UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~September 29, 2017~~June 28, 2019

¨ 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.)

~~655 Space Center Drive,~~2424 Garden of the Gods Road, Colorado Springs, Colorado ~~80915~~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 class	Trading symbol(s)	Name of each exchange on which registered
Common Stock, Par Value $0.01 Per Share	VEC	New 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 þ No ¨

Indicate by check mark whether the registrant has submitted electronically ~~and posted on its corporate Web site, if any,~~ every Interactive Data File required to be submitted ~~and posted~~ 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 ~~and post~~ such files). Yes þ 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 þ	Non-accelerated filer ¨	~~(Do not check if a smaller reporting company)~~
Smaller reporting company ¨	Emerging growth company ¨

Table of Contents

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 is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨

No þ

As of ~~November~~August 2, ~~2017,~~2019, there were ~~11,114,546~~11,506,228 shares of common stock ($0.01 par value per share) outstanding.

Table of Contents

VECTRUS, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS



		Page No.
	PART I. FINANCIAL INFORMATION	31
Item 1.	Financial Statements	31
	Condensed Consolidated Statements of Income	31
	Condensed Consolidated Statements of Comprehensive Income	42
	Condensed Consolidated Balance Sheets	53
	Condensed Consolidated Statements of Cash Flows	64
	Condensed Consolidated Statements of Changes to Shareholders' Equity	5
	Note 1. Description of Business and Summary of Significant Accounting Policies	76
	Note 2. Recent Accounting Pronouncements	97
	Note 3. Revenue	7
	Note 4. SENTEL Acquisition	10
	Note 5. Income Taxes	11
	Note 6. Earnings Per Share	11
	Note 7. Receivables	12
	Note ~~4. Earnings Per Share~~8. Debt	12
	Note ~~5. Receivables~~9. Derivative Instruments	13
	Note ~~6. Debt~~	13
	~~Note 7. Derivative Instruments~~10. Leases	14
	Note ~~8. Composition of Certain Financial Statement Captions~~11. Goodwill and Intangible Assets	15
	Note ~~9. Work Force Reduction~~12. Stock-based Compensation	15
	Note 13. Commitments and ~~Executive Separations~~Contingencies	16
	Note ~~10. Post Employment Benefit Plans~~14. Subsequent Events	17
	~~Note 11. Stock-based Compensation~~	17
	~~Note 12. Commitments and Contingencies~~	19
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	2017
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	2925
Item 4.	Controls and Procedures	2926
	PART II. OTHER INFORMATION	2926
Item 1.	Legal Proceedings	2926
Item 1A.	Risk Factors	2926
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	2926
Item 3.	Defaults upon Senior Securities	2926
Item 4.	Mine Safety Disclosures	3026
Item 5.	Other Information	3026
Item 6.	Exhibits	3027
	Signatures	3027

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VECTRUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)


	Three Months Ended						Nine Months Ended						Three Months Ended						Six Months Ended
	September 29,			September 30,			September 29,			September 30,			June 28,			June 29,			June 28,			June 29,
(In thousands, except per share data)	2017			2016			2017			2016			2019			2018			2019			2018
Revenue	$	269,625		$	283,782		$	819,005		$	902,359		$	331,589		$	321,132		$	657,517		$	641,649
Cost of revenue	245,219			257,687			743,502			822,042			300,553			292,064			596,149			586,114
Selling, general and administrative expenses	14,316			14,933			44,560			46,046			19,843			16,070			39,762			33,865
Operating income	10,090			11,162			30,943			34,271			11,193			12,998			21,606			21,670
Interest (expense) income, net	(1,058		)	(1,348		)	(3,262		)	(4,396		)
Interest expense, net													(1,329		)	(1,140		)	(2,904		)	(2,305		)
Income from operations before income taxes	9,032			9,814			27,681			29,875			9,864			11,858			18,702			19,365
Income tax expense	3,232			3,207			9,751			10,629			2,247			2,663			3,994			4,058
Net income	$	5,800		$	6,607		$	17,930		$	19,246		$	7,617		$	9,195		$	14,708		$	15,307

Earnings per share
Basic	$	0.52		$	0.62		$	1.63		$	1.80		$	0.66		$	0.82		$	1.29		$	1.37
Diluted	$	0.51		$	0.60		$	1.61		$	1.76		$	0.66		$	0.81		$	1.28		$	1.35
Weighted average common shares outstanding - basic	11,075			10,733			10,991			10,688			11,455			11,235			11,376			11,191
Weighted average common shares outstanding - diluted	11,272			11,061			11,168			10,966			11,605			11,383			11,512			11,351

The accompanying notes are an integral part of these financial statements.

Table of Contents

VECTRUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)



	Three Months Ended						Six Months Ended
	June 28,			June 29,			June 28,			June 29,
(In thousands)	2019			2018			2019			2018
Net income	$	7,617		$	9,195		$	14,708		$	15,307
Other comprehensive income, net of tax
Changes in derivative instruments:
Net change in fair value of interest rate swap	(994		)	360			(1,375		)	881
Net change in fair value of foreign currency forward contracts	183			(156		)	85			(161		)
Net gain (loss) reclassified to interest expense	31			—			51			(1		)
Tax benefit (expense)	169			(77		)	268			(190		)
Net change in derivative instruments	(611		)	127			(971		)	529
Foreign currency translation adjustments, net of tax	547			(1,388		)	(276		)	(900		)
Accounting Standards Update (ASU) 2018-02 reclassification of certain tax effects to Retained Earnings	—			—			(259		)	—
Other comprehensive (loss), net of tax	(64		)	(1,261		)	(1,506		)	(371		)
Total comprehensive income	$	7,553		$	7,934		$	13,202		$	14,936

The accompanying notes are an integral part of these financial statements.

Table of Contents

VECTRUS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS



	June 28,			December 31,
(In thousands, except share information)	2019			2018
Assets	(unaudited)
Current assets
Cash	$	70,329		$	66,145
Receivables	237,247			232,119
Other current assets	20,907			15,063
Total current assets	328,483			313,327
Property, plant, and equipment, net	16,253			13,419
Goodwill	233,619			233,619
Intangible assets, net	13,853			8,630
Right-of-use assets	17,987			—
Other non-current assets	4,233			3,248
Total non-current assets	285,945			258,916
Total Assets	$	614,428		$	572,243
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable	$	157,486		$	156,393
Compensation and other employee benefits	45,577			41,790
Short-term debt	5,500			4,500
Other accrued liabilities	37,217			22,303
Total current liabilities	245,780			224,986
Long-term debt, net	66,338			69,137
Deferred tax liability	52,460			55,358
Other non-current liabilities	10,174			1,462
Total non-current liabilities	128,972			125,957
Total liabilities	374,752			350,943
Commitments and contingencies (Note 13)
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; 11,506,228 and 11,266,906 shares issued and outstanding as of June 28, 2019 and December 31, 2018, respectively	115			113
Additional paid in capital	76,642			71,729
Retained earnings	167,583			152,616
Accumulated other comprehensive loss	(4,664		)	(3,158		)
Total shareholders' equity	239,676			221,300
Total Liabilities and Shareholders' Equity	$	614,428		$	572,243

The accompanying notes are an integral part of these financial statements.

Table of Contents

VECTRUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF ~~COMPREHENSIVE INCOME~~CASH FLOWS (UNAUDITED)

Three Months Ended Nine Months Ended
September 29, September 30, September 29, September 30,
(In thousands) 2017 2016 2017 2016
Net income $ 5,800
$ 6,607
$ 17,930
$ 19,246
Other comprehensive income, net of tax
Changes in derivative instrument:
Net change in fair value of interest rate swap —
264
95
(342 )
Net (loss) gain reclassified to interest expense —
(2 ) —
3
Tax benefit (expense) —
(94 ) (34 ) 121
Net change in derivative instrument —
168
61
(218 )
Foreign currency translation adjustments 893
512
2,724
360
Other comprehensive income, net of tax 893
680
2,785
142
Total comprehensive income $ 6,693
$ 7,287
$ 20,715
$ 19,388

~~The accompanying notes are an integral part of these financial statements.~~

~~Table of Contents~~

~~VECTRUS, INC.~~

~~CONDENSED CONSOLIDATED BALANCE SHEETS~~

September 29, December 31,
(In thousands, except share information) 2017 2016
Assets (unaudited)
Current assets
Cash $ 63,446
$ 47,651
Receivables 174,943
172,072
Costs incurred in excess of billings 11,751
11,002
Other current assets 8,509
13,412
Total current assets 258,649
244,137
Property, plant, and equipment, net 3,259
3,061
Goodwill 216,930
216,930
Other non-current assets 2,413
1,177
Total non-current assets 222,602
221,168
Total Assets $ 481,251
$ 465,305
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable $ 109,100
$ 118,055
Billings in excess of costs 3,070
1,421
Compensation and other employee benefits 42,770
34,917
Short-term debt 21,000
15,750
Other accrued liabilities 18,996
17,693
Total current liabilities 194,936
187,836
Long-term debt, net 52,653
67,842
Deferred tax liability 89,710
89,667
Other non-current liabilities 2,322
2,559
Total non-current liabilities 144,685
160,068
Total liabilities 339,621
347,904
Commitments and contingencies (Note 12)

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; 11,075,220 and 10,894,924 shares issued and outstanding 111
109
Additional paid in capital 67,464
63,910
Retained earnings 75,847
57,959
Accumulated other comprehensive loss (1,792 ) (4,577 )
Total shareholders' equity 141,630
117,401
Total Liabilities and Shareholders' Equity $ 481,251
$ 465,305



	Six Months Ended
	June 28,			June 29,
(In thousands)	2019			2018
Operating activities
Net income	$	14,708		$	15,307
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense	1,538			687
Amortization of intangible assets	1,277			937
Loss on disposal of property, plant, and equipment	2			51
Stock-based compensation	4,031			2,521
Amortization of debt issuance costs	201			213
Changes in assets and liabilities:
Receivables	(224		)	(8,820		)
Other assets	(7,128		)	(4,518		)
Accounts payable	2,038			693
Deferred taxes	(2,579		)	(1,274		)
Compensation and other employee benefits	3,324			(1,950		)
Other liabilities	(1,738		)	325
Net cash provided by operating activities	15,450			4,172
Investing activities
Purchases of capital assets and intangibles	(11,739		)	(764		)
Acquisition of business, net of cash acquired	—			(37,210		)
Net cash used in investing activities	(11,739		)	(37,974		)
Financing activities
Repayments of long-term debt	(2,000		)	(2,000		)
Proceeds from revolver	98,000			55,000
Repayments of revolver	(98,000		)	(55,000		)
Proceeds from exercise of stock options	3,467			1,358
Payments of employee withholding taxes on share-based compensation	(768		)	(803		)
Net cash provided by (used in) financing activities	699			(1,445		)
Exchange rate effect on cash	(226		)	(1,248		)
Net change in cash	4,184			(36,495		)
Cash-beginning of year	66,145			77,453
Cash-end of period	$	70,329		$	40,958

Supplemental disclosure of cash flow information:
Interest paid	$	2,818		$	2,119
Income taxes paid	$	4,198		$	7,891
Non-cash investing activities:
Purchase of capital assets on account	$	301		$	481

The accompanying notes are an integral part of these financial statements.

Table of Contents

VECTRUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF ~~CASH FLOWS (UNAUDITED)~~CHANGES TO SHAREHOLDERS' EQUITY

Nine Months Ended
September 29, September 30,
(In thousands) 2017 2016
Operating activities
Net income $ 17,930
$ 19,246
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense 1,141
1,453
Loss on disposal of property, plant, and equipment —
402
Stock-based compensation 3,341
3,542
Amortization of debt issuance costs 561
915
Changes in assets and liabilities:
Receivables (96 ) 47,501
Other assets 3,196
(2,954 )
Accounts payable (11,470 ) (31,593 )
Billings in excess of costs 1,649
(2,828 )
Deferred taxes (1,007 ) (7,138 )
Compensation and other employee benefits 6,817
9,252
Other liabilities 336
(4,314 )
Net cash provided by operating activities 22,398
33,484
Investing activities
Purchases of capital assets (901 ) (400 )
Proceeds from the disposition of assets —
116
Distributions from equity investment —
346
Net cash (used in) investing activities (901 ) 62
Financing activities
Repayments of long-term debt (10,500 ) (20,500 )
Proceeds from revolver 27,500
74,000
Repayments of revolver (27,500 ) (74,000 )
Proceeds from exercise of stock options 1,886
568
Payment of debt issuance costs —
(221 )
Payments of employee withholding taxes on share-based compensation (612 ) (651 )
Net cash (used in) financing activities (9,226 ) (20,804 )
Exchange rate effect on cash 3,524
614
Net change in cash 15,795
13,356
Cash-beginning of year 47,651
39,995
Cash-end of period $ 63,446
$ 53,351
Supplemental Disclosure of Cash Flow Information:
Interest paid $ 3,014
$ 4,224
Income taxes paid $ 3,801
$ 20,598
Non-cash investing activities:
Purchase of capital assets on account $ 438
$ —

~~The accompanying notes are an integral part of these financial statements.~~



	Common Stock Issued			Additional Paid-in Capital						Accumulated Other Comprehensive Loss			Total Shareholders' Equity
(In thousands)	Shares	Amount		Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders' Equity
Balance at December 31, 2017	11,121	$	111	$	67,526		$	117,415		$	(1,680	)	$	183,372
Net income							6,111						6,111
Cumulative effects of adoption of Accounting Standards Codification (ASC) Topic 606 revenue recognition guidance							(77		)				(77		)
Foreign currency translation adjustments										487			487
Unrealized gain on cash flow hedge										403			403
Employee stock awards and stock options	101	1		522									523
Stock-based compensation				867									867
Balance at March 30, 2018	11,222	$	112	$	68,915		$	123,449		$	(790	)	$	191,686
Net income							9,195						9,195
Foreign currency translation adjustments										(1,388		)	(1,388		)
Unrealized gain on cash flow hedge										127			127
Employee stock awards and stock options	26			32									32
Stock-based compensation				908									908
Balance at June 29, 2018	11,248	$	112	$	69,855		$	132,644		$	(2,051	)	$	200,560

Balance at December 31, 2018	11,267	$	113	$	71,729		$	152,616		$	(3,158	)	$	221,300
Net income							7,091						7,091
Cumulative effects of adoption of Accounting Standards Update (ASU) 2018-02 reclassification of certain tax effects from AOCI							259			(259		)	—
Foreign currency translation adjustments										(823		)	(823		)
Unrealized loss on cash flow hedge										(360		)	(360		)
Employee stock awards and stock options	85	1		(82		)							(81		)
Stock-based compensation				1,117									1,117
Balance at March 29, 2019	11,352	$	114	$	72,764		$	159,966		$	(4,600	)	$	228,244
Net income							7,617						7,617
Foreign currency translation adjustments										547			547
Unrealized loss on cash flow hedge										(611		)	(611		)
Employee stock awards and stock options	154	1		2,779									2,780
Stock-based compensation				1,099									1,099
Balance at June 28, 2019	11,506	$	115	$	76,642		$	167,583		$	(4,664	)	$	239,676

Table of Contents

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 ~~U.S.~~United States (U.S.) government worldwide. We operate inas one segment and offer facility and logistics services and information technology and network communications services.

