees on each contract. While our future revenues from these GSA work schedules and omnibus contracts cannot be predicted with certainty, they, along with our CFT Program contract, allow us to pursue task order awards for new work.


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. We believe the following critical accounting policies affect the more significant accounts, particularly those that involve judgments, estimates and assumptions used in the preparation of our consolidated financial statements.

Revenue Recognition

Substantially all of our services are performed for our customers on a contract basis. The three primary types of contracts used are time and materials, cost-type, and fixed-price. Revenues result from work performed on these contracts by our employees and our subcontractors and from costs for materials and other work related costs allowed under our contracts.

Revenues for time and materials contracts are recorded on the basis of contract allowable labor hours worked multiplied by the contract defined billing rates, plus the direct costs and indirect cost burdens associated with materials and subcontract work used in performance on the contract. Generally, profits on time and materials contracts result from the difference between the cost of services performed and the contract defined billing rates for these services.

Revenues on cost-type contracts are recorded as contract allowable costs are incurred and fees earned. Our Global contract and our PIEP contract are cost plus award fee contracts. Both of these contracts have terms that specify award fee payments that are determined by performance and level of contract activity. Award fees are made during the year a contract modification authorizing the award fee payment is issued subsequent to the period in which the work is performed. We do not recognize award fee income until the fees are certain, generally upon contract notification confirming the award fee. Due to such timing, and to fluctuations in the level of revenues, profits as a percentage of revenues on these contracts will fluctuate from period to period.

Revenue recognition methods on fixed-price contracts will vary depending on the nature of the work and the contract terms. Revenues on fixed-price service contracts are recorded as work is performed, typically ratably over the service period. Revenues on fixed-price contracts that require delivery of specific items may be recorded based on a price per unit as units are delivered.

Revenues by contract type for the years ended December 31 were as follows (in thousands):

  
Contract Type
 
2010
Revenues
   
%
   
2009
Revenues
   
%
   
2008
Revenues
   
%
 
Time and   materials
  $ 547,368       63.2     $ 761,644       75.1     $ 759,693       72.8  
Cost-type  
    261,801       30.2       209,946       20.7       247,857       23.7  
Fixed-price  
    56,867       6.6       43,049       4.2       36,185       3.5  
    $ 866,036       100.0     $ 1,014,639       100.0     $ 1,043,735       100.0  

 
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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.

We will occasionally perform work at risk, which is work performed prior to the government formalizing funding for such work. Revenue related to work performed at risk is not recognized until it can be reliably estimated and its realization is probable. We recognize this “risk funding” as revenue when the associated costs are incurred or the work is performed. We are at risk of loss for any risk funding not received. We provide for anticipated losses on contracts by a charge to income during the period in which losses are first identified. Revenues recognized in 2010 include approximately $4.2 million for which we had not received formalized funding as of December 31, 2010. We believe that we are entitled to reimbursement and will receive funding for all of this risk funding revenue.  

Long-Lived Assets

In assessing the recoverability of long-lived assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets not previously recorded.

Earn-out Obligations

In connection with acquisitions completed after January 1, 2009, the effective date of new accounting rules for business combinations, we estimate the fair value of any earn-out payments by using the expected cash flow approach with probability-weighted revenue inputs and using an appropriate discount rate. Interest expense and subsequent changes in the fair value of the earn-out obligations are recognized in earnings in the period of the change through settlement.

In connection with acquisitions completed before January 1, 2009, payments made related to earn-out arrangements are recorded as goodwill.

