Business context and reporting period
This is Vectrus, Inc.’s unaudited Form 10-Q for the quarter ended September 28, 2018; the filing does not identify the registrant as V2X. Vectrus provides facility, logistics, information technology and network communications services, primarily to U.S. government customers. All revenue in the first nine months came from U.S. government customers; the Army accounted for approximately 74% of revenue.
Results include SENTEL, acquired January 23, 2018, from the acquisition date. The filing adopted ASC 606 on January 1, 2018 using the modified retrospective method.
Financial results and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $308.1 million | $269.6 million | $949.7 million | $819.0 million |
| Operating income | $14.0 million | $10.1 million | $35.7 million | $30.9 million |
| Operating margin | 4.5% | 3.7% | 3.8% | 3.8% |
| Net income | $9.9 million | $5.8 million | $25.2 million | $17.9 million |
| Diluted EPS | $0.86 | $0.51 | $2.21 | $1.61 |
- Q3 revenue rose 14.3%; operating income increased 38.8% and net income 70.1%. Nine-month revenue rose 16.0%, operating income 15.3%, and net income 40.4%.
- Q3 cost of revenue was 90.5% of sales versus 90.9% a year earlier. For nine months, it was 91.1% versus 90.8%. SG&A was 4.9% of Q3 revenue versus 5.3%; nine-month SG&A was 5.2% versus 5.4%.
- Effective tax rates declined to 22.3% for Q3 and 21.5% for the nine-month period, from 35.8% and 35.2%, respectively, primarily reflecting the Tax Act and one-time discretionary items.
- Operating cash flow was $8.7 million for the first nine months, down from $22.4 million. Cash used in investing was $42.9 million, including $36.9 million for SENTEL and $6.1 million of capital spending. Cash used in financing was $2.4 million. Cash declined by $37.9 million to $39.6 million.
- At quarter-end, gross term-loan debt was $76.0 million (net carrying amount $74.5 million); there were no revolver borrowings and $109.8 million of revolver capacity remained available. Cash less gross debt was approximately negative $36.4 million. The company reported covenant ratios of 1.29x debt to EBITDA and 11.40x EBITDA to interest, and compliance with its covenants.
- Current assets were $275.1 million and current liabilities $196.8 million. Receivables were $223.4 million, including $188.4 million of unbilled contract assets. Days sales outstanding rose to 66 from 54 at year-end. Of cash, $15.7 million was held by foreign subsidiaries.
Material changes versus the prior comparable period
- SENTEL contributed $27.4 million of Q3 revenue and $80.7 million for the nine months; its contribution to pretax income was described as insignificant. The acquisition added $347.6 million to backlog, while total backlog excluding that addition declined $273.1 million.
- Revenue growth also reflected higher U.S. and European program activity. For the nine months, Middle East revenue increased only $2.7 million; the U.S. Army share of revenue fell from 83% to 74%, partly as other customers and programs grew.
- Q3 operating income included a one-time $1.4 million benefit from resolving an item on a closed contract. Q3 cumulative contract estimate adjustments reduced operating income by $1.6 million, compared with a $3.7 million increase in Q3 2017. Nine-month adjustments increased operating income by $4.9 million, versus $8.6 million in the prior-year period.
- ASC 606 increased reported nine-month revenue by $6.0 million compared with the former revenue guidance, but reduced operating income by $2.8 million. Adoption resulted in a $0.1 million unfavorable opening retained-earnings adjustment. The new treatment for fixed-price contracts may increase period-to-period revenue variability.
- Operating cash flow fell despite higher earnings, principally because of working-capital outflows, including receivables timing. DSO and unbilled receivables increased.
Outlook, management commentary, risks and unusual items
- Management said cash, operating cash flows and revolver availability should fund anticipated operations, capital expenditures and debt payments for at least the next 12 months. The filing provides no quantified earnings or revenue guidance.
- Remaining performance obligations were $774 million, up $55 million from year-end; management expected approximately 39% to be recognized in 2018 and 61% in 2019. Total funded and unfunded backlog was $3.0 billion. Backlog includes options and unfunded orders and is not guaranteed revenue.
- K-BOSSS, the largest contract, accounted for 40.4% of nine-month revenue. The government had exercised the period through December 28, 2018 and sent a letter of intent for a three-month extension through March 28, 2019; exercise remained at government discretion. The contract is to be recompeted under LOGCAP V, with the award announcement anticipated in April 2019. Losing the recompete could adversely affect future Army bidding opportunities.
- OMDAC-SWACA accounted for 14.2% of nine-month revenue. A $106 million contract modification extended work through November 30, 2018; discussions to extend into 2019 were ongoing.
- Management cited government budget and funding changes, contract cancellations and recompetes, acquisition integration, audits and cost adjustments, competition, cost control, staffing, cybersecurity, and the ability to realize backlog as risks. The government may terminate or suspend contracts, and options are not assured.
- The company had accrued $8.5 million for legal proceedings and government-contract claims. A Kuwait employment class action settlement of up to $3.75 million plus payroll taxes received court approval on October 16, 2018, after quarter-end. Potential adjustments relating to historical indirect costs allocated by the former parent could not be reasonably estimated.
- Tax accounting under the Tax Act remained provisional; the company expected to complete its analysis by December 31, 2018. Approximately $15 million of future operating lease payments were not then on the balance sheet; lease accounting changes were expected to increase assets and liabilities upon adoption.
Important facts for investors to verify
- Confirm the issuer identity: this filing is for Vectrus, Inc., notwithstanding the V2X request metadata.
- Track K-BOSSS and OMDAC-SWACA extension, recompete and award outcomes, and the impact of any transition or lost work.
- Assess cash conversion, receivables collection, DSO and unbilled contract asset growth against reported earnings.
- Separate organic performance from SENTEL’s contribution and evaluate integration costs, acquired contract profitability and final purchase accounting.
- Consider the Q3 one-time $1.4 million benefit, contract estimate adjustments and ASC 606 effects when assessing recurring margins and year-over-year comparability.
- Monitor government audit and contract claims, the approved class-action settlement, provisional tax accounting, and covenant headroom.