NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1
DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business and Basis of Presentation
Our Business
Vectrus, Inc. is a leading provider of services to the United States (U.S.) government worldwide. The Company operates as one segment and offers facility and logistics services and information technology and network communications services.
Vectrus was incorporated in the State of Indiana on February 4, 2014. On September 27, 2014, Exelis Inc. (Exelis) completed a spin-off (the Spin-off) of Vectrus, and Vectrus became an independent, publicly traded company. Unless the context otherwise requires, references in these notes to "Vectrus", "we," "us," "our," "the Company" and "our Company" refer to Vectrus, Inc. References in these notes to Exelis or "Former Parent" refer to Exelis Inc. and its consolidated subsidiaries (other than Vectrus).
Basis of Presentation
Our quarterly financial periods end on the Friday closest to the last day of the calendar quarter (September 27, 2019 for the third quarter of 2019 and September 28, 2018 for the third quarter of 2018), except for the last quarter of the fiscal year, which ends on December 31. For ease of presentation, the quarterly financial statements included herein are described as three and nine months ended.
The unaudited interim Condensed Consolidated Financial Statements of Vectrus have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Accordingly, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the U.S. (GAAP) have been omitted. These unaudited interim Condensed Consolidated Financial Statements should be read in conjunction with our audited Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2018.
It is management’s opinion that these financial statements include all normal and recurring adjustments necessary for a fair presentation of the Company’s financial position and operating results. Net sales and net earnings for any interim period are not necessarily indicative of future or annual results.
Leases
On January 1, 2019, the Company adopted the new lease accounting standard Accounting Standards Codification Topic 842, Leases (ASC Topic 842). Operating leases are included on our Condensed Consolidated Balance Sheets as right-of-use (“ROU”) assets, other accrued liabilities and other non-current liabilities.
ROU assets represent the Company's right to use an underlying asset for the lease term and lease liabilities represent the Company's obligation to make lease payments arising from the lease. Lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit interest rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The incremental borrowing rate as of January 1, 2019 was applied to operating leases in effect as of that date. The operating lease ROU asset also includes any prepaid lease payments and excludes lease incentives. Many of our leases include one or more options to renew or terminate the lease, solely at our discretion. Such options are factored into the lease term when it is reasonably certain that we will exercise the option. Lease expense for lease payments is recognized on a straight-line basis over the term of the lease.
As allowed under ASC Topic 842, the Company elected the package of practical expedients permitted under the transition guidance which allowed the Company to carry forward the historical lease classification, assessment of whether a contract was or contained a lease and assessment of initial direct costs. In addition, we have made policy elections to apply the short-term leases practical expedient, whereby leases with a term of 12 months or less are not capitalized and recorded on our balance sheet, and the practical expedient to not separate lease components from non-lease components. The latter expedient is applied to all of our leases. We did not elect to apply the hindsight practical expedient in determining lease terms and assessing impairment of ROU assets. See Note 2, "Recent Accounting Pronouncements" and Note 10, "Leases" for further information.
Reclassifications
Certain reclassifications have been made to the presentation of amounts in our Condensed Consolidated Statements of Cash Flows for the nine months ended September 28, 2018 to conform to the current year presentation. Specifically, depreciation and amortization, which were combined and disclosed as one amount are now presented separately.
NOTE 2
RECENT ACCOUNTING PRONOUNCEMENTS
Accounting Standards Issued But Not Yet Effective
In August 2018, the Financial Accounting Standards Board (FASB) issued ASU 2018-15 to provide guidance on accounting for implementation costs incurred in a cloud computing arrangement (CCA) hosted by the vendor - that is a service contract. Under the new guidance, a customer will apply the same criteria for capitalizing implementation costs of a CCA as it would for an on-premises internal-use software license. Presentation of such costs, however, will vary from those required for licensed internal-use software. ASU 2018-15 is effective January 1, 2020 and can be adopted prospectively or retrospectively. Early adoption is permitted. The standard is not expected to have a material impact on the Company's consolidated financial statements.
ASU 2016-13 was issued in June 2016 with the intent of providing financial statement users with more useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. Current treatment uses the incurred loss methodology for recognizing credit losses that delays the recognition until it is probable a loss has been incurred. The accounting update adds a new impairment model, known as the current expected credit loss model, which is based on expected losses rather than incurred losses. Under the new guidance, an entity will recognize as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. The standard is not expected to have a material impact on our consolidated financial statements.
For a discussion of other accounting standards that have been issued by the FASB but are not yet effective, refer to the Accounting Standards Updates section in our Annual Report on Form 10-K for the year ended December 31, 2018. These standards are not expected to have a material impact on our results of operations or cash flows.
Accounting Standards That Were Adopted
In February 2018, the FASB issued ASU 2018-02, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (Tax Act). The Company adopted the provisions of ASU 2018-02 during the first quarter of 2019 and recorded a $0.3 million decrease to accumulated other comprehensive income and a corresponding increase to beginning retained earnings to reflect the changes in the U.S. federal corporate income tax rate as a result of the Tax Act. As a result of the adoption of ASU 2018-02, the Company's policy to release income tax effects in accumulated other comprehensive income is consistent with the underlying book method.
In February 2016, the FASB issued ASU 2016-02, with amendments issued in 2018. The objective of ASU 2016-02 is to recognize lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The standard requires lessees to recognize most leases on the Condensed Consolidated Balance Sheets but does not change the manner in which expenses are recorded in the income statement. We adopted the standard during the first quarter of 2019 using the cumulative-effect adjustment transition method, which applies the provisions of the standard at the effective date without adjusting comparative periods presented.
See Note 1, "Description of Business and Summary of Significant Accounting Policies" and Note 10,"Leases" for further information.
