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Executives

David Gray – Director, Financial Reporting

Anthony L. Otten - CEO

Cynthia A. Downes – EVP & CFO

Analysts

Jeremy Hellman - Avenue T Fund

Mark Jordan - Noble Financial

Bhakti Pavani - C. K. Cooper & Company

Versar, Inc. (VSR) F3Q 2013 Earnings Conference Call May 13, 2013 2:00 PM ET

Operator

Greetings and welcome to the Versar, Inc.'s Third Quarter Fiscal Year 2103 Conference call. At this time all participants are on a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder this conference is being recorded. It is now my pleasure to introduce your host, David Gray, Director of Financial Reporting for Versar, Inc. Thank you Mr. Gray. You may begin.

David Gray

Good afternoon. I am David Gray, Versar's Director of Financial Reporting. Welcome to Versar's Investor's conference call for the third quarter of fiscal year 2013. With me today are Versar's Chief Executive Officer, Tony Otten, Versar's President, Jeff Wagonhurst and Cynthia Downes, our Executive Vice President and Chief Financial Officer.

Before we begin let me make a brief statement about the contents of this call. Statements made on this call may include forward-looking statements which are based on management's current expectations, estimates, forecasts and projections about the company's business. These statements are forward-looking statements within the meaning of Section 27(a) of the Securities Act of 1933, Section 21(e) of the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995 and are subject to safe harbors created by such laws.

Words such as expects, anticipates, plans and believes and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions which are difficult to predict. Therefore actual outcomes and results may differ materially from what is expressed on this call. We do not undertake to update publicly any forward-looking statements, except as required by law. For a description of factors that could cause actual results to differ materially from those anticipated on this call you are referred to the company's public filings.

I'd now like to introduce Versar's CEO, Anthony Otten.

Anthony L. Otten

Good afternoon. This was a solid quarter for Versar. Most notably we achieved an increase in revenue for the first time since the first quarter of fiscal year 2012. This 23% increase was a result of our growing backlog and our ability to target critical areas of ongoing government expenditures in-spite of a difficult environment and DoD budget constraints. Our revenue growth was primarily driven by two items; one, our performance based remediation contracts or as we call them PBRs, with the United States Air Force and two by the revenues related to the construction management projects acquired through our purchase of Charron Construction Consulting.

Additionally our work in Afghanistan has been reinvigorated by our $170 million Personal Services Contract with the Army Corps of Engineers announced back in October of 2012, largely offsetting the wind-down of our similar Title II works that we were doing for the United States air force in that country.

We have been successfully implementing a clear set of strategic goals for profitable growth and our sales and marketing efforts continue to pay off as evidenced by our 25% growth in funded backlog from approximately 97 million at the end of the 3rd quarter last year to approximately $121 million at the end of the third quarter of this year. This backlog includes several new PBR awards for various U.S. Air Force installations and new awards and contract extensions for our work in Afghanistan. This backlog does not capture the additional award of the $4.3 million for Fort Irwin that we announced in our April press release.

We are very pleased with our backlog position at this time and believe that our robust pipeline is a direct result of the investment in our business development efforts to fine tune our sales, marketing and proposal processes. Additionally we believe that our continued strong funded backlog bodes well for our future performance.

Gross margins at 10% were lower compared to last year's gross margins of 17%. The lower gross profit was primarily due to a shift in revenue composition within our ECM segment. We completed two particularly high margin projects last year, the electrical inspection program in Iraq or what we call Task Force SAFE as well as the Tooele Chemical Demilitarization program. As such we feel that gross margin for the quarter was abnormally low.

To put this in context our average gross margins since the beginning of 2011 was approximately 12.5% with last year third quarter well above that average. The entire organization did an excellent job managing fixed costs. SG&A was $0.25 million lower than last year at 6% of sales compared to 8% last year. We continue to very carefully control expenses and realize efficiencies.

