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V2X, Inc. - Quarter Report: 2021 October (Form 10-Q)

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
☑ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 1, 2021
or
☐    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to    
Commission File Number: 001-36341        
Vectrus, Inc.
(Exact name of registrant as specified in its charter)
Indiana
 
38-3924636
(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.)
2424 Garden of the Gods Road, Colorado Springs, Colorado 80919
(Address of Principal Executive Offices) (Zip Code)
Registrant’s telephone number, including area code:
(719)591-3600
Securities Registered Under Section 12(b) of the Act:
Title of each classTrading symbol(s)Name of each exchange on which registered
Common Stock, Par Value $0.01 Per ShareVECNew York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☑   No  ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☑    No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☐
Accelerated filer
☑
Non-accelerated filer
☐
Smaller reporting company
☐Emerging growth company☐

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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ☐
No  ☑
As of November 3, 2021, there were 11,728,076 shares of common stock ($0.01 par value per share) outstanding.

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VECTRUS, INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
Page No.
Item 1.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VECTRUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months EndedNine Months Ended
October 1,October 2,October 1,October 2,
(In thousands, except per share data)2021202020212020
Revenue$459,408 $352,415 $1,364,257 $1,040,212 
Cost of revenue418,900 320,234 1,235,209 951,743 
Selling, general, and administrative expenses27,618 17,344 77,045 58,718 
Operating income12,890 14,837 52,003 29,751 
Interest expense, net(1,955)(939)(6,140)(3,988)
Income from operations before income taxes10,935 13,898 45,863 25,763 
Income tax expense677 3,507 7,623 5,593 
Net income$10,258 $10,391 $38,240 $20,170 
Earnings per share
Basic$0.87 $0.89 $3.27 $1.74 
Diluted$0.87 $0.88 $3.23 $1.72 
Weighted average common shares outstanding - basic11,726 11,621 11,696 11,590 
Weighted average common shares outstanding - diluted11,849 11,751 11,830 11,743 
The accompanying notes are an integral part of these financial statements.
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VECTRUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months EndedNine Months Ended
October 1,October 2,October 1,October 2,
(In thousands)2021202020212020
Net income$10,258 $10,391 $38,240 $20,170 
Other comprehensive income (loss), net of tax
  Changes in derivative instruments:
  Net change in fair value of interest rate swaps242 290 766 (1,035)
  Net change in fair value of foreign currency forward contracts(62)204 (557)338 
  Tax (expense) benefit(3)(202)(30)56 
  Net change in derivative instruments177 292 179 (641)
  Foreign currency translation adjustments, net of tax(3,093)2,042 (5,019)2,578 
Other comprehensive income (loss) net of tax(2,916)2,334 (4,840)1,937 
Total comprehensive income$7,342 $12,725 $33,400 $22,107 
The accompanying notes are an integral part of these financial statements.

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VECTRUS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
October 1,December 31,
(In thousands, except share information)20212020
Assets
Current assets
Cash and cash equivalents$56,232 $66,949 
Restricted cash— 1,778 
Receivables337,072 314,959 
Other current assets39,331 24,702 
Total current assets432,635 408,388 
Property, plant, and equipment, net23,560 22,573 
Goodwill316,978 339,702 
Intangible assets, net69,088 48,105 
Right-of-use assets43,111 18,718 
Other non-current assets9,379 6,325 
Total non-current assets462,116 435,423 
Total Assets$894,751 $843,811 
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable$211,585 $159,586 
Compensation and other employee benefits73,521 79,568 
Short-term debt10,400 8,600 
Other accrued liabilities46,803 40,657 
Total current liabilities342,309 288,411 
Long-term debt, net116,623 168,751 
Deferred tax liability39,966 39,386 
Other non-current liabilities54,052 42,325 
Total non-current liabilities210,641 250,462 
Total liabilities552,950 538,873 
Commitments and contingencies (Note 10)
Shareholders' Equity
Preferred stock; $0.01 par value; 10,000,000 shares authorized; No shares issued and outstanding
— — 
Common stock; $0.01 par value; 100,000,000 shares authorized; 11,726,707 and 11,624,717 shares issued and outstanding as of October 1, 2021 and December 31, 2020, respectively
117 116 
Additional paid in capital86,285 82,823 
Retained earnings260,266 222,026 
Accumulated other comprehensive loss(4,867)(27)
Total shareholders' equity341,801 304,938 
Total Liabilities and Shareholders' Equity$894,751 $843,811 

The accompanying notes are an integral part of these financial statements.
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VECTRUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended
October 1,October 2,
(In thousands)20212020
Operating activities
Net income$38,240 $20,170 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense4,788 3,001 
Amortization of intangible assets7,521 3,031 
Loss on disposal of property, plant, and equipment65 63 
Stock-based compensation6,927 6,499 
Amortization of debt issuance costs689 286 
Changes in assets and liabilities:
Receivables(22,835)3,584 
Other assets(15,743)(8,826)
Accounts payable55,653 (1,988)
Deferred taxes780 (7,575)
Compensation and other employee benefits(5,737)813 
Other liabilities(16,970)18,597 
Net cash provided by operating activities53,378 37,655 
Investing activities
Purchases of capital assets and intangibles(7,650)(3,348)
Proceeds from the disposition of assets16 — 
Business acquisition purchase price adjustment262 — 
Contribution to joint venture(2,496)— 
Net cash used in investing activities(9,868)(3,348)
Financing activities
Repayments of long-term debt(6,000)(4,500)
Proceeds from revolver352,000 151,000 
Repayments of revolver(397,000)(151,000)
Proceeds from exercise of stock options113 59 
Payment of debt issuance costs(17)— 
Payments of employee withholding taxes on share-based compensation(2,317)(1,918)
Net cash used in financing activities(53,221)(6,359)
Exchange rate effect on cash(2,784)468 
Net change in cash, cash equivalents and restricted cash(12,495)28,416 
Cash, cash equivalents and restricted cash-beginning of year 68,727 35,318 
Cash, cash equivalents and restricted cash-end of period$56,232 $63,734 
Supplemental disclosure of cash flow information:
Interest paid $4,706 $3,030 
Income taxes paid$9,068 $12,570 
Purchase of capital assets on account$480 $373 

