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Versar Inc. (NYSEMKT:VSR)

F2Q 2014 Earnings Call

February 10, 2014 02:00 PM ET

Executives

David Gray - Director, Financial Reporting

Tony Otten - President and CEO

Cynthia Downes - EVP and CFO

Analysts

Richard Magnuson - B. Riley & Company

Vincent Staunton - Wedbush Securities

Igor Novgorodtsev - Lares

Operator

Greetings, and welcome to the Versar Incorporated Second Quarter Fiscal Year 2014 Earnings Conference Call. At this time all participants are in 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.

I would now like to turn the conference over to your host, David Gray. Thank you. You may now begin.

David Gray

Thank you. Good afternoon. I’m David Gray, Versar’s Director of Financial Reporting. Welcome to Versar’s investors conference call for the second quarter of fiscal year 2014. Joining me today on the call are Versar’s Chief Executive Officer, Tony Otten; Versar’s President and Chief Operating Officer, 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 that anticipated on this call, you are referred to the Company’s public filing.

I’d like to now introduce Versar’s CEO, Tony Otten.

Tony Otten

Good afternoon. Given the headwinds that our entire industry has been facing, this was a solid quarter for Versar and I'm very, very proud of the team. Revenues increased 16% to $28 million and our backlog increased as well. Please remember that the U.S. government shutdown in October delaying some of our contractor rewards and causing a temporary slowdown in activity for some of our existing projects. We managed through this as well as could have expected.

Our revenue growth was driven by revenue generated by GMI Our continued construction support activity in Afghanistan with the U.S. Army Corp of Engineers or USACE and the continued ramp up of our Performance Based Remediation projects or PBR work, for the Air Force in New England and the Great Lakes Region.

We did see a decline in gross margin for the quarter, related to the wind down in our Title II work in Afghanistan which is expected to end this summer. Additionally, margins were affected by a decline in gross profit as our professional services group continues to experience pressure from a shifting contract solicitations to small business program. We no longer qualify as a small businesses. So we are working through partnerships and collaborations to effectively access these types of contracts.

Generally speaking our margins were below where they have been historically, and this contributed to a slight loss from continuing operations for the quarter. Lower margins were due to a few factors including higher purchase services related to our PDR program and our personal services or PSD contract in Afghanistan, as well as severance cost associated with the GMI acquisition.

We expect the severance cost to be non-reoccurring and to the extent we have any more layoffs, there will be isolated incidents during the normal course of business. Over the long-term Versar should be able to achieve operating margins of 6% to 8% as it has in the past. Frankly, we should be able to achieve higher operating margins as the business scales up to 200 million in sales.

Backlog grew 11% to $120 million at the end of the second quarter from the end of the last fiscal year, both because of the continued success of our business development initiatives, as well as contributions from GMI. During the quarter we were awarded $1.1 million of new awards and $440,000 in sub-contract extensions from HDR for continued construction management and quality assurance work in support of the U.S. Air Force operations in Afghanistan. This is an addition to the $8.8 million in awards we received during the last quarter of fiscal 2013 and the first quarter of this fiscal year. These awards and extensions bring our HDR sub-contract total to over almost $40 million over the life of the subcontract.

This is one of the many contracts we hold in the region and it demonstrates our leadership role and the reconstruction efforts in certain parts of the Middle East and the U.S. government’s ongoing confidence in our capability. Following the close of the quarter we were also awarded a $2.25 million contract with Frederick County, Maryland to provide Municipal Stormwater Permit Support, $1.5 million extension of our personal services and support contract for the Corp Engineers in Iraq. This will extend our efforts in Iraq through the end of September.

Our integration of GMI is progressing well, contributing $4.2 million in revenue in the second quarter. We still have work to do but we are pleased with the Company’s strategic benefits, particularly increasing our technical capabilities and further diversifying our customer base, most notably by enabling Versar’s strength in its relationship with the U.S. Navy.

Our balance sheet remains solid, reflecting a cash balance of $4 million, working capital of $25.1 million and minimal long-term debt. Strength of our balance sheet is a key competitive advantage in positioning the company for continued organic growth while maintaining liquidity to pursue strategic acquisitions. We’ve always acknowledged the challenges of having U.S. government as our biggest customer. Having said that, and despite the particular challenges the October shutdown created, we still believe that will continue to be many opportunities for us to pursue profitable work in our areas of expertise such as sustainable military range management, contingency operation support and environmental assessments and remediation.