Other new accounting pronouncements issued but not yet effective until after September 27, 2019 are not expected to have a material impact on our financial position, results of operations or cash flows.
NOTE 3
REVENUE
Performance Obligations
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. To determine the proper revenue recognition method, consideration is given as to whether a single contract should be accounted for as more than one performance obligation. For most of our contracts, the customer contracts with us to perform an integrated set of tasks and deliverables as
a single service solution, whereby each service is not separately identifiable from other promises in the contract. As a result, when this integrated set of tasks exists, the contract is accounted for as one performance obligation. The vast majority of our contracts have a single performance obligation. Unexercised contract options and indefinite delivery and indefinite quantity (IDIQ) contracts are considered to be separate contracts when the option or IDIQ task order is exercised or awarded.
Contract modifications are routine in the performance of our contracts. Contracts are often modified to account for changes in contract specifications or requirements. In most instances, contract modifications are for goods or services that are not distinct, and therefore, are accounted for as part of the existing contract.
The Company's performance obligations are satisfied over time as services are provided throughout the contract term. We recognize revenue over time using the input method (e.g., costs incurred to date relative to total estimated costs at completion) to measure progress. Our over time recognition is reinforced by the fact that our customers simultaneously receive and consume the benefits of our services as the services are performed. This continuous transfer of control requires that the Company tracks progress towards completion of performance obligations in order to measure and recognize revenue. Determining progress on performance obligations requires the Company to make judgments that affect the timing of revenue recognition. Remaining performance obligations represent firm orders by the customer and exclude potential orders under IDIQ contracts, unexercised contract options and contracts awarded to us that are being protested by competitors with the U.S. Government Accountability Office (GAO) or in the U.S. Court of Federal Claims. The level of order activity related to programs can be affected by the timing of government funding authorizations and project evaluation cycles. Year-over-year comparisons could, at times, be impacted by these factors, among others.
The Company's contracts are multi-year contracts and typically include an initial period of one year or less with annual one-year (or less) option periods. The number of option periods varies by contract, and there is no guarantee that an option period will be exercised. The right to exercise an option period is at the sole discretion of the U.S. government when we are the prime contractor or of the prime contractor when we are a subcontractor. We expect to recognize a substantial portion of our performance obligations as revenue within the next 12 months. However, the U.S. government or the prime contractor may cancel any contract at any time through a termination for convenience or for cause. Most of our contracts have terms that would permit us to recover all or a portion of our incurred costs and fees for work performed in the event of a termination for convenience.
Remaining performance obligations increased by $101.3 million to $959 million as of September 27, 2019 as compared to $858 million as of December 31, 2018. The Company expects to recognize approximately 34% of the remaining performance obligations as revenue in 2019, and the remaining 66% during 2020. Remaining performance obligations as of September 27, 2019 and December 31, 2018 are presented in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
September 27,
|
|
December 31,
|
(In millions)
|
|
2019
|
|
2018
|
Performance Obligations
|
|
$
|
959
|
|
|
$
|
858
|
|
Contract Estimates
Accounting for contracts and programs involves the use of various techniques to estimate total contract revenue and costs. For contracts, we estimate the profit on a contract as the difference between the total estimated revenue and expected costs to complete a contract and recognize that profit over the life of the contract.
Contract estimates are based on various assumptions to project the outcome of future events. These assumptions include labor productivity and availability; the complexity of the services being performed; the cost and availability of materials; the performance of subcontractors; and the availability and timing of funding from the customer.
The impact of adjustments in contract estimates on our operating income can be reflected in either revenue or cost of revenue. Cumulative adjustments for the three and nine months ended September 27, 2019 were favorable by $0.7 million and $1.5 million, respectively. Cumulative adjustments for the three and nine months ended September 28, 2018 were unfavorable by $1.6 million and favorable by $4.9 million, respectively.
For the three and nine months ended September 27, 2019, the net favorable adjustments to operating income increased revenue by $4.0 million and $4.2 million, respectively. For the three months ended September 28, 2018, the net unfavorable adjustments to operating income decreased revenue by $2.0 million. For the nine months ended September 28, 2018, the net favorable adjustments to operating income increased revenue by $4.7 million.
Revenue by Category
Generally, the sales price elements for the Company's contracts are cost-plus, cost-reimbursable or firm-fixed-price. The Company commonly has elements of cost-plus, cost-reimbursable and firm-fixed-price contracts in a single contract. On a cost-plus type contract, the Company is paid our allowable incurred costs plus a profit, which can be fixed or variable depending on the contract’s fee arrangement, up to funding levels predetermined by our customers. On cost-plus type
contracts, we do not bear the risks of unexpected cost overruns, provided that we do not incur costs that exceed the predetermined funded amounts. Most of our cost-plus contracts also contain a firm-fixed-price element. Cost-plus type contracts with award and incentive fee provisions are our primary variable contract fee arrangement. Award fees provide for a fee based on actual performance relative to contractually specified performance criteria. Incentive fees provide for a fee based on the relationship between total allowable and target cost. On most of our contracts, a cost-reimbursable element captures consumable materials required for the program. Typically, these costs do not bear fees.
On a firm-fixed-price type contract, we agree to perform the contractual statement of work for a predetermined contract price. A firm-fixed-price type contract typically offers higher profit margin potential than a cost-plus type contract, which is commensurate with the greater levels of risk we assume on a firm-fixed-price type contract. Although a firm-fixed-price type contract generally permits us to retain profits if the total actual contract costs are less than the estimated contract costs, we bear the risk that increased or unexpected costs may reduce our profit or cause us to sustain losses on the contract. Although the overall scope of work required under the contract may not change, profit may be adjusted as experience is gained and as efficiencies are realized or costs are incurred.