The accompanying notes are an integral part of these financial statements.
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VECTRUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES TO SHAREHOLDERS' EQUITY (UNAUDITED)
Common Stock IssuedAdditional Paid-in CapitalAccumulated Other Comprehensive LossTotal Shareholders' Equity
(In thousands)SharesAmountRetained Earnings
Balance at December 31, 201911,524 $115 $78,757 $185,075 $(5,082)$258,865 
Net income8,668 8,668 
Foreign currency translation adjustments(1,934)(1,934)
Unrealized loss on cash flow hedge(1,290)(1,290)
Employee stock awards and stock options64 1 — 1 
Taxes withheld on restricted stock unit compensation awards(1,787)(1,787)
Stock-based compensation1,720 1,720 
Balance at April 3, 202011,588 $116 $78,690 $193,743 $(8,306)$264,243 
Net income1,111 1,111 
Foreign currency translation adjustments2,470 2,470 
Unrealized gain on cash flow hedge357 357 
Employee stock awards and stock options32 — 58 58 
Taxes withheld on restricted stock unit compensation awards(86)(86)
Stock-based compensation1,282 1,282 
Balance at July 3, 202011,620 $116 $79,944 $194,854 $(5,479)$269,435 
Net income10,391 10,391 
Foreign currency translation adjustments2,042 2,042 
Unrealized gain on cash flow hedge292 292 
Employee stock awards and stock options2 — — — 
Conversion of liability-based stock compensation awards to equity-based stock compensation awards405 405 
Taxes withheld on restricted stock unit compensation awards(44)(44)
Stock-based compensation1,284 1,284 
Balance at October 2, 202011,622 $116 $81,589 $205,245 $(3,145)$283,805 
Balance at December 31, 202011,625 $116 $82,823 $222,026 $(27)$304,938 
Net income12,048 12,048 
Foreign currency translation adjustments(2,356)(2,356)
Unrealized loss on cash flow hedge(77)(77)
Employee stock awards and stock options75 1 113 114 
Taxes withheld on stock compensation awards(2,184)(2,184)
Stock-based compensation1,983 1,983 
Balance at April 2, 202111,700 $117 $82,735 $234,074 $(2,460)$314,466 
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Net income15,934 15,934 
Foreign currency translation adjustments430 430 
Unrealized loss on cash flow hedge79 79 
Employee stock awards and stock options24 — — — 
Taxes withheld on restricted stock unit compensation awards(88)(88)
Stock-based compensation2,003 2,003 
Balance at July 2, 202111,724 $117 $84,650 $250,008 $(1,951)$332,824 
Net income10,258 10,258 
Foreign currency translation adjustments(3,093)(3,093)
Unrealized loss on cash flow hedge177 177 
Employee stock awards and stock options3 — — — 
Taxes withheld on stock compensation awards(45)(45)
Stock-based compensation1,680 1,680 
Balance at October 1, 202111,727 $117 $86,285 $260,266 $(4,867)$341,801 
The accompanying notes are an integral part of these financial statements.
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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 Government (U.S. government) worldwide. The Company operates as one segment and provides the following services and offerings: facility and base operations, supply chain and logistics services, information technology mission support, and engineering and digital integration services, including integration, security, maintenance, repair and overhaul.
Vectrus was incorporated in the State of Indiana in February 2014. On September 27, 2014, Exelis Inc. (Exelis) completed the spin-off (the Spin-off) of Vectrus and Vectrus became an independent, publicly traded company. 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., an Indiana corporation, and its consolidated subsidiaries (other than Vectrus). Exelis was acquired by Harris Corporation in May 2015.
Equity Investments
In 2011, we entered into a joint venture agreement with Shaw Environmental & Infrastructure, Inc., which is now APTIM Federal Services LLC. Pursuant to the joint venture agreement, High Desert Support Services, LLC (HDSS) was established to pursue and perform work on the Ft. Irwin Installation Support Services Contract, which was awarded to HDSS in October 2012. In 2018, we entered into a joint venture agreement with J&J Maintenance. Pursuant to the joint venture agreement, J&J Facilities Support, LLC (J&J) was established to pursue and perform work on various U.S. government contracts.
We account for our investments in HDSS and J&J under the equity method as we have the ability to exercise significant influence, but do not hold a controlling interest. We record our proportionate 40% and 50% shares, respectively, of income or losses from HDSS and J&J in selling, general and administrative expenses in the Consolidated Statements of Income. Income or losses from HDSS and J&J are insignificant. Our joint venture investment in HDSS and J&J is recorded in other non-current assets in the Consolidated Balance Sheets.
When we receive cash distributions from our equity method investments, the cash distribution is compared to cumulative earnings and cumulative cash distributions. Cash distributions received are recorded as a return on investment in operating cash flows within the Consolidated Statements of Cash Flows to the extent cumulative cash distributions are less than cumulative earnings. Any cash distributions in excess of cumulative earnings are recorded as a return of investment in investing cash flows within the Consolidated Statements of Cash Flows. During the nine months ended October 1, 2021, Vectrus made cash contributions of $2.5 million to our joint ventures. As of October 1, 2021 and December 31, 2020 our joint venture investment balance was $4.2 million and $1.4 million, respectively.
Basis of Presentation
Our quarterly financial periods end on the Friday closest to the last day of the calendar quarter (October 1, 2021 for the third quarter of 2021 and October 2, 2020 for the third quarter of 2020), 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 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 note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles (GAAP) in the U.S. 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, 2020.
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. Revenue and net income for any interim period are not necessarily indicative of future or annual results.
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Deferred Compensation Plan
During the first quarter of 2021, the Company established a non-qualified deferred compensation plan under which participants are eligible to defer a portion of their compensation on a tax deferred basis. The assets in the plan are held in a Rabbi trust. Plan investments and obligations were recorded in other non-current assets and other non-current liabilities, respectively, in the condensed consolidated balance sheets, representing the fair value related to the deferred compensation plan. Adjustments to the fair value of the plan investments and obligations are recorded in operating expenses. The plan assets and liabilities as of October 1, 2021 and operating expenses for the three and nine months ended October 1, 2021 were not material.
NOTE 2
RECENT ACCOUNTING STANDARDS UPDATE
Accounting Standards Issued but Not Yet Effective     
There were no accounting standards issued during the first nine months of 2021 that are expected to have a material impact on the Company's financial statements.
Accounting Standards That Were Adopted
In December 2019, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2019-12, Income Taxes (Topic 740) Simplifying the Accounting for Income Taxes (ASU 2019-12). The objectives of ASU 2019-12 are (i) to simplify the accounting for income taxes by removing certain exceptions, (ii) to update certain requirements to simplify the accounting for income taxes, and (iii) to make minor codification improvements for income taxes. The Company adopted the standard as of January 1, 2021 and it did not have a material impact on the Company’s financial statements.    
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 for revenue 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 and therefore is not distinct. 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 performance obligations 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. Modifications to exercise option years create new enforceable rights and obligations and therefore are treated as separate performance obligations.
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 they are performed. This continuous transfer of control requires that we track progress towards completion of performance obligations in order to measure and recognize revenue. Determining progress on performance obligations requires us to make judgments that affect the timing of revenue recognition. Remaining performance obligations represent firm orders by the customer and excludes 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 contracts can be affected by the timing of U.S. government funding authorizations and their 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. Substantially all 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.
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Remaining performance obligations as of October 1, 2021 and December 31, 2020 are presented in the following table:
October 1,December 31,
(In millions)20212020
Performance Obligations$1,560 $993 
We expect to recognize approximately 24% of the remaining performance obligations as of October 1, 2021 as revenue in 2021 and the remaining 76% during 2022.
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 catch-up adjustments for the three and nine months ended October 1, 2021 increased operating income by $2.6 million and decreased operating income by $0.4 million, respectively. For the three and nine months ended October 2, 2020, the adjustments increased operating income by less than $0.1 million and decreased operating income by $3.8 million, respectively.
For the three and nine months ended October 1, 2021, the cumulative catch-up adjustments to operating income increased revenue by $3.0 million and $1.4 million, respectively. For the three and nine months ended October 2, 2020, the cumulative catch-up adjustments to operating income decreased revenue by $1.1 million and $0.5 million, respectively.
Revenue by Category
Generally, the sales price elements for our contracts are cost-plus, cost-reimbursable or firm-fixed-price. We commonly have elements of cost-plus, cost-reimbursable and firm-fixed-price contracts on a single contract. On a cost-plus type contract, we are 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 contract. 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.
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The following tables present our revenue disaggregated by several categories. Revenue by contract type for the three and nine months ended October 1, 2021 and October 2, 2020 is as follows:
Three Months EndedNine Months Ended
October 1,October 2,%October 1,October 2,%
(In thousands)20212020Change20212020Change
Cost-plus and cost-reimbursable ¹$353,789 $249,484 41.8 %$1,018,465 $748,543 36.1 %
Firm-fixed-price105,619 102,931 2.6 %345,792 291,669 18.6 %
Total revenue$459,408 $352,415 $1,364,257 $1,040,212 
¹ Includes time and material contracts
Revenue by geographic region in which the contract is performed for the three and nine months ended October 1, 2021 and October 2, 2020 is as follows:
Three Months EndedNine Months Ended
October 1,October 2,%October 1,October 2,%
(In thousands)20212020Change20212020Change
Middle East$263,257 $223,544 17.8 %$761,758 $677,449 12.4 %
United States139,357 87,979 58.4 %435,717 250,900 73.7 %
Europe34,902 38,108 (8.4)%111,604 106,171 5.1 %
Asia21,892 2,784 686.3 %55,178 5,692 869.4 %
Total revenue$459,408 $352,415 $1,364,257 $1,040,212 

Revenue by contract relationship for the three and nine months ended October 1, 2021 and October 2, 2020 is as follows:
Three Months EndedNine Months Ended
October 1,October 2,%October 1,October 2,%
(In thousands)20212020Change20212020Change
Prime contractor$429,370 $332,564 29.1 %$1,272,671 $980,301 29.8 %
Subcontractor30,038 19,851 51.3 %91,586 59,911 52.9 %
Total revenue$459,408 $352,415 $1,364,257 $1,040,212 

Revenue by customer for the three and nine months ended October 1, 2021 and October 2, 2020 is as follows:
Three Months EndedNine Months Ended
October 1,October 2,%October 1,October 2,%
(In thousands)20212020Change20212020Change
Army$304,341 $236,267 28.8 %$869,690 $711,173 22.3 %
Air Force63,569 79,425 (20.0)%207,565 231,088 (10.2)%
Navy52,556 18,785 179.8 %165,391 48,564 240.6 %
Other38,942 17,938 117.1 %121,611 49,387 146.2 %
Total revenue$459,408 $352,415 $1,364,257 $1,040,212 
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.
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As of October 1, 2021 and December 31, 2020, we had contract assets of $249.3 million and $203.1 million, respectively. Refer to Note 5, "Receivables" for additional information regarding the composition of our receivable balances. As of both October 1, 2021 and December 31, 2020, our contract liabilities were insignificant.
NOTE 4
ACQUISITIONS
Zenetex
On December 31, 2020, we acquired Zenetex, LLC (Zenetex) a leading provider of technical and strategic solutions focused on enabling mission readiness, performance, and enhanced protection for defense and national security clients globally.
The total net consideration paid for the acquisition was approximately $117.6 million, consisting of the purchase price of $122.8 million, net of cash acquired, less $5.2 million for a working capital shortfall compared with the working capital requirement agreed upon in the stock purchase agreement. The acquisition was funded by utilizing available capacity from our Amended Revolver (as defined in Note 7, “Debt”) and cash on hand.
A breakdown of the preliminary purchase price allocation, net of cash acquired, is as follows:
(In thousands)Allocation of Purchase Price
Receivables$40,343 
Deferred taxes88 
Other current assets1,261 
Property, plant and equipment1,108 
Goodwill48,959 
Intangible assets57,100 
Right-of-use assets7,930 
Accounts payable(7,381)
Other current liabilities(11,385)
Accrued compensation(12,087)
Lease liabilities(8,275)
Other non-current liabilities(55)
Purchase price, net of cash acquired$117,606 