Vectrus was incorporated in the State of Indiana on February 4, 2014. On September 27, 2014, Exelis Inc. (Exelis) completed a spin-off (the Spin-off) of Vectrus, and Vectrus became an independent, publicly traded company.

Unless the context otherwise requires, references in these notes to "Vectrus", "we," "us," "our," "the Company" and "our Company" refer to Vectrus, Inc. References in these notes to Exelis or "Former Parent" refer to Exelis Inc. and its consolidated subsidiaries (other than Vectrus). ~~Exelis was acquired by Harris Corporation in May 2015.~~

~~Principles of Consolidation and Equity Investment~~

~~Vectrus consolidates companies in which it has a controlling financial interest. All intercompany transactions and balances have been eliminated.~~

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. We account for our investment in HDSS 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% share of income or losses, which has historically been insignificant, in the Condensed Consolidated Statements of Income. Our investment in HDSS is recorded in other non-current assets in the Condensed Consolidated Balance Sheets. When we receive cash distributions from HDSS, the cash distribution is compared to cumulative earnings and any excess is recorded as a distribution from equity investment in the Condensed Consolidated Statements of Cash Flows. Any remaining cash distribution is recorded in other assets in the Condensed Consolidated Statements of Cash Flows.

Basis of Presentation

Our quarterly financial periods end on the Friday closest to the last day of the calendar quarter ~~(September 29, 2017~~(June 28, 2019 for the ~~third~~second quarter of ~~2017~~2019 and ~~September 30, 2016~~June 29, 2018 for the ~~third~~second quarter of ~~2016)~~2018), except for the last quarter of the fiscal year, which ends on December 31. For ease of presentation, the quarterly financial statements included herein are described as three months ended.

The unaudited interim Condensed Consolidated Financial Statements of Vectrus have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Accordingly, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the U.S. (GAAP) have been omitted. These unaudited interim Condensed Consolidated Financial Statements should be read in conjunction with our audited ~~consolidated~~Consolidated Financial Statements and ~~combined financial statements and~~ notes thereto included in our Annual Report on Form 10-K for the year ended December 31, ~~2016.~~2018.

It is management’s opinion that these financial statements include all normal and recurring adjustments necessary for a fair presentation of the Company’s financial position and operating results. Net sales and net earnings for any interim period are not necessarily indicative of future or annual results.

Leases

Beginning with our January 1, 2019 adoption of the new lease accounting standard, operating leases are included on our Condensed Consolidated Balance Sheets as right-of-use (“ROU”) assets, other accrued liabilities and other non-current liabilities.

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Lease ROU assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit interest rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The incremental borrowing rate as of January 1, 2019 was applied to operating leases in effect as of that date. The operating lease ROU asset also includes any prepaid lease payments and excludes lease incentives. Many of our leases include one or more options to renew or terminate the lease, solely at our discretion. Such options are factored into the lease term when it is reasonably certain that we will exercise the option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.

As allowed under ASC Topic 842, we elected the package of practical expedients permitted under the transition guidance which allowed us to carry forward the historical lease classification, assessment of whether a contract was or contained a lease and assessment of initial direct costs. In addition, we have made policy elections to apply the short-term leases practical expedient, whereby leases with a term of 12 months or less are not capitalized and recorded on our balance sheet, and the practical expedient to not separate lease components from non-lease components. The latter expedient is applied to all of our leases. We did not elect to apply the hindsight practical expedient in determining lease terms and assessing impairment of ROU assets. See Note 2, "Recent Accounting Pronouncements" and Note 10, "Leases" for further information.

Table of Contents

~~Use~~Reclassifications

Certain reclassifications have been made to the presentation of ~~Estimates~~

~~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 are revised as additional information becomes available. Estimates and assumptions are used for, but not limited to, revenue recognition, income tax contingency accruals, fair value and impairment of goodwill and valuation of assets and certain contingent liabilities. Actual results could differ from these estimates.

~~Revenue Recognition~~

As a defense contractor engaging in long-term contracts, the majority of our revenue is derived from long-term service contracts for which revenue is recognized under the percentage-of-completion method based on levels of effort or percentage of costs incurred to total costs. For levels of effort, revenue and profits are recognized based upon the ratio of actual services delivered to estimated total services to be delivered under the contract. Under the cost-to-total cost method, revenue is recognized based upon the ratio of costs incurred to estimated total costs at completion. Revenue under cost-reimbursable contracts is recorded as costs are incurred and includes estimated earned fees or profits calculated on the basis of the relationship between costs incurred and total estimated costs. Revenue and profits on time-and-material type contracts are recognized based on billable rates multiplied by direct labor hours incurred plus material and other reimbursable costs incurred. The completed-contract method is utilized when reasonable and reliable cost estimates for a project cannot be made. Amounts invoiced to customers in excess of revenue recognized are recorded as deferred revenue, until the revenue recognition criteria are satisfied, and are recorded as billings in excess of costs in the Condensed Consolidated Balance Sheets. Revenue that is earned and recognized in excess of amounts invoiced is recorded as a component of receivables.

During the performance of our long-term contracts, estimated final contract prices and costs are reviewed periodically and changes are made as required and recorded as changes in revenue and cost of revenue in the period 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 contract revenue and cost estimates and the related effect to operating income are recognized using a cumulative catch-up adjustment, which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a contract’s percentage of completion. Changes in estimated revenue and cost could result in a forward loss or an adjustment to a forward loss. Provisions for estimated losses on uncompleted long-term contracts are made in the period in which such losses are determined and are recorded as a component of cost of revenue.

~~Cumulative catch-up adjustments for the three and nine months ended September 29, 2017 and September 30, 2016 are presented in the following table:~~

Three Months Ended Nine Months Ended
September 29, September 30, September 29, September 30,
(In thousands) 2017 2016 2017 2016
Favorable adjustments $ 5,779
$ 2,374
$ 14,104
$ 9,238
Unfavorable adjustments (2,111 ) (1,202 ) (5,518 ) (5,036 )
Net favorable adjustments $ 3,668
$ 1,172
$ 8,586
$ 4,202

Our primary customer is the U.S. Department of Defense, with a high concentration in the U.S. Army. For the three and nine months ended September 29, 2017 and September 30, 2016, we had total revenue of $269.6 million and $819.0 million, respectively, and $283.8 millionand $902.4 million, respectively, all of which was derived from U.S. government customers. For the three and nine months ended September 29, 2017, we generated approximately 80% and 83%, respectively, of our total revenue from the U.S. Army. For the three and nine months ended September 30, 2016, we generated approximately 85% and 84%, respectively, of our total revenue from the U.S. Army.

~~Table of Contents~~

Beginning in 2018, our revenue recognition will be impacted by our adoption of a comprehensive new revenue recognition accounting standard. Refer to Note 2, "Recent Accounting Pronouncements" for additional information.

~~Derivative Instruments~~

~~Derivative instruments are recognized as either an asset or liability at fair value~~ in our Condensed Consolidated ~~Balance Sheets~~Statements of Cash Flows for the six months ended June 29, 2018 to conform to the current year presentation. Specifically, depreciation and amortization, which were combined and disclosed as one amount are classified as current or long-term based on the scheduled maturity of the instrument. Our derivative instruments have been formally designated and qualify as part of a cash flow hedging relationship under applicable accounting standards.

The derivative instruments are adjusted to fair value through accumulated other comprehensive income (loss). If we were to determine that a derivative was no longer highly effective as a hedge, we would discontinue the hedge accounting prospectively. Gains or losses would be immediately reclassified from accumulated other comprehensive income (loss) to earnings relating to hedged forecasted transactions that are no longer probable of occurring. Gains or losses relating to terminations of effective cash flow hedges in which the forecasted transactions would still be probable of occurring would be deferred and recognized consistent with the income or loss recognition of the underlying hedged item.

~~Refer to~~ ~~Note 7, "Derivative Instruments" for additional information regarding our derivative activities.~~

now presented separately.

NOTE 2

RECENT ACCOUNTING PRONOUNCEMENTS

Accounting Standards Issued But Not Yet Effective

In ~~May 2014,~~August 2018, the Financial Accounting Standards Board (FASB) issued ~~Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09). In addition,~~ASU 2018-15 to provide guidance on accounting for implementation costs incurred in a cloud computing arrangement (CCA) hosted by the FASB issued related revenue recognition guidance in five ASUs: principal versus agent considerations (ASU 2016-08), identifying performance obligations and licensing (ASU 2016-10), a revision of certain SEC staff observer comments (ASU 2016-11), implementation guidance (ASU 2016-12), and technical corrections and improvements (ASU 2016-20).

~~ASU 2014-09~~vendor - that is a ~~comprehensive~~service contract. Under the new ~~revenue recognition standard that supersedes nearly all revenue recognition~~ guidance, ~~under GAAP, provides enhancements to~~a customer will apply the ~~quality~~same criteria for capitalizing implementation costs of a CCA as it would for an on-premises internal-use software license. Presentation of such costs, however, will vary from those required for licensed internal-use software. ASU 2018-15 is effective January 1, 2020 and ~~consistency of how revenue~~can be adopted prospectively or retrospectively. Early adoption is ~~reported, and improves comparability in financial statements presented under GAAP and International Financial Reporting Standards.~~permitted. The ~~guidance in this~~ standard is ~~principles-based, and consequently, entities will be required~~not expected to use more judgment and make more estimates than under prior guidance. The core principle of this standard is that entities should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services.

This standard is effective for fiscal years and interim periods within those years beginning after December 15, 2017, which for us is our first quarter 2018. We will apply new revenue recognition guidance to new contracts and existing contracts with remaining performance obligations as of January 1, 2018 and recognize the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings. Upon adopting the new standard, we will provide additional disclosures in the notes to the consolidated financial statements, specifically related to disaggregated revenue, contract balances and performance obligations.

ASU 2014-09 allows for either “full retrospective” adoption (application to all periods presented) or “modified retrospective” adoption (application to the most current period presented in the financial statements, with certain additional required footnote disclosures). We will adopt the standard using the “modified retrospective method”.

~~In preparation for the adoption of the new standard, we~~ have ~~made progress against~~ a ~~detailed implementation plan we developed in the following areas:~~

Completing an accounting guidance gap analysis, consisting of a review of representative contracts to determine potential changes to our existing accounting policies and potential impacts to our consolidated financial statements;

~~Completing an inventory of our outstanding contracts;~~

~~Table of Contents~~

~~Drafting a Company-wide revenue recognition policy reflecting the requirements of the new standard and tailored to our programs;~~

~~Providing Company-wide training to affected employees, including in the areas of accounting, finance, contracts, and program operations;~~

~~Applying the five-step model of the new standard to our contracts to evaluate the quantitative and qualitative impacts the new standard will have~~material impact on our consolidated financial ~~statements,~~statements.

ASU 2016-13 was issued in June 2016 with the intent of providing financial statement users with more useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. Current treatment uses the incurred loss methodology for recognizing credit losses that delays the recognition until it is probable a loss has been incurred. The accounting ~~and operating policies, accounting systems, internal control structure and business practices; and~~

~~Initiating~~update adds a new impairment model, known as the ~~process of reviewing the additional disclosure requirements of the new standard and the potential impact~~current expected credit loss model, which is based on ~~our accounting systems and internal control structure.~~

Our revenue is derived from long-term contracts, with revenue recognized using the percentage-of-completion method for a large majority of our contracts and the completed contract method for the remainder. The completed contact method is no longer allowed under ASU 2014-09. We expect to recognize revenue on an “over time” basis for all contracts by using cost inputs to measure progress toward the completion of our performance obligations. We believe the most significant impact ofexpected losses rather than incurred losses. Under the new guidance, ~~relates to our accounting for firm-fixed-price contracts,~~an entity will recognize as an allowance its estimate of expected credit losses, which ~~accounted for 25% of our revenue for~~ the nine months ended September 29, 2017. Our firm-fixed-price contracts will continue to recognize revenue and earnings over time because of the continuous transfer of services to the customer. However, for firm-fixed-price contracts, we will be precluded from recognizing adjustments in estimated costs at completion as costs incurred in excess of billings or billings in excess of cost on the balance sheet. Adjustments in contract estimates for firm-fixed-price contractsFASB believes will result in more ~~variability~~timely recognition of such losses. The standard is not expected to ~~revenue~~have a material impact on our consolidated financial statements.

For a discussion of other accounting standards that have been issued by the FASB but are not yet effective, refer to the Accounting Standards Updates section in our Annual Report on Form 10-K for the year ended December 31, 2018. These standards are not expected to have a material impact on our results of operations or cash flows.

Accounting Standards That Were Adopted

In February 2018, the FASB issued ASU 2018-02, which allows a reclassification from ~~period~~accumulated other comprehensive income to ~~period depending on when costs are incurred. Despite this variability,~~retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (Tax Act). We adopted the provisions of ASU 2018-02 during the first quarter of 2019 and recorded a ~~firm-fixed-price contract’s cash flows~~$0.3 million decrease to accumulated other comprehensive income and ~~overall profitability at completion are~~a corresponding increase to beginning retained earnings to reflect the ~~same. The total impact of an adjustment in estimated profit recorded to date on a contract will continue to be recognized~~changes in the ~~period it is identified through cumulative catch-up adjustments. Anticipated losses on contracts will continue to be recognized in~~U.S. federal corporate income tax rate as a result of the ~~quarter in which they are identified.~~

~~In 2017, we are developing new internal controls in connection with our pending~~Tax Act. As a result of the adoption of ASU 2018-02, our policy to release income tax effects in accumulated other comprehensive income is consistent with the new revenue recognition standard. These internal controls include development of new policies based on the five-step model provided in the new revenue standard; providing Company-wide training to affected employees, including accounting, finance, contracts, and program operations; ongoing contract review requirements; gathering of information provided for disclosures; and holding regular meetings with management and the Audit Committee to review implementation plan progress. Upon adoption, we expect to implement new internal controls related to our accounting policies and procedures. We will require new internal controls to address risks associated with applying the five-step model. Additionally, we will establish monitoring controls to identify new contractual arrangements, modifications to existing contractual arrangements, and changes in our business environment that could impact our current accounting assessment. We are in the process of redesigning impacted processes, policies and controls.underlying book method.

In February 2016, the FASB issued ASU ~~No.~~ 2016-02, ~~Leases (Topic 842) (ASU 2016-02).~~with amendments issued in 2018. The objective of ASU 2016-02 is to recognize lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. ~~ASU 2016-02~~The standard requires lessees to ~~account for~~recognize most leases ~~as finance leases or operating leases. Both finance and operating leases will result~~on the Condensed Consolidated Balance Sheets but does not change the manner in which expenses are recorded in the ~~lessee recognizing a right-of-use asset and corresponding lease liability. For finance leases,~~income statement. We adopted the ~~lessee would recognize interest expense and amortization~~standard during the first quarter of 2019 using the cumulative-effect adjustment transition method, which applies the provisions of the ~~right-of use asset~~standard at the effective date without adjusting comparative periods presented.