The following tables present our revenue disaggregated by several categories. Revenue by contract type for the three and nine months ended September 27, 2019 and September 28, 2018 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 27,
|
|
September 28,
|
|
September 27,
|
|
September 28,
|
(In thousands)
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Cost-plus and cost-reimbursable ¹
|
|
$
|
272,810
|
|
|
$
|
240,338
|
|
|
$
|
781,024
|
|
|
$
|
713,289
|
|
Firm-fixed-price
|
|
87,044
|
|
|
67,757
|
|
|
236,347
|
|
|
236,455
|
|
Total revenue
|
|
$
|
359,854
|
|
|
$
|
308,095
|
|
|
$
|
1,017,371
|
|
|
$
|
949,744
|
|
|
|
|
|
|
|
|
|
|
¹ Includes time and material contracts
|
|
|
|
|
|
|
|
|
Revenue by geographic region in which the contract is performed for the three and nine months ended September 27, 2019 and September 28, 2018 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 27,
|
|
September 28,
|
|
September 27,
|
|
September 28,
|
(In thousands)
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Middle East
|
|
$
|
244,142
|
|
|
$
|
223,636
|
|
|
$
|
695,626
|
|
|
$
|
662,734
|
|
United States
|
|
77,228
|
|
|
54,379
|
|
|
219,534
|
|
|
203,015
|
|
Europe
|
|
38,484
|
|
|
30,080
|
|
|
102,211
|
|
|
83,995
|
|
Total revenue
|
|
$
|
359,854
|
|
|
$
|
308,095
|
|
|
$
|
1,017,371
|
|
|
$
|
949,744
|
|
Revenue by contract relationship for the three and nine months ended September 27, 2019 and September 28, 2018 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 27,
|
|
September 28,
|
|
September 27,
|
|
September 28,
|
(In thousands)
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Prime contractor
|
|
$
|
334,383
|
|
|
$
|
290,090
|
|
|
$
|
954,172
|
|
|
$
|
892,206
|
|
Subcontractor
|
|
25,471
|
|
|
18,005
|
|
|
63,199
|
|
|
57,538
|
|
Total revenue
|
|
$
|
359,854
|
|
|
$
|
308,095
|
|
|
$
|
1,017,371
|
|
|
$
|
949,744
|
|
Revenue by customer for the three and nine months ended September 27, 2019 and September 28, 2018 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 27,
|
|
September 28,
|
|
September 27,
|
|
September 28,
|
(In thousands)
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Army
|
|
$
|
245,817
|
|
|
$
|
224,038
|
|
|
$
|
698,377
|
|
|
$
|
700,265
|
|
Air Force
|
|
86,557
|
|
|
64,278
|
|
|
227,081
|
|
|
189,954
|
|
Navy
|
|
13,344
|
|
|
8,567
|
|
|
45,249
|
|
|
26,912
|
|
Other
|
|
14,136
|
|
|
11,212
|
|
|
46,664
|
|
|
32,613
|
|
Total revenue
|
|
$
|
359,854
|
|
|
$
|
308,095
|
|
|
$
|
1,017,371
|
|
|
$
|
949,744
|
|
Contract Balances
The timing of revenue recognition, billings and cash collections results in billed and unbilled accounts receivable (contract assets) and customer advances and deposits (contract liabilities) on the Condensed Consolidated Balance Sheets. Amounts are billed as work progresses in accordance with agreed-upon contractual terms at periodic intervals (e.g., biweekly or monthly). Generally, billing occurs subsequent to revenue recognition, resulting in contract assets. However, we may receive advances or deposits from our customers, before revenue is recognized, resulting in contract liabilities. These advance billings and payments are not considered significant financing components because they are frequently intended to ensure that both parties are in conformance with the primary contract terms. These assets and liabilities are reported on the Condensed Consolidated Balance Sheets on a contract-by-contract basis at the end of each reporting period.
As of September 27, 2019, we had contract assets of $194.7 million. Refer to Note 7, "Receivables" for additional information regarding the composition of our receivables balances. As of September 27, 2019, our contract liabilities were $0.9 million.
NOTE 4
ACQUISITIONS
Advantor
On July 8, 2019, we acquired Advantor Systems Corporation and Advantor Systems, LLC (collectively, Advantor) from Infrasafe Holding, Inc. and Infrasafe, LLC (collectively, Infrasafe). Advantor is a leading provider of integrated electronic security systems to the U.S. government. In accordance with ASC Topic 805, Business Combinations, we accounted for this transaction using the acquisition method. We conducted valuations of certain acquired assets and liabilities for inclusion in our Condensed Consolidated Balance Sheets as of the date of acquisition. Assets that normally would not be recorded in ordinary operations (i.e. intangibles related to contractual relationships) were recorded at their estimated fair values. The excess purchase price over the estimated fair value of the net assets acquired was recorded as goodwill.
The total net consideration paid for the acquisition was $44.0 million, consisting of the purchase price, net of cash acquired, and $0.3 million estimated working capital in excess of the working capital requirement agreed upon in the stock purchase agreement. The acquisition was funded by utilizing cash on hand and available capacity from our Amended Revolver (as defined in Note 8, “Debt”).