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 Condensed Consolidated Statement of Income for the first nine months of 2021 was not impacted by any such adjustments.
The Company recognized customer related intangible assets arising from the acquisition. The fair value was $57.1 million with an amortization period of 11.8 years. Additionally, the Company recognized goodwill of $49.0 million arising from the acquisition, which relates primarily to acquired services strengthening our position as a leading fully-integrated provider in the converged infrastructure market, as well as extending our operations and maintenance services to increase content and scope at client installations. Goodwill also includes other intangibles that do not qualify for separate recognition. The goodwill recognized for the Zenetex acquisition is fully deductible for income tax purposes.
Zenetex's results of operations have been included in our Condensed Consolidated Statements of Income for the periods subsequent to acquisition on December 31, 2020. For the three and nine months ended October 1, 2021, Zenetex recognized revenue of $57.4 million and $183.0 million, respectively. For the three and nine months ended October 1, 2021, income from operations before income taxes was $2.5 million and $7.0 million, respectively. For the three and nine months ended October 2, 2020, on a pro forma basis, the acquired business would have recognized revenue of $62.6 million and $177.5 million, respectively and an insignificant amount of income from operations before income taxes after pro forma adjustments.
HHB
On December 31, 2020, we acquired Higgins, Hermansen, Banikas, LLC (HHB). HHB is a leading provider of high-end solutions for facilities management, logistics, engineering, enterprise operations and asset management solutions for supporting Intelligence Community (IC) projects. The total net consideration paid for the acquisition was approximately $15.5 million. The acquisition was funded by utilizing available capacity from our Amended Revolver (as defined in Note 7, “Debt”) and cash on hand.
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The Company recognized customer related intangible assets arising from the acquisition. The fair value was $8.6 million with an amortization period of 7.4 years. Additionally, the Company recognized goodwill of $6.1 million arising from the acquisition, which relates primarily to growth opportunities in the IC as a converged infrastructure provider. Goodwill also includes other intangibles that do not qualify for separate recognition. The goodwill recognized for the HHB acquisition is fully deductible for income tax purposes.
The remainder of the preliminary purchase price allocation was primarily working capital.
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 Condensed Consolidated Statement of Income for the first nine months of 2021 was not impacted by any such adjustments.
NOTE 5
RECEIVABLES
Receivables were comprised of the following:
(In thousands)October 1, 2021December 31, 2020
Billed receivables$81,737 $102,045 
Unbilled receivables (contract assets)249,299 203,127 
Other 6,036 9,787 
Total receivables$337,072 $314,959 
As of October 1, 2021 and December 31, 2020, substantially 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 the Company's billed receivables are with the U.S. government, the Company does not believe it 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 expect to bill customers for the majority of the October 1, 2021 contract assets during the next twelve months. Changes in the balance of receivables are primarily due to the timing differences between our performance and customers' payments.
NOTE 6
GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying amount of goodwill for the nine months ended October 1, 2021 are as follows:
(In thousands)
Balance at December 31, 2020$339,702 
Adjustments to preliminary purchase price allocation of Zenetex(18,140)
Adjustments to preliminary purchase price allocation of HHB(4,584)
Balance at October 1, 2021$316,978 
The Company tests goodwill for impairment on the first day of the Company's fourth fiscal quarter each year, or more frequently should circumstances change or events occur that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
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Identifiable intangible assets consist of the following:
October 1, 2021December 31, 2020
(In thousands)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying Amount
Contract backlogs and recompetes$77,300 $(12,902)$64,398 $48,800 $(6,645)$42,155 
Customer contracts7,200 (3,212)3,988 7,200 (2,133)5,067 
Trade names and other1,248 (546)702 1,243 (360)883 
Balance$85,748 $(16,660)$69,088 $57,243 $(9,138)$48,105 
Identifiable intangible asset amortization expense was $2.6 million and $7.5 million for the three and nine months ended October 1, 2021, respectively. Intangible amortization for the three and nine months ended October 2, 2020 was $1.0 million and $3.0 million, respectively. As of October 1, 2021, the remaining average intangible asset amortization period was 9.7 years.
Future estimated amortization expense is as follows (in thousands):
PeriodAmortization
2021 (excluding the nine months ended October 1, 2021) $2,507 
2022$8,499 
2023$8,403 
2024$7,296 
2025$6,499 
After 2025$35,884 
NOTE 7
DEBT
Senior Secured Credit Facilities
Term Loan and Revolver. In September 2014, we and our wholly-owned subsidiary, Vectrus Systems Corporation (VSC), entered into a credit agreement. The credit agreement was subsequently amended, with the most recent amendment occurring on December 24, 2020 and is collectively referred to as the Amended Agreement. The credit agreement consists of a term loan (Amended Term Loan) and a $270.0 million revolving credit facility (Amended Revolver) as of October 1, 2021.
Additionally, the Amendment Agreement includes an accordion feature that allows the Company to draw up to an additional $100.0 million, subject to the lender's consent on the same terms and conditions as the existing commitments. 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 Term Loan amortizes in an amount equal to $2.6 million for the fiscal quarters ending December 31, 2021 through September 30, 2022, with the balance of $47.6 million due on November 15, 2022. Amounts borrowed under the Amended Term Loan that are repaid or prepaid may not be re-borrowed. Any unpaid amounts must be repaid by the maturity dates. As of October 1, 2021, the balance outstanding under the Amended Term Loan was $58.0 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. As of October 1, 2021, there were two letters of credit outstanding in the aggregate amount of $2.7 million, and $70.0 million outstanding borrowings under the Amended Revolver resulting in borrowing capacity of $197.3 million under the Amended Revolver. The outstanding borrowings under the Amended Revolver have been reduced by $45.0 million in the first nine months of 2021 from an outstanding balance of $115.0 million as of December 31, 2020. The Amended Revolver will mature and the commitments thereunder will terminate on November 15, 2022.
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The aggregate scheduled maturities of the Amended Term Loan and Amended Revolver as of October 1, 2021, are as follows:
(In thousands)Payments due
2021 (excluding the nine months ended October 1, 2021)$2,600 
2022125,400 
Total$128,000 
Voluntary Prepayments. 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.
Covenants. The Amended Credit Facilities contain customary covenants, including covenants that, under certain circumstances and 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 (3.50 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 October 1, 2021, we had a ratio of total consolidated indebtedness to EBITDA of 1.33 to 1.00 and a ratio of consolidated EBITDA to consolidated interest expense of 15.55 to 1.00. We were in compliance with all covenants related to the Amended Credit Facilities as of October 1, 2021.
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 October 1, 2021 was 2.34%.
Carrying Value and Fair Value. As of October 1, 2021 and December 31, 2020, the fair value of the Amended Credit Facilities approximated the carrying value because 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 8
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. For our derivative instruments, which are designated as cash flow hedges, gains and losses are initially reported as a component of accumulated other comprehensive loss and subsequently recognized in earnings with the corresponding hedged item.
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 $43.7 million at October 1, 2021, are recorded at fair value.
The following table summarizes the amount at fair value and location of the derivative instruments in our balance sheet for our interest rate hedges in the Condensed Consolidated Balance Sheets as of October 1, 2021:
(In thousands)Fair Value
Balance sheet captionAmount
Interest rate swap designated as cash flow hedgeOther accrued liabilities$904 
Interest rate swap designated as cash flow hedgeOther non-current liabilities$95 
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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, 2020:
(In thousands)Fair Value
Balance sheet captionAmount
Interest rate swap designated as cash flow hedgeOther accrued liabilities$1,015 
Interest rate swap designated as cash flow hedgeOther non-current liabilities$750 
We regularly assess the creditworthiness of the counterparty. As of October 1, 2021, 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.
Net interest rate derivative losses of $0.8 million and $0.7 million were recognized in interest expense, net, in our Condensed Consolidated Statements of Income during the first nine months of 2021 and 2020, respectively. We expect $0.9 million of existing interest rate swap losses reported in accumulated other comprehensive loss as of October 1, 2021 to be recognized in earnings within the next 12 months.
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 October 1, 2021:
(In thousands)Fair Value
Balance sheet captionAmount
Foreign currency forward designated as cash flow hedgeOther accrued liabilities$153 
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, 2020:
(In thousands)Fair Value
Balance sheet captionAmount
Foreign currency forward designated as cash flow hedgeOther current assets$404 
At October 1, 2021, we had outstanding foreign currency forward contracts, for the exchange of U.S. dollars and Euros, with a notional amount of $3.4 million and expiration dates through January 2022.
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 October 1, 2021.
Net foreign currency derivative gains of $0.2 million and losses of $0.2 million were recognized in selling, general and administrative expenses during the first nine months of 2021 and 2020, respectively. We expect $0.2 million of existing foreign currency forward contract losses reported in accumulated other comprehensive loss as of October 1, 2021 to be recognized in earnings within the next 12 months.
NOTE 9
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.
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The components of lease expense are as follows:
Three Months EndedNine Months Ended
(In thousands)October 1, 2021October 2, 2020October 1, 2021October 2, 2020
Operating lease expense$3,307 $1,349 $7,372 $5,621 
Variable lease expense184 191 599 546 
Short-term lease expense16,630 14,323 47,367 40,483 
Total lease expense$20,121 $15,863 $55,338 $46,650 
Supplemental balance sheet information related to our operating leases is as follows:
(In thousands)October 1, 2021December 31, 2020
Right-of-use assets$43,111 $18,718 
Current lease liabilities (recorded in other accrued liabilities)$11,280 $6,245 
Long-term lease liabilities (recorded in other non-current liabilities)34,308 13,970 
Total operating lease liabilities$45,588 $20,215 
Additional right-of-use assets of $31.4 million were recognized as non-cash asset additions that resulted from new operating lease liabilities during the first nine months of 2021.
The weighted average remaining lease term and discount rate for our operating leases at October 1, 2021 was 5.3 years and 3.7%, respectively.
Maturities of lease liabilities at October 1, 2021 were as follows:
(In thousands)Payments due
2021 (excluding the nine months ended October 1, 2021)$3,300 
202212,020 
202311,825 
20247,435 
20253,488 
After 202513,139 
Total minimum lease payments51,207 
Less: Imputed interest(5,619)
Total operating lease liabilities$45,588 