See Note 1, "Description of Business and Summary of Significant Accounting Policies" and Note 10,"Leases" for operating leases, the lessee would recognize a straight-line lease expense. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoptionfurther information.

No other accounting standards newly issued or adopted as of ASU 2016-02 is permitted. We have begun analyzing our operating lease agreements, and management anticipates our assets and liabilities will increase proportionally after the adoption of ASU 2016-02. As of September 29, 2017, there are approximately $5.5 million in future minimum rental payments for operating leases that are not currently on our balance sheet; therefore, this standard is not expected to haveJanuary 1, 2019, had a material impact on our ~~consolidated balance sheet~~financial statements or disclosures.

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 ~~related disclosures.~~is the unit of account in ASC Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. To determine the proper revenue recognition method, consideration is given as to whether a single contract should be accounted for as more than one performance obligation. For most of our contracts, the customer contracts with us to perform an integrated set of tasks and deliverables as

~~In October 2016,~~

Table of Contents

a single service solution, whereby each service is not separately identifiable from other promises in the ~~FASB issued ASU No. 2016-16, Intra-Entity Transfers~~contract. As a result, when this integrated set of ~~Assets Other than Inventory (ASU 2016-16).~~tasks exists, the contract is accounted for as one performance obligation. The ~~objective~~vast majority of ~~ASU 2016-16~~our contracts have a single performance obligation. Unexercised contract options and indefinite delivery and indefinite quantity (IDIQ) contracts are considered to be separate contracts when the option or IDIQ task order is ~~to require companies~~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 ~~income tax effects of intercompany sales and transfers of assets other than inventory~~existing contract.

Our 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., ~~intangible~~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 exclude potential orders under IDIQ contracts, unexercised contract options and contracts awarded to us that are being protested by competitors with the U.S. Government Accountability Office (GAO) or in the U.S. Court of Federal Claims. The level of order activity related to programs can be affected by the timing of government funding authorizations and 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. The number of option periods varies by contract, and there is no guarantee that an option period will be exercised. The right to exercise an option period is at the sole discretion of the U.S. government when we are the prime contractor or of the prime contractor when we are a subcontractor. We expect to recognize a substantial portion of our performance obligations as revenue within the next 12 months. However, the U.S. government or the prime contractor may cancel any contract at any time through a termination for convenience or for cause. Most of our contracts have terms that would permit us to recover all or a portion of our incurred costs and fees for work performed in the event of a termination for convenience.

Remaining performance obligations increased by $302.3 million as of June 28, 2019 as compared to December 31, 2018. We expect to recognize approximately 47% of the remaining performance obligations as of June 28, 2019 as revenue in 2019, and the remaining 53% during 2020. Remaining performance obligations as of June 28, 2019 and December 31, 2018 are presented in the following table:



	June 28,		December 31,
(In millions)	2019		2018
Performance Obligations	$	1,160	$	858

Contract Estimates

Accounting for contracts and programs involves the use of various techniques to estimate total contract revenue and costs. For contracts, we estimate the profit on a contract as the difference between the total estimated revenue and expected costs to complete a contract and recognize that profit over the life of the contract.

Contract estimates are based on various assumptions to project the outcome of future events. These assumptions include labor productivity and availability; the complexity of the services being performed; the cost and availability of materials; the performance of subcontractors; and the availability and timing of funding from the customer.

The impact of adjustments in contract estimates on our operating income can be reflected in either revenue or cost of revenue. Cumulative adjustments for the three and six months ended June 28, 2019 and June 29, 2018 are presented in the following table:



	Three Months Ended						Six Months Ended
	June 28,			June 29,			June 28,			June 29,
(In thousands)	2019			2018			2019			2018
Favorable adjustments	$	2,660		$	6,282		$	5,162		$	10,435
Unfavorable adjustments	(783		)	(2,573		)	(4,368		)	(3,884		)
Net favorable adjustments	$	1,877		$	3,709		$	794		$	6,551

Table of Contents

For the three and six months ended June 28, 2019, the net favorable adjustments to operating income increased revenue by $0.6 million and $0.2 million, respectively, and for the three and six months ended June 29, 2018, the net favorable adjustments to operating income increased revenue by $3.3 million and $6.6 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 program. Typically, these costs do not bear fees.

On a firm-fixed-price type contract, we agree to perform the contractual statement of work for a predetermined contract price. A firm-fixed-price type contract typically offers higher profit margin potential than a cost-plus type contract, which is commensurate with the greater levels of risk we assume on a firm-fixed-price type contract. Although a firm-fixed-price type contract generally permits us to retain profits if the total actual contract costs are less than the estimated contract costs, we bear the risk that increased or unexpected costs may reduce our profit or cause us to sustain losses on the contract. Although the overall scope of work required under the contract may not change, profit may be adjusted as experience is gained and as efficiencies are realized or costs are incurred.

The following tables present our revenue disaggregated by several categories. Revenue by contract type for the three and six months ended June 28, 2019 and June 29, 2018 is as follows:



	Three Months Ended				Six Months Ended
	June 28,		June 29,		June 28,		June 29,
(In thousands)	2019		2018		2019		2018
Cost-plus and cost-reimbursable ¹	$	256,737	$	242,742	$	508,215	$	472,951
Firm-fixed-price	74,852		78,390		149,302		168,698
Total revenue	$	331,589	$	321,132	$	657,517	$	641,649

¹ Includes time and material contracts

Revenue by geographic region in which the contract is performed for the three and six months ended June 28, 2019 and June 29, 2018 is as follows:



	Three Months Ended				Six Months Ended
	June 28,		June 29,		June 28,		June 29,
(In thousands)	2019		2018		2019		2018
Middle East	$	223,588	$	219,218	$	450,004	$	439,098
United States	72,376		74,847		143,786		148,636
Europe	35,625		27,067		63,727		53,915
Total revenue	$	331,589	$	321,132	$	657,517	$	641,649

Revenue by contract relationship for the three and six months ended June 28, 2019 and June 29, 2018 is as follows:



	Three Months Ended				Six Months Ended
	June 28,		June 29,		June 28,		June 29,
(In thousands)	2019		2018		2019		2018
Prime contractor	$	312,732	$	301,088	$	619,789	$	602,116
Subcontractor	18,857		20,044		37,728		39,533
Total revenue	$	331,589	$	321,132	$	657,517	$	641,649

Table of Contents

Revenue by customer for the three and six months ended June 28, 2019 and June 29, 2018 is as follows:



	Three Months Ended				Six Months Ended
	June 28,		June 29,		June 28,		June 29,
(In thousands)	2019		2018		2019		2018
Army	$	225,867	$	238,381	$	452,559	$	476,228
Air Force	72,593		60,420		140,524		125,676
Navy	16,796		9,987		31,906		18,344
Other	16,333		12,344		32,528		21,401
Total revenue	$	331,589	$	321,132	$	657,517	$	641,649

Contract Balances

The timing of revenue recognition, billings and cash collections results in billed and unbilled accounts receivable (contract assets) ~~when~~and customer advances and deposits (contract liabilities) on the ~~transfer occurs. Prior~~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 ~~implementation~~primary contract terms. These assets and liabilities are reported on the Condensed Consolidated Balance Sheets on a contract-by-contract basis at the end of each reporting period.

As of June 28, 2019, we had contract assets of $190.8 million. Refer to Note 7, "Receivables" for additional information regarding the composition of our receivables balances. As of June 28, 2019, our contract liabilities were insignificant.

NOTE 4

SENTEL ACQUISITION

On January 23, 2018, we acquired 100% of the outstanding common stock of SENTEL Corporation (SENTEL). In accordance with ASC Topic 805, Business Combinations, we accounted for this ~~standard, companies are required to defer~~transaction using the ~~income tax effects~~acquisition method. We conducted valuations of ~~intercompany transfers of~~certain acquired assets until the asset has been sold to an outside party or otherwise recognized (e.g., depreciated, amortized, or impaired). Companies will still be required to defer the income tax effects of intercompany sales and ~~transfers of inventory~~liabilities for inclusion in ~~an exception to the income tax accounting guidance. The standard is effective in annual periods beginning after December 15, 2017, and interim periods within those periods. Early adoption is permitted~~our Condensed Consolidated Balance Sheets as of the ~~beginning~~date of acquisition. Assets that normally would not be recorded in ordinary operations (i.e., intangibles related to contractual relationships) were recorded at their estimated fair values. The excess of the purchase price over the estimated fair value of the net assets acquired was recorded as goodwill.

The total net consideration paid for the acquisition was $36.9 million, consisting of the purchase price of $36.0 million and $0.9 million in excess of the working capital requirement agreed upon in the stock purchase agreement entered into among our wholly-owned subsidiary Vectrus Systems Corporation (VSC), SENTEL, R&R Enterprises, Inc. and Russell T. Wright. The acquisition was funded by utilizing cash on hand and available capacity from our Amended Revolver (as defined in Note 8, "Debt").

A breakdown of the purchase price allocation, net of cash acquired, is as follows:



(In thousands)	Allocation of Purchase Price
Receivables	$	23,339
Property, plant and equipment	810
Goodwill	16,689
Intangible assets	10,500
Other current assets	975
Accounts payable	(10,012		)
Other current liabilities	(5,446		)
Purchase price, net of cash acquired	$	36,855

With the acquisition of SENTEL, we recognized two intangible assets related to customer contracts, the backlog and the contract re-competes arising from the acquisition. The fair value of the backlog was $6.5 million, and the fair value of the contract re-competes was $4.0 million with an ~~annual period. We are evaluating the impact~~amortization period of ~~adopting ASU 2016-16; however, the standard is not expected to have a material impact on our consolidated financial statements.~~4.0 years and 8.0 years, respectively.

Table of Contents

~~In January 2017,~~Additionally, we recognized goodwill of $16.7 million arising from the ~~FASB issued ASU 2017-01, Clarifying~~acquisition, which relates primarily to growth opportunities based on a broader service offering in the ~~Definition of a Business (ASU 2017-01).~~converging physical and digital infrastructure market, and enhancing our information technology, technical solutions and logistics capabilities, while expanding our client base to customers in the U.S. intelligence community. The ~~objective of ASU 2017-01~~goodwill recognized for the SENTEL acquisition is ~~to add guidance to assist entities in evaluating whether transactions should be accounted~~fully deductible for as acquisitions or disposals of assets or of businesses. ASU 2017-01 is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. Early adoption is permitted for interim and annual periods in which the financial statements have not been issued or made available for issuance. We are evaluating the impact of adopting ASU 2017-01; however, the standard is not expected to have a material impact on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment (ASU 2017-04). The objective of ASU 2017-04 is to simplify the subsequent measurement of goodwill by entities performing their annual goodwill impairment tests by comparing the fair value of a reporting unit, including income tax ~~effects from any tax-deductible goodwill, with its carrying amount and recognizing an impairment charge for~~purposes.

SENTEL’s operating results have been included in our reported results since the ~~amount by which the carrying amount exceeds fair value. ASU 2017-04 is effective for fiscal years beginning after December 31, 2021, and interim periods within those fiscal years. Early adoption~~date of ASU 2017-04 is permitted on goodwill impairment tests performed after January 1, 2017. ASU 2017-04 should be applied on a prospective basis. We are evaluating the impact of adopting ASU 2017-04; however, the standard is not expected to have a material impact on our consolidated financial statements.acquisition.

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (ASU 2017-12). The objective of ASU 2017-12 is to improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities, and to reduce the complexity of and simplify the application of hedge accounting by preparers. The standard is effective in annual periods beginning after December 15, 2018, and interim periods within those periods. Early adoption is permitted as of the beginning of the annual period. We are evaluating the impact of adopting ASU 2017-12; however, the standard is not expected to have a material impact on our consolidated financial statements.

~~Other new pronouncements issued but not effective until after September 29, 2017 are not expected to have a material impact on our financial position, results of operations or cash flows.~~

~~Accounting Standards That Were Adopted~~

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). The objective of ASU 2016-09 is to simplify the accounting for share-based payment transactions, including recording all excess tax benefits and tax deficiencies through income tax on the statement of earnings and eliminating the requirement that excess tax benefits be realized before they can be recognized. ASU 2016-09 also simplifies several other aspects of the accounting for employee share-based payments, including forfeitures, statutory tax withholding requirements and classification on the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. We adopted this standard in the first quarter of 2017.

~~The adoption of ASU 2016-09 did not have a material impact on our financial statements but did impact the following:~~

~~All excess tax benefits and tax deficiencies are recognized as income tax expense or benefit in the income statement prospectively.~~

The tax effects of exercised or vested awards are treated as discrete items in the reporting period in which they occur, and we recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period.

We also adopted a new accounting policy in which we account for award forfeitures as they occur. We no longer estimate the total number of awards for which the requisite service period will not be rendered.

Cash paid by us when directly withholding shares for tax-withholding purposes is classified as a financing activity and excess tax benefits are classified along with other income tax cash flows as an operating activity in the consolidated statement of cash flows.

~~Table of Contents~~

NOTE 35

INCOME TAXES

Effective Tax Rate

Our quarterly income tax expense is measured using an estimated annual effective income tax rate. The comparison of effective income tax rates between periods may be significantly affected by discrete items recognized during the periods, the level and mix of earnings by tax jurisdiction and permanent differences.

~~The Company~~For the three months ended June 28, 2019 and June 29, 2018, we recorded income tax ~~expense~~provisions of ~~$3.2~~$2.2 million and ~~$9.8~~$2.7 million, ~~for the three and nine months ended~~ ~~September 29, 2017, respectively, and $3.2 million and $10.6 million for the three and nine months ended~~ ~~September 30, 2016,~~ respectively, representing effective income tax rates of ~~35.8%~~22.8% and ~~35.2%, respectively, and 32.7% and 35.6%~~22.5%, respectively. For the six months ended June 28, 2019 and June 29, 2018, we recorded income tax provisions of $4.0 million and $4.1 million, respectively, representing effective income tax rates of 21.4% and 21.0%, respectively. The higher effective income tax rates for the 2019 periods are the result of one-time discretionary items. The effective income tax rates ~~may~~ vary from the federal statutory rate of ~~35.0%~~21.0% due to state taxes, ~~the~~required tax ~~effect of stock-based compensation,~~income exclusions, nondeductible expenses and ~~other permanent book-tax differences.~~available deductions not reflected in book income.

Uncertain Tax Provisions

As of ~~September 29, 2017~~June 28, 2019 and December 31, ~~2016,~~2018, unrecognized tax benefits from uncertain tax positions were ~~$0.4 million. Management believes the uncertain tax positions will be resolved by December 31, 2017. The settlement of uncertain tax positions will not affect our effective tax rate.~~

$2.3 million and $1.8 million, respectively.

NOTE 46

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 ~~share-based~~stock-based compensation outstanding after application of the treasury stock method.