Goodwill and Intangible Assets

Goodwill and intangible assets with indefinite lives are subject to a review for impairment at least annually. We perform our annual impairment test as of October 1. The annual impairment assessment requires us to estimate the fair value of our reporting units.  This estimation process involves the use of subjective assumptions. As of December 31, 2010, we had an aggregate of approximately $38.7 million of goodwill and intangible assets with indefinite lives associated with our acquisitions as follows:

 
 
 
Acquired Company
 
Goodwill and intangible assets
 with indefinite lives
as of December 31, 2010
 (in millions)
 
Energetics
  $ 1.0  
ICRC
    8.0  
G&B
    14.6  
Akimeka
    15.1  
  Total
  $ 38.7  


Recoverability of Deferred Tax Assets

The carrying value of our net deferred tax assets is based on assumptions regarding our ability to generate sufficient future taxable income to utilize these deferred tax assets. If the estimates and related assumptions regarding our future taxable income change in the future, we may be required to record valuation allowances against our deferred tax assets, resulting in additional income tax expense.
 
 
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Results of Operations
Revenues
 (dollars in thousands)
 Years ended December 31,
   
2010
   
%
   
2009
   
%
   
2008
   
%
 
Federal Group
                                   
CED
  $ 290,061       33.5     $ 440,165       43.4     $ 587,044       56.2  
SED
    36,989       4.3       28,338       2.8       26,520       2.5  
ELD
    65,896       7.6       79,256       7.8       43,954       4.2  
FSS
    61,714       7.1       38,079       3.7       7,999       0.8  
Other
    -       -       113       0.0       1,890       0.2  
Group Total
    454,660       52.5       585,951       57.7       667,407       63.9  
                                                 
International Group
                                               
GLOBAL
    143,671       16.6       105,464       10.4       81,731       7.8  
FMD
    117,828       13.6       208,669       20.6       137,655       13.2  
Other
    -       -       1       0.0       635       0.1  
Group Total
    261,499       30.2       314,134       31.0       220,021       21.1  
                                                 
IT, Energy and Management Consulting Group
                                               
Energetics
    29,778       3.4       22,482       2.2       19,161       1.8  
G&B                      
    52,723       6.1       51,309       5.1       30,664       3.0  
Akimeka
    12,005       1.4                                  
Other
    290       -       326       -       102       -  
Group Total
    94,796       10.9       74,117       7.3       49,927       4.8  
                                                 
Infrastructure Group                 
                                               
   ICRC
    55,081       6.4       40,437       4.0       106,380       10.2  
                                                 
    Total
  $ 866,036       100.0     $ 1,014,639       100.0     $ 1,043,735       100.0  


Our revenues decreased by approximately $149 million or 15% for the year ended December 31, 2010 as compared to the prior year. The decline in revenues for this period resulted from decreases in revenues in our Federal Group of approximately $131 million and in our International Group of approximately $53 million; increases in revenues in our Infrastructure Group of approximately $15 million; and increases in revenues in our IT, Energy, and Management Consulting Group of approximately $20 million, including revenues attributable to the acquisition of Akimeka of approximately $12 million in 2010.

Our revenues decreased by approximately $29 million or 3% for the year ended December 31, 2009 as compared to the prior year. The slight decline in revenues for this period resulted from decreases in revenues in our Federal Group of approximately $81 million and in our Infrastructure Group of approximately $66 million; increases in revenues in our International Group of approximately $94 million; and increases in revenues in our IT, Energy, and Management Consulting Group of approximately $24 million.

 
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Consolidated Statements of Income
 
   
(dollars in thousands)
 
   
Years ended December 31,
 
   
2010
   
%
   
2009
   
%
   
2008
   
%
 
Revenues
  $ 866,036       100.0     $ 1,014,639       100.0     $ 1,043,735       100.0  
Contract costs
    825,619       95.3       974,897       96.1       1,011,408       96.9  
Selling, general and administrative expenses
    2,204       0.3       1,263       0.1       1,193       0.1  
Operating income
    38,213       4.4       38,479       3.8       31,134       3.0  
Interest (income) expense, net
    180       -       (120 )     -       (115 )     -  
                                                 
Income before income taxes
    38,033       4.4       38,599       3.8       31,249       3.0  
Provision for income taxes
    14,346       1.7       14,575       1.4       12,209       1.2  
                                                 
Net income
  $ 23,687       2.7     $ 24,024       2.4     $ 19,040       1.8  

Selling, general and administrative expenses consist primarily of costs and expenses that are not chargeable or reimbursable on our operating unit contracts. As a percentage of revenues, these expenses varied little in 2010 and 2009 as compared to the respective prior years. The increase in these costs in 2010 is primarily attributable to costs associated with our acquisition of Akimeka.