A breakdown of the preliminary purchase price allocation, net of cash acquired, is as follows:
|
|
|
|
|
|
(In thousands)
|
|
Allocation of Purchase Price
|
Receivables
|
|
$
|
11,535
|
|
Other current assets
|
|
2,719
|
|
Property, plant and equipment
|
|
155
|
|
Goodwill
|
|
27,253
|
|
Intangible assets
|
|
8,300
|
|
Other non-current assets
|
|
1,868
|
|
Accounts payable
|
|
(4,223
|
)
|
Other current liabilities
|
|
(1,519
|
)
|
Accrued compensation
|
|
(907
|
)
|
Other non-current liabilities
|
|
(1,218
|
)
|
Purchase price, net of cash acquired
|
|
$
|
43,963
|
|
The Company is in the process of finalizing the details related to the amounts allocated to receivables, prepaid assets, property, plant and equipment and accounts payables. The amount paid relating to working capital was based on an estimate at the closing of the acquisition. Any differences between the estimate and the actual amount at closing will be finalized subsequent to September 27, 2019. Adjustments to the initial purchase accounting for the acquired net assets will be completed, as needed, up to one year from the acquisition date as we obtain additional information regarding facts and circumstances that existed as of the acquisition date.
The Company recognized two intangible assets related to customer contracts (backlog) and the Advantor trade name arising from the acquisition. The fair value of the customer contracts was $7.2 million, and the fair value of the Advantor trade name was $1.1 million with amortization periods of 5.0 years and 4.5 years, respectively. The weighted-average remaining useful life of these two intangible assets is 4.7 years. Accordingly, the Company recorded amortization expense of $0.4 million during the three months and nine months ended September 27, 2019. The amortization expense is included in cost of revenue in our Condensed Consolidated Statements of Income.
Additionally, the Company recognized goodwill of $27.3 million arising from the acquisition, which relates primarily to acquired product and services strengthening our advance into a higher value, technology-enabled and differentiated platform, as well as extending our facilities and logistics services to include the electronic protection and security of facilities. Goodwill also includes other intangibles that do not qualify for separate recognition. The goodwill recognized for the Advantor acquisition is fully deductible for income tax purposes.
Through September 27, 2019, the Company recorded acquisition-related costs of $1.0 million. These costs are included in selling, general and administrative expenses in our Condensed Consolidated Statements of Income and do not reflect any other one-time internal non-recurring integration costs.
Advantor's results of operations have been included in our Condensed Consolidated Statements of Income for the period subsequent to acquisition on July 8, 2019. For the three and nine months ended September 27, 2019, Advantor contributed $10.2 million of revenue and an insignificant amount of income from operations before income taxes. For the three months and nine months ended September 28, 2018, the acquired business recognized revenue of $8.4 million and $24.1 million, respectively. Income from operations before income taxes for the acquired business was insignificant during the same prior year periods.
SENTEL
On January 23, 2018, the Company acquired 100% of the outstanding common stock of SENTEL Corporation (SENTEL). In accordance with ASC Topic 805, Business Combinations, we accounted for this transaction using the acquisition method. We conducted valuations of certain acquired assets and liabilities for inclusion in our Condensed Consolidated Balance Sheets as of the date of acquisition. Assets that normally would not be recorded in ordinary operations (i.e., intangibles related to contractual relationships) were recorded at their estimated fair values. The excess of the purchase price over the estimated fair value of the net assets acquired was recorded as goodwill.
The total net consideration paid for the acquisition was $36.9 million, consisting of the purchase price of $36.0 million and $0.9 million in excess of the working capital requirement agreed upon in the stock purchase agreement entered into among our wholly-owned subsidiary Vectrus Systems Corporation (VSC), SENTEL, R&R Enterprises, Inc. and Russell T. Wright. The acquisition was funded by utilizing cash on hand and available capacity from our Amended Revolver (as defined in Note 8, "Debt").
A breakdown of the purchase price allocation, net of cash acquired, is as follows:
|
|
|
|
|
(In thousands)
|
Allocation of Purchase Price
|
Receivables
|
$
|
23,339
|
|
Property, plant and equipment
|
810
|
|
Goodwill
|
16,689
|
|
Intangible assets
|
10,500
|
|
Other current assets
|
975
|
|
Accounts payable
|
(10,012
|
)
|
Other current liabilities
|
(5,446
|
)
|
Purchase price, net of cash acquired
|
$
|
36,855
|
|
With the acquisition of SENTEL, the Company recognized two intangible assets relating to customer contracts, backlog and contract re-competes. The fair value of the backlog was $6.5 million, and the fair value of the contract re-competes was $4.0 million with an amortization period of 4.0 years and 8.0 years, respectively.
Additionally, the Company recognized goodwill of $16.7 million arising from the acquisition, which relates primarily to growth opportunities resulting from a broader service offering in the converging physical and digital infrastructure market, enhancing our information technology, technical solutions and logistics capabilities, and expanding our client base to customers in the U.S. intelligence community. The goodwill recognized for the SENTEL acquisition is fully deductible for income tax purposes.
SENTEL’s operating results have been included in our reported results since the date of acquisition.
NOTE 5
INCOME TAXES
Effective Tax Rate
Our quarterly income tax expense is measured using an estimated annual effective income tax rate. The comparison of effective income tax rates between periods may be significantly affected by discrete items recognized during the periods, the level and mix of earnings by tax jurisdiction and permanent differences.
For the three months ended September 27, 2019 and September 28, 2018, we recorded income tax provisions of $3.1 million and $2.8 million, respectively, representing effective income tax rates of 24.8% and 22.3%, respectively. For the nine months ended September 27, 2019 and September 28, 2018, we recorded income tax provisions of $7.1 million and $6.9 million, respectively, representing effective income tax rates of 22.7% and 21.5%, respectively. The higher effective income tax rates for the 2019 periods are the result of an increase in state taxes due to additional continental United States (CONUS) activity, the impact of foreign taxes due to additional guidance on the implementation of the Tax Act and a reduction in employment tax credits. The effective income tax rates vary from the federal statutory rate of 21.0% due to state taxes, required tax income exclusions, nondeductible expenses and available deductions not reflected in book income.