On September 30, 2021, the Company signed a forward-starting lease agreement in support of its contractual obligations under a task order issued under the Logistics Civil Augmentation Program (LOGCAP) V support services contract in support of the U.S. Military. The lease commencement date, which is anticipated in early 2022, is subject to the completion of certain documents and the receipt of related government regulatory and other third-party approvals. The lease term consists of eight one-year extension options and one additional six month option period. The annual rent obligations are $20 million per year, subject to a market adjustment beginning in the sixth year, and additional rent obligations for certain operating expenses.
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NOTE 10
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 $8.2 million and $11.7 million as of October 1, 2021 and December 31, 2020, respectively, in "Other accrued liabilities" in the Condensed Consolidated Balance Sheets for legal proceedings and for claims with respect to our U.S. government contracts as discussed below, including years where the U.S. government has not completed its incurred cost audits. 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 U.S. 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 (DCAA), the Defense Contract Management Agency (DCMA) and others, routinely audit and review our performance on U.S. 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 U.S. 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 adjustments to costs previously allocated by our Former Parent to our business, which was formerly Exelis’ Mission Systems Business, from 2007 through 2014. We are in discussions with our Former Parent and the U.S. government regarding these cost adjustments from 2007 through 2014 and believe that our potential cumulative liability for these years is insignificant. Between June 2019 and March 2021, the U.S. government provided us with three Contracting Officers Final Decisions (COFD) for the years from 2007 through 2014 related to Former Parent costs. We filed appeals of the COFDs with the Armed Services Board of Contract Appeals (ASBCA), which have been consolidated. The ASBCA has granted Vectrus’ and the U.S. government’s joint requests to stay proceedings in the appeal, most recently through November 12, 2021, to enable ongoing discussions regarding the matter between the parties. The U.S. government subsequently offered a settlement to reduce the costs to an insignificant amount to address errors and costs related to contracts novated to our Former Parent, which we are currently reviewing. 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.
COVID-19 Pandemic
On March 11, 2020, the World Health Organization designated the outbreak of COVID-19 as a global pandemic. Governments and businesses around the world have taken unprecedented actions to mitigate the spread of COVID-19, including, but not limited to, shelter-in-place orders, quarantines, significant restrictions on travel, social distancing guidelines, and restrictions on employees going to work. Uncertainty with respect to the economic impacts of the pandemic has introduced significant volatility in the financial markets. The Company has observed, and continues to experience, some
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disruptions on its operations due to government and supply chain delays related to the global pandemic. While the extent to which COVID-19 ultimately impacts the Company’s future results will depend on future developments, the pandemic and associated economic impacts, particularly with respect to newly issued vaccine mandates for government contractors and subcontractors, could result in a material impact to the Company’s future financial condition, results of operations and cash flows.
NOTE 11
STOCK-BASED COMPENSATION
The Company maintains an equity incentive plan, the 2014 Omnibus Incentive Plan, as amended and restated effective as of May 13, 2016 (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 EndedNine Months Ended
(In thousands)October 1, 2021October 2, 2020October 1, 2021October 2, 2020
Compensation costs for equity-based awards$1,680 $1,284 $5,666 $4,286 
Compensation costs for liability-based awards324 (196)1,261 2,213 
Total compensation costs, pre-tax$2,004 $1,088 $6,927 $6,499 
Future tax benefit$435 $235 $1,504 $1,404 
Liability-based awards are revalued at the end of each reporting period to reflect changes in fair value.
As of October 1, 2021, total unrecognized compensation costs related to equity-based awards and liability-based awards were $7.2 million and $2.7 million, respectively, which are expected to be recognized ratably over a weighted average period of 1.79 years and 1.71 years, respectively.
The following table provides a summary of the activities for NQOs and RSUs for the nine months ended October 1, 2021:
NQOsRSUs
(In thousands, except per share data)SharesWeighted Average Exercise Price Per ShareSharesWeighted Average Grant Date Fair Value Per Share
Outstanding at January 1, 202174 $23.37 253 $41.67 
Granted— $— 155 $56.43 
Exercised(5)$20.62 — $— 
Vested— $— (135)$57.23 
Forfeited or expired— $— (25)$50.73 
Outstanding at October 1, 202169 $23.59 248 $51.05 