Our operating income decreased by approximately $266 thousand or 1% in 2010 as compared to 2009. The decrease resulted primarily from: 1) decreased profits of approximately $679 thousand from lower revenues in our Federal Group; 2) decreased profits in our International Group of approximately $432 thousand; 3) increased profits in our IT, Energy and Management Consulting Group of approximately $2.9 million, including profits of approximately $1.6 million attributable to our acquisition of Akimeka in 2010; and 4) decreased profits in our Infrastructure Group of approximately $703 thousand.

Our operating income increased by approximately $7.4 million or 23% in 2009 as compared to 2008. The increase resulted primarily from: 1) increased profits from revenues in our Federal Group of approximately $3.2 million; 2) increased profits from revenues in our International Group of approximately $4.3 million; 3) increased profits from revenues in our IT, Energy and Management Consulting Group of approximately $4.2 million; and 4) decreased profits from revenues in our Infrastructure Group of approximately $2.5 million.

We had net interest expense in 2010 as compared to net interest income in 2009 and 2008 due to borrowing associated with our acquisition of Akimeka. Our net interest income increased in 2009 as compared to 2008 as profits from operations and resulting cash surpluses were invested.


Provision for Income Taxes

Our effective tax rates were 37.7% for 2010, 37.8% for 2009, and 39.1% for 2008.

 
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Federal Group Results

The following table shows consolidated operating results for our Federal Group (in thousands).

      2010              2009              2008         
Revenues
  $ 454,660       100.0     $ 585,951       100.0     $ 667,407       100.0  
Contract costs
    434,008       95.5       564,628       96.4       649,149       97.3  
Selling, general and administrative expenses
    109       -       101       -       43       -  
Operating income
    20,543       4.5       21,222       3.6       18,215       2.7  
Interest income, net
    (31 )     -       (89 )     -       (379 )     (0.1 )
Income before income taxes
  $ 20,574       4.5     $ 21,311       3.6     $ 18,594       2.8  

Revenues for our Federal Group decreased approximately $131 million or 22% for the year ended December 31, 2010, as compared to the prior year. The decrease in revenues for 2010 was primarily attributable to the winding down of programs and expiration of delivery orders on our R2 program as this contract neared its conclusion. The decline in R2 program activity resulted in decreased Federal Group revenues of approximately $144 million in 2010. Revenues from our ELD equipment refurbishment services, decreased by approximately $13 million in 2010. These decreases were partially offset by a net increase in revenues of approximately $26 million from our other Federal Group activities.

Revenues for our Federal Group decreased approximately $81 million or 12% for the year ended December 31, 2009, as compared to the prior year. The decrease in revenues for 2009 was primarily attributable to a decrease in revenues on the CED Army Equipment Support Program of approximately $265 million. The decrease in revenues was partially offset by an increase in revenues on the RCV Modernization Program of approximately $79 million, an increase in revenues on the CED U.S. Army PM Assured Mobility Systems Program of approximately $52 million, and an increase in revenues of approximately $35 million from ELD’s equipment refurbishment services.

Operating income for our Federal Group decreased by approximately $679 thousand or 3% for the year ended December 31, 2010 as compared to the prior year. The decrease in operating income is primarily due to a decrease in profits on our ELD equipment refurbishment services of approximately $6 million and a decrease in profits of approximately $916 thousand on R2 Program work, resulting from the revenue decreases. These decreases were partially offset by increased profits of approximately $6 million resulting from the revenue increases from our other Federal Group activities and from improved profit margins.