Uncertain Tax Positions
As of September 27, 2019 and December 31, 2018, unrecognized tax benefits from uncertain tax positions were $6.7 million and $1.8 million, respectively. The increase in the uncertain tax positions was principally the result of the additional Foreign Derived Intangible Income (FDII) deduction.
NOTE 6
EARNINGS PER SHARE
Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities such as stock options and restrictive stock units were exercised or converted into common stock. Diluted EPS includes the dilutive effect of stock-based compensation outstanding after application of the treasury stock method.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 27,
|
|
September 28,
|
|
September 27,
|
|
September 28,
|
(In thousands, except per share data)
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Net income
|
|
$
|
9,382
|
|
|
$
|
9,866
|
|
|
$
|
24,090
|
|
|
$
|
25,173
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
11,506
|
|
|
11,248
|
|
|
11,420
|
|
|
11,210
|
|
Add: Dilutive impact of stock options
|
|
37
|
|
|
68
|
|
|
45
|
|
|
75
|
|
Add: Dilutive impact of restricted stock units
|
|
135
|
|
|
90
|
|
|
101
|
|
|
95
|
|
Diluted weighted average common shares outstanding
|
|
11,678
|
|
|
11,406
|
|
|
11,566
|
|
|
11,380
|
|
|
|
|
|
|
|
|
|
|
Earnings per share
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.82
|
|
|
$
|
0.88
|
|
|
$
|
2.11
|
|
|
$
|
2.25
|
|
Diluted
|
|
$
|
0.80
|
|
|
$
|
0.86
|
|
|
$
|
2.08
|
|
|
$
|
2.21
|
|
The following table provides a summary of securities that could potentially dilute basic earnings per share in the future that were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 27,
|
|
September 28,
|
|
September 27,
|
|
September 28,
|
(In thousands)
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Anti-dilutive stock options
|
|
—
|
|
|
1
|
|
|
1
|
|
|
2
|
|
Anti-dilutive restricted stock units
|
|
—
|
|
|
—
|
|
|
3
|
|
|
—
|
|
Total
|
|
—
|
|
|
1
|
|
|
4
|
|
|
2
|
|
NOTE 7
RECEIVABLES
Receivables were comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
|
September 27,
|
|
December 31,
|
(In thousands)
|
|
2019
|
|
2018
|
Billed receivables
|
|
$
|
48,297
|
|
|
$
|
44,868
|
|
Unbilled receivables (contract assets)
|
|
194,729
|
|
|
181,009
|
|
Other
|
|
11,770
|
|
|
6,242
|
|
Total receivables
|
|
$
|
254,796
|
|
|
$
|
232,119
|
|
As of September 27, 2019 and December 31, 2018, all billed receivables are due from the U.S. government, either directly as prime contractor to the U.S. government or as subcontractor to another prime contractor to the U.S. government. Because our billed receivables are with the U.S. government, we do not believe the Company has a material credit risk exposure.
Unbilled receivables are contract assets that represent revenue recognized on long-term contracts in excess of amounts billed as of the balance sheet date. We estimate that approximately $3.7 million of our unbilled receivables as of September 27, 2019 may not be collected within the next 12 months. These amounts relate to the timing of the U.S.
government review of indirect rates and contract line item realignments with our customers. Changes in the balance of receivables are primarily due to the timing differences between our performance and customers' payments.
NOTE 8
DEBT
Senior Secured Credit Facilities
Term Loan and Revolver. In September 2014, we and our wholly-owned subsidiary, VSC, entered into a credit agreement with a group of lenders, including JPMorgan Chase Bank, N.A. as administrative agent. The credit agreement was subsequently amended in November 2017 by the Amendment and Restatement Agreement (the Amendment Agreement) with a group of lenders, including JPMorgan Chase Bank, N.A., as administrative agent. The Amendment Agreement provides for $200.0 million in senior secured financing, consisting of a $80.0 million five-year term loan facility (the Amended Term Loan) and a $120.0 million five-year senior secured revolving credit facility (the Amended Revolver, and together with the Amended Term Loan, the Amended Credit Facilities).
Additionally, the Amendment Agreement includes an accordion feature that allows the Company to request up to an additional $100.0 million subject to the lender's consent on the same terms and conditions as the existing Amended Term Loan. The Amendment Agreement also permits the Company to borrow up to $75.0 million in unsecured debt as long as the aggregated sum of both the unsecured debt and the accordion does not exceed $100.0 million.
The Amended Revolver is available for working capital, capital expenditures, and other general corporate purposes. Up to $25.0 million of the Amended Revolver is available for the issuance of letters of credit. There were no outstanding borrowings under the Amended Revolver at September 27, 2019. As of September 27, 2019, there were seven letters of credit outstanding in the aggregate amount of $8.1 million, which reduced our borrowing availability to $111.9 million under the Amended Revolver. The Amended Revolver will mature and the commitments thereunder will terminate on November 15, 2022.
The aggregate scheduled maturities of the Amended Term Loan are as follows:
|
|
|
|
|
|
(In thousands)
|
|
Payments due
|
2019 (excluding the nine months ended September 27, 2019)
|
|
$
|
2,500
|
|
2020
|
|
6,500
|
|
2021
|
|
8,600
|
|
2022
|
|
55,400
|
|
Total
|
|
$
|
73,000
|
|
We may voluntarily prepay the Amended Term Loan in whole or in part at any time without premium or penalty, subject to the payment of customary breakage costs under certain conditions. Amounts borrowed under the Amended Term Loan that are repaid or prepaid may not be re-borrowed.