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During the nine months ended October 1, 2021, we granted long term incentive awards to employees consisting of 134,442 RSUs with a weighted average grant date fair value per share of $57.15 and to our directors consisting of 21,020 RSUs with a weighted average grant date fair value per share of $51.86.
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 October 1, 2021, we granted TSR awards with an outstanding aggregate target TSR value of $2.4 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 12
INCOME TAXES
Effective Tax Rate
Income tax expense during interim periods is based on an estimated annual effective income tax rate, plus discrete items that may occur in any given interim periods. The computation of the estimated effective income tax rate at each interim period requires certain estimates and judgment including, but not limited to, forecasted operating income for the year, projections of the income earned and taxed in various jurisdictions, newly enacted tax rate and legislative changes, permanent and temporary differences, and the likelihood of recovering deferred tax assets generated in the current year.
For the three months ended October 1, 2021 and October 2, 2020, we recorded an income tax provision of $0.7 million and $3.5 million, representing effective income tax rates of 6.2% and 25.2%, respectively. For the nine months ended October 1, 2021 and October 2, 2020, we recorded income tax provisions of $7.6 million and $5.6 million, representing effective income tax rates of 16.6% and 21.7%, respectively. The reduction in our effective tax rate is due to the utilization of tax credits on previously filed tax returns. The effective income tax rates vary from the federal statutory rate of 21.0% due to state and foreign taxes, required tax income exclusions, nondeductible expenses, available deductions not reflected in book income, and income tax credits.
Uncertain Tax Provisions
As of October 1, 2021 and December 31, 2020, unrecognized tax benefits from uncertain tax positions were $9.1 million and $7.4 million, respectively. The increase in the uncertain tax positions was principally the result of the additional Foreign Derived Intangible Income (FDII) deduction as the Company reserves a portion of the FDII benefit claimed or expected to be claimed on its income tax return filings.
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NOTE 13
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 potential dilution that could occur if securities to issue common stock 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 EndedNine Months Ended
October 1,October 2,October 1,October 2,
(In thousands, except per share data)2021202020212020
Net income $10,258 $10,391 $38,240 $20,170 
Weighted average common shares outstanding11,726 11,621 11,696 11,590 
Add: Dilutive impact of stock options34 34 38 38 
Add: Dilutive impact of restricted stock units89 96 96 115 
Diluted weighted average common shares outstanding11,849 11,751 11,830 11,743 
Earnings per share
Basic$0.87 $0.89 $3.27 $1.74 
Diluted$0.87 $0.88 $3.23 $1.72 
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 EndedNine Months Ended
October 1,October 2,October 1,October 2,
(In thousands)2021202020212020
Anti-dilutive restricted stock units3 3 3 2 
NOTE 14
MULTIEMPLOYER PENSION PLANS
Certain Company employees that perform work on contracts within the continental United States participate in multiemployer pension plans of which the Company is not the sponsor. Expense recognized for these plans was $0.2 million and $0.8 million for the three and nine months ended October 1, 2021, respectively, and $1.0 million and $3.1 million for the three and nine months ended October 2, 2020, respectively. Contributions were made to one plan for the first nine months of 2021 and eight plans for the first nine months of 2020. The decrease in expense and the amount of multiemployer pension plan participation by the Company is attributable to the completion of a subcontract in September 2020. At the time the contract was completed, the individuals ceased being Vectrus employees. Those employees were hired by the successor contractor who then inherited the contractual obligation to fund the related multiemployer pension plans on the individual's behalf.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and notes thereto included in this Quarterly Report on Form 10-Q as well as the audited Consolidated Financial Statements and notes thereto and the information under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 31, 2020. This Quarterly Report provides additional information regarding the Company, our services, industry outlook and forward-looking statements that involve risks and uncertainties, including those related to the potential impact of the coronavirus pandemic (COVID-19), and any current or future government mandated COVID-19 precautions, including mandatory vaccination, and its impact on us, our operations, or our future financial or operational results. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements. Refer to "Forward-Looking Information" for further information regarding forward-looking statements. Amounts presented in and throughout this Item 2 are rounded and, as such, any rounding differences could occur in period over period changes and percentages reported.
Overview
Vectrus is a leading provider of global service solutions with a history in the services market that dates back more than 75 years. The company provides facility and base operations; supply chain and logistics services; information technology mission support; and engineering and digital technology services, including integration, security, maintenance, repair and overhaul, primarily to U.S. government customers around the world. Vectrus is differentiated by operational excellence, superior program performance, a history of long-term customer relationships and a strong commitment to its clients’ mission success.
Our primary customer is the U.S. Department of Defense (DoD), with a high concentration in the U.S. Army. For the nine months ended October 1, 2021 and October 2, 2020, we had total revenue of $1,364.3 million and $1,040.2 million, respectively, substantially all of which was derived from U.S. government customers. For the nine months ended October 1, 2021 and October 2, 2020, we generated approximately 64% and 68% of our total revenue from the U.S. Army, respectively.
Executive Summary
Our revenue increased $107.0 million, or 30.4%, for the three months ended October 1, 2021 compared to the three months ended October 2, 2020. The increase in revenue was attributable to a $45.8 million expansion on our existing contracts and $61.2 million from our acquisitions of Zenetex and HHB. Revenue from our U.S., Middle East, and Asia programs increased by $51.4 million, $39.7 million, and $19.1 million, respectively, and decreased from our Europe programs by $3.2 million.
Operating income for the three months ended October 1, 2021, was $12.9 million, a decrease of $1.9 million, or 13.1%, compared to the three months ended October 2, 2020. The increase was due to improved operating performance and the impact of the acquisitions of Zenetex and HHB.
During the performance of our contracts, we periodically review estimated final contract prices and costs and make revisions as required, which are recorded as changes in revenue and cost of revenue in the periods in which they are determined. Additionally, the fees under certain contracts may be increased or decreased in accordance with cost or performance incentive provisions which measure actual performance against established targets or other criteria. Such incentive fee awards or penalties are included in revenue when there is sufficient information to reasonably assess anticipated contract performance. Amounts representing contract change orders, claims, requests for equitable adjustment, or limitations in funding on contracts are recorded only if it is probable the claim will result in additional contract revenue and the amounts can be reliably estimated. Changes in estimated revenue, cost of revenue and the related effect to operating income are recognized using cumulative catch-up adjustments, which recognize in the current period the cumulative effect of the changes on current and prior periods based on a contract's percentage of completion. Cumulative catch-up adjustments due to aggregate changes in contract estimates increased operating income by $2.6 million and less than $0.1 million for the three months ended October 1, 2021 and October 2, 2020, respectively. Cumulative catch-up adjustments are driven by changes in contract terms, program performance, customer scope changes and changes to estimates in the reported period. These changes can increase or decrease operating income depending on the dynamics of each contract.
Further details related to our financial results for the three and nine months ended October 1, 2021, compared to the three and nine months ended October 2, 2020, are contained in the "Discussion of Financial Results" section.
Recent Developments
Information regarding certain significant contracts is discussed in "Significant Contracts" below.
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COVID-19 Impact
The COVID-19 pandemic continues to present significant business challenges in 2021. During the first nine months of 2021, we continued to experience impacts related to COVID-19, including continued increased coronavirus-related costs, global supply chain disruptions, local immigration regulations limiting the ability to deploy personnel, delays in supplier deliveries, impacts of travel restrictions, site access and quarantine restrictions, and the impacts of remote work and adjusted work schedules. In addition, President Biden announced new vaccine mandates on September 9, 2021 for government contractors and subcontractors. If these mandates are implemented, the extent of the regulatory impact is unclear and could have a material adverse impact on the Company's operations. As new variants of the virus emerge, we remain cautious as many factors remain unpredictable. We continue to take measures to protect the health and safety of our employees, including measures to facilitate the provision of vaccines to our employees in line with state and local guidelines, to work with our customers to minimize ultimate potential disruptions, and to support our community in addressing the challenges posed by this global pandemic.
The extent of the ultimate impact of the COVID-19 pandemic on our operational and financial performance, including our ability to execute our programs in the expected timeframe, will depend on future developments, including any potential subsequent waves of COVID-19 infection, the effectiveness, distribution and acceptance of COVID-19 vaccines, new government regulations for defense contractors and other related actions taken by the U.S. government, state and local government officials, and international governments to prevent disease spread, all of which remain uncertain and cannot be predicted.
For the three months ended October 1, 2021, the impact of COVID-19 was immaterial to our financial results.
In accordance with the DoD guidance issued in March 2020 designating the Defense Industrial Base as a critical infrastructure workforce, our U.S. facilities have continued to operate in support of essential products and services required to meet our commitments to the U.S. government and the U.S. military; however, facility closures or work slowdowns or supply chain disruptions have affected our financial results and projections. In addition, other countries are responding to the pandemic differently which have affected our international operations and the operations of our suppliers and customers. However, any closures to date have not significantly impacted Vectrus' business.
We continue to work with our customers, employees, suppliers and communities to address the impacts of COVID-19. We continue to assess possible implications to our business, supply chain and customers and to take actions in an effort to mitigate adverse consequences in order to support our customers' mission critical business and national security.
For additional risks to the company related to the COVID-19 pandemic, see Item 1A, Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2020.
Significant Contracts
The following table reflects contracts that accounted for more than 10% of our total revenue for the nine months ended October 1, 2021 and October 2, 2020:
% of Total Revenue
Nine Months Ended
Contract NameOctober 1, 2021October 2, 2020
Kuwait Base Operations and Security Support Services (K-BOSSS)19.9%33.3%
Logistics Civil Augmentation Program (LOGCAP) V - Iraq Task Order10.3%0.1%
Operations, Maintenance and Defense of Army Communications in Southwest Asia and Central Asia (OMDAC-SWACA)8.0%15.2%
Revenue associated with a contract will fluctuate based on increases or decreases in the work being performed on the contract, award fee payment assumptions, and other contract modifications within the term of the contract resulting in changes to the total contract value. See "Backlog" below.
The K-BOSSS contract is currently exercised through August 28, 2022 and is our largest base operations support services contract within the State of Kuwait. Components of the K-BOSSS contract were re-competed as a task order under the LOGCAP V contract vehicle and were awarded to us on April 12, 2019. The K-BOSSS contract contributed $271.4 million and $346.8 million of revenue for nine months ended October 1, 2021 and October 2, 2020, respectively.
The LOGCAP V - Iraq Task Order is currently exercised through June 21, 2022, with four additional twelve-month options and one six-month option through December 21, 2026. The task order provides services to support the Geographical Combatant Commands and Army Service Component Commands throughout the full range of military operations in the Iraq region. The LOGCAP V - Iraq Task Order contributed $141.2 million and $0.8 million of revenue for nine months ended October 1, 2021 and October 2, 2020, respectively.
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On December 29, 2020, the U.S. Army announced that Vectrus Systems Corporation (VSC), our wholly-owned subsidiary was awarded an $882.5 million cost-plus-fixed-fee contract to continue Operations, Maintenance, and Defense of Army Communications in Southwest Asia and Central Asia (OMDAC-SWACA). Work will be based in Kuwait with additional locations throughout Southeast Asia. On March 8, 2021, the U.S. government received a protest from a competitor, which was filed at the Government Accountability Office (GAO). The GAO decided the case and denied the protest on June 1, 2021. Subsequently, on July 13, 2021, the unsuccessful competitor filed a protest at the U.S. Court of Federal Claims (COFC). Performance is ongoing on the contract awarded to Vectrus as there is no "stay" of performance due to the filing of the protest. A hearing at the COFC is expected by the end of 2021. The estimated completion date of this contract is December 26, 2025. The OMDAC-SWACA contract contributed $109.2 million and $158.5 million of revenue for the nine months ended October 1, 2021 and October 2, 2020, respectively.
Backlog
Total backlog includes remaining performance obligations, consisting of both funded backlog (firm orders for which funding is contractually authorized and appropriated by the customer) and unfunded backlog (firm orders for which funding is not currently contractually obligated by the customer and unexercised contract options). Total backlog excludes potential orders under IDIQ contracts and contracts awarded to us that are being protested by competitors with the GAO or in the COFC. The value of the backlog is based on anticipated revenue levels over the anticipated life of the contract. Actual values may be greater or less than anticipated. Total backlog is converted into revenue as work is performed. The level of order activity related to programs can be affected by the timing of U.S. government funding authorizations and their project evaluation cycles. Year-over-year comparisons could, at times, be impacted by these factors, among others.
Our contracts are multi-year contracts and typically include an initial period of one year or less with annual one-year (or less) option periods for the remaining contract period. The number of option periods vary 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. The U.S. government may also extend the term of a program by issuing extensions or bridge contracts, typically for periods of one year or less.
We expect to recognize a substantial portion of our funded backlog 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. 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.
For the nine months ended October 1, 2021, total backlog was $4.9 billion as compared to $5.1 billion at December 31, 2020. The following is a summary of our backlog as of October 1, 2021 and December 31, 2020:
October 1,December 31,
(In millions)20212020
Funded backlog$1,197 $843 
Unfunded backlog3,713 4,221 
Total backlog$4,910 $5,064 
    