Our balance sheet remains robust. This is a key asset for our company and provides an important platform upon which to drive shareholder value. We have a healthy cash position, virtually no debt, our shareholders equity and current ratio continue to improve and we have a strong return on equity relative to others in the sector.

In terms of the current economic environment and how it affects Versar it appears that the U.S. economy will continue to be challenged in the near term by reduced government funding, high unemployment and debt reduction pressures that affect government spending pattern in all levels including the sequestration process that commenced on March 1st of this year. Thus our broad range of project management skills will provide us with the capabilities to effectively target areas where ongoing government expenditures, both domestically and internationally will be necessary, areas such as sustainable military range management, contingency operational support and environmental assessments and remediation.

We are not naïve to the challenges we face with the government contract and we have seen impact to our revenues over the past year. But as a smaller player with a unique set of critical capabilities we are confident about our ability to deliver for our shareholders. As I have said in the past the DoD is a great long-term client. We are good at servicing them and they will continue to provide the lion's share of our revenues. That said we are also focusing on business development efforts with other U.S. government agencies and non-government entities in the Middle East in order to offset any future slowdown in DoD business. Our recent contract wins are a validation of this strategic commitment and an endorsement of our capabilities to serve a broader market place.

I will now turn it over to our Executive Vice President and CFO, Cynthia Downes to review our financial results for the third quarter of fiscal year 2013.

Cynthia A. Downes

Thank you, Tony. Versar recorded grossed revenue of 31.6 million in the third quarter of fiscal year 2013 an increase of 22% compared to the third quarter of fiscal year '12. As outlined earlier the increase in revenue was primarily due to 5.4 million increase in revenue from our PBR works within the U.S. air force and an additional 1 million in revenue related to the operations from Charron which was acquired in May 2012.

Gross profit margin for the third quarter decreased 10% compared to 17% in fiscal year 2012. As Tony mentioned this decrease in gross margin was primarily the result of the completion of two particularly high margin contracts. SG&A expenses were 1.9 million during the quarter, a decrease of 12% when compared to the third quarter of fiscal year 2012. This decrease is primarily due to a reduction of rent expense as we reduced the size of our space of our headquarters in Springfield and negotiated rent reductions for our locations in Columbia and Maryland.

We also continue to focus on cost savings initiatives in areas such as –direct labor and travel during the quarter. The company achieved net income of 1 million or $0.11 per share, up from $0.10 per share during the third quarter of fiscal year 2012.

Now focusing on the operating results of our recently realigned business segments for the third quarter of fiscal year 2013, note that in discussing the business segment operations all prior period [amounts] [ph] have been reclassified to conform to the current segment presentation.

Engineering and Construction Management; Gross revenue was 15.1 million, an increase of 2% when compared to third quarter of last year. This increase was partially related to the addition of 1 million in revenue from Charron operations offset in part by a decrease of U.S. Air Force spending in Afghanistan.

As previously mentioned the recent award of the 170 Afghan PSC contract is [set] [ph] with our pipeline of work in Afghanistan. Gross profit margin was [12%] [ph] as compared to 22% last year. This decrease is related to the previously mentioned completion of two particularly high margin contracts.

Environmental Services; revenue was 12.8 million, an increase of 81% compared to 7.1 million in the third quarter last year. The increase was primarily due to a 5.4 million increase in PBR work for the U.S. Air Force and [Joint Administration] [ph] across the U.S. Additionally we recognized a $300,000 increase in revenue related to the unexploded ordnance based projects at Fort Irwin, California and at Nellis Air Force base in Nevada. Gross profit margin for the segment was 9% compared to 3% last year. The improved margin is due to increases in direct labor provided by new PBR awards and our UXO range maintenance project.

Professional Services; gross revenue was 3.7 million, a decrease of 4% as compared to the third quarter of last year. The decrease is primarily due to a reduction in work from various installations and more delays. We have noted that our clients have an increased interest in working with small business and we continue to look for new ways to increase in sub and prime contracting relationship with smaller firms to provide value to our customers.