The Amended Credit Facilities contain customary covenants, including covenants that, under certain circumstances are subject to certain qualifications and exceptions: limit or restrict our ability to incur additional indebtedness; merge, dissolve, liquidate or consolidate; make acquisitions, investments, advances or loans; dispose of or transfer assets; pay dividends; redeem or repurchase certain debt; and enter into certain restrictive agreements.
In addition, we are required to comply with (a) a maximum ratio of total consolidated indebtedness to consolidated earnings before interest, tax, depreciation and amortization (EBITDA) of 3.00 to 1.00 (3.25 to 1.00 for the 12 months following a qualified acquisition), and (b) a minimum ratio of consolidated EBITDA to consolidated interest expense (net of cash interest income) of 4.50 to 1.00. As of September 27, 2019, the Company had a ratio of total consolidated indebtedness to EBITDA of 1.04 to 1.00 and a ratio of consolidated EBITDA to consolidated interest expense of 11.02 to 1.00 and was in compliance with all covenants related to the Amended Credit Facilities.
Interest Rates and Fees. Outstanding borrowings under the Amended Credit Facilities accrue interest, at our option, at a per annum rate of (i) LIBOR plus the applicable margin, which ranges from 1.75% to 2.50% depending on the leverage ratio, or (ii) a base rate plus the applicable margin, which ranges from 0.75% to 1.50% depending on the leverage ratio. The interest rate under the Amended Credit Facilities at September 27, 2019 was 4.12%.
Carrying Value and Fair Value. As of September 27, 2019 and December 31, 2018, the fair value of the Amended Credit Facilities approximated the carrying value since the debt bears interest at a floating rate of interest. The fair value is based on observable inputs of interest rates that are currently available to us for debt with similar terms and maturities for non-public debt.
NOTE 9
DERIVATIVE INSTRUMENTS
During the periods covered by this report, we have made no changes to our policies or strategies for the use of derivative instruments and there has been no change in our related accounting methods.
Interest Rate Derivative Instruments
Our interest rate swaps are designated and qualify as effective cash flow hedges. The contracts, with expiration dates through November 2022 and notional amounts totaling $54.9 million at September 27, 2019, are recorded at fair value.
The following table summarizes the amount at fair value and location of the derivative instruments used for our interest rate hedges in the Condensed Consolidated Balance Sheets as of September 27, 2019:
|
|
|
|
|
|
|
|
(In thousands)
|
|
Fair Value
|
|
|
Balance sheet caption
|
|
Amount
|
Interest rate swap designated as cash flow hedge
|
|
Other accrued liabilities
|
|
$
|
315
|
|
Interest rate swap designated as cash flow hedge
|
|
Other non-current liabilities
|
|
$
|
995
|
|
The following table summarizes the amount at fair value and location of the derivative instruments used for our interest rate hedges in the Condensed Consolidated Balance Sheets as of December 31, 2018:
|
|
|
|
|
|
|
|
(In thousands)
|
|
Fair Value
|
|
|
Balance sheet caption
|
|
Amount
|
Interest rate swap designated as cash flow hedge
|
|
Other current assets
|
|
$
|
121
|
|
Interest rate swap designated as cash flow hedge
|
|
Other non-current assets
|
|
$
|
104
|
|
We regularly assess the creditworthiness of the counterparty. As of September 27, 2019, the counterparty to the interest rate swaps had performed in accordance with its contractual obligations. Both the counterparty credit risk and our credit risk were considered in the fair value determination.
Foreign Currency Derivative Instruments
The following table summarizes the amount at fair value and location of the derivative instruments used for our forward contract hedges in the Condensed Consolidated Balance Sheets as of September 27, 2019:
|
|
|
|
|
|
|
|
(In thousands)
|
|
Fair Value
|
|
|
Balance sheet caption
|
|
Amount
|
Foreign currency forward designated as cash flow hedge
|
|
Other accrued liabilities
|
|
$
|
423
|
|
Foreign currency forward designated as cash flow hedge
|
|
Other non-current liabilities
|
|
$
|
58
|
|
The following table summarizes the amount at fair value and location of the derivative instruments used for our forward contract hedges in the Condensed Consolidated Balance Sheets as of December 31, 2018:
|
|
|
|
|
|
|
|
(In thousands)
|
|
Fair Value
|
|
|
Balance sheet caption
|
|
Amount
|
Foreign currency forward designated as cash flow hedge
|
|
Other accrued liabilities
|
|
$
|
351
|
|
Foreign currency forward designated as cash flow hedge
|
|
Other non-current liabilities
|
|
$
|
7
|
|
At September 27, 2019, we had outstanding foreign currency forward contracts, for the exchange of U.S. dollars and Euros, with a notional amount of $9.2 million and expiration dates through December 2020.
Counterparty default risk is considered low because the forward contracts that we entered into are over-the-counter instruments transacted with highly-rated financial institutions. We were not required to, and did not, post collateral as of September 27, 2019.
The current estimated value of net losses for the above derivative instruments anticipated to be transferred from accumulated other comprehensive income into earnings over the next 12 months is $0.7 million.
NOTE 10
Leases
We determine whether an arrangement contains a lease at inception. We have operating leases for office space, apartments, vehicles, and machinery and equipment. Our operating leases have lease terms of less than one year to ten years.
We do not separate lease components from non-lease components (e.g., common area maintenance, property taxes, and insurance) but account for both components in a contract as a single lease component.