I will now turn it over to our Executive Vice President and CFO, Cynthia Downes, to review our finance results for the second quarter of fiscal year 2014.

Cynthia Downes

Thank you, Tony. Versar recorded gross revenue of $28 million in the second quarter, an increase of 16% compared to $24.1 million during the second quarter of 2013. The increase in revenue is primarily related to a combination of the GMI acquisition, continued activity associated with our contract with USACE and the continued ramp up of our PBR work for the U.S. Air Force in New England and the Great Lakes region. Gross profit declined $2.3 million or 8.4%, compared to $4 million or 16%. As Tony mentioned, decline is due to a decrease in gross profits, which the wind down of our Title II work in Afghanistan expected to be completed this summer.

Additionally gross profit in our PSG group declined relating to a shift in contract solicitations and awards to companies designated as small businesses. Net loss from continuing operations was $79,000 or $0.01 per share for the quarter. On the net basis we reported income of a $100,000 or $0.01 for the quarter, primarily because of $0.02 from discontinued operations due to a sizeable overdue receivable that we collected during the quarter.

SG&A expenses were $2.4 million during the quarter, an increase of 7% compared to the second quarter of the prior year. SG&A for the quarter was approximately a 100,000 of final check payments from the Charron acquisition and approximately a $100,000 in severance expenses associated with the GMI acquisition.

Now, focusing on the operating results for business segments for the second quarter of fiscal 2014. Engineering and construction management, gross revenue of $13.5 million, an increase of 8% compared to last year. The increase primarily resulted from our ongoing professional services contract, [indiscernible] USACE construction program in Afghanistan. Gross profit this segment was 11% as compared to 19% last year. This decrease is principally due to the Title II program previously discussed.

Environmental services; revenue was $11.9 million, an increase of 52%, compared to $7.8 million in the second quarter of 2013. This increase was primarily due to the ramp up of our work on the Great Lakes, New England, and PBR program for the U.S. Air Force. GMI contributed $1.2 million to this increase.

Gross profit for the segment was $650,000, gross margin of 5% compared to gross profit of $700,000 and gross margin of 9% in same quarter last year. The majority of this decrease was a result of a greater than 100% increase in construction services associated with the subcontracting work in our PBR project, and the decrease in direct labor utilization associated with GMI as we work through staff alignments through the integration process.

The Professional Services Group; gross revenue for the quarter of fiscal 2014 was $2.7 million, a decrease of 30%, compared to $3.9 million during the second quarter of last fiscal year. This decrease was due to the completion of contracts at numerous sites, most notably within the Moyo District and the Fort Lee site. We continue to see a decline in our contract positions due to continued delays in requests for proposals as well as a continued shift for more contract verification targeted at companies that qualify for small business programs.

Gross profit margin for the division was 8%, compared to 24% last year. The lower margin was primarily due to the decline in direct labor hours associated with the contracts previously discussed. Additionally, although we experienced external [indiscernible] government shutdown, we continued to partially fund the salaries of effected employees.

With that I will turn it back to Tony to wrap it up.

Tony Otten

Thank you, Cynthia. We are pleased we’re able to deliver revenue growth and overall profitability in a difficult economic environment while maintaining a strong balance sheet and healthy pipelines for future growth. Our company has a specialized set of capabilities that allow us to complete dangerous projects in both challenging and relatively normal operating environments.

Additionally, Versar is able to competitively execute fairly standard construction management projects in dangerous locations such as parts of the Middle East. Most important to us however is that we continue to provide effective solutions for our customers regardless of the location or the task. We believe our recent contract wins demonstrate marketplace recognition of our ability to deliver a wide variety of capabilities in a full range of situations.