Gross profit was 6.6 million, a decrease of 32% compared to third quarter of last year. Gross margin decreased to 15% compared to gross margin of 22% in the third quarter of 2012. With that I will turn it back to Tony to wrap up.

Anthony L. Otten

Thank you. We are very pleased to have been able to continue to deliver strong results in a difficult economic environment, while maintaining a strong balance to support future growth. We believe our edge in the marketplace comes from our consistent ability to deliver a full complement of capabilities in a wide range of situations to customers around the world. From somewhat standard construction management projects in the United States to more complex projects such as our PBR task force and (pointing) to our work in remote international locations such as Afghanistan, while not every project we work on or location we visit is high risk Versar's unique in its ability to successfully complete the more challenging ones.

As we look forward we are focused on three initiatives to drive growth. We continue to pursue larger contract opportunity. Enhancements over the past two years including strong internal infrastructure and associate technology are allowing us to focus on pursuing larger prime contracts and expand our pool of opportunities. We continue to strengthen our relationship with other contractors to create teaming arrangements that better serve our clients and create future opportunities.

We are leveraging our services, a combination of our multiple skillsets and broad service offerings will allow us to work efficiently in the new economic environment whether we are selling sustainable risk management services, utilizing our energy and environmental assets, or by effective use of our project and construction management skills in relation to complex oversight.

And finally we are expanding our international footprint. While we have a strong international presence in the construction management business, incorporation of our non-construction services into our overseas client base will allow for the replication of our proven domestic skills in the international market and position us to meet growing needs overseas.

Our management team remains committed to our goal of profitable growth. We believe that our capabilities and strengths will enable us to meet the future needs and demands of our client base. Thank you all for your continued support and I will now turn it back over to Dave to begin the Q&A portion of the call.

David Gray

Thanks Tony.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Thank you. Our first question comes from the line of Jeremy Hellman with Avenue T Fund. Please proceed with your questions.

Jeremy Hellman - Avenue T Fund

Hi, good afternoon, everybody.

Anthony L. Otten

Hi, Jeremy. How are you?

Jeremy Hellman - Avenue T Fund

Good Tony. Kind of a multi-headed question around margins. Was wondering - if you look out over your backlog, are the margins of those contracts -- obviously they are going to have, you are going to have a different range of margins for each contract you have bid and won and I am wondering if you look at that book do you see your margins getting more to that kind of normalized level, you referenced of about 12.5%, number one. And number two with the contracts you have in place are the margins generally going to be fixed once you have signed the contract or is there some variability that may come down the line, either once you actually start the work and do any other true up process?

Anthony L. Otten

Sure. I am actually, probably going to answer that with one. I mean we don't generally aside from someone who wants to track our awards announcements we don't generally give great detail on our backlog. As we have always said the backlog is made up of some projects that will end up, finish up the next six to nine months and some projects that will run, say 18 months or something. So there is a hybrid in there.

What I can say is that the majority of our work, I mean we have openly said this, well over 80% of what we do today is from fixed priced work. And so what that means is that we go in and bid on a project with a margin that we kind of think is appropriate, that we think will hit, but we also think with firm fixed price work that if we can figure out better smarter ways to do things, we will be able to improve those margins. And historically we have been able to do that.

So if I can say without giving any sort of read ahead because we don't generally give the read ahead, our feeling is as we bid on more and more of this firm fixed type work, we are getting smarter and better at doing these projects. A lot of that new backlog is the PBRs that we are starting to execute again. And we think we have room to improve margin as we go forward.

Jeremy Hellman - Avenue T Fund

Okay, thanks, and then second one from me and I will hop back. Just wondering if you have anything, any color to provide on the M&A side of things, anything that might be in latter innings or potentially happening?