The components of lease expense are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
(In thousands)
|
|
September 27, 2019
|
|
September 27, 2019
|
Operating lease expense
|
|
$
|
3,827
|
|
|
$
|
10,890
|
|
Variable lease expense
|
|
196
|
|
|
594
|
|
Short-term lease expense
|
|
12,436
|
|
|
35,055
|
|
Total lease expense
|
|
$
|
16,459
|
|
|
$
|
46,539
|
|
Supplemental balance sheet information related to our operating leases is as follows:
|
|
|
|
|
|
|
(In thousands)
|
|
|
September 27, 2019
|
Right-of-use assets
|
|
|
$
|
18,233
|
|
|
|
|
|
Current lease liabilities (recorded in other accrued liabilities)
|
|
|
$
|
8,402
|
|
Long-term lease liabilities (recorded in other non-current liabilities)
|
|
|
10,683
|
|
Total operating lease liabilities
|
|
|
$
|
19,085
|
|
Initial ROU assets of $19.2 million were recognized as non-cash asset additions when the new lease accounting standard was adopted on January 1, 2019. Additional ROU assets from operating lease arrangements of $7.1 million were recognized as non-cash asset additions during the nine months ended September 27, 2019, and; ROU assets of $1.9 million were recognized with the Advantor acquisition.
The weighted average remaining lease term and discount rate for our operating leases at September 27, 2019 were 4.1 years and 5.9%, respectively.
Maturities of lease liabilities at September 27, 2019 were as follows:
|
|
|
|
|
|
(In thousands)
|
|
|
2019 (excluding the nine months ended September 27, 2019)
|
|
$
|
3,832
|
|
2020
|
|
6,445
|
|
2021
|
|
3,315
|
|
2022
|
|
2,589
|
|
2023
|
|
1,426
|
|
2024 and beyond
|
|
4,537
|
|
Total lease payments
|
|
22,144
|
|
Less: Imputed interest
|
|
3,059
|
|
Total
|
|
$
|
19,085
|
|
NOTE 11
GOODWILL AND INTANGIBLE ASSETS
As of September 27, 2019 and December 31, 2018, the carrying amount of goodwill was $260.9 million and $233.6 million, respectively. The increase during the first nine months of 2019 is due to the acquisition of Advantor.
Other identifiable intangible assets were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 27, 2019
|
|
December 31, 2018
|
(In thousands)
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
Amortizing intangible assets
|
|
$
|
19,900
|
|
|
$
|
4,102
|
|
|
$
|
10,500
|
|
|
$
|
1,999
|
|
Non-amortizing intangible assets
|
|
136
|
|
|
—
|
|
|
129
|
|
|
—
|
|
Balance
|
|
$
|
20,036
|
|
|
$
|
4,102
|
|
|
$
|
10,629
|
|
|
$
|
1,999
|
|
As of September 27, 2019 and December 31, 2018, the carrying amount of intangible assets was approximately $15.9 million and $8.6 million, respectively. The increase during the first nine months of 2019 was due to $8.3 million from the acquisition of Advantor and $1.1 million of amortizable intangible assets purchased during the first quarter of 2019. This increase was offset by intangible amortization expense of approximately $0.8 million and $2.1 million for the three and nine months ended September 27, 2019, respectively. Intangible amortization expense for the three and nine months ended September 28, 2018 was $0.6 million and $1.5 million, respectively.
During the third quarter ending September 27, 2019, the Company received $5.4 million from the seller of a contract acquired by the Company in the first quarter of 2019 due to the inability to have this contract novated to the Company. The Company eliminated the previously established intangible asset during the third quarter of 2019.
Amortizing intangible assets, which carry a remaining average life of approximately four years, are principally composed of customer contracts and related backlogs, re-competes and trade names.
NOTE 12
STOCK-BASED COMPENSATION
We maintain an equity incentive plan (the 2014 Omnibus Plan) to govern awards granted to Vectrus employees and directors, including nonqualified stock options (NQOs), restricted stock units (RSUs), total shareholder return (TSR) awards and other awards. We account for NQOs and stock-settled RSUs as equity-based compensation awards. TSR awards, described below, and cash-settled RSUs are accounted for as liability-based compensation awards.
Stock-based compensation expense and the associated tax benefits impacting our Condensed Consolidated Statements of Income were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
(In thousands)
|
|
September 27, 2019
|
|
September 28, 2018
|
|
September 27, 2019
|
|
September 28, 2018
|
Compensation costs for equity-based awards
|
|
$
|
1,124
|
|
|
$
|
874
|
|
|
$
|
3,339
|
|
|
$
|
2,650
|
|
Compensation costs for liability-based awards
|
|
798
|
|
|
14
|
|
|
2,613
|
|
|
760
|
|
Total compensation costs, pre-tax
|
|
$
|
1,922
|
|
|
$
|
888
|
|
|
$
|
5,952
|
|
|
$
|
3,410
|
|
Future tax benefit
|
|
$
|
416
|
|
|
$
|
192
|
|
|
$
|
1,288
|
|
|
$
|
737
|
|
Liability-based awards are revalued at the end of each reporting period to reflect changes in fair value.
As of September 27, 2019, total unrecognized compensation costs related to equity-based awards and liability-based awards were $5.6 million and $3.9 million, respectively, which are expected to be recognized ratably over a weighted average period of 1.81 years and 1.97 years, respectively.