Funded orders (different from funded backlog) represent orders for which funding was received during the period. We received funded orders of $1,718.4 million during the nine months ended October 1, 2021, which was an increase of $130.8 million compared to the nine months ended October 2, 2020.
Economic Opportunities, Challenges and Risks
The U.S. government’s investment in services and capabilities in response to changing security challenges creates a complex and fluid business environment for Vectrus and other firms in this market segment. The pace and depth of U.S. government acquisition reform and cost savings initiatives, combined with increased industry competitiveness to win long-term positions on key programs, could add pressure to revenue levels and profit margins going forward. However, we expect the U.S. government will continue to place a high priority on national security and will continue to invest in affordable solutions for its facilities, logistics, equipment, operational technology, and communication needs, which aligns with our services and strengths. Further, the DoD budget remains the largest in the world and management believes our addressable portion of the DoD budget offers substantial opportunity for growth.
The U.S. government's fiscal year (FY) begins on October 1 and ends on September 30. On April 9, 2021, the Biden Administration introduced the initial FY 2022 discretionary budget plan. The proposal requests $753 billion in discretionary funding for national defense and includes $715 billion for the DoD. The $715 billion DoD request compares to the FY 2021 enacted amount of $704 billion. While a proposal has been introduced, risks remain to FY 2022 as the budget has not yet been passed. On September 30, 2021, the President signed a continuing resolution (CR) into law that provides continuing FY 2022 appropriations to federal agencies through the earlier of December 3, 2021, or the enactment of the applicable appropriations act. The CR funds most programs and activities at the FY2021 levels with several exceptions. Congress will have to pass a broader funding package or another short-term bill by December 3, 2021, to avoid a government shutdown.
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There are risks associated with the timing and amount of future appropriations. If annual appropriations bills are not enacted, the U.S. government may operate under a CR, restricting new contract or program starts and additional government shutdowns, which might involve all government agencies, including the DoD, could arise. Future CR’s and government shutdowns may lead to delays in procurement of services due to lack of funding, and; those delays may adversely affect our revenue, results of operations and cash flow. Finally, there remains uncertainty surrounding future discretionary defense funding levels and priorities of the Administration and Congress, which could adversely impact demand for our services.
We believe spending on operation and maintenance of defense assets, as well as civilian agency infrastructure and equipment, will continue to be a U.S. government priority. Our focus is on sustaining facilities, equipment, and IT networks, while utilizing operational technologies and converged solutions to improve efficiency and the outcomes of our clients' missions. We believe this aligns with our customers' intent to utilize existing equipment and infrastructure rather than executing new purchases. Many of the core functions we perform are mission-essential. The following are examples of a few of these core functions: (i) keeping communications networks operational; (ii) maintaining airfields; and (iii) providing emergency services. While customers may reduce the level of services required from us, we do not currently anticipate the complete elimination of these services.
The information provided above does not represent a complete list of trends and uncertainties that could impact our business in either the near or long-term and should be considered along with the risk factors identified under the caption “Risk Factors” identified in Part 1, Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2020 and the matters identified under the caption “Forward-Looking Statement Information" herein.
DISCUSSION OF FINANCIAL RESULTS
Operating Income (Expense)
Three months ended October 1, 2021, compared to three months ended October 2, 2020
Selected financial highlights are presented in the following table:
Three Months EndedChange
(In thousands, except for percentages)October 1, 2021October 2, 2020$%
Revenue $459,408 $352,415 $106,993 30.4 %
Cost of revenue 418,900 320,234 98,666 30.8 %
% of revenue 91.2 %90.9 %
Selling, general, and administrative expenses27,618 17,344 10,274 59.2 %
% of revenue 6.0 %4.9 %
Operating income 12,890 14,837 (1,947)(13.1)%
Operating margin 2.8 %4.2 %
Interest expense, net(1,955)(939)1,016 108.2 %
Income from operations before income taxes10,935 13,898 (2,963)(21.3)%
% of revenue2.4 %3.9 %
Income tax expense677 3,507 (2,830)(80.7)%
Effective income tax rate 6.2 %25.2 %
Net Income $10,258 $10,391 $(133)(1.3)%
Revenue
Revenue for the three months ended October 1, 2021 was $459.4 million, an increase of $107.0 million, or 30.4%, as compared to the three months ended October 2, 2020. The increase in revenue was attributable to a $45.8 million expansion on our existing contracts and $61.2 million from our acquisitions of Zenetex and HHB. Revenue from our U.S., Middle East, and Asia programs increased by $51.4 million, $39.7 million, and $19.1 million, respectively, and decreased from our Europe programs by $3.2 million.
Cost of Revenue
Cost of revenue as a percentage of revenue was 91.2% compared to 90.9% for the three months ended October 1, 2021 and October 2, 2020, respectively. The increase in cost of revenue of $98.7 million, or 30.8%, for the three months ended October 1, 2021, as compared to the three months ended October 2, 2020, was primarily due to the volume fluctuations described for revenue.
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Selling, General, & Administrative (SG&A) Expenses
For the three months ended October 1, 2021, SG&A expenses of $27.6 million increased by $10.3 million, or 59.2%, as compared to October 2, 2020. The increase was due to the addition of SG&A expenses from Zenetex and HHB and an increase in M&A, integration and related costs.
Operating Income
Operating income for the three months ended October 1, 2021 decreased by $1.9 million, or 13.1%, as compared to the three months ended October 2, 2020. The decrease was due primarily to the fluctuations described for SG&A.
Operating income as a percentage of revenue was 2.8% for the three months ended October 1, 2021, compared to 4.2% for the three months ended October 2, 2020. The decrease in operating income is a result of an increase in M&A integration and related costs.
Aggregate cumulative catch-up adjustments increased operating income by $2.6 million and less than $0.1 million for the three months ended October 1, 2021 and October 2, 2020, respectively. The aggregate cumulative catch-up adjustments for the three months ended October 1, 2021 and October 2, 2020 related to changes in contract terms, program performance, customer scope changes and changes to estimates in the reported period. Operating income is also impacted by labor mix and the cost differential between internal resources and subcontractors as well as the volume of Other Direct Cost (ODCs) purchases.
Nine months ended October 1, 2021, compared to nine months ended October 2, 2020
Selected financial highlights are presented in the following table:
Nine Months EndedChange
(In thousands, except for percentages)October 1, 2021October 2, 2020$%
Revenue $1,364,257 $1,040,212 $324,045 31.2 %
Cost of revenue 1,235,209 951,743 283,466 29.8 %
% of revenue 90.5 %91.5 %
Selling, general, and administrative expenses77,045 58,718 18,327 31.2 %
% of revenue 5.6 %5.6 %
Operating income 52,003 29,751 22,252 74.8 %
Operating margin 3.8 %2.9 %
Interest expense, net(6,140)(3,988)(2,152)54.0 %
Income from operations before income taxes45,863 25,763 20,100 78.0 %
% of revenue3.4 %2.5 %
Income tax expense7,623 5,593 2,030 36.3 %
Effective income tax rate 16.6 %21.7 %
Net Income $38,240 $20,170 $18,070 89.6 %
Revenue
Revenue for the nine months ended October 1, 2021 was $1,364.3 million, an increase of $324.0 million, or 31.2%, as compared to the nine months ended October 2, 2020. The increase in revenue was attributable to a $129.6 million expansion on our existing contracts and $194.5 million from our acquisitions of Zenetex and HHB. Revenue from our U.S., Middle East, Asia and Europe programs increased by $184.8 million, $84.3 million, $49.5 million, and $5.4 million, respectively.
Cost of Revenue
Cost of revenue as a percentage of revenue was 90.5% compared to 91.5% for the nine months ended October 1, 2021 and October 2, 2020, respectively. The increase in cost of revenue of $283.5 million, or 29.8%, for the nine months ended October 1, 2021, as compared to the nine months ended October 2, 2020, was primarily due to the volume fluctuations described for revenue.
Selling, General, & Administrative Expenses
For the nine months ended October 1, 2021, SG&A expenses of $77.0 million increased by $18.3 million, or 31.2%, as compared to October 2, 2020. The increase was primarily due to the addition of SG&A expenses from Zenetex and HHB.
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Operating Income
Operating income for the nine months ended October 1, 2021 increased by $22.3 million, or 74.8%, as compared to the nine months ended October 2, 2020. The increase was due to improved operating performance and the impact of the acquisitions of Zenetex and HHB.
Operating income as a percentage of revenue was 3.8% for the nine months ended October 1, 2021, compared to 2.9% for the nine months ended October 2, 2020.
Aggregate cumulative catch-up adjustments decreased operating income by $0.4 million and $3.8 million for the nine months ended October 1, 2021 and October 2, 2020, respectively. The aggregate cumulative catch-up adjustments for the nine months ended October 1, 2021 and October 2, 2020 related to changes in contract terms, program performance, customer scope changes and changes to estimates in the reported period. Operating income is also impacted by labor mix and the cost differential between internal resources and subcontractors as well as the volume of Other Direct Cost (ODCs) purchases.
Interest (Expense) Income, Net
Interest (expense) income, net for the three and nine months ended October 1, 2021 and October 2, 2020 was as follows:
Three Months EndedChangeNine Months EndedChange
(In thousands, except for percentages)October 1, 2021October 2, 2020$%October 1, 2021October 2, 2020$%
Interest income$15 $27 $(12)(42.7)%$48 $109 $(61)(55.7)%
Interest expense(1,970)(966)1,004 103.9 %(6,188)(4,097)2,091 51.0 %
Interest expense, net
$(1,955)$(939)$1,016 108.1 %$(6,140)$(3,988)$2,152 54.0 %
Interest income is directly related to interest earned on our cash. Interest expense is directly related to borrowings under our senior secured credit facilities, with the amortization of debt issuance costs, and derivative instruments used to hedge a portion of our exposure to interest rate risk. The increase in interest expense, net of $2.2 million for the nine months ended October 1, 2021 compared to the nine months ended October 2, 2020 was due to the use of our revolving credit facility in 2021 for the December 31, 2020 acquisitions of Zenetex and HHB.
Income Tax Expense
We recorded income tax expense of $0.7 million and $3.5 million for the three months ended October 1, 2021 and October 2, 2020, respectively, representing effective income tax rates of 6.2% and 25.2%, respectively. For the nine months ended October 1, 2021 and October 2, 2020, we recorded income tax expense of $7.6 million and $5.6 million, respectively, representing effective income tax rates of 16.6% and 21.7%, respectively. The reduction in our effective tax rate is due to the utilization of tax credits on previously filed tax returns. The effective income tax rates vary from the federal statutory rate of 21.0% due to state and foreign taxes, required tax income exclusions, nondeductible expenses, available deductions not reflected in book income, and income tax credits.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