Operating income for our Federal Group increased by approximately $3.1 million or 17% for the year ended December 31, 2009 as compared to the prior year. The increase in operating income is primarily due to an increase in profits on our ELD equipment refurbishment services of approximately $8.4 million resulting from the increase in ELD revenues and an improvement in the profit margins, and an increase in profits of approximately $2.1 million on the RCV Modernization Program. These increases helped to replace a decrease in profits of approximately $4.7 million due to the completion of the TBPS program in 2008 and the resulting absence of this program from our operating results in 2009, and a decrease in profits of approximately $3.0 million associated with the expiration of the CED Army Equipment Support Program in February 2009. Profit margins also improved in 2009 as compared to the prior year due to an increased level of direct labor generated revenues, primarily in ELD, and a decline in lower margin subcontractor generated revenue in CED.


The Federal Group realized interest income from cash invested in 2010, 2009, and 2008. During these years, we benefited from efficient cash flow cycles on certain CED task order work.



 
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International Group Results

The following table shows consolidated operating results for our International Group (in thousands).

   
2010
   
%
   
2009
   
%
   
2008
   
%
 
Revenues  
  $ 261,499       100.0     $ 314,134       100.0     $ 220,021       100.0  
Contract costs
    251,820       96.3       303,972       96.8       214,146       97.3  
Selling, general and administrative expenses
    106       -       157       -       46       -  
Operating income
    9,573       3.7       10,005       3.2       5,829       2.7  
Interest expense, net  
    197       0.1       436       0.1       110       0.1  
Income before income taxes
  $ 9,376       3.6     $ 9,569       3.0     $ 5,719       2.6  

Revenues for our International Group decreased approximately $53 million or 17% for the year ended December 31, 2010, as compared to the same period for the prior year. The decrease in revenues resulted from a decrease of approximately $100 million in the level of FMD services provided on engineering and technical services task orders. This revenue decrease was partly offset by an increase in revenues of approximately $38 million from services performed by our GLOBAL division, and revenue increases from our other International Group activities.

Revenues for our International Group increased approximately $94 million or 43% for the year ended December 31, 2009, as compared to the same period for the prior year. The increase in revenues resulted primarily from an increase of approximately $67 million in the level of FMD services provided on engineering and technical services task orders; an increase of approximately $24 million in the level of GLOBAL services, including increased revenues of approximately $10 million to provide support services to the government of Romania; and to an increase in revenues on the CFT Program in 2009 of approximately $14 million. The revenue increases for this period were partly offset by a decrease in revenues on the Treasury Seized Asset Program of approximately $10 million.

Operating income for our International Group decreased by approximately $432 thousand or 4% for the year ended December 31, 2010, as compared to the prior year. The decrease is primarily due to a decrease in profits of approximately $1.5 million from the decreased level of FMD services provided on engineering and technical services task orders, and a decrease in profits of approximately $1.2 million on the CFT Program. These decreases were partially offset by an increase in profits of approximately $1.3 million from the increase in revenues from our GLOBAL division, and an increase in profits of approximately $1 million associated with activity on our Treasury Seized Asset Program.

Operating income for our International Group increased by approximately $4.3 million or 73% for the year ended December 31, 2009, as compared to the prior year. The increase is primarily due to an increase in profits of approximately $2.3 million on the Treasury Seized Asset Program resulting from an increase in incentive fees earned associated with re-negotiated target cost levels; an increase in profits of approximately $621 thousand from the increased level of FMD services provided on engineering and technical services task orders; and an increase in profits of approximately $487 thousand from the increase in revenues on the CFT Program.
 

Our International Group had net interest expense in 2010, 2009 and 2008. Interest income and expense vary from year to year due to growth in work performed and to normal fluctuations in our billing and collections cycle.








 
31

IT, Energy and Management Consulting Group Results

The following table shows consolidated operating results for our IT, Energy and Management Consulting Group (in thousands).