	Three Months Ended				Nine Months Ended				Three Months Ended				Six Months Ended
	September 29,		September 30,		September 29,		September 30,		June 28,		June 29,		June 28,		June 29,
(In thousands, except per share data)	2017		2016		2017		2016		2019		2018		2019		2018
Net income	$	5,800	$	6,607	$	17,930	$	19,246	$	7,617	$	9,195	$	14,708	$	15,307

Weighted average common shares outstanding	11,075		10,733		10,991		10,688		11,455		11,235		11,376		11,191
Add: Dilutive impact of stock options	68		142		63		109		41		68		42		72
Add: Dilutive impact of restricted stock units	129		186		114		169		109		80		94		88
Diluted weighted average common shares outstanding	11,272		11,061		11,168		10,966		11,605		11,383		11,512		11,351

Earnings per share
Basic	$	0.52	$	0.62	$	1.63	$	1.80	$	0.66	$	0.82	$	1.29	$	1.37
Diluted	$	0.51	$	0.60	$	1.61	$	1.76	$	0.66	$	0.81	$	1.28	$	1.35

Table of Contents

The following table provides a summary of securities that could potentially dilute basic earnings per share in the future that were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented:


	Three Months Ended		Nine Months Ended		Three Months Ended		Six Months Ended
	September 29,	September 30,	September 29,	September 30,	June 28,	June 29,	June 28,	June 29,
(In thousands)	2017	2016	2017	2016	2019	2018	2019	2018
Anti-dilutive stock options	3	2	12	9	—	1	1	1
Anti-dilutive restricted stock units	—	—	—	—	—	—	2	—
Total	3	2	12	9	—	1	3	1

~~Table of Contents~~

NOTE 57

RECEIVABLES

Receivables were comprised of the following:


	September 29,		December 31,		June 28,		December 31,
(In thousands)	2017		2016		2019		2018
Billed receivables	$	31,750	$	41,992	$	35,321	$	44,868
Unbilled contract receivables	140,483		127,150
Unbilled receivables (contract assets)					190,802		181,009
Other	2,710		2,930		11,124		6,242
Receivables	$	174,943	$	172,072
Total receivables					$	237,247	$	232,119

As of ~~September 29, 2017~~June 28, 2019 and December 31, ~~2016,~~2018, all billed receivables are due from the U.S. government, either directly as prime contractor to the U.S. government or as subcontractor to another prime contractor to the U.S. government. Because ~~the Company’s~~our billed receivables are with the U.S. government, ~~the Company does~~we do not believe ~~it has~~they represent a material credit risk exposure.

Unbilled receivables are contract ~~receivables~~assets that represent revenue recognized on long-term contracts in excess of amounts billed as of the balance sheet date. We estimate that approximately ~~$5.4~~$5.2 million of our unbilled ~~contract~~ receivables as of ~~September 29, 2017~~June 28, 2019 may not be collected within the next 12 months. These amounts relate to the timing of the U.S. government review of indirect rates and contract line item realignments with our customers.

Changes in the balance of receivables are primarily due to the timing differences between our performance and customers' payments.

NOTE 68

DEBT

Senior Secured Credit Facilities

Term Loan and ~~Revolver.~~ Revolver. In September 2014, ~~Vectrus, Inc.~~we and ~~its~~our wholly-owned subsidiary, ~~Vectrus Systems Corporation~~VSC, entered into a credit agreement with a group of lenders, including JPMorgan Chase Bank, N.A. as administrative agent. The credit agreement was subsequently amended in November 2017 by the Amendment and Restatement Agreement (the Amendment Agreement) with a group of lenders, including JPMorgan Chase Bank, N.A., as ~~of April 19, 2016, to modify certain financial and negative covenants (as so amended, the Credit Agreement).~~administrative agent. The ~~Credit~~Amendment Agreement provides for ~~$215.0~~$200.0 million in senior secured financing, consisting of a ~~$140.0~~$80.0 million five-year term loan facility (the Amended Term Loan) and a ~~$75.0~~$120.0 million five-year senior secured revolving credit facility (the Amended Revolver, and together with the Amended Term Loan, the ~~Senior Secured~~Amended Credit Facilities).

~~We used $136.3 million from the Term Loan to pay a distribution to a subsidiary of Exelis on September 26, 2014.~~ The remaining $3.7 million from the Term Loan consisted of debt financing fees, which are included in long-term debt, net in the Condensed Consolidated Balance Sheets and are being amortized as an adjustment to interest expense over the life of the Credit Agreement. Amortization expenses relating to debt issuance costs were $0.2 million and $0.3 million for the three months ended September 29, 2017 and September 30, 2016, respectively, and $0.6 million and $0.9 million for the nine months ended September 29, 2017 and September 30, 2016, respectively. These costs are included in interest expense in the Condensed Consolidated Statements of Income. The Term Loan amortizes in quarterly installments at the following rates per annum: 7.5% in year one, 10.0% in each of years two and three, 15.0% in year four and 57.5% in year five. Amounts borrowed under the Term Loan that are repaid or prepaid may not be re-borrowed. Any unpaid amounts must be repaid by September 17, 2019. As of September 29, 2017, the balance outstanding under the Term Loan was $74.5 million.

~~The~~Amended Revolver is available for working capital, capital expenditures, and other general corporate purposes. Up to ~~$35.0~~$25.0 million of the Amended Revolver is available for the issuance of letters of credit. There were no outstanding borrowings under the Amended Revolver at June 28, 2019. As of June 28, 2019, there were seven letters of credit ~~and there is a swingline facility~~outstanding in anthe aggregate amount ~~equal~~of $8.1 million, which reduced our borrowing availability to ~~$10.0 million.~~$111.9 million under the Amended Revolver. The Amended Revolver will mature and the commitments thereunder will terminate on ~~September 17, 2019. As~~November 15, 2022.

The aggregate scheduled maturities of ~~September 29, 2017, there were eight letters~~the Amended Term Loan are as follows:



(In thousands)	Payments due
2019 (excluding the six months ended June 28, 2019)	$	2,500
2020	6,500
2021	8,600
2022	55,400
Total	$	73,000

Table of ~~credit outstanding~~Contents

We may voluntarily prepay the Amended Term Loan in whole or in part at any time without premium or penalty, subject to the ~~aggregate amount~~payment of ~~$12.2 million, which reduced our borrowing availability to $62.8 million~~customary breakage costs under certain conditions. Amounts borrowed under the ~~Revolver.~~Amended Term Loan that are repaid or prepaid may not be re-borrowed.

~~Covenants~~. The ~~Senior Secured~~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. As of ~~September 29, 2017,~~June 28, 2019, the maximum amount of dividends we could pay was ~~$12.9~~$19.3 million.

~~Table~~ For further discussion on dividends, please refer to "Liquidity and Capital Resources - Dividends" in Item 2. Management's Discussion and Analysis of ~~Contents~~

Financial Condition and Results of Operations.

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 ~~3.25 to 1.00, which stepped down to~~ 3.00 to 1.00 ~~beginning with the first quarter of 2017 and will step down to 2.75~~(3.25 to 1.00 ~~beginning with~~for the ~~first quarter of 2018,~~12 months following a qualified acquisition), and (b) a minimum ratio of consolidated EBITDA to consolidated interest expense (net of cash interest income) of 4.50 to 1.00. As of ~~September 29, 2017,~~June 28, 2019, we had a ratio of total consolidated indebtedness to EBITDA of ~~1.58~~1.17 to 1.00 and a ratio of consolidated EBITDA to consolidated interest expense of ~~10.40~~10.84 to 1.00. We were in compliance with all covenants related to the ~~Senior Secured~~Amended Credit Facilities as of ~~September 29, 2017.~~

June 28, 2019.

Interest Rates and ~~Fees~~Fees.. Outstanding borrowings under the ~~Senior Secured~~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% ~~to 3.00%,~~depending on the leverage ratio, or (ii) a base rate plus the applicable ~~margin.~~margin, which ranges from 0.75% to 1.50% depending on the leverage ratio. The interest rate under the ~~Senior Secured~~Amended Credit Facilities at ~~September 29, 2017~~June 28, 2019 was ~~3.99%~~4.41%. ~~We pay a commitment fee on the undrawn portion of the Revolver ranging from 0.40% to 0.50%, depending on the leverage ratio.~~

Carrying Value and Fair ~~Value~~Value.~~. The~~ As of June 28, 2019 and December 31, 2018, the fair value of the ~~Senior Secured~~Amended Credit Facilities ~~approximates~~approximated the carrying value ~~as of September 29, 2017~~ 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.

~~Carrying values and fair values of the Term Loan on the Condensed Consolidated Balance Sheet as of September 29, 2017 were as follows:~~

(In thousands) Carrying Amount Fair Value
Short-term debt $ 21,000
$ 21,000
Long-term debt 53,500
53,500
Total debt 74,500
$ 74,500
Debt financing fees (847 )
Total debt with debt financing fees $ 73,653

~~Carrying values and fair values of the Term Loan on the Condensed Consolidated Balance Sheet as of December 31, 2016 were as follows:~~

(In thousands) Carrying Amount Fair Value
Short-term debt $ 15,750
$ 15,750
Long-term debt 69,250
69,250
Total debt 85,000
$ 85,000
Debt financing fees (1,408 )
Total debt with debt financing fees $ 83,592

NOTE 79

DERIVATIVE INSTRUMENTS

~~Risk Management Policy~~

~~We are exposed~~During the periods covered by this report, we have made no changes to our policies or strategies for the risk that our earnings and cash flows could be adversely impacted due to fluctuations in interest rates. We periodically enter into interest rate swaps to manage interest costs in which we agree to exchange, at specified intervals, the difference between variable and fixed interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and our outstandinguse of derivative instruments ~~do not contain credit risk~~and there has been no change in our related ~~contingent features. Collateral is generally not required.~~accounting methods.

~~Table of Contents~~

Interest Rate Derivative Instruments

On May 5, 2016 and May 5, 2015, we entered into derivative instruments to hedge a portion of our exposure to interest rate risk under the variable-rate portion of the Term Loan (the interest rate swaps). TheOur interest rate swaps are designated and qualify as effective cash flow hedges. The contracts, with expiration dates through November 2022 and notional amounts totaling ~~$46.7~~$54.9 million at ~~September 29, 2017,~~June 28, 2019, are recorded at fair value.

The interest rate swaps are measured at fair value on a recurring basis and are determined using the income approach based on a discounted cash flow model to determine the present value of future cash flows over the remaining terms of the contracts incorporating observable market inputs such as prevailing interest rates as of the reporting date (Level 2). Changes in fair value of the interest rate swaps are recorded, net of tax, as a component of accumulated other comprehensive loss in the Condensed Consolidated Balance Sheets. We reclassify the effective gain or loss from accumulated other comprehensive loss, net of tax, to interest expense on the Condensed Consolidated Statements of Income as the interest expense is recognized on the related debt. The ineffective portion of the change in fair value of the interest rate swap, if any, is recognized directly in earnings in interest expense.

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 ~~Sheet~~Sheets as of ~~September 29, 2017:~~June 28, 2019:

Fair Value

(In thousands)

Balance sheet caption

Amount

Fair Value

Balance sheet caption

Amount

Interest rate swap designated as cash flow hedge

Other current assets

132

Other accrued liabilities

207

Interest rate swap designated as cash flow hedge

Other non-current assets

138

Other non-current liabilities

891

2018:

Fair Value

(In thousands)

Balance sheet caption

Amount

Fair Value

Balance sheet caption

Amount

Interest rate swap designated as cash flow hedge

Other accrued liabilities

Other current assets

121

Interest rate swap designated as cash flow hedge

Other non-current assets

259

Other non-current assets

104

By utilizing interest rate swaps, we are exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, we entered into interest rate swaps with a major financial institution based upon credit ratings and other factors. We regularly assess the creditworthiness of the counterparty. As of ~~September 29, 2017,~~June 28, 2019, the counterparty to the interest rate swaps had performed in accordance with its contractual obligations. Both the counterparty credit risk and our credit risk were considered in the fair value determination.

~~NOTE 8~~

~~COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS~~Foreign Currency Derivative Instruments

The following ~~tables present financial information underlying certain balance sheet captions.~~

~~Compensation~~table summarizes the amount at fair value and ~~other employee benefits~~

~~Compensation and other employee benefits are affected by short-term fluctuations~~location of the derivative instruments used for our forward contract hedges in the ~~timing~~Condensed Consolidated Balance Sheets as of ~~payments and were comprised of the following:~~

(In thousands) September 29,
2017 December 31,
2016
Accrued salaries and wages $ 23,587
$ 14,741
Accrued bonus 3,052
4,371
Accrued employee benefits 16,131
15,805
Total $ 42,770
$ 34,917

June 28, 2019:

1513

Table of Contents

~~Other accrued liabilities~~

~~Other accrued liabilities were comprised~~

The following table summarizes the amount at fair value and location of the ~~following:~~derivative instruments used for our forward contract hedges in the Condensed Consolidated Balance Sheets as of December 31, 2018:

(In thousands) September 29,
2017 December 31,
2016
Workers' compensation, auto and general liability reserve $ 5,507
$ 6,123
Other accrued liabilities 13,489
11,570
Total $ 18,996
$ 17,693

At June 28, 2019, we had outstanding foreign currency forward contracts, for the exchange of U.S. dollars and Euros, with a notional amount of $7.9 million and expiration dates through December 2020.

Counterparty default risk is considered low because the forward contracts that we entered into are over-the-counter instruments transacted with highly-rated financial institutions. We were not required to, and did not, post collateral as of June 28, 2019.

The current estimated value of net losses for the above derivative instruments anticipated to be transferred from accumulated other comprehensive income into earnings over the next 12 months is $0.5 million.

NOTE 910

~~WORK FORCE REDUCTION AND EXECUTIVE SEPARATIONS~~Leases

~~Work Force Reduction~~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.

On October 18, 2016, we announced a corporate reduction in force and a realignment of effort that resulted in the elimination of 62 positions at our Colorado Springs headquarters. As a result, we recognized $1.5 million in severance expenseWe do not separate lease components (e.g., fixed payments for rent) from non-lease components (e.g., common area maintenance) but account for the ~~year ended December 31, 2016.~~

~~Executive Separations~~

~~On November 30, 2016, Kenneth Hunzeker, our former CEO, notified us of his intention to retire. On December 7, 2016, the Company~~non-lease components and ~~Mr. Hunzeker entered into~~non-components (e.g., property taxes and insurance) in a Separation Agreement, under which we agreed to continue to pay Mr. Hunzeker his present salary through December 5, 2018 (the Hunzeker Severance Pay Period) and to continue his participation in the Company's medical, dental, and vision plans through the Hunzeker Severance Pay Period. Mr. Hunzeker also received a bonus related to 2016. We recognized $1.2 million in severance expense for the year ended December 31, 2016 related to Mr. Hunzeker's separation.