The following table provides a summary of the activities for NQOs and RSUs for the nine months ended September 27, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NQOs
|
|
RSUs
|
(In thousands, except per share data)
|
|
Shares
|
|
Weighted Average Exercise Price Per Share
|
|
Shares
|
|
Weighted Average Grant Date Fair Value Per Share
|
Outstanding at January 1, 2019
|
|
251
|
|
|
$
|
23.00
|
|
|
257
|
|
|
$
|
28.90
|
|
Granted
|
|
—
|
|
|
—
|
|
|
205
|
|
|
$
|
30.03
|
|
Exercised
|
|
152
|
|
|
$
|
22.89
|
|
|
—
|
|
|
—
|
|
Vested
|
|
—
|
|
|
—
|
|
|
126
|
|
|
$
|
27.66
|
|
Forfeited or expired
|
|
12
|
|
|
$
|
24.47
|
|
|
21
|
|
|
$
|
29.04
|
|
Outstanding at September 27, 2019
|
|
87
|
|
|
$
|
22.98
|
|
|
315
|
|
|
$
|
30.14
|
|
During the nine months ended September 27, 2019, we granted long term incentive awards to employees consisting of 180,409 RSUs with a weighted average grant date fair value per share of $28.85 and to our directors consisting of 25,246 RSUs with a weighted average grant date fair value per share of $38.42.
For employee RSUs, one-third of the award vests on each of the three anniversary dates following the grant date. Director RSUs are granted on the date of an annual meeting of shareholders and vest on the business day immediately prior to the next annual meeting. The fair value of each RSU grant was determined based on the closing price of Vectrus common stock on the date of grant. Stock compensation expense will be recognized ratably over the vesting period of the awards.
Total Shareholder Return Awards
TSR awards are performance-based cash awards that are subject to a three-year performance period. Any payments earned are made in cash following completion of the performance period according to the achievement of specified performance goals. During the nine months ended September 27, 2019, we granted TSR awards with an aggregate target TSR value of $2.5 million. The fair value of TSR awards is measured quarterly and is based on the Company’s performance relative to the performance of the Aerospace and Defense Companies in the S&P 1500 Index. Depending on the Company’s performance during the three-year performance period, payments can range from 0% to 200% of the target value.
NOTE 13
COMMITMENTS AND CONTINGENCIES
General
From time to time, we are involved in legal proceedings that are incidental to the operation of our business. Some of these proceedings seek remedies relating to employment matters, matters in connection with our contracts and matters arising under laws relating to the protection of the environment. Additionally, U.S. government customers periodically advise the Company of claims and penalties concerning certain potential disallowed costs. When such findings are presented, Vectrus and the U.S. government representatives engage in discussions to enable Vectrus to evaluate the merits of these claims as well as to assess the amounts being claimed. Where appropriate, provisions are made to reflect probable losses related to the matters raised by the U.S. government representatives. Such assessments, along with any assessments regarding provisions for legal proceedings, are reviewed on a quarterly basis for sufficiency based on the most recent information available to us. We have estimated and accrued $12.0 million and $7.8 million as of September 27, 2019 and December 31, 2018, respectively, in "Other accrued liabilities" in the Condensed Consolidated Balance Sheets for legal proceedings and for claims with respect to our government contracts as discussed below, including open years subject to audit. Although the ultimate outcome of any legal matter or claim cannot be predicted with certainty, based on present information, including our assessment of the merits of the particular claim, we do not expect that any asserted or unasserted legal or contractual claims or proceedings, individually or in the aggregate, including the lawsuit discussed below, will have a material adverse effect on our cash flow, results of operations or financial condition.
U.S. Government Contracts, Investigations and Claims
We have U.S. government contracts that are funded incrementally on a year-to-year basis. Changes in government policies, priorities or funding levels through agency or program budget reductions by the U.S. Congress or executive agencies could have a material adverse effect on our financial condition or results of operations. Furthermore, our contracts with the U.S. government may be terminated or suspended by the U.S. government at any time, with or without cause. Such contract suspensions or terminations could result in unreimbursable expenses or charges or otherwise adversely affect our financial condition and results of operations.
Departments and agencies of the U.S. government have the authority to investigate various transactions and operations of the Company, and the results of such investigations may lead to administrative, civil or criminal proceedings, the ultimate outcome of which could be fines, penalties, repayments or compensatory or treble damages. U.S. government regulations provide that certain findings against a contractor may lead to suspension or debarment from future U.S. government contracts or the loss of export privileges for a company or an operating division or subdivision. Suspension or debarment could have a material adverse effect on the Company because of its reliance on U.S. government contracts.
U.S. government agencies, including the Defense Contract Audit Agency, the Defense Contract Management Agency and others, routinely audit and review our performance on government contracts, indirect rates and pricing practices, and compliance with applicable contracting and procurement laws, regulations and standards. Accordingly, costs billed or billable to U.S. government customers are subject to potential adjustment upon audit by such agencies. The U.S. government agencies also review the adequacy of our compliance with government standards for our business systems, including our accounting, earned value management, estimating, materials management and accounting, purchasing, and property management systems.
As a result of final indirect rate negotiations between the U.S. government and our Former Parent, we may be subject to potential adjustments to costs previously allocated by our Former Parent to our business, which was formerly Exelis’ Mission Systems Business, from 2007 through September 2014. Because we do not participate in indirect rate negotiations between the U.S. government and our Former Parent, we cannot reasonably predict the likelihood of such adjustments or the ultimate responsible party. We have recently been in discussions with our Former Parent regarding the negotiated adjustments for 2007-2014 and believe that our potential cumulative liability for these years is insignificant. In June 2019, the U.S. government provided us with the Contracting Officer's Final Decision (COFD) for the years 2007 - 2010 related to Former Parent costs. In August 2019, we filed an appeal of the COFD with the Armed Services Board of Contract Appeals (ASBCA). In October 2019, the ASBCA granted Vectrus’ and the U.S. government’s joint request to stay proceedings in the appeal through December 30, 2019 to enable ongoing discussions regarding the matter between Vectrus and our Former Parent. We believe we are fully indemnified under our Distribution Agreement with our Former Parent and have notified our Former Parent of our appeal of the U.S. government's decision in this matter.