   
2010
   
%
   
2009
   
%
   
2008
   
%
 
Revenues
  $ 94,796       100.0     $ 74,117       100.0     $ 49,927       100.0  
Contract costs
    84,225       88.8       66,344       89.5       45,148       90.4  
Selling, general and administrative expenses
    345       0.4       406       0.5       375       0.8  
Operating income
    10,226       10.8       7,367       9.9       4,404       8.8  
Interest income, net
    (49 )     (0.1 )     (35 )     -       (198 )     (0.4 )
Income before income taxes
  $ 10,275       10.8     $ 7,402       10.0     $ 4,602       9.2  

Our acquisitions of G&B in April 2008 and Akimeka in August 2010 have had a significant impact on the operating results of this segment over the past three years. G&B revenues and profits are included in this segment for 12 months in 2010 and 2009 and 8½ months in 2008. Akimeka revenues and profits are included in this segment beginning in August 2010. The inclusion of G&B and Akimeka revenues and profits in this segment for different lengths of time in each year is the primary reason for significant increases to the segment’s revenues and profits in 2010 and 2009.

Revenues for our IT, Energy and Management Consulting Group increased by approximately $21 million for the year ended December 31, 2010, as compared to the prior year. Operating income for this segment increased by approximately $2.9 million for the year ended December 31, 2010, as compared to the prior year. Approximately $12 million of the revenue increase and $1.6 million of the profit increase is attributable to the inclusion of Akimeka’s results in this segment beginning in August 2010. Increases in Energetics’ revenues of approximately $7 million and Energetics profits of approximately $2 million contributed to the increases in this segment in 2010. G&B’s revenue increased approximately $1.4 million in 2010.

Revenues for our IT, Energy and Management Consulting Group increased by approximately $24 million for the year ended December 31, 2009, as compared to the prior year. Operating income for this segment increased by approximately $3.0 million for the year ended December 31, 2009, as compared to the prior year. Approximately $14 million of the revenue increase and $1.4 million of the profit increase is attributable to the inclusion of G&B’s results in this segment for a full year in 2009 as compared to 8½ months in 2008. Approximately $7 million of the revenue increase and $1.2 million of the profit increase is attributable to additional contract awards for G&B and increases in G&B’s employee workforce in 2009. Increases in Energetics’ revenues of approximately $3 million and Energetics profits of approximately $481 thousand also contributed to the increases in this segment in 2009.

Our IT, Energy and Management Consulting Group realized interest income from cash invested in 2010, 2009, and 2008. Interest income and expense vary from year to year due to growth in work performed and to normal fluctuations in our billing and collections cycle.

 
32


Infrastructure Group

The following table shows consolidated operating results for the Infrastructure Group (in thousands).

      2010              2009              2008         
Revenues
  $ 55,081       100.0     $ 40,437       100.0     $ 106,380       100.0  
Contract costs
    54,591       99.1       39,313       97.2       102,131       96.0  
Selling, general and administrative expenses
    217       0.4       148       0.4       154       0.1  
Operating income
    273       0.5       976       2.4       4,095       4.0  
Interest income, net
    (19 )     -       (14 )     -       (72 )     -  
Income before income taxes
  $ 292       0.5     $ 990       2.4     $ 4,167       3.9  

This segment consists of our ICRC subsidiary. Revenues increased by approximately $15 million or 38% for the year ended December 31, 2010, as compared to the prior year. Operating income for this segment decreased by approximately $703 thousand or 72% for the year ended December 31, 2010, as compared to the prior year.

Changes in revenues and operating income for this segment are primarily attributable to revenue and profit activity on the PIEP. During 2010, the customer funded the cost of certain work we performed on this project, but has not funded 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 are currently in discussions with our customer regarding resolution of the fee issue. If the fee on this work is funded for performance through December 31, 2010, the additional revenue and operating income could be as high as approximately $1.5 million.

Revenues decreased by approximately $66 million or 62% for the year ended December 31, 2009, as compared to the prior year. Operating income for this segment decreased by approximately $3.1 million or 74% for the year ended December 31, 2009, as compared to the prior year.

