V2X, Inc. (identified in the filing as Vectrus, Inc.) — Q3 2014 Form 10-Q
Reporting period: Quarter ended September 30, 2014; financial statements are unaudited and presented in millions of dollars. Vectrus completed its spin-off from Exelis on September 27, 2014. Pre-spin-off results are combined historical results that include Exelis expense allocations and may not reflect costs or performance as a standalone company.
Business context and financial results
Vectrus provides infrastructure asset management, logistics and supply-chain, and IT and network communications services, primarily to the U.S. government. It operates in 18 countries and reports one segment. For the first nine months of 2014, approximately 87% of revenue came from the U.S. Army; four largest contracts represented approximately 67% of revenue.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $301 | $349 | $918 | $1,185 |
| Operating income | $3 | $29 | $30 | $106 |
| Operating margin | 1.0% | 8.3% | 3.3% | 8.9% |
| Net income | $2 | $19 | $19 | $68 |
| Adjusted operating income | $9 | $28 | $41 | $103 |
| Operating cash flow | Not presented for quarter | Not presented for quarter | $40 | $0 |
Adjusted operating income is a non-GAAP measure; the company adds back separation costs and removes operating income associated with the TARS business retained by Exelis. Separation costs were $7 million in Q3 and $13 million for the nine-month period.
Liquidity, debt, and other financial metrics
- At September 30, 2014, cash was $42 million, current assets were $248 million, current liabilities were $194 million, and total assets and liabilities were $485 million and $417 million, respectively.
- Total debt was $140 million: $11 million current and $129 million long-term. Vectrus had an additional $75 million available under its revolving facility, with no letters of credit outstanding at September 26.
- The five-year term loan was issued in September to fund a $136 million distribution to an Exelis subsidiary. The disclosed interest rate at September 30 was 2.99%, floating-rate exposure applies, and the company reported compliance with its financial covenants.
- Operating cash flow of $40 million less $2 million of capital expenditures resulted in $38 million before financing and foreign-exchange effects. Cash increased $32 million from year-end 2013.
- Receivables were $188 million, including $151 million unbilled; the company expected to bill and collect substantially all of the unbilled balance within 12 months. Days sales outstanding fell to 58 days from 67 at December 31, 2013.
- Total backlog was $2.193 billion at September 30, down from $2.869 billion at December 31, 2013. Funded backlog was $922 million and unfunded backlog $1.271 billion.
Material changes and management commentary
- Q3 revenue fell 13.8%; nine-month revenue fell 22.5%. Management attributed the declines mainly to reduced activity in Afghanistan and the Middle East as U.S. forces withdrew, facilities closed, and service levels and maintenance requirements declined.
- Operating income declined 89.7% in Q3 and 71.7% for the nine-month period. Lower revenue reduced fixed-cost leverage; Q3 SG&A also included higher separation costs. Operating margin contracted materially.
- The 2013 comparison included positive cumulative contract estimate adjustments of approximately $5 million for Q3 and $39 million for nine months; corresponding 2014 adjustments were de minimis.
- The company does not plan to pay a regular dividend. Management said cash, operating cash flow, and the revolver should cover anticipated operating costs, capital expenditures, and current debt repayments for at least 12 months.
Outlook, risks, contingencies, and unusual items
- No formal financial guidance was provided. Management expected Afghanistan-related funding and revenue to keep declining as U.S. forces draw down, while citing possible opportunities in the U.S. and Middle East and North Africa and potential expansion to other government customers.
- Two contracts were awarded during the quarter: a five-year, $517 million U.S. Army Corps of Engineers IT-support contract, subject to an incumbent’s protest and a stay; and a seven-year, $458 million U.S. Air Force support contract in Turkey and Spain, with transition beginning in January 2015. A further $411 million Thule Air Base contract award was announced October 31, after quarter-end.
- Key risks include dependence on U.S. government and Army spending, contract funding and termination discretion, Afghanistan drawdown, award protests, competitive and procurement pressures, government audits and potential cost adjustments, and the company’s ability to operate independently after the spin-off.
- Government audits were underway covering control environment, accounting, billing, indirect and direct costs, and Cost Accounting Standards compliance. The filing does not quantify a clear expected loss for potential audit adjustments.
- Environmental accruals were approximately $4 million, while the disclosed estimated loss range at September 30 was $3 million to $30 million across 28 active sites. The filing states that environmental liabilities existing at the spin-off date were retained by Exelis under the Distribution Agreement.
- Unrecognized tax benefits were $11 million; management did not expect uncertain tax positions to change significantly within 12 months. Management reported disclosure controls effective and no material change in internal control during the quarter.
Important facts for investors to verify
- How revenue, margins, and contract economics evolve as Afghanistan and Middle East activity declines, and whether new awards offset the reductions.
- Status and financial impact of the $517 million contract protest, and whether announced awards proceed to full performance and funding.
- Standalone corporate costs after separation, including the sustainability of reported SG&A and adjusted operating income.
- Debt repayment, floating-rate interest exposure, covenant headroom, and actual use of the revolving facility.
- Backlog funding, conversion to revenue, government audit outcomes, and any environmental or other contingent liabilities.