Our leadership team remains focused on delivering profitable growth and we believe that our capabilities and strengths will enable us to meet the future needs and demands of existing and new customers. As we’ve discussed in previous calls, we are focused on several initiatives to drive growth. We continue to pursue larger contracts and expand our pool of opportunities. We are strengthening our relationships with other contractors to form partnerships that better serve our clients and create additional opportunities. We also continue to aggressively approve asset acquisitions. GMI’s integration is moving along relatively well and we anticipate that it will positively affect our business development initiatives as well as our operating results. And evaluating potential acquisitions, we look at companies that have the potential to enhance Versar’s existing capabilities that are a good cultural fit and have the ability to provide new strategic client relationships. We continue to build on our unique capabilities and we believe we are well positioned to meet the future needs and demands of both our existing client base and to capitalize on new opportunities. Among our upcoming investor outreach efforts, I will be presenting at the B. Riley conference in Los Angeles in May.

Thank you for joining us today and I’ll now turn it back over to Dave to begin the Q&A portion of the call.

David Gray

Thanks Tony. If you give us just a moment, we will get our questions started.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. And our first question is from the line of Richard Magnuson with B. Riley & Company. Please proceed with your question.

Richard Magnuson - B. Riley & Company

My question is regarding the purchased services rather that affected the margins. There is a note in the Q2 that said that you can expect these costs as a percentage of revenue to continue to exceed prior years; and my question is are we pretty much at the highest level or can we expect further increase in those costs that would further impact margins?

Tony Otten

I don’t know that I could tell you whether we are at the peak or whether we are going to be flat or declining. What I can speak to is the type of projects, and the three major contributors to our purchase services are our PBRs, Performance Based Remediation projects, and those will certainly run for a number of years, that’s in our Environmental Services group. Within the Engineering Construction group we have two things going on. We have the decline in the efforts under our Title II work for the Air Force and so we will see those purchase services declining.

But at the same time the work that we were doing for the core under the PSC contract are either flat or slightly increasing, versus a year ago those would be substantial because we just were awarded that contract a year ago on October, and the first quarter was the ramp up quarter which would have been the second quarter of fiscal year ‘13. So there is certainly a dramatic change in purchase services for the PSC contract from last year to this year.

I would not necessarily expect to see as dramatic a change from this year to say the next quarter, either going forward chronologically for a year from now. In terms of margin we certainly continue to see better margins in our overseas work than we do on our domestic work and so certainly as we’ve pointed out with the decline of the work in the Iraq, I mean the Afghanistan Title II work, we are seeing some margin pressure there as that work starts to decline.

Operator

And your next question comes from the line of Vincent Staunton with Wedbush Securities. Please proceed with your question.

Vincent Staunton - Wedbush Securities

Tony, you mentioned that you expect Afghanistan Title II work to end summer -- this summer? What percentage of the current quarter’s revenue was Afghanistan Title II?

Tony Otten

I don’t know that we would be giving that sort of percentage. What I will say is that we’re not seeing an overall decline in revenue from Afghanistan because of the ramp up of the PSC contract, and so we’ve typically said that we seem to be running at about 45% international revenue and about 55% domestic. And so far we’re not seeing a dramatic shift. So what we are seeing and have seen is the increase from the PSC contract offsetting the decline from the Title II work.

Vincent Staunton - Wedbush Securities

But the Title II work, would that have higher margins in the PSC?

Tony Otten

It does, and so what’s happening now is, we have a certain amount of fixed cost, in terms of a program management office et cetera that we have for the Title II work and that’s our labor -- direct labor declines, we are having to spread that fixed cost over small labor base. And so that’s what happening on margin. We will -- that should at some point kind of stabilize. I don’t know that we’re quite there from the Title II side of it. But we have other ways for us to manage that. We’re just -- as is often the case with fixed cost, you have kind of a step function, and so right now we’re caught kind of in this intermediary spot where we can’t take a cost down just yet, but the revenue is declining.

Vincent Staunton - Wedbush Securities

And in regards to the -- you mentioned that you expect eventually to get back to operating margins of 6% to 8%. Do you have a timeline of when you should expect to get there?

Tony Otten

No. Again Vince, we generally don’t give guidance. We do believe that that’s achievable. We think it’s achievable in the near term. Whether the near term is a quarter or two quarters, I’m not going to speculate. We are very comfortable in the levers that we have to move, but some of these levers just take time. For example we talked about it the second quarter, the utilization impact of the acquisition of GMI, we know when we bought GMI that they were significantly below our levels of utilization. And we have to be very judicious in how we manage through that. We didn’t want to just let people go, if we figured it out they were actually the right people to keep, whatever. So for example we’ve seen as much as a 5 or 6 percentage point delta in historical levels of utilizations versus utilizations of GMI. We’ve now pretty much right sized this and so a lot of that drag according to second quarter. We expect not to feel that drag in the third quarter, but whether that allows us to get all the way back in the third quarter, that’s to be determined. And that’s still -- I think we have to see how it plays out.