On April 28, 2017, Kelvin Coppock, the Company’s Senior Vice President, Contracts notified the Company of his intention to retire, effective June 30, 2017. On June 30, 2017, the Company and Mr. Coppock entered into a Separation Agreement (the Coppock Separation Agreement). Pursuant to the Coppock Separation Agreement, the Company and Mr. Coppock agreed that his last day of active full-time employment with the Company was June 30, 2017. The Company agreed to continue to pay Mr. Coppock his present salary from July 1, 2017 through February 28, 2019 (the Coppock Severance Pay Period). In addition, Mr. Coppock is eligible for consideration for a pro-rata bonus for 2017 payable in 2018 based on six months of active employment in 2017 and to continue his participation in the Company’s medical, dental and vision plans through the Coppock Severance Pay Period. We recognized $0.5 million in severance expense for the three months ended June 30, 2017 related to Mr. Coppock's separation.

~~Severance and related benefit costs are accrued for~~contract as ~~necessary within compensation and other employee benefits and other non-current liabilities on the Condensed Consolidated Balance Sheets. A portion~~part of the ~~severance payments have been paid out pursuant~~single lease component to ~~agreements entered into with affected employees, and we do not expect to incur significant additional charges related to these activities in future periods. Changes in the carrying amount~~which they are related.

The components of ~~the severance and benefits liability related to the work force reduction and executive separations~~lease expense are ~~summarized in the following table:~~as follows:

(In thousands)

Balance, December 31, 2016    $ 2,014
Severance and related benefit costs - executive separations    468
Payments (1,260 )
Adjustments (46 )
Balance, September 29, 2017    $ 1,176



	Three Months Ended		Six Months Ended
(In thousands)	June 28, 2019		June 28, 2019
Operating lease expense	$	3,647	$	7,063
Variable lease expense	225		398
Short-term lease expense	11,422		22,619
Total lease expense	$	15,294	$	30,080

Supplemental balance sheet information related to our operating leases is as follows:



(In thousands)	June 28, 2019
Right-of-use assets	$	17,987

Current lease liabilities (recorded in other accrued liabilities)	$	10,112
Long-term lease liabilities (recorded in other non-current liabilities)	8,658
Total operating lease liabilities	$	18,770

Initial ROU assets of $19.2 million were recognized as non-cash asset additions when the new lease accounting standard was adopted on January 1, 2019. Additional ROU assets of $5.2 million were recognized as non-cash asset additions that resulted from new operating lease liabilities during the first half of 2019.

The weighted average remaining lease term and discount rate for our operating leases at June 28, 2019 were 3.9 years and 6.0%, respectively.

1614

Table of Contents

~~NOTE 10~~Maturities of lease liabilities at June 28, 2019 were as follows:

~~POST EMPLOYMENT BENEFIT PLANS~~

Vectrus sponsors one defined contribution savings plan, which allows employees to contribute a portion of their pre-tax and/or after-tax income in accordance with specified guidelines. The Company matches a percentage of the employee contributions up to certain limits of employee base pay. Our portion of the matching contributions charged to expense was $0.9 million for both the three months ended September 29, 2017 and September 30, 2016 and $2.3 million and $2.1 million for the nine months ended September 29, 2017 and September 30, 2016, respectively.

On September 11, 2014, our Board of Directors adopted and approved the Vectrus Systems Corporation Excess Savings Plan (the Excess Savings Plan). Since federal law limits the amount of compensation that can be used to determine employee and employer contribution amounts to our tax-qualified plans, we established the Excess Savings Plan to allow for Company contributions based on an eligible employee's base salary in excess of these limits. No employee contributions are permitted. All balances under the Excess Savings Plan are maintained on the books of the Company. Credits and deductions are made to the accumulated savings under the plan based on the earnings or losses attributable to a stable value fund as defined in the Excess Savings Plan. Benefits will be paid in a lump sum generally in the seventh month following the date on which the employee's separation from service occurs. Employees are 100% vested at all times in any amounts credited to their accounts. As of September 29, 2017 and December 31, 2016, we had accrued $0.1 million and $0.2 million, respectively, of contributions under the Excess Savings Plan.

On November 9, 2016, the Compensation and Personnel Committee of the Board of Directors approved an amendment and restatement of the Company’s Senior Executive Severance Pay Plan (as amended and restated, the “Amended Plan”). The Amended Plan removed (i) a provision that disallowed severance pay in the event of a termination of the executive’s employment by the Company with a scheduled termination date after the executive’s “Normal Retirement Date” (i.e., the first of the month which coincides with or follows the executive’s 65th birthday) and (ii) a provision that used the executive’s Normal Retirement Date in determining the maximum period of time for which severance pay is calculated. The Amended Plan did not change the schedule of severance pay. Termination benefits offered under the Company’s Amended Plan are other post employment benefits as defined by FASB Accounting Standards Codification 712-10 - Compensation - Nonretirement Postemployment Benefits. Benefits under the Amended Plan vest or accumulate with the employee’s years of service; however, the payment of benefits is not probable and the Company does not have the ability to reliably estimate when there will be an involuntary termination without cause under the Amended Plan. Accordingly, the Company does not accrue a benefit obligation for severance costs under the Amended Plan over the duration of executive employment.



(In thousands)
2019 (excluding the six months ended June 28, 2019)	$	7,143
2020	5,511
2021	2,076
2022	1,248
2023	1,282
2024 and beyond	4,543
Total lease payments	21,803
Less: Imputed interest	3,033
Total	$	18,770

NOTE 11

GOODWILL AND INTANGIBLE ASSETS

As of both June 28, 2019 and December 31, 2018, the carrying amount of goodwill was $233.6 million. There was no related activity during the first six months of 2019.

As of June 28, 2019 and December 31, 2018, the carrying amount of intangible assets was approximately $13.9 million and $8.6 million, respectively. The increase during the first six months of 2019 was due to $6.5 million of new amortizable intangible assets purchased during the first quarter of 2019. This increase was offset by intangible amortization expense of approximately $0.7 million and $1.3 million for the three and six months ended June 28, 2019, respectively. Intangible amortization expense for the three and six months ended June 29, 2018 was $0.5 million and $0.9 million, respectively.

Amortizing intangible assets, which carry a remaining average life of approximately 6 years, are principally composed of customer contracts, related backlogs and re-competes.

NOTE 12

STOCK-BASED COMPENSATION

~~The Company maintains~~We maintain an equity incentive plan (the 2014 Omnibus Plan) to govern awards granted to Vectrus employees and directors, including nonqualified stock options (NQOs), restricted stock units (RSUs), total shareholder return (TSR) awards and other awards. We account for NQOs and stock-settled RSUs as equity-based compensation awards. TSR awards, described below, and cash-settled RSUs are accounted for as liability-based compensation awards.

Stock-based compensation expense and the associated tax benefits impacting our Condensed Consolidated Statements of Income were as follows:


	Three Months Ended						Nine Months Ended
	September 29,			September 30,			September 29,		September 30,		Three Months Ended				Six Months Ended
(In thousands)	2017			2016			2017		2016		June 28, 2019		June 29, 2018		June 28, 2019		June 29, 2018
Compensation costs for equity-based awards	$	695		$	1,002		$	2,241	$	3,350	$	1,099	$	908	$	2,216	$	1,775
Compensation costs for liability-based awards	(349		)	(728		)	1,100		192		1,470		198		1,815		746
Total compensation costs, pre-tax	$	346		$	274		$	3,341	$	3,542	$	2,569	$	1,106	$	4,031	$	2,521
Future tax benefit	$	123		$	97		$	1,188	$	1,260	$	556	$	239	$	872	$	545

Liability-based awards are revalued at the end of each reporting period to reflect changes in fair value.

As of ~~September 29, 2017,~~June 28, 2019, total unrecognized compensation costs related to equity-based awards and liability-based awards were ~~$3.3~~$6.4 million and ~~$1.5~~$4.1 million, respectively, which are expected to be recognized ratably over a weighted average period of ~~1.88~~1.95 years and ~~2.00~~2.15 years, respectively.

1715

Table of Contents

The following table provides a summary of the activities for NQOs and RSUs for the ~~nine~~six months ended ~~September 29, 2017:~~

June 28, 2019:


	NQOs			RSUs			NQOs			RSUs
(In thousands, except per share data)	Shares		Weighted Average Exercise Price Per Share	Shares		Weighted Average Grant Date Fair Value Per Share	Shares	Weighted Average Exercise Price Per Share		Shares	Weighted Average Grant Date Fair Value Per Share
Outstanding at January 1, 2017	384		$21.47	285		$23.01
Outstanding at January 1, 2019							251	$	23.00	257	$	28.90
Granted	71		$22.27	136		$23.25	—	—		195	$	29.40
Exercised	(105	)	$18.01				152	$	22.89	—	—
Vested				(110	)	$24.33	—	—		126	$	27.66
Forfeited or expired	(23	)	$22.61	(35	)	$21.61	14	$	24.18	20	$	29.12
Outstanding at September 29, 2017	327		$22.67	276		$22.79
Outstanding at June 28, 2019							85	$	23.00	306	$	29.73

During the ~~nine~~six months ended ~~September 29, 2017,~~June 28, 2019, we granted ~~long-term~~long term incentive awards to employees consisting of ~~70,985 NQOs and 135,833~~170,361 RSUs with ~~respective~~a weighted average grant date fair ~~values~~value per share of ~~$8.26~~$28.06 and ~~$23.25. The NQOs vest in one-third cumulative annual installments on the first, second, and third anniversaries~~to our directors consisting of ~~the~~25,246 RSUs with a weighted average grant date ~~and expire 10 years from the date of grant. Based on the closing price of Vectrus common stock on the grant dates, the weighted average option exercise price is $22.27. The~~ fair value per share of ~~each NQO grant was estimated on the date of grant using the Black-Scholes option pricing model.~~ $38.42.

For employee RSUs, one-third of the award vests on each of the three anniversary dates following the grant date. Director RSUs are granted on the date of an annual meeting of shareholders and vest on the business day immediately prior to the next annual meeting. The fair value of each RSU grant was determined based on the closing price of Vectrus common stock on the date of grant. Stock compensation expense will be recognized ratably over the vesting period of the awards.

The fair value of stock options is determined on the date of grant utilizing a Black-Scholes valuation model. The following weighted-average assumptions were utilized in deriving the fair value for NQOs for the nine months ended September 29, 2017:



~~Expected volatility~~	~~30.7~~	%
~~Expected life (in years)~~	7
~~Risk-free rates~~	~~2.30~~	%
~~Weighted-average grant date fair value per share~~	~~$8.26~~

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~~six months ended ~~September 29, 2017,~~June 28, 2019, we granted ~~2017~~ TSR awards with an aggregate target TSR value of ~~$1.3~~$2.3 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.

~~Table of Contents~~

NOTE 1213

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 ~~$5.2~~$11.3 million and ~~$2.8~~$7.8 million as of ~~September 29, 2017~~June 28, 2019 and December 31, ~~2016,~~2018, respectively, in ~~other~~"Other accrued ~~liabilities~~liabilities" in the Condensed Consolidated Balance Sheets for legal proceedings and for claims with respect to our government contracts as discussed below, including open years subject to audit. Although the ultimate outcome of any legal matter or claim cannot be predicted with certainty, based on present information, including our assessment of the merits of the particular claim, we do not expect that any asserted or unasserted legal or contractual claims or proceedings, individually or in the aggregate, including the lawsuit discussed below, will have a material adverse effect on our cash flow, results of operations or financial condition.

~~Legal Proceedings~~

We are defending a class action employment lawsuit that was initiated in the United States District Court for the Western District of Washington in April 2010 against the predecessor of our Former Parent by individuals who worked on a particular contract in Kuwait after April 12, 2009. The plaintiffs are alleging a breach of employment contract by the predecessor of our Former Parent due to an alleged violation of Kuwait labor law. In November 2016, following an interlocutory appeal by Vectrus, the Ninth Circuit Court of Appeals affirmed the District Court’s decision certifying a class of plaintiffs. We filed a petition for certiorari with the U.S. Supreme Court on the class certification decision in March 2017. On October 2, 2017, the U.S. Supreme Court denied certiorari. Vectrus continues to vigorously defend the lawsuit.

U.S. Government Contracts, Investigations and Claims

We have U.S. government contracts that are funded incrementally on a year-to-year basis. Changes in government policies, priorities or funding levels through agency or program budget reductions by the U.S. Congress or executive agencies could have a material adverse effect on our financial condition or results of operations. Furthermore, our contracts with the U.S. government may be terminated or suspended by the U.S. government at any time, with or without cause. Such contract suspensions or terminations could result in unreimbursable expenses or charges or otherwise adversely affect our financial condition and results of operations.

Table of Contents

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 government contracts, indirect rates and pricing practices, and compliance with applicable contracting and procurement laws, regulations and standards. Accordingly, costs billed or billable to U.S. government customers are subject to potential adjustment upon audit by such agencies. The U.S. government agencies also review the adequacy of our compliance with government standards for our business systems, including our accounting, earned value management, estimating, materials management and accounting, purchasing, and property management systems.

As a result of final indirect rate negotiations between the U.S. government and our Former Parent, we may be subject to potential adjustments to costs previously allocated by our Former Parent to our business, which was formerly Exelis’ Mission Systems Business, from 2007 through September 2014. AsBecause we do not participate in indirect rate negotiations between the U.S. government and our Former Parent, we cannot ~~predict the outcome of any negotiated adjustment or the ultimate responsible party. Accordingly, we cannot~~ reasonably predict the likelihood of such adjustments or ~~estimate~~ the ~~amount~~ultimate responsible party. We have recently been in discussions with our Former Parent regarding the negotiated adjustments for 2007-2014 and believe that our potential cumulative liability for these years is insignificant. In June 2019, the U.S. government provided us with the Contracting Officer's Final Decision for the years 2007 - 2010 related to Former Parent costs. We believe we are fully indemnified under our Distribution Agreement with our Former Parent. We have notified our Former Parent of ~~any potential impact~~the U.S. government's decision in this matter.

NOTE 14

SUBSEQUENT EVENTS

On July 8, 2019, we acquired Advantor Systems Corporation and Advantor Systems, LLC (collectively, "Advantor") from Infrasafe Holding, Inc. and Infrasafe, LLC (collectively, "Infrasafe"). Advantor, a leading provider of integrated electronic security systems to the ~~Company.~~U.S. government, was acquired for cash consideration of $44 million, subject to customary adjustments at and following the closing. The transaction was funded with cash on hand and from our credit facility.

~~Table of Contents~~

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~~Condensed Consolidated Financial Statements and notes thereto included in this Quarterly Report on Form 10-Q as well as the audited ~~consolidated~~Consolidated Financial Statements and ~~combined financial statements and the~~ 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, ~~2016~~. 2018. This Quarterly Report provides additional information regarding the Company, our services, industry outlook and forward-looking statements that involve risks and uncertainties. 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. ~~See~~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 services to the U.S. government worldwide. We operate in one segment and ~~offer:~~offer facility and logistics services and information technology and network communications services.