Anthony L. Otten

We remain very aggressive and continue to look through a lot of companies. One of the joys, I guess, or one of the curses of buying small companies is that you can get pretty far down the pipe and then have something pop up that is a problem like a bust in their financials or something like that. So we continue to look very aggressively. We believe we will have additional acquisitions. We had a number that we have liked and for various reasons haven't moved forward as fast as we'd like, but we are optimistic and Charron we think was a good example. That's proven to be a very good acquisition for us and we are very pleased with the results and they are exceeding our expectations.

Jeremy Hellman - Avenue T Fund

Did the sequester change the tone of any of the conversations you are having?

Anthony L. Otten

I think it's gotten people to maybe become a little bit more realistic about the time, that it maybe time to exit and I think it's also making people realize that what they always assumed was just locked in the bag is no longer. So yeah I think we are finding it a more welcome environment.

Jeremy Hellman - Avenue T Fund

Okay, thanks Tony.

Operator

Thank you. Our next question comes from the line of Mark Jordan with Noble Financial. Please proceed with your questions.

Mark Jordan - Noble Financial

Good afternoon, a question relative to the visibility of the PBR business, specifically the -- what is the contract duration that you typically see and how good a visibility do you have into the Air Force intentions in this area, in the out years?

Anthony L. Otten

Sure, well most of these -- yeah, we are bidding on these in a combination of us as the prime with a number of subs on the team and then in other cases, other teams, other companies as the prime and us as a sub. But these are multi-year, eight to 10-year long programs, sizeable both, so obviously sizeable duration but also sizeable dollars, for example tanker which was the first one we won was a $45 million eight year program. Some of the other ones that we've won more recently in the last kind of eight to nine months are ranged in 25 to 35 million [RFPs] [ph], in one case it was a sub and our [RFP] [ph] is about I think we said it was like 7 million or 8 million. So these are all multi-year programs with sizeable dollars of funding.

Typically what we see on those is that these projects have an interesting kind of schematic with a lot of the work being done upfront, a lot of the work as the development of the actual remediation programs and the implementation of that remediation program and the back end of that program is really more kind of monitoring whether the program's been effective and then writing the report. So while I won't say that it's 80% in the first couple of years and 20% in the back end it's not necessarily 12% a year over an eight year time frame.

To your second point what we are hearing from the Air Force in a number of different venues we have a person who literally just walks the halls of San Antonio all the time talking and he's not being told anything it’s inappropriate but what we are hearing is that the air force is fully committed both in current funding as well as future funding to continue to drive these sort of large scale remediation programs. We expect to see significant dollars this fiscal year still and even into fiscal years '14 and '15.

Mark Jordan - Noble Financial

Have you seen or do you have a sense of how significant the sort age of pivot is with regards to the navy changing its focus and what that might do in terms of project opportunity for you over the next few years?

Anthony L. Otten

We really haven't. We are hearing that the Navy is probably not going to be as aggressive as the Air Force and the Army in the facilities and the remediation. They are going to put more of their dollars into the equipment side. But that said, as someone once said to me if you have a lot of boats you still need to put them somewhere and dock them somewhere. So our expectation is that while in the immediate time frame in the next year or so, the navy may not be that aggressive, eventually they are going to have to start spending some money against their facilities as well.

Mark Jordan - Noble Financial

Okay, thank you very much.

Operator

Thank you. Our next question comes from the line of Bhakti Pavani with CK Cooper & Company. Please proceed with your questions.

Bhakti Pavani - C. K. Cooper & Company

Hi, Tony, Hi, Cynthia. Congratulations on the quarter.

Anthony L. Otten

Thank you.

Bhakti Pavani - C. K. Cooper & Company

Just a quick question, your funded backlog has been increasing and it's really nice to know but could you maybe talk a little bit more about your pipeline of opportunity especially in the EPM arena.

Anthony L. Otten

Sure, again we will be somewhat general here, but we believe our pipeline remains very robust and very good quality. We see nothing different in the quality and the expectations of wins today than what we say 12 months ago. And as you pointed out we had a very good stretch of 12 months in terms of backlog and wins. What we are seeing however and I don't think we are at all alone in this, I think every government contractor out there is seeing this as that, it's just taking longer for those awards to come out.

