V2X, Inc. quarterly report, Q3 FY2016

Business context and reporting period

This is Vectrus, Inc.’s unaudited Form 10-Q for the quarter ended September 30, 2016, with comparisons to the quarter ended September 25, 2015, and nine-month comparisons to the corresponding 2015 periods. The request metadata names V2X, Inc.; the filing itself identifies the registrant as Vectrus, Inc.

Vectrus provides services primarily to the U.S. government, including facility and logistics services and IT and network communications. All revenue in the first nine months of 2016 came from U.S. government customers; the U.S. Army accounted for 84.5%.

Financial results and liquidity

• Cash was $53.4 million at September 30, 2016, including $8.5 million held by foreign subsidiaries. Current assets were $231.2 million and current liabilities $176.3 million.
• Total debt was $93.5 million, comprising $14.0 million short-term and $77.8 million long-term net of issuance costs on the balance sheet. No revolver borrowings were outstanding; $62.7 million of revolver capacity remained available.
• Debt maturities are in September 2019. The company reported compliance with covenants, leverage of 1.76x and interest coverage of 8.30x. Its stated interest rate was 3.28%, and the debt is floating-rate.
• For the first nine months, the company repaid $20.5 million of term debt, including $10.0 million in voluntary prepayments. Cash increased by $13.4 million.

Material changes versus prior comparable periods

• Q3 revenue declined 5.1%, while nine-month revenue rose 3.8%. Q3 decreases in Afghanistan and U.S./European programs outweighed Middle East growth; year-to-date Middle East growth was partly offset by declines elsewhere.
• Operating income increased 31.8% in Q3 and 19.5% year to date, with margin improvement in both periods. Net income nevertheless fell 52.9% in Q3 and 23.1% year to date, largely reflecting the comparison with 2015 tax benefits.
• The effective tax rate was 32.7% in Q3 2016 versus a tax benefit rate of (103.7)% in Q3 2015; year-to-date rates were 35.6% and (4.0)%. Management said the 2016 rate was not expected to represent a future trend.
• Nine-month operating cash flow improved from $10.0 million to $33.5 million, primarily due to favorable working-capital timing. Days sales outstanding fell to 55 from 68 at year-end 2015; management cautioned it did not expect 55 days to persist.
• Total backlog fell $304.8 million to $2.1 billion from December 31, 2015. Funded backlog increased to $768 million from $685 million, while unfunded backlog declined to $1.339 billion from $1.727 billion.

Outlook, risks and unusual items

• No specific revenue or earnings guidance is provided. Management expected cash, operating cash flows and available revolver capacity to fund anticipated needs and debt repayments for at least the next 12 months.
• Vectrus was not awarded renewals of two major Kuwait contracts: APS-5 Kuwait, representing 14.8% of nine-month 2016 revenue, and K-BOSSS, representing 35.9%. The current contracts were scheduled to end February 28, 2017 and December 28, 2016, respectively, with K-BOSSS having a possible extension through March 28, 2017.
• The company protested both contract awards. After quarter-end, the Army said it would take corrective action on K-BOSSS, including revising the solicitation and making a new award decision. The APS-5 Kuwait/Qatar protest remained pending, with a GAO decision expected by December 22, 2016. Outcomes and replacement work are uncertain.
• The LOGCAP Afghanistan program ended in June 2016. Management cited possible further Afghanistan funding reductions, government budget and procurement changes, contract competition, and contract termination or non-renewal as risks.
• After quarter-end, Vectrus announced a 64-position headquarters reduction, expecting approximately $2.0 million of Q4 2016 severance expense and approximately $8.0 million of annual savings.
• Following the lost-contract announcements and a sharp share-price decline, the company performed an interim goodwill impairment test and reported no impairment as of September 30, 2016. Goodwill remained $216.9 million.
• The Thule Base Maintenance award, valued at approximately $411 million, cleared appellate challenges after the quarter; the Danish subsidiary was discussing a 2017 start with the Air Force.
• Long-term government contract estimates can create cumulative catch-up adjustments. These increased operating income by $1.2 million in Q3 and $4.2 million year to date in 2016. The company also accrued $2.8 million for open government audit years.
• Management reported no legal matters expected to have a material adverse effect and no material change to previously disclosed risk factors. Government audits, potential cost disallowances, funding changes, and suspension or debarment remain relevant risks.

Important facts for investors to verify

• Confirm the intended issuer: the supplied filing is for Vectrus, Inc., not a registrant named V2X, Inc.
• Check the final outcomes and revenue replacement for the APS-5 and K-BOSSS protests and contract expirations, given their substantial revenue concentration.
• Assess the pace of backlog conversion, especially the reduction in unfunded backlog, and monitor Afghanistan program declines and new awards.
• Review whether improved cash flow and receivable collection persist, and whether debt covenant headroom remains adequate as leverage limits tighten.
• Track the announced workforce savings against severance costs and monitor goodwill assumptions after the contract losses.