Our primary customer is the U.S. Department of Defense (DoD), with a high concentration in the U.S. Army. For the ~~three and nine~~six months ended ~~September~~June 28, 2019 and June 29, ~~2017 and September 30, 2016,~~2018, we had total revenue of ~~$269.6~~$657.5 million and ~~$819.0 million, respectively, and $283.8 millionand $902.4~~$641.6 million, respectively, all of which was derived from U.S. government customers. For the ~~three and nine~~six months ended ~~September~~June 28, 2019 and June 29, ~~2017,~~2018, we generated approximately ~~80%~~69% and ~~83%~~74%, respectively, of our total revenue from the U.S. Army. ~~For the three and nine months ended September 30, 2016, we generated approximately 85% and 84%, respectively, of our total revenue from the U.S. Army.~~

Executive Summary

~~Vectrus reported $269.6~~Our revenue increased by $10.5 million, ~~of revenue~~or 3.3%, for the ~~quarter~~three months ended ~~September~~June 28, 2019 compared to the three months ended June 29, ~~2017, a decrease of $14.2 million, or 5.0%, from the $283.8 million of revenue reported for the corresponding period in 2016.~~2018. The ~~decrease~~increase in revenue was attributable to ~~lower activity~~increases from our European programs of $8.6 million and our Middle East programs of $4.4 million, offset by a decrease of $2.5 million from our U.S. programs.

Operating income for the three months ended June 28, 2019, was $11.2 million, a decrease of $1.8 million, or 13.9%, compared to the three months ended June 29, 2018. This decrease was primarily due to a decrease of $2.1 million from our U.S. programs and $1.2 million from our Middle East programs, ~~of $14.1 million and our U.S. programs of $2.9 million~~ offset by an increase of ~~$2.3~~$1.5 million from our European ~~programs~~programs.

Table of Contents

During the performance of our contracts, we periodically review estimated final contract prices and ~~$0.5 million from our Afghanistan programs.~~

~~Aggregate~~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 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 adjustments due to aggregate changes in contract estimates ~~recognized using the cumulative catch-up method of accounting~~ increased operating income by ~~$3.7~~$1.9 million and ~~$1.2~~$3.7 million for the three months ended ~~September~~June 28, 2019 and June 29, ~~2017 and September 30, 2016,~~2018, 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.~~

~~Operating~~ income ~~inclusive~~depending on the dynamics of aggregate cumulative catch-up adjustments, for the quarter ended September 29, 2017 was $10.1 million, a decrease of $1.1 million, or 9.6%, compared to $11.2 million for the quarter ended September 30, 2016. This decrease was due to lower operating income from our U.S. programs of $3.4 million and our Afghanistan programs of $0.3 million offset by higher operating income from our Middle East programs of $1.7 million and our European programs of $0.9 million.each contract.

Further details related to our financial results for the three and ~~nine~~six months ended ~~September 29, 2017,~~June 28, 2019, compared to the three and ~~nine~~six months ended ~~September 30, 2016~~June 29, 2018, are contained in the "Discussion of Financial Results" section.

Recent Developments

On July 8, 2019, we acquired Advantor Systems Corporation and Advantor Systems, LLC (collectively, "Advantor") from Infrasafe Holding, Inc. and Infrasafe, LLC (collectively, "Infrasafe"). Advantor, a leading provider of integrated electronic security systems to the U.S. government, was acquired for cash consideration of $44 million, subject to customary adjustments at and following the closing. The ~~Kuwait Base Operation~~transaction was funded with cash on hand and ~~Security Support Services (K-BOSSS) contract commenced~~from our credit facility.

On April 12, 2019, the U.S. Army Contracting Command-Rock Island (ACC-RI) awarded four IDIQ, Multiple Award Task Order Contracts (MATOC), for the Logistics Civil Augmentation Program (LOGCAP) V support services in ~~November 2010 and currently is exercised through March 28, 2018. The right to exercise an option period is at the sole discretion~~support of the U.S. ~~government. On September 29, 2016, we announced that we were not awarded~~military worldwide. The services are to support the ~~renewal~~Geographical Combatant Commands (GCCs) and Army Service Component Commands (ASCCs) throughout the full range of military operations. Each basic IDIQ contract Ordering Period will be an initial five-year ordering period and options for five additional one-year ordering periods.

Vectrus is one of the ~~K-BOSSS contract. We filed a post-award protest with the U.S. Government Accountability Office (GAO) on the K-BOSSS~~four award ~~on October 11, 2016. On November 7, 2016, we were notified by the Army that it was taking corrective action to resolve the protest~~recipients of the ~~K-BOSSS~~basic IDIQ contract ~~award. As such,~~and received the ~~solicitation for~~following task orders: PACOM Setting the ~~K-BOSSS contract was amended~~Theater Task Order and ~~re-issued to~~associated Performance Task Order; and CENTCOM Setting the original bidders. On March 23, 2017, Vectrus announced that the U.S. government awarded a modification to extend the K-BOSSS contract. The K-BOSSS contract extension is from March 29, 2017 to March 28, 2018, with an evaluated nine-month optionTheater Task Order and associated Performance Task Order. Each task order has its own period of March 29, 2018 through December 28, 2018 and an evaluated three-month option of December 29, 2018 through March 28, 2019. The modification will continue critical base operations support and security support services throughout the Kuwait area of responsibility including forms, publications, and reproductive services; Army postal operations; operations; logistics; information management; public works; environmental services; medical administrative support; installation services; security services; fire services; and emergency services. The K-BOSSS contract contributed $348 million of revenue during the nine months ended September 29, 2017 and $438 million of revenue during the year ended December 31, 2016.

~~Table of Contents~~

In October 2014, a Danish company owned by Vectrus received notice of award of an approximately $411 million, seven year, Hybrid Firm-Fixed-Price Contract for Thule Base Maintenance (the Thule Contract). In February 2015, the GAO deniedperformance. Several protests of the ~~Thule Contract~~LOGCAP V award have been filed ~~by three unsuccessful bidders, and all three of them filed subsequent protests~~ with the ~~U.S. Court of Federal Claims. Following a lengthy litigation process,~~GAO. We cannot predict the cases related to the Thule Contract award protests were dismissed in October 2016. On December 14, 2016, the Air Force directed our Danish subsidiary to begin the transition process for the Thule Contract. On January 31, 2017, the Court of Federal Claims granted one protestor’s motion for reconsideration to address two claims that were not expressly ruled upon in the court’s dismissaltiming or outcome of the ~~case in October 2016. On April 4, 2017,~~resolution of these or other protests of this award.

During the ~~Court denied the protestor's motions~~first quarter of 2019 we were awarded a new, five year, $117 million, cost-plus fixed-fee award to provide defensive cyber operations and ~~entered judgment in favor of the~~operational and maintenance IT to a U.S. government ~~and our Danish subsidiary. Our Danish subsidiary began full contract operations on October 1, 2017.~~ client.

Information regarding ~~the K-BOSSS contract and~~ certain other significant contracts is ~~provided~~discussed in "Significant Contracts" below.

Significant Contracts

The following table reflects contracts that accounted for more than 10% of our total revenue for the ~~nine~~six months ended ~~September~~June 28, 2019 and June 29, ~~2017 or September 30, 2016:~~2018:


	% of Total Revenue		% of Total Revenue
	Nine Months Ended		Six Months Ended
Contract Name	September 29, 2017	September 30, 2016	June 28, 2019	June 29, 2018
Kuwait Base Operations and Security Support Services (K-BOSSS)	42.5%	35.9%	36.6%	40.3%
Operations, Maintenance and Defense of Army Communications in Southwest Asia and Central Asia (OMDAC-SWACA)	15.1%	12.6%	15.9%	14.0%
Kuwait-based Army Pre-Positioned Stocks-5 (APS-5 Kuwait)	7.3%	14.8%

Revenue associated with a contract will fluctuate based on increases or decreases in the work being performed on the contract, award fee payments, and other contract modifications within the term of the contract resulting in changes to the total contract value.

U.S. government 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 by the U.S. government. The right to exercise an option period is at the sole discretion of the U.S. government. 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.

~~For a discussion of the K-BOSSS contract, see "Recent Developments" above.~~

Performance on the OMDAC-SWACA contract commenced in July 2013 with a base period of 11 months and four option years. The U.S. government has exercised four option years which run through May 2018. Although the current contract is exercised through May 2018, the U.S. government has stated that its anticipated timeline for the re-competition award is for the solicitation to be released in February 2019 and performance to commence sometime in 2019.

The APS-5 Kuwait contract commenced in April 2010 and ran through April 7, 2017. On September 1, 2016, we announced that we were not awarded the renewal of the APS-5 Kuwait contract. For the re-competition award, the APS-5 Kuwait contract was combined with the APS-5 Qatar contract as the APS-5 Kuwait/Qatar contract. We operated the APS-5 Qatar contract since May 2011. In each of the periods presented, the APS-5 Qatar contract did not exceed 10% of our revenue. We accounted for the APS-5 Kuwait and APS-5 Qatar contracts separately through the end date of the contracts. We filed a post-award protest on the APS-5 Kuwait/Qatar contract award with the GAO on September 13, 2016. On December 21, 2016, the GAO issued its decision denying our protest of the APS-5 Kuwait/Qatar contract award. The APS-5 Kuwait and APS-5 Qatar contracts' final extensions ran through April 7, 2017. The conclusion of the APS-5 Kuwait and APS-5 Qatar contracts with associated revenue and costs did not have a material impact on our liquidity. See "Backlog" below.

2118

Table of Contents

The K-BOSSS contract currently is exercised through March 28, 2020, with an additional six-month option through September 28, 2020. K-BOSSS, our largest base operations support services contract, supports geographically-dispersed locations within the State of Kuwait, including several camps and a range training complex. K-BOSSS provides critical base operations support and security support services, including forms, publications, and reproduction services; U.S. Army postal operations; range operations and maintenance; logistics; information management; public works; environmental services; medical administrative support; morale, welfare and recreation; and security, fire and emergency services. The K-BOSSS contract was re-competed as a task order under the LOGCAP V contract vehicle, which was awarded April 12, 2019 (see "Recent Developments" above). The K-BOSSS contract contributed $241 million and $258 million of revenue for the six months ended June 28, 2019 and June 29, 2018, respectively.

The OMDAC-SWACA contract is currently exercised through November 30, 2019, with a one-month option and a two-month option through February 28, 2020. The contract provides for enterprise network capabilities and services support of the U.S. Central Command. Work is based in Kuwait with additional locations throughout Southwest Asia. Technical support activities include the Southwest Asia Regional Cyber-Center (RCC-SWA) operations, regional network operations and security centers (RNOSCs), local area and wide area network administration, systems administration, service desk administration, computer repair (ADPE), email administration, the Defense Red Switch Network, satellite communications, microwave communications, tower and antenna maintenance, technical control facilities, high frequency and ultra-high frequency radios, telephone switches, telephone operations, inside and outside cable plants, prime power and backup power generators, HVAC systems, uninterruptible power supplies, logistics support services, and other contingency requirements for the warfighter. The OMDAC-SWACA contract contributed $104 million and $90 million of revenue for the six months ended June 28, 2019 and June 29, 2018, respectively.

Backlog

Total backlog includes ~~both~~remaining performance obligations, consisting of funded backlog (firm orders for which funding is contractually obligated by the customer) and unfunded backlog (firm orders for which funding is not currently contractually obligated by the ~~customer)~~customer, and ~~represents firm orders and potential options on multi-year contracts.~~unexercised contract options). Total backlog excludes potential orders under ~~indefinite delivery~~IDIQ contracts and ~~indefinite quantity (IDIQ) contracts. Backlog also excludes~~ contracts awarded to ~~Vectrus but~~us that are ~~in protest~~being protested by competitors with the GAO or in the U.S. Court of Federal Claims. The value of the backlog is based on anticipated revenue levels over the anticipated life of the contract. Actual ~~volumes~~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 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~~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 ~~also~~ 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.

~~Total~~For the six months ended June 28, 2019, total backlog increased by ~~$702.4 million in the nine months ended September 29, 2017.~~$209 million. As of ~~September 29, 2017,~~June 28, 2019, total backlog (funded and unfunded) was ~~$3.1 billion. We expect to recognize a substantial portion of our funded backlog~~$3.2 billion as ~~revenue within~~set forth in the ~~next 12 months.~~

following table:


	September 29,		December 31,		June 28,		December 31,
(In millions)	2017		2016		2019		2018
Funded backlog	$	824	$	665	$	934	$	689
Unfunded backlog	2,234		1,691		2,287		2,323
Total backlog	$	3,058	$	2,356	$	3,221	$	3,012

Funded orders (different from funded backlog) represent orders for which funding was received during the period. We received funded orders of ~~$978.7~~$812.1 million during the ~~nine~~six months ended ~~September 29, 2017,~~June 28, 2019, which was ~~a decrease~~an increase of ~~$7.0~~$27.4 million compared to the ~~nine~~six months ended ~~September 30, 2016 due to the timing~~June 29, 2018.

Table of ~~funded orders for some of our contracts.~~Contents

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 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 has not yet passed an appropriations bill for fiscal year 2018 (the U.S. government’s fiscal year begins on October 1 and ends on September 30). However, on September 8, 2017, the U.S. government passed a continuing resolution funding measure to finance all U.S. government activities through December 8, 2017. Under this continuing resolution, partial-year funding at amounts consistent with appropriated levels for fiscal year 2017 are available, subject to certain restrictions, but new spending initiatives are not authorized. During periods covered by continuing resolutions or until the regular appropriation bills are passed, we may experience delays in procurement of services due to lack of funding, and those delays may affect our results of operations.

We anticipate and will be experiencing reductions in revenue and profitability related to certain programs in which we participate, including from the contracts that expire without an award to Vectrus of the re-compete contract. However, other programs are expanding. 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, which we believe 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:~~mission-essential, including the following: (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.

~~Table of Contents~~

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, ~~2016~~2018 and the matters identified under the caption “Forward-Looking Information" herein.

DISCUSSION OF FINANCIAL RESULTS

Three months ended ~~September 29, 2017,~~June 28, 2019, compared to three months ended ~~September 30, 2016~~June 29, 2018

Selected financial highlights are presented in the following table:


	Three Months Ended						Change					Three Months Ended						Change
	September 29,			September 30,
(In thousands)	2017			2016			$			%
(In thousands, except for percentages)												June 28, 2019			June 29, 2018			$			%
Revenue	$	269,625		$	283,782		$	(14,157	)	(5.0	)%	$	331,589		$	321,132		$	10,457		3.3	%
Cost of revenue	245,219			257,687			(12,468		)	(4.8	)%	300,553			292,064			8,489			2.9	%
% of revenue	90.9		%	90.8		%						90.6		%	90.9		%
Selling, general and administrative expenses	14,316			14,933			(617		)	(4.1	)%	19,843			16,070			3,773			23.5	%
% of revenue	5.3		%	5.3		%						6.0		%	5.0		%
Operating income	10,090			11,162			(1,072		)	(9.6	)%	11,193			12,998			(1,805		)	(13.9	)%
Operating margin	3.7		%	3.9		%						3.4		%	4.0		%
Interest (expense) income, net	(1,058		)	(1,348		)	(290		)	(21.5	)%
Interest expense, net												(1,329		)	(1,140		)	(189		)	16.6	%
Income before taxes	9,032			9,814			(782		)	(8.0	)%	9,864			11,858			(1,994		)	(16.8	)%
% of revenue	3.3		%	3.5		%						3.0		%	3.7		%
Income tax expense	3,232			3,207			25			0.8	%	2,247			2,663			(416		)	(15.6	)%
Effective income tax rate	35.8		%	32.7		%						22.8		%	22.5		%
Net Income	$	5,800		$	6,607		$	(807	)	(12.2	)%	$	7,617		$	9,195		$	(1,578	)	(17.2	)%

Revenue

Revenue for the three months ended ~~September 29, 2017,~~June 28, 2019 was ~~$269.6~~$331.6 million, ~~a decrease~~an increase of ~~$14.2~~$10.5 million, or ~~5.0%~~3.3%, as compared to the three months ended ~~September 30, 2016.~~June 29, 2018. The ~~decrease~~increase in revenue was attributable to ~~lower activity~~increases from our European programs of $8.6 million and our Middle East programs of ~~$14.1 million and our U.S. programs of $2.9~~$4.4 million, offset by ~~an increase~~a decrease of ~~$2.3~~$2.5 million from our ~~European programs and $0.5 million from our Afghanistan~~U.S. programs.