Operator

[Operator Instruction] Our next question comes from the line of Igor Novgorodtsev with Lares. Please proceed with your question.

Igor Novgorodtsev - Lares

My question is about your backlog. So, I know that the backlog is up year-over-year, but I if you look quarter-over-quarter it looks like about $2 million [ph] came off your backlog. So most of your revenue are basically came -- or it seems came from $15 million of backlog. So, could you just give a little bit more color, why the backlog came down by $16 million and basically nothing was awarded? Was it due to the government shutdown or it was some other reasons?

Tony Otten

Sure. In fact you’re actually right. We issued 136 million at the end of the first quarter. We’re about $120 million at the end of this quarter. Some of that backlog burn was our -- Versar's historical backlog. Some of that was backlog that we picked up through GMI. This is was probably the lowest quarter we have seen in terms of new awards since I’ve been here.

We’re not worried, our pipeline actually more than doubled. So we have got a lot of proposals out there that we feel high, high levels of confidence in. It’s just that with the shut down and then the catch up, the awards just weren’t coming. We do think with the budget -- Balance Budget Act was resolved, that we will start to see more money is growing and I think that’s – we’re already kind of getting that sense of it. But back to the point, when you look at what we’re seeing in terms of opportunities, when you look at the proposal effort what we have waiting for award, we’re very, very comfortable that we’ll be reporting significant improvements in backlog as we go forward.

It’s just simply a timing, if you go back to give you an example of that -- and during the second quarter, during the two week shutdown, we actually on top of that had to shut down other parts of our business for an additional two months because the awards that we had told were one at the end of the quarter didn’t get issued, in fact weren’t issued till the middle of December.

So that gives you a sense of how much we were affected by the government shutdown. It wasn’t just a fact that we were shut down for two weeks in certain operations. It was awards got delayed by up to 60 days in some cases. Those are all now onboard. We’re now operating those at full capacity but that’s indicative of what we were seeing across the board. But we’re not unduly worried at all in terms of the backlog and what we see in our pipeline and what we fully expect to move out of the pipeline into backlog over the coming months.

Igor Novgorodtsev - Lares

Well, following up on that, would it be fair to say that you should expect a little bit of a bounce back rehearsal next quarter. Since nothing was awarded in the previous quarter?

Tony Otten

You know Igor, we don’t give guidance on revenues but we feel very comfortable that we will see an improvement in backlog and of course as you burn your backlog, that’s certainly translates through equity into revenue.

Igor Novgorodtsev - Lares

And also a quick follow up question. Correct me I’m wrong, I recall that seriously you stated that the Title II work in Afghanistan will go on until the end of this year, calendar year and now you say that it’s going to be ending in the summer. Am I…?

Tony Otten

This is not an exact science, Igor. I mean the honest – if you think about it, we’ve been saying for years that we’re going to out of Iraq and yet we’re still in Iraq and that’s running through the end of September. So in terms of actual work that we have and that’s all we can commit to, we have [indiscernible] take us through at the end of the summer which is certainly the end of our first quarter fiscal year ’15.

Do we think we’ll continue to have additional projects? Yes, what we we’re reading in -- what we’re hearing in the -- to the theories is that there will be more work to come but I’m not comfortable committing to that when right now all I have in terms of signed committed funds takes us through the end of the summer. But again, as I said when you look at what’s going on the Iraq, we’re still there and for all we know, we could be there a year from now.

Operator

Thank you. We have no further questions at this time. I’d like to turn the floor back over to management for closing comments.

David Gray

Thank you everybody. We’ll be posting this broadcast to our website in next couple of hours for anyone that would like to access it. We’ll also be releasing our Q3 2014 results in May and of course as always we’ll continue to announce our wins and awards as they occur. Lastly thank you for your continued support of Versar. And we look forward to talking with you again soon.

Operator

Thank you. This does conclude today’s conference. You may disconnect your lines at this time. Thank you for participation.

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