Certain environmental, technical and weather issues near the site on which ICRC conducts its POA Project work caused temporary work schedule delays in 2009. These delays had a negative impact on 2009 revenues and profits, with revenues from the PIEP work decreasing by approximately $54 million and profits from the POA Project decreasing by approximately $2.8 million. The environmental and technical issues were not caused by the work conducted by ICRC, but ICRC was required to comply with changes and delays from environmental restrictions, endangered species declarations and delays due to permit application requirements, permit conditions that slow the field work to best mitigate environmental impacts, and the study, review, and approval of certain technical issues by the client prior to moving planned work forward.

We also transferred certain work performed by ICRC prior to 2009 to our other groups to better align the work or the customers served with our longer term corporate level strategies. Specifically, information technology services work was transferred to our IT, Energy and Management Consulting Group and certain U. S. Army vehicle work was transferred to our Federal Group. The decreases in our Infrastructure Group’s revenues and profits in 2009 that are not attributable to the decrease in PIEP work are primarily the result of transferring work to our other groups.


Financial Condition

Our financial condition did not change materially during 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. Additionally, accounting rules require us to record an asset and a liability on our balance sheet as a non-cash transaction associated with the lease of our future headquarters office building currently under construction.


 
33

Liquidity and Capital Resources

Cash Flows

Cash and cash equivalents decreased by approximately $2.3 million during 2010.

Cash provided by operating activities decreased by approximately $6.6 million in 2010 as compared to 2009. The decrease is attributable to a decrease of approximately $337 thousand in cash provided by net income, an increase of approximately $1.5 million from an increase in depreciation and amortization and other non-cash operating activities, and a decrease of approximately $7.8 million due to changes in the levels of working capital components. Of these working capital components, 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 government services ordered, the timing of billings received from subcontractors and materials vendors to fulfill these services, and the timing of payments received from government customers in payment of these services. Such timing differences have the potential to cause significant increases and decreases in our accounts receivable and accounts payable in short time periods.

Cash used in our investing activities in 2010 increased by approximately $26.4 million as compared to 2009. This was primarily due to cash payments of approximately $30.2 million related to the acquisition of Akimeka in 2010.

Cash of approximately $16.6 million was provided by financing activities in 2010 as compared to cash used for financing activities of approximately $6.7 million in 2009. This difference was primarily due to borrowings on our bank loan in 2010 to finance our acquisition of Akimeka.

Cash and cash equivalents increased by approximately $7.4 million during 2009.

Cash provided by operating activities increased by approximately $1.5 million in 2009 as compared to 2008. An increase of approximately $5 million in cash provided by net income and an increase of approximately $1.4 million from an increase in depreciation and amortization and other non-cash operating activities was offset by a decrease of approximately $1.5 million for the acquisition of a software license and a decrease of approximately $3.4 million due to changes in the levels of working capital components. Of these working capital components, 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 government services ordered, the timing of billings received from subcontractors and materials vendors to fulfill these services, and the timing of payments received from government customers in payment of these services. Such timing differences have the potential to cause significant increases and decreases in our accounts receivable and accounts payable in short time periods.

Cash used in our investing activities in 2009 decreased by approximately $18.5 million as compared to 2008. This was primarily due to the acquisition of G&B for which we expended cash at closing of approximately $17.1 million in 2008.

 
34

Cash of approximately $6.7 million was used for financing activities in 2009 as compared to cash provided by financing activities of approximately $6.4 million for the same period of 2008. This difference was primarily due to paying down borrowings on our bank loan in 2009 as compared to 2008 when we borrowed to finance our acquisition of G&B.

We paid quarterly cash dividends totaling $0.22 per share during 2010. Pursuant to our bank loan agreement, our payment of cash dividends is subject to annual 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. Our acquisitions of G&B in 2008 and Akimeka in 2010 required a significant use of our cash. We continue to seek opportunities for growth through strategic acquisitions and such potential acquisitions could require the use of our future cash flows.