Cost of Revenue

The decrease in cost of revenue of $12.5 million, or 4.8%, for the three months ended September 29, 2017, as compared to the three months ended September 30, 2016, was primarily due to lower revenue as described above. Cost of revenue as a percentage of revenue was 90.6% compared to 90.9% for the three months ended ~~September~~June 28, 2019 and the three months ended June 29, ~~2017 and 90.8%~~2018, respectively. The increase in cost of revenue of $8.5 million, or 2.9%, for the three months ended ~~September 30, 2016.~~June 28, 2019, as compared to the three months ended June 29, 2018, was primarily due to increased revenue as described above.

Table of Contents

Selling, General & Administrative (SG&A) Expenses

For the three months ended ~~September 29, 2017,~~June 28, 2019, SG&A expenses of ~~$14.3~~$19.8 million ~~decreased~~increased by ~~$0.6~~$3.8 million, or ~~4.1%~~23.5%, as compared to ~~$14.9~~the three months ended June 29, 2018. The increase was due primarily to increased M&A costs of $0.7 million, stock-based compensation of $1.5 million and legal fees of $0.6 million.

Operating Income

Operating income for the three months ended June 28, 2019 decreased by $1.8 million, or 13.9%, as compared to the three months ended June 29, 2018. This decrease was due to lower operating income of $2.1 million from our U.S. programs and $1.2 million from our Middle East programs, offset by an increase of $1.5 million from our European programs. Overall operating income decreased primarily as a result of increased SG&A expenses, as noted above.

Operating income as a percentage of revenue was 3.4% for the three months ended June 28, 2019, compared to 4.0% for the three months ended June 29, 2018.

Aggregate cumulative adjustments increased operating income by $1.9 million and $3.7 million for the three months ended ~~September 30, 2016 primarily due to prior cost savings initiatives.~~

~~Operating Income~~

~~Aggregate~~June 28, 2019 and June 29, 2018, respectively. The aggregate cumulative ~~catch-up~~ adjustments for the three months ended ~~September 29, 2017~~June 28, 2019 related to higher margins associated with operational efficiencies related to labor and ~~the three months ended September 30, 2016 increased operating income by $3.7 million and $1.2 million, respectively.~~management of contract staffing. The aggregate cumulative ~~catch-up~~ adjustments for the three months ended ~~September~~June 29, ~~2017~~2018 related to approved extensions with higher margins associated with labor-related items and management of contract staffing, ~~and favorable resolution of contract claims,~~partially offset by higher subcontractor ~~costs. The aggregate cumulative catch-up adjustments for the three months ended September 30, 2016 related to changes in contract terms, program performance, customer scope changes,~~costs and ~~changes to estimates in the reported period. These changes can increase or decrease operating income.~~seasonal costs. The gross aggregate effects of these favorable and unfavorable changes in estimates ~~for~~in the three months ended ~~September~~June 28, 2019 and June 29, ~~2017 and September 30, 2016~~

~~Table of Contents~~

2018 were ~~$5.8~~$2.7 million and ~~$2.4~~$6.3 million favorable to operating income, respectively, and ~~$2.1~~$0.8 million and ~~$1.2~~$2.6 million unfavorable to operating income, respectively.

~~Operating income, inclusive of aggregate cumulative catch-up adjustments, for the quarter~~Six months ended ~~September 29, 2017 was $10.1 million, a decrease of $1.1 million, or 9.6%,~~June 28, 2019, compared to the $11.2 million for the quarter ended September 30, 2016. This decrease was due to lower operating income from our U.S. programs of $3.4 million and our Afghanistan programs of $0.3 million offset by higher operating income from our Middle East programs of $1.7 million and our European programs of $0.9 million.

~~Operating income as a percentage of revenue was 3.7% for the three~~six months ended ~~September~~June 29, ~~2017, compared to 3.9% for the three months ended September 30, 2016.~~

~~Nine months ended September 29, 2017, compared to nine months ended September 30, 2016~~2018

Selected financial highlights are presented in the following table:


	Nine Months Ended						Change					Six Months Ended						Change
	September 29,			September 30,
(In thousands)	2017			2016			$			%
(In thousands, except for percentages)												June 28, 2019			June 29, 2018			$			%
Revenue	$	819,005		$	902,359		$	(83,354	)	(9.2	)%	$	657,517		$	641,649		$	15,868		2.5	%
Cost of revenue	743,502			822,042			(78,540		)	(9.6	)%	596,149			586,114			10,035			1.7	%
% of revenue	90.8		%	91.1		%						90.7		%	91.3		%
Selling, general and administrative expenses	44,560			46,046			(1,486		)	(3.2	)%	39,762			33,865			5,897			17.4	%
% of revenue	5.4		%	5.1		%						6.0		%	5.3		%
Operating income	30,943			34,271			(3,328		)	(9.7	)%	21,606			21,670			(64		)	(0.3	)%
Operating margin	3.8		%	3.8		%						3.3		%	3.4		%
Interest (expense) income, net	(3,262		)	(4,396		)	(1,134		)	(25.8	)%
Interest expense, net												(2,904		)	(2,305		)	(599		)	(26.0	)%
Income before taxes	27,681			29,875			(2,194		)	(7.3	)%	18,702			19,365			(663		)	(3.4	)%
% of revenue	3.4		%	3.3		%						2.8		%	3.0		%
Income tax expense	9,751			10,629			(878		)	(8.3	)%	3,994			4,058			(64		)	(1.6	)%
Effective income tax rate	35.2		%	35.6		%						21.4		%	21.0		%
Net Income	$	17,930		$	19,246		$	(1,316	)	(6.8	)%	$	14,708		$	15,307		$	(599	)	(3.9	)%

Revenue

Revenue for the ~~nine~~six months ended ~~September 29, 2017,~~June 28, 2019 was ~~$819.0~~$657.5 million, ~~a decrease~~an increase of ~~$83.4~~$15.9 million, or ~~9.2%~~2.5%, as compared to the ~~nine~~six months ended ~~September 30, 2016.~~June 29, 2018. The ~~decrease~~increase in revenue was attributable to ~~lower activity~~increases from our Middle East programs of ~~$38.1 million, our Afghanistan programs of $36.5~~$10.9 million and our ~~U.S.~~European programs of ~~$10.1~~$9.8 million, offset by ~~an increase~~a decrease of ~~$1.3~~$4.8 million from our ~~European~~U.S. programs.

Cost of Revenue

The decrease in cost of revenue of $78.5 million, or 9.6%, for the nine months ended September 29, 2017, as compared to the nine months ended September 30, 2016, was primarily due to lower revenue as described above. Cost of revenue as a percentage of revenue was ~~90.8%~~90.7% compared to 91.3% for the ~~nine~~six months ended ~~September~~June 28, 2019 and the six months ended June 29, ~~2017 and 91.1%~~2018, respectively. The increase in cost of revenue of $10.0 million, or 1.7%, for the ~~nine~~six months ended ~~September 30, 2016.~~June 28, 2019, as compared to the six months ended June 29, 2018, was primarily due to increased revenue as described above.

~~Selling, General & Administrative (SG&A)~~SG&A Expenses

For the ~~nine~~six months ended ~~September 29, 2017,~~June 28, 2019, SG&A expenses of ~~$44.6~~$39.8 million ~~decreased~~increased by ~~$1.5~~$5.9 million, or ~~3.2%~~17.4%, as compared to ~~$46.1 million for~~ the ~~nine~~six months ended ~~September 30, 2016~~June 29, 2018. The increase was due primarily ~~due~~ to ~~prior cost savings initiatives.~~increased M&A costs of $1.7 million, stock-based compensation of $1.5 million, legal fees of $0.6 million and various miscellaneous expenses of $2.1 million.

2421

Table of Contents

Operating Income

Operating income for the six months ended June 28, 2019 decreased by $0.1 million, or 0.3%, as compared to the six months ended June 29, 2018. This decrease was primarily due to higher operating income of $1.0 million from our Middle East programs and $0.4 million from our European programs, offset by a decrease of $1.5 million from our U.S. programs. Overall operating income decreased primarily as a result of increased SG&A expense, as noted above.

Operating income as a percentage of revenue was 3.3% for the six months ended June 28, 2019, compared to 3.4% for the six months ended June 29, 2018.

Aggregate cumulative ~~catch-up~~ adjustments ~~for the nine months ended September 29, 2017 and the nine months ended September 30, 2016~~ increased operating income by ~~$8.6~~$0.8 million and ~~$4.2~~$6.6 million for the six months ended June 28, 2019 and June 29, 2018, respectively. The aggregate cumulative ~~catch-up~~ adjustments for the ~~nine~~six months ended ~~September 29, 2017~~June 28, 2019 related to ~~approved extensions~~higher margins associated with operational efficiencies related to labor and management of contract staffing. The aggregate cumulative adjustments for the six months ended June 29, 2018 related to higher margins associated with labor-related items and management of contract staffing, favorable resolution of contract claims, and contract close out costs, offset by higher subcontractor costs. The aggregate cumulative catch-up adjustments for the nine months ended September 30, 2016 related to changes in contract terms, program performance, customer scope changes, and changes to estimates in the reported period.staffing. The gross aggregate effects of these favorable and unfavorable changes in estimates ~~for~~in the ~~nine~~six months ended ~~September~~June 28, 2019 and June 29, ~~2017 and the nine months ended September 30, 2016~~2018 were ~~$14.1~~$5.2 million and ~~$9.2~~$10.4 million favorable to operating income, respectively, and ~~$5.5~~$4.4 million and ~~$5.0~~$3.9 million unfavorable to operating income, respectively.

Operating income, inclusive of aggregate cumulative catch-up adjustments, for the nine months ended September 29, 2017, decreased by $3.3 million, or 9.7%, as compared to the nine months ended September 30, 2016. This decrease was primarily due to lower operating income from our U.S. programs of $3.8 million and our Middle East programs of $0.6 million offset by higher operating income from our European programs of $0.8 million and our Afghanistan programs of $0.3 million.

~~Operating income as a percentage of revenue was 3.8% for both the nine months ended September 29, 2017 and September 30, 2016.~~

Interest (Expense) Income, Net

Interest (expense) income, net for the three and ~~nine~~six months ended ~~September~~June 28, 2019 and June 29, ~~2017 and September 30, 2016~~2018 was as follows:

Three Months Ended Change Nine Months Ended Change
September 29, September 30, September 29, September 30,
(In thousands) 2017 2016 $ % 2017 2016 $ %
Interest income $ 20
$ 6
$ 14
+(100)% $ 34
$ 39
$ (5 ) (12.8)%
Interest (expense) (1,078 ) (1,354 ) (276 ) (20.4)% (3,296 ) (4,435 ) (1,139 ) (25.7)%
Interest (expense) income, net $ (1,058 ) $ (1,348 ) $ (290 ) (21.5)% $ (3,262 ) $ (4,396 ) $ (1,134 ) (25.8)%



	Three Months Ended						Change					Six Months Ended						Change
(In thousands, except for percentages)	June 28, 2019			June 29, 2018			$			%		June 28, 2019			June 29, 2018			$			%
Interest income	$	69		$	23		$	46		200.6		$	108		$	39		$	69		176.9
Interest expense	(1,398		)	(1,163		)	(235		)	(20.2	)	(3,012		)	(2,344		)	(668		)	(28.5	)
Interest expense, net	$	(1,329	)	$	(1,140	)	$	(189	)	(16.6	)	$	(2,904	)	$	(2,305	)	$	(599	)	(26.0	)

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 ~~decrease~~increase in interest expense of ~~$0.3~~$0.2 million and ~~$1.1~~$0.6 million for the three and ~~nine~~six months ended ~~September 29, 2017~~June 28, 2019 compared to the three and ~~nine~~six months ended ~~September 30, 2016,~~June 29, 2018, respectively, was due to ~~a lower average debt balance~~increased use of our revolving credit facility in ~~the 2017 period.~~2019 to finance short-term working capital requirements.

Income Tax Expense

WeFor the three months ended June 28, 2019 and June 29, 2018, we recorded income tax ~~expense~~provisions of ~~$3.2~~$2.2 million and ~~$9.8~~$2.7 million ~~for the three and nine months ended~~ ~~September 29, 2017, respectively, and $3.2 million and $10.6 million for the three and nine months ended~~ ~~September 30, 2016,~~ respectively, representing effective income tax rates of ~~35.8%~~22.8% and ~~35.2%, respectively, and 32.7% and 35.6%~~22.5%, respectively. ~~The~~For the six months ended June 28, 2019 and June 29, 2018, we recorded income tax provisions of $4.0 million and $4.1 million, respectively, representing effective income tax rates ~~may vary from~~of 21.4% and 21.0%, respectively. The higher effective income tax rates in the ~~federal statutory rate~~2019 periods are the result of ~~35.0% due to state taxes, the tax effect of stock-based compensation, and other permanent book-tax differences.~~one-time discretionary items.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Historically, we have generated operating cash flow sufficient to fund our working capital, capital ~~expenditures,~~expenditure and financing requirements. We expect to fund our ongoing working capital, capital expenditure and financing requirements ~~and pursue additional growth via new development and potential acquisition opportunities~~ through cash flows from operations, cash on hand and access to capital ~~markets and credit facilities.~~markets. When necessary we will utilize our revolving credit facility to satisfy short-term working capital requirements.

~~Table of Contents~~

If our cash flows from operations are less than 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 or absence of a credit rating, (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. ~~The conclusion of the APS-5 Kuwait and APS-5 Qatar contracts with associated revenue and costs in April 2017 did not have a material impact on our liquidity.~~

The cash presented on our Condensed Consolidated Balance ~~Sheet~~Sheets consists of U.S. and international cash from wholly owned subsidiaries. Approximately ~~$11.5~~$15.8 million of our total ~~$63.4~~$70.3 million in cash at ~~September 29, 2017~~June 28, 2019 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.