So what's going to be interesting I think is what the last quarter of the government year, so the first quarter of our fiscal year looks like because I do think there will be an increase in awards coming out and the question really going to be whether the government is going to be able to manage those dollars through the process in such a tight timeframe, given what's going on right now with sequestration and the budgets. But when we look at our pipeline, when we look the sort of work we won last year both in ECM and overseas and domestically as well as ESG, our pipeline looks and feels very similar to what we had last year in terms of the type of work, the expectations in terms of wins et cetera. We are pretty confident we think we are well received by our clients and that we have good opportunities ahead of us.

I mean I don't know too many other government contractors that over the last 12 months have been able to increase the backlog as we have been able to do. So we are quite pleased.

Bhakti Pavani - C. K. Cooper & Company

Yeah, that's certainly helpful Just a quick question on the funded backlog, what is the cycle time on the backlog?

Anthony L. Otten

Yeah, what we have always said and I think I said it earlier, was to Jeremy's question, yeah, we have money in there that's going to burn out in the next six months. We have money in there, some of the PBR money that will burn for 18 more months. We have typically said, the best rule of thumb we have got is that the plus or minus about a 12 months cycle in terms of burning our backlog.

Bhakti Pavani - C. K. Cooper & Company

Okay, just a quick question on the balance sheet. Just looking at the receivables, payables and inventory, seem to be quite high than the normal. Would you maybe share some color on the correlation there and was it more related to might, if you could please provide some color?

Cynthia A. Downes

On the increase to the receivables it's just because our (inaudible) went up that month. We had basically had one-offs. The increase, decreases to the inventory piece we are managing our inventory in a better methodology be more efficient. And your third question was related to --, this is a function of sub-contractor payments. It's a paid when paid capital, we are committed as (inaudible) to the subs.

Anthony L. Otten

A lot of our work as Cynthia said is paid when paid. So we don't pay a sub-contractor until we get paid, which is a nice situation to have obviously.

Bhakti Pavani - C. K. Cooper & Company

And my last question on SG&A, I am sorry Cynthia I kind of missed on what you said, the SG&A was very low compared to your previous quarters. What was the reason and how I should be looking at going forward?

Cynthia A. Downes

We are a very aggressive about reducing our rent costs. We also reduced the space that we had in our Springfield office. We re-negotiated the rent in Columbia. So I would expect, I mean the rent expense will continue at the flat rate now but certainly a decrease from the last period this year.

Anthony L. Otten

As I've said on a number of occasions, our whole approach on a fixed cost and indirect cost is to bring them down. In situations where you can eliminate we will eliminate, in situations where we can divert it from fixed to variable, we will. This is a very good time to be a tenant. Most landlords are looking to kind of get you to sign up for longer periods of time and so we are using that opportunity to right-size. So for example in Springfield where we used to be heavily, heavily located our footprints are shifting.

We have more people working in different parts of the country and different parts of the world and less people at corporate and we were able to use that as an opportunity to negotiate some new terms with our landlord here at the corporate office and it was a nice outcome, And we were able to do some improvements or some tenant improvement and still reduce our overall footprint and our overall cost.

Bhakti Pavani - C. K. Cooper & Company

Right, that's it from my side. Thank you very much.

Anthony L. Otten

Thank you. Bhakti, appreciate it. Appreciate your ongoing watching us.

Operator

Thank you. Mr. Gray, there are no further questions at this time. I would like to turn the floor back over to you for closing comments.

David Gray

Okay thank you very much.

Anthony L. Otten

Thank you everybody. We look forward to -- we will be releasing our year-end numbers in early September. Obviously as we get new releases in terms of wins or awards we will put those out. This recording will be posted up on the website within the next couple of hours. And thank you again for your ongoing support of Versar. Appreciate it.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.

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