Our external financing consists of a loan agreement with a group of banks that provides us several types of financing. The loan agreement consists of a term loan, revolving loans, and letters of 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 December 31, 2010 is approximately $17.8 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 December 31, 2010 was $50 million and under the loan agreement we may elect to increase this maximum availability up to $75 million. This amount is subject to certain conditions, including a borrowing formula based on our billed receivables. We 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 had approximately $6.9 million of letters of credit outstanding and no revolving loan amounts outstanding as of December 31, 2010. During 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 Asset Coverage Ratio that we were in compliance with at December 31, 2010.

 
35



 
Maximum Ratio
Actual Ratio
Leverage Ratio
3.00 to 1
0.53 to 1

 
Minimum Ratio
Actual Ratio
Fixed Charge Coverage Ratio
1.25 to 1
2.68 to 1

 
Minimum Ratio
Actual Ratio
Asset Coverage Ratio
1.5 to 1
6.02 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.

Contractual Obligations

The following table shows our consolidated contractual obligations as of December 31, 2010 (in thousands):

                             Payments Due by Period
         
Less than
      1-3       4-5    
After 5
 
Contractual Obligations
 
Total
   
1 year
   
years
   
years
   
years
 
Long-term debt
  $ 17,778     $ 6,667     $ 11,111     $ -     $ -  
Operating leases, net of non-cancelable sublease income
    28,503       7,805       12,345       6,369       1,984  
Corporate headquarters lease
    67,538       -       6,202       7,843       53,493  
Purchase obligations
    378       378       -       -       -  
Total
  $ 114,197     $ 14,850     $ 29,658     $ 14,212     $ 55,477  

Operating lease commitments are primarily for our principal executive and administrative offices and leased facilities for office, shop, and warehouse space located near customer sites or to serve customer needs. We also have some equipment and software leases that are included in these amounts.

In 2009, we signed a 15-year lease agreement that begins in the Spring of 2012 for a new executive and administrative headquarters. Our current headquarters lease expires in April 2013.

Purchase obligations consist primarily of contractual commitments associated with our information technology systems. The table excludes contractual commitments for materials or subcontractor work purchased to perform U.S. Government contracts. Such commitments for materials and subcontractors are reimbursable when used on the contracts, and generally are also reimbursable if a contract is “terminated for convenience” by the government pursuant to federal contracting regulations.


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.

 
36


ITEM 7A.   Quantitative and Qualitative Disclosures About Market Risks


Interest Rates

Our bank loan provides 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 believe that there is a low risk 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 increase this risk.





 
37






ITEM 8.    Financial Statements and Supplementary Data




Index To Financial Statements
   
   
 
Page
   
Report of Independent Registered Public Accounting Firm
39
Consolidated Balance Sheets as of December 31, 2010 and 2009
40
Consolidated Statements of Income for the years ended
    December 31, 2010, 2009, and 2008
41
Consolidated Statements of Stockholders' Equity
    for the years ended December 31, 2010, 2009, and 2008
42
Consolidated Statements of Cash Flows for the years ended  
    December 31, 2010, 2009, and 2008
43
Notes to Consolidated Financial Statements
44
   





































 
38


Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of VSE Corporation

We have audited the accompanying consolidated balance sheets of VSE Corporation and Subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2010.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of VSE Corporation and Subsidiaries at December 31, 2010 and 2009, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), VSE Corporation's internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 2, 2011 expressed an unqualified opinion thereon.