We have generated operating cash flows sufficient to fund our working capital, capital expenditures, and financing requirements. We expect to fund our ongoing working capital, capital expenditure and financing requirements and pursue additional growth through new business development and potential acquisition opportunities by using cash flows from operations, cash on hand, our credit facilities, and access to capital markets. When necessary, we will utilize our revolving credit facility to satisfy short-term working capital requirements.
If our cash flows from operations are less than what we expect, we may need to access the long-term or short-term capital markets. Although we believe that our current financing arrangements will permit us to finance our operations on acceptable terms and conditions, our access to and the availability of financing on acceptable terms and conditions in the future will be impacted by many factors, including: (i) our credit ratings, (ii) the liquidity of the overall capital markets, and (iii) the current state of the economy. We cannot provide assurance that such financing will be available to us on acceptable terms or that such financing will be available at all.
In September 2014, we and our wholly-owned subsidiary, VSC, entered into a credit agreement. The credit agreement was subsequently amended, with the most recent amendment occurring December 24, 2020 and is collectively referred to as the Amended Agreement. The Amended Agreement consists of a term loan (Amended Term Loan) and a $270.0 million revolving credit facility (Amended Revolver).
To date, COVID-19 has not had a significant impact on our liquidity, cash flows or capital resources. However, the continued spread of COVID-19 has also led to disruption and volatility in the global capital markets, which, depending on
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future developments, could impact our capital resources and liquidity in the future. To meet current and potential short-term working capital requirements and strengthen the Company's cash position in response to COVID-19 uncertainties, Vectrus drew $115 million from its revolving credit facility during the first quarter of 2020. This amount was repaid in full during the second quarter of 2020. Vectrus had net debt of $71.8 million as of October 1, 2021 and $112.1 million as of December 31, 2020. At October 1, 2021, there were $70.0 million of outstanding borrowings under the Amended Revolver that were used for the December 31, 2020 acquisitions of Zenetex and HHB.
The CARES Act provides a deferral of payroll tax payments from which we have benefited by deferring cash outlays of $16.8 million in 2020. This will have the effect of increasing cash outlays for payroll taxes during the first quarter of 2022 and 2023. On March 11, 2021, the President signed the American Rescue Plan Act of 2021 into law. The legislation provides additional relief to address the continued impact of COVID-19 on the economy, public health, state and local governments, individuals, and businesses. It extends Section 3610 of the CARES Act through September 2021, which gives DoD and federal agencies discretion to reimburse contractors for paid leave, including sick leave, a contractor provides during the pandemic to keep its employees in a ready state. We continue to refine the effect of the CARES Act and ongoing government guidance related to COVID-19 that may be issued and assess the potential impacts on our liquidity and capital resources.
The cash presented on our Condensed Consolidated Balance Sheets consists of U.S. and international cash from wholly owned subsidiaries. Approximately $25.5 million of our total $56.2 million in cash and cash equivalents at October 1, 2021 is held by our foreign subsidiaries and is not available to fund U.S. operations unless repatriated. We do not currently expect that we will be required to repatriate undistributed earnings of foreign subsidiaries. We expect our U.S. domestic cash resources will be sufficient to fund our U.S. operating activities and cash commitments for financing activities.
At October 1, 2021, there were two letters of credit outstanding in the aggregate amount of $2.7 million, which reduced our borrowing availability under the Amended Revolver to $197.3 million.
Dividends
We do not currently plan to pay a regular dividend on our common stock. The declaration of any future cash dividends and the amount of any such dividends, if declared, will depend upon our financial condition, earnings, capital requirements, financial covenants and other contractual restrictions and the discretion of our Board of Directors. In deciding whether to pay future dividends on our common stock, our Board of Directors may take into account such matters as general business conditions, industry practice, our financial condition and performance, our future prospects, our cash needs and capital investment plans, income tax consequences, applicable law and such other factors as our Board of Directors may deem relevant.
Sources and Uses of Liquidity
Cash, accounts receivable, unbilled receivables, and accounts payable are the principal components of our working capital and are generally driven by our level of revenue with other short-term fluctuations related to payment practices by our customers and the timing of our billings. Our receivables reflect amounts billed to our customers, as well as the revenue that was recognized in the preceding month, which is normally billed the month following each balance sheet date.
The total amount of our accounts receivable can vary significantly over time and is sensitive to revenue levels and the timing of payments received from our customers. Days sales outstanding (DSO) is a metric used to monitor accounts receivable levels. The Company determines its DSO by calculating the number of days necessary to exhaust its ending accounts receivable balance based on its most recent historical revenue. Our DSO was 67 and 66 days as of October 1, 2021 and December 31, 2020, respectively.
The following table sets forth net cash used in operating activities, investing activities and financing activities:
Nine Months Ended
(In thousands)October 1, 2021October 2, 2020
Operating activities$53,378 $37,655 
Investing activities(9,868)(3,348)
Financing activities(53,221)(6,359)
Foreign exchange1
(2,784)468 
Net change in cash, cash equivalents and restricted cash$(12,495)$28,416 
1 Impact on cash balances due to changes in foreign exchange rates.
Net cash provided by operating activities for the nine months ended October 1, 2021 consisted of cash inflows from net income of $38.2 million, the favorable impact of non-cash items of $20.0 million and a favorable net change in working capital requirements of $1.0 million. This was partially offset by cash outflows for other long-term assets and liabilities of $5.8 million.
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Net cash provided by operating activities during the nine months ended October 2, 2020 consisted of net income of $20.2 million, the favorable impact of non-cash items of $12.9 million and favorable net changes in other long-term assets and liabilities of $9.3 million, partially offset by an increase in net working capital requirements of $4.7 million. Tax deferrals related to the CARES Act contributed $9.9 million to our cash flows from operating activities.
Net cash used in investing activities for the nine months ended October 1, 2021 consisted of $7.7 million of capital expenditures for the purchase of software and hardware, and vehicles and equipment related to ongoing operations and $2.5 million for a joint venture contribution. These outflows were partially offset by inflows from a $0.3 million business acquisition purchase price adjustment. During the nine months ended October 2, 2020, $3.3 million was used for the purchase of software and hardware, and vehicles and equipment.
Net cash used in financing activities during the nine months ended October 1, 2021 consisted of repayments of long-term debt of $6.0 million and payments of $2.3 million for employee withholding taxes on share-based compensation. This was partially offset by $0.1 million received from the exercise of stock options. During the nine months ended October 1, 2021, we also borrowed and repaid $352.0 million and $397.0 million, respectively, on the Amended Revolver.
Net cash used in financing activities during the nine months ended October 2, 2020 consisted of repayments of long-term debt of $4.5 million and payments related to employee withholding taxes on share-based compensation in the amount of $1.9 million. During the nine months ended October 2, 2020, we borrowed and repaid $151.0 million on the Amended Revolver. The outstanding borrowings under the Amended Revolver were reduced by $45.0 million in the first nine months of 2021 from an outstanding balance of $115.0 million as of December 31, 2020.
Capital Resources
At October 1, 2021, we held cash and cash equivalents of $56.2 million, which included $25.5 million held by foreign subsidiaries, and had $197.3 million of available borrowing capacity under the Amended Revolver, which expires on November 15, 2022. We believe that our cash at October 1, 2021, as supplemented by cash flows from operations and the Amended Revolver, will be sufficient to fund our anticipated operating costs, capital expenditures, and current debt repayment obligations for at least the next 12 months.
We have a shelf registration statement with the SEC that became effective in January 2020 under which we may issue, from time to time, up to $250 million of common stock, preferred stock, depository shares, warrants, rights and debt securities. If necessary, we may seek to obtain additional term loans or issue debt or equity under the registration statement to supplement our working capital and investing requirements or to fund acquisitions. A financing transaction may not be available on terms acceptable to us, or at all, and a financing transaction may be dilutive to our current stockholders.
Contractual Obligations
During the nine months ended October 1, 2021, we paid $6.0 million in quarterly installment payments on the Amended Term Loan. See Note 9, "Leases" in the notes to our unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for additional contractual obligation information.
Off-Balance Sheet Arrangements
We have obligations relating to operating leases and letters of credit outstanding. Our Amended Revolver permits borrowings up to $270.0 million, of which $25.0 million is available for the issuance of letters of credit. At October 1, 2021, there were two letters of credit outstanding in the aggregate amount of $2.7 million, which reduced our borrowing availability under the Amended Revolver to $197.3 million.
On September 30, 2021, Vectrus Systems Corporation, a wholly owned subsidiary of Vectrus, Inc. (collectively, the “Company”) signed and delivered a guaranty of certain obligations (the “Guaranty”) in connection with a lease agreement entered into by an entity controlled by the Company in support of its contractual obligations under a task order issued under Logistics Civil Augmentation Program (LOGCAP) V support services contract in support of the U.S. Military and the INDO-PACOM Setting the Theater Task Order and associated Performance Task Order (the “Lease”). Under the terms of the Guaranty, the Company is required to guarantee the annual rent obligations under the Lease of $20 million per year for up to eight years and six months, subject to a market adjustment beginning in the sixth year, and additional rent obligations for certain operating expenses. The Guaranty is limited to the failure to pay such annual rent and additional rent amounts under the Lease due to (i) offset, suspension or termination of payments by the U.S. Government for the Company’s non-compliance or acts or omissions in connection with the lease or other contracts with the U.S. Government, or (ii) termination of payments by the U.S. Government due to the Company’s fraud, willful misconduct or material breach or similar bad acts.
The aforementioned arrangements have not had, and management does not believe it is likely that they will in the future, have a material effect on our liquidity, capital resources, operations or financial condition.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Estimates
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are revised as additional information becomes available. Management believes that the accounting estimates employed and the resulting balances are reasonable; however, actual results in these areas could differ from management's estimates under different assumptions or conditions.