/s/ Ernst & Young LLP

McLean, VA
March 2, 2011










 
39


VSE Corporation and Subsidiaries
Consolidated Balance Sheets                                

(in thousands, except share and per share amounts)

   
As of December 31,
 
   
2010
   
2009
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 5,764     $ 8,024  
Receivables, principally U.S. Government, net
    156,938       175,185  
Deferred tax assets
    1,602       2,036  
Other current assets
    9,552       7,979  
          Total current assets
    173,856       193,224  
 
               
Property and equipment, net
    42,315       24,683  
Intangible assets
    25,003       9,336  
Goodwill
    36,282       19,530  
Deferred tax assets
    838       -  
Other assets
    10,132       7,217  
          Total assets
  $ 288,426     $ 253,990  
 
               
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Current portion of long-term debt
  $ 6,667     $ -  
Accounts payable
    75,724       112,995  
Accrued expenses
    36,584       34,069  
Dividends payable
    312       258  
          Total current liabilities
    119,287       147,322  
 
               
Long-term debt
    11,111       -  
Deferred compensation
    6,034       3,934  
Long-term lease obligations
    20,258       1,100  
Deferred income taxes
    -       324  
Other liabilities
    7,960       -  
          Total liabilities
    164,650       152,680  
 
               
Commitments and contingencies
               
 
               
Stockholders’ equity:
               
Common stock, par value $0.05 per share, authorized 15,000,000 shares; issued and outstanding 5,193,891 and 5,170,190, respectively
    260       258  
Additional paid-in capital
    15,692       15,720  
Retained earnings
    107,824       85,332  
    Total stockholders’ equity
    123,776       101,310  
    Total liabilities and stockholders’ equity
  $ 288,426     $ 253,990  

















The accompanying notes are an integral part of these financial statements.

 
40


VSE Corporation and Subsidiaries
Consolidated Statements of Income        

(in thousands, except share and per share amounts)



   
For the years ended December 31,
 
   
2010
   
2009
   
2008
 
                   
Revenues
  $ 866,036     $ 1,014,639     $ 1,043,735  
Contract costs
    825,619       974,897       1,011,408  
Selling, general and administrative expenses
    2,204        1,263        1,193  
Operating income
    38,213       38,479       31,134  
Interest expense (income), net
    180       (120 )     (115 )
Income before income taxes
    38,033       38,599       31,249  
Provision for income taxes
    14,346       14,575       12,209  
Net income
  $ 23,687     $ 24,024     $ 19,040  
                         
Basic earnings per share:
  $ 4.56     $ 4.68     $ 3.75  
                         
Basic weighted average shares outstanding
    5,189,263       5,128,344       5,072,131  
                         
Diluted earnings per share:
  $ 4.56     $ 4.67     $ 3.74  
                         
Diluted weighted average shares outstanding
    5,189,263       5,146,347       5,096,186  



























The accompanying notes are an integral part of these financial statements.

 
41


VSE Corporation and Subsidiaries
Consolidated Statements of Stockholders’ Equity

(in thousands except per share data)                                                    

               
Additional
         
Total
 
   
Common Stock
   
Paid-In
   
Retained
   
Stockholders’
 
   
Shares
   
Amount
   
Capital
   
Earnings
   
Equity
 
Balance at  December 31, 2007
    5,053     253     $ 11,963     $ 44,160     $ 56,376  
                                         
Net income for the year
    -       -       -       19,040       19,040  
Stock-based compensation
    14       1       955       -       956  
Exercised stock options
    32       1       324       -       325  
Excess tax benefits from share-based payment arrangements
    -       -       315       -       315  
Dividends declared ($0.175)
    -       -       -       (889 )     (889 )
Balance at December 31, 2008
    5,099       255       13,557       62,311       76,123  
                                         
Net income for the year
    -       -       -       24,024       24,024  
Stock-based compensation
    32       1       1,234       -       1,235  
Exercised stock options
    39       2       432       -       434  
Excess tax benefits from share-based payment arrangements
    -       -       497       -       497  
Dividends declared ($0.195)
    -       -       -       (1,003 )     (1,003 )
Balance at December 31, 2009
    5,170        258        15,720        85,332        101,310   
                                         
 Net income for the year                       23,687        23,687   
 Stock-based compensation     24              1,035              1,037   
 Other                 (1,063  )           (1,063  )
 Dividends declared ($0.23)                       (1,195  )     (1,195  )
 December 31, 2010
    5,194     $ 260