We believe that the assumptions and estimates associated with revenue recognition, business combinations, goodwill and other intangible assets, and income taxes have the greatest potential impact on our financial statements. Therefore, we consider these to be our critical accounting policies and estimates. There have been no material changes in our critical accounting policies and estimates from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2020.
New Accounting Pronouncements
Refer to Part I, Item 1, Note 2 "Recent Accounting Standards Update" in the notes to our unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for information regarding accounting pronouncements and accounting standards updates.
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q and certain information incorporated herein by reference contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), and Section 27A of the Securities Act of 1933, as amended (the Securities Act), and the Private Securities Litigation Reform Act of 1995 and, as such, may involve risks and uncertainties. All statements included or incorporated by reference in this report, other than statements that are purely historical, are forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “could,” “potential,” “continue” or similar terminology. These statements are based on the beliefs and assumptions of the management of the Company based on information currently available to management. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements.
We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from the Company's historical experience and our present expectations or projections. These risks and uncertainties include, but are not limited to: the continued impact of COVID-19 on the global economy and any current or future government mandated COVID-19 precautions, including mandatory vaccination; our ability to submit proposals for and/or win all potential opportunities in our pipeline; our ability to retain and renew our existing contracts; our ability to compete with other companies in our market; security breaches and other disruptions to our information technology and operation; our mix of cost-plus, cost-reimbursable, and firm-fixed-price contracts; maintaining our reputation and relationship with the U.S. government; protests of new awards; economic, political and social conditions in the countries in which we conduct our businesses; changes in U.S. or international government defense budgets; government regulations and compliance therewith, including changes to the DoD procurement process; changes in technology; intellectual property matters; governmental investigations, reviews, audits and cost adjustments; contingencies related to actual or alleged environmental contamination, claims and concerns; delays in completion of the U.S. government's budget; our success in extending, deepening, and enhancing our technical capabilities; our success in expanding our geographic footprint or broadening our customer base; our ability to realize the full amounts reflected in our backlog; impairment of goodwill; misconduct of our employees, subcontractors, agents, prime contractors and business partners; our ability to control costs; our level of indebtedness; terms of our credit agreement; interest rate risk; subcontractor performance; economic and capital markets conditions; our ability to maintain safe work sites and equipment; our ability to retain and recruit qualified personnel; our ability to maintain good relationships with our workforce; our teaming relationships with other contractors; changes in our accounting estimates; the adequacy of our insurance coverage; volatility in our stock price; changes in our tax provisions or exposure to additional income tax liabilities; risks and uncertainties relating to the Spin-off; changes in GAAP; and other factors contained below under Part II, Item 1A, “Risk Factors,” and described in Item 1A, “Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2020 and described from time to time in our future reports filed with the SEC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our earnings, cash flows and financial position are exposed to market risks relating to fluctuations in interest rates and foreign currency exchange rates. All of the potential changes noted below are based on information available at October 1, 2021.
Interest Rate Risk
Each one percentage point change associated with the variable rate Amended Term Loan would result in a $0.1 million change in our annual cash interest expenses, net of interest rate swaps in place as of October 1, 2021 to hedge a portion of this risk
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Assuming our Amended Revolver was fully drawn to a principal amount equal to $270.0 million, each one percentage point change in interest rates would result in a $2.7 million change in our annual cash interest expense.
As of October 1, 2021, the notional value of our interest rate swap agreements totaled $43.7 million. The difference to be paid or received under the terms of the interest rate swap agreements is accrued as interest rates change and recognized as an adjustment to interest expense for the related debt in the period incurred. Changes in the variable interest rates to be paid pursuant to the terms of the interest rate swap agreements will have a corresponding effect on future cash flows. Refer to Note 8, "Derivative Instruments" in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for additional information regarding our interest rate swaps.
Foreign Currency Exchange Risk
The majority of our business is conducted in U.S. dollars. However, we are required to transact in foreign currencies for some of our contracts, resulting in some assets and liabilities denominated in foreign currencies. Therefore, our earnings may experience some volatility related to movements in foreign currency exchange rates. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings. As of October 1, 2021, the U.S. dollar notional value of our outstanding foreign currency forward contracts was approximately $3.4 million.
We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our foreign currency forward contracts. To perform the sensitivity analysis, we assess the risk of loss in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the U.S. dollar. As of October 1, 2021, a 5% appreciation in the value of the U.S. dollar would result in a net decrease in the fair value of our derivative portfolio of approximately $0.2 million.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of October 1, 2021. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of October 1, 2021, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed in reports the Company files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) accumulated and communicated to management to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
Changes in Internal Control over Financial Reporting
On December 31, 2020, we completed our acquisitions of HHB and Zenetex. We are in the process of integrating Zenetex's financial reporting processes and procedures and internal controls over financial reporting into our financial reporting processes, procedures and internal controls. In the course of integrating Zenetex's financial reporting processes and procedures with ours, we may implement changes to financial reporting processes and procedures and internal controls over financial reporting and will disclose any such changes, if material, as required by the rules of the SEC. We have integrated HHB into our financial reporting processes, procedures and internal controls. Management's assessment of the Company's effectiveness of internal control over financial reporting as of December 31, 2021 is expected to be inclusive of the acquired businesses.
We substantially completed the implementation of our new Enterprise Resource Planning (ERP) system during our fiscal quarter ended April 2, 2021. The implementation of that ERP system is expected to, among other things, improve user access security and automate a number of accounting, back office and reporting processes and activities, thereby decreasing the amount of manual processes previously required.
Except for the matters noted above, there was no change in our internal control over financial reporting that occurred during the period ended October 1, 2021, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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.
Although the ultimate outcome of any legal matter 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 claims or proceedings, individually or in the aggregate, will have a material adverse effect on our cash flow, results of operations or financial condition.
Refer to Note 10 "Commitments and Contingencies" in the notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information.
ITEM 1A. RISK FACTORS
New regulations including Executive Order 14042 concerning mandatory COVID-19 vaccination of employees of government contractors and subcontractors could have a material adverse impact on our business and results of operations.
On September 9, 2021, President Biden announced proposed new rules, including Executive Order 14042, requiring COVID-19 vaccinations for all US-based federal government contractor and subcontractor employees (subject to medical and religious exemptions), regardless of company size, with a deadline for compliance of December 8, 2021. On September 24, 2021, the SAFER Federal Workforce Task Force issued guidance, protocols, and frequently asked questions governing implementation of the Executive Order. As a result, on October 14, 2021 we announced that we will implement the COVID-19 vaccinate requirement to comply with Executive Order 14042 and the SAFER Federal Workforce Task Force, and require all U.S.-based Company employees, suppliers, and contractors to be fully vaccinated (subject to medical and religious exemptions), if and when, the requirement is applied to our individual contracts through contractual modification. Further, for our global employees based outside of the U.S., we will comply with both contractual and/or host nation requirements as it relates to the vaccine.
It is currently not possible to predict with certainty the exact impact the new regulations will have on us. As a government contractor, any requirement to mandate COVID-19 vaccination of our workforce or require our unvaccinated employees to be tested weekly (if there are enough testing kits available) could be difficult. Compliance with these new regulations could result in increased costs, employee attrition and difficulty securing future labor needs, which may have a material adverse effect on our business, revenues and results of operation. In addition, any requirement to impose mandatory vaccination obligations on our suppliers and subcontractors could impact the price and continuity of supply of materials or labor and our results of operations and financial condition could be further adversely affected. We continue to actively monitor the evolving situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees and our customers.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
None.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS
101The following materials from Vectrus, Inc.’s Quarterly Report on Form 10-Q for the quarter ended October 1, 2021, formatted in iXBRL (Inline Extensible Business Reporting Language): (i) Unaudited Condensed Consolidated Statements of Income, (ii) Unaudited Condensed Consolidated Statements of Comprehensive Income, (iii) Unaudited Condensed Consolidated Balance Sheets, (iv) Unaudited Condensed Consolidated Statements of Cash Flows, (v) Unaudited Condensed Consolidated Statements of Changes to Shareholders' Equity and (vi) Notes to Condensed Consolidated Financial Statements. #
104Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) #

* Indicates management contract or compensatory plan or arrangement.
+ Indicates this document is filed as an exhibit herewith.
# Submitted electronically with this report.

The Company’s Commission File Number for Reports on Form 10-K, Form 10-Q and Form 8-K is 001-36341.

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
VECTRUS, INC.
/s/ William B. Noon
By: William B. Noon
Corporate Vice President and Chief Accounting Officer
(Principal Accounting Officer)
Date: November 9, 2021

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