Table of Contents

In ~~connection with the Spin-off,~~September 2014, we and our wholly-owned subsidiary, VSC, entered into a credit agreement with a group of lenders, including JPMorgan Chase Bank, N.A. as administrative agent. The credit agreement was amended as of April 19, 2016, to modify certain financial and negative covenants (as so amended, the Credit Agreement). On November 15, 2017, we and VSC entered into an Amendment and Restatement Agreement (the Amendment Agreement) with a group of lenders, including JPMorgan Chase Bank, N.A., as administrative agent, which provides for the amendment and restatement of the Credit Agreement. The Amendment Agreement provides for $200.0 million in senior secured ~~credit facility~~financing, consisting of a $80.0 million five-year term loan facility (the Amended Term Loan) ~~in the aggregate principal amount of $140.0 million~~ and a $120.0 million five-year senior secured revolving credit facility (the ~~Revolver) that permits borrowings up to $75.0~~Amended Revolver, and together with the Amended Term Loan, the Amended Credit Facilities). We used $74.6 million ~~of which $35.0 million will be available for the issuance of letters of credit (see Note 6, "Debt" in the Notes to the Condensed Consolidated Financial Statements). Net proceeds~~ from the Term Loan were used to fund a $136.3 million distribution to a subsidiary of Exelis on September 26, 2014. During 2016, 2015 and 2014, we made principal payments on the Term Loan of $29.0 million, $23.4 million and $2.6 million, respectively, reducing the principal balance on theAmended Term Loan to ~~$85.0 million as of December 31, 2016. As of September 29, 2017, the balance outstanding under the Term Loan was $74.5 million. In addition to the quarterly installments~~repay principal and accrued but unpaid interest on the ~~Term Loan, we voluntarily prepaid $15.0 million and $12.0 million of the principal of the Term Loan during the years ended December 31, 2016 and 2015, respectively.~~Credit Agreement. There were no outstanding borrowings under the Amended Revolver at ~~September 29, 2017.~~June 28, 2019. At ~~September 29, 2017,~~June 28, 2019, there were ~~eight~~seven letters of credit outstanding in the aggregate amount of ~~$12.2~~$8.1 million, which reduced our borrowing availability under the Amended Revolver to ~~$62.8~~$111.9 million. The Revolver expires on September 17, 2019. We have negotiated commitment letters and a term sheet for a new credit facility that we anticipate closing during the fourth quarter of 2017. Completion of the new credit facility and the timing of closing are subject to the negotiation of definitive agreements and market conditions.

Dividends

We do not currently plan to pay a regular dividend on our common stock. The declaration of any future cash dividends and if declared, the amount of any such dividends, 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~~consider 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. As of ~~September 29, 2017,~~June 28, 2019, the maximum amount of dividends we could pay ~~under~~was $19.3 million based upon the limitations within our ~~credit facility was $12.9 million.~~Amended Credit Facilities.

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. Our DSO was 5763 days as of ~~September 29, 2017~~both June 28, 2019 and December 31, ~~2016.~~

~~Table of Contents~~

2018.

The following table sets forth net cash ~~provided by (used in)~~used in operating activities, investing activities and financing activities:


	Nine Months Ended
	September 29,			September 30,			Six Months Ended
(In thousands)	2017			2016			June 28, 2019			June 29, 2018
Operating activities	$	22,398		$	33,484		$	15,450		$	4,172
Investing activities	(901		)	62			(11,739		)	(37,974		)
Financing activities	(9,226		)	(20,804		)	699			(1,445		)
Foreign exchange¹	3,524			614			(226		)	(1,248		)
Net change in cash	$	15,795		$	13,356		$	4,184		$	(36,495	)
¹Impact on cash balances due to changes in foreign exchange rates.

Trends in our operating cash flows tend to follow trends in ~~our~~ operating income, excluding non-cash charges. Net cash provided by operating activities for the ~~nine~~six months ended ~~September 29, 2017~~June 28, 2019 consisted of net income of ~~$17.9~~$14.7 million, increased by non-cash items of ~~$5.0~~$7.0 million and offset by unfavorable net working capital changes of ~~$0.6~~$1.9 million primarily due to the timing of cash ~~collections and~~ payments as reflected in ~~accounts payable, compensation and~~our increase in other ~~employee benefits,~~assets. Unfavorable net changes in other long-term assets and ~~receivables.~~liabilities contributed an additional $4.3 million to operating cash outflows.

Net cash provided by operating activities during the ~~nine~~six months ended ~~September 30, 2016~~June 29, 2018 consisted of net income of ~~$19.2~~$15.3 million, increased by non-cash items of ~~$6.3~~$4.4 million ~~and favorable~~offset by unfavorable net working capital changes of ~~$7.9~~$15.5 million primarily due to the timing of cash collections, ~~and payments,~~ as reflected in ~~receivables, accounts payable and compensation and other employee benefits.~~an increase in receivables.

Net cash used in investing activities for the ~~nine~~six months ended ~~September 29, 2017~~June 28, 2019 consisted of capital expenditures for the purchase of ~~capital~~intangible assets, software and hardware, leasehold improvements, and vehicles and equipment related to ongoing operations. Net cash used in investing activities during the six months ended June 29, 2018 consisted of ~~$0.9~~$37.2 million for the acquisition of SENTEL and $0.8 million for the purchase of hardware and software related to ongoing operations.

Net cash provided by ~~investing~~financing activities during the ~~nine~~six months ended ~~September 30, 2016~~June 28, 2019 consisted of ~~capital expenditures for purchases of capital assets offset by proceeds~~$3.5 million in cash received from the ~~disposition~~exercise of ~~capital assets~~stock options offset by repayments of long-term debt of $2.0 million and ~~a distribution from an equity investment (see Note 1, "Description~~payments related to

Table of ~~Business and Summary of Significant Accounting Policies - Principles of Consolidation and Equity Investment, "~~Contents

employee withholding taxes on share-based compensation in the ~~notes~~amount of $0.8 million. During the six months ended June 28, 2019, we borrowed and repaid a total of $98.0 million from the Amended Revolver to ~~our unaudited Condensed Consolidated Financial Statements).~~meet short-term working capital requirements.

Net cash used in financing activities ~~during~~for the ~~nine~~six months ended ~~September~~June 29, ~~2017~~2018 consisted of repayments of long-term debt of ~~$10.5~~$2.0 million and payments related to employee withholding taxes on share-based compensation in the amount of ~~$0.6~~$0.8 million, offset by ~~$1.9~~$1.4 million in cash received from the exercise of stock options. During the ~~nine~~six months ended ~~September~~June 29, ~~2017,~~2018, we borrowed and repaid a total of ~~$27.5~~$55.0 million from the Amended Revolver to meet short-term working capital ~~requirements.~~

~~Net cash used in financing activities during~~requirements and to fund a portion of the ~~nine months ended September 30, 2016 consisted primarily~~purchase price for the acquisition of repayments of long-term debt of $20.5 million, payments related to employee withholding taxes on share-based compensation in the amount of $0.7 million and a payment of $0.2 million related to an amendment of our credit agreement, offset by $0.6 million in cash received from the exercise of stock options. During the nine months ended September 30, 2016, we borrowed and repaid a total of $74.0 million from the Revolver to meet short-term working capital requirements.SENTEL.

Capital Resources

At ~~September 29, 2017,~~June 28, 2019, we held cash of ~~$63.4~~$70.3 million, which included ~~$11.5~~$15.8 million held by foreign subsidiaries, and had ~~$62.8~~$111.9 million of available borrowing capacity under the Amended Revolver, which expires on ~~September 17, 2019.~~November 15, 2022. We believe that our cash at ~~September 29, 2017,~~June 28, 2019, 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.

Contractual Obligations

During the ~~nine~~six months ended ~~September 29, 2017,~~June 28, 2019, we paid ~~$10.5~~$2.0 million in quarterly installment payments ~~due~~ on the Amended Term Loan. See Note 10, "Leases" for additional contractual obligation information.

Off-Balance Sheet Arrangements

We have obligations relating to operating leases and outstanding letters of ~~credit outstanding.~~credit. Our Amended Revolver permits borrowings up to ~~$75.0~~$120.0 million, of which ~~$35.0~~$25.0 million is available for the issuance of letters of credit. At ~~September 29, 2017,~~June 28, 2019, there were ~~eight~~seven letters of credit outstanding in the aggregate amount of ~~$12.2~~$8.1 million, which reduced our borrowing availability

~~Table of Contents~~

~~to $62.8 million~~ under the ~~Revolver.~~Amended Revolver to $111.9 million. These 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. At June 28, 2019, we had no material off-balance sheet arrangements.

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 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, goodwill impairment assessments and income taxes have the greatest potential impact on our financial statements. Therefore, we consider these to be our critical accounting policies and estimates.

Beginning January 1, 2019, we adopted ASU 2016-02 related to lease accounting. Refer to Note 10, "Leases" for further discussion regarding the impact of the adoption of this standard. There have been no other 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, ~~2016.~~2018.

New Accounting Pronouncements

~~See~~Refer to Part I, Item 1, Note 2, "Recent Accounting Pronouncements" 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

Table of Contents

uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. These risks and uncertainties include, but are not limited to: 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; integration of acquisitions into our business; 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; and 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; ~~security breaches~~ and ~~other disruptions~~ to maintain good relationships with our ~~information technology and operations;~~workforce; our teaming relationships with 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 and other~~liabilities; risks and uncertainties relating to the Spin-off; changes in U.S. generally accepted accounting principles; and other factors described in Item 1A, “Risk Factors,” and elsewhere in our Annual Report on Form 10-K for the year ended December 31, ~~2016~~2018 and described from time to time in our future reports filed with the SEC.

~~Table of Contents~~

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

~~Vectrus has limited exposure~~Our earnings, cash flows and financial position are exposed to market risks relating to fluctuations in interest rates and foreign currency exchange ~~risk as~~rates. All of the ~~substantial majority of our business is conducted in U.S. dollars. We~~potential changes noted below are ~~subject to interest rate risk with our Term Loan and Revolver, as both require us to pay interest~~based on ~~outstanding borrowings~~information available at ~~variable rates. Without giving effect to the impact of our interest rate swaps, each~~June 28, 2019.

Interest Rate Risk

Each one percentage point change associated with the variable rate Amended Term Loan would result in a $0.7 million change in our annual cash interest expenses. However, we have interest rate swaps in place to hedge a portion of this risk. Refer to Note 9, "Derivative Instruments" for additional information regarding our interest rate swaps.

Assuming our Amended Revolver was fully drawn to a principal amount equal to ~~$75.0~~$120.0 million, each one percentage point change in interest rates would result in a ~~$0.8~~$1.2 million change in our annual cash interest expense.

As of June 28, 2019, the notional value of our interest rate swap agreements totaled $54.9 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.

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 June 28, 2019, the U.S. dollar notional value of our outstanding foreign currency forward contracts was approximately $7.9 million. The net fair value of these contracts at June 28, 2019 was a liability of $0.3 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 June 28, 2019, 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 $0.4 million.

Table of Contents

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 Acting 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 ~~September 29, 2017.~~June 28, 2019. Based on such evaluation, the Chief Executive Officer and Acting Chief Financial Officer concluded that, as of ~~September 29, 2017,~~June 28, 2019, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed in reports the Company files or ~~submit~~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

Beginning January 1, 2019, we implemented ASC Topic 842. In connection with its adoption, we implemented changes to our processes and control activities related to lease accounting. These changes included updating policies and procedures to reflect the lease accounting and disclosure requirements.

There were no changes in our internal control over financial reporting that occurred during the quarter ended ~~September 29, 2017~~June 28, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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.

~~Among these proceedings, we are defending~~As a ~~class action employment lawsuit that was initiated in~~result of final indirect rate negotiations between the ~~United States District Court for the Western District of Washington in April 2010 against the predecessor of~~U.S. government and our Former Parent, we may be subject to potential adjustments to costs previously allocated by ~~individuals who worked on a particular contract in Kuwait after April 12, 2009. The plaintiffs are alleging a breach of employment contract by the predecessor of~~ our Former Parent ~~due~~ to ~~an alleged violation~~our business, which was formerly Exelis’ Mission Systems Business, from 2007 through September 2014. Because we do not participate in indirect rate negotiations between the U.S. government and our Former Parent, we cannot reasonably predict the likelihood of ~~Kuwait labor law.~~such adjustments or the ultimate responsible party. We have recently been in discussions with our Former Parent regarding the negotiated adjustments for 2007-2014 and believe that our potential cumulative liability for these years is insignificant. In ~~November 2016, following an interlocutory appeal by Vectrus,~~June 2019, the ~~Ninth Circuit Court of Appeals affirmed the District Court’s decision certifying a class of plaintiffs. We filed a petition for certiorari~~U.S. government provided us with the Contracting Officer's Final Decision for the years 2007 - 2010 related to Former Parent costs. We believe we are fully indemnified under our Distribution Agreement with our Former Parent. We have notified our former parent of the U.S. ~~Supreme Court on the class certification~~government's decision in ~~March 2017. On October 2, 2017, the U.S. Supreme Court denied certiorari. Vectrus continues to vigorously defend the lawsuit.~~this matter.

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.

~~See~~ Refer to Note 12,13, "Commitments and Contingencies" in the ~~Notes~~notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information.

ITEM 1A. RISK FACTORS

None.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

~~Table of Contents~~

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None.

Table of Contents

ITEM 6. EXHIBITS



3.1	Amended and Restated Articles of Incorporation of Vectrus, Inc. (incorporated by reference to Exhibit 3.1 to Vectrus, Inc.'s Current Report on Form 8-K filed on May 22, 2019)
3.2	Amended and Restated By-Laws of Vectrus, Inc. (incorporated by reference to Exhibit 3.2 to Vectrus, Inc.'s Current Report on Form 8-K filed on May 22, 2019)
31.1	Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 + +
31.2	Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 + +
32.1	Certification ~~Pursuant~~pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This Exhibit is intended to be furnished in accordance with Regulation S-K Item 601(b) (32) (ii) and shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934 or incorporated by reference into any future filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except as shall be expressly set forth by specific reference. + +
32.2	Certification ~~Pursuant~~pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This Exhibit is intended to be furnished in accordance with Regulation S-K Item 601(b) (32) (ii) and shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934 or incorporated by reference into any future filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except as shall be expressly set forth by specific reference. + +
101	The following materials from Vectrus, Inc.’s Quarterly Report on Form 10-Q for the quarter ended ~~September 29, 2017,~~June 28, 2019, formatted in XBRL (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 ~~(v)~~(vi) Notes to Condensed Consolidated Financial Statements. #

+ 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, Acting Chief Financial Officer and Chief Accounting Officer
(Principal Accounting Officer)
Date: ~~November 7, 2017~~August 6, 2019

3027



(In thousands)	Carrying Amount			Fair Value
Short-term debt	$	21,000		$	21,000
Long-term debt	53,500			53,500
Total debt	74,500			$	74,500
Debt financing fees	(847		)
Total debt with debt financing fees	$	73,653



(In thousands)	September 29, 2017		December 31, 2016
Accrued salaries and wages	$	23,587	$	14,741
Accrued bonus	3,052		4,371
Accrued employee benefits	16,131		15,805
Total	$	42,770	$	34,917



(In thousands)
Balance, December 31, 2016	$	2,014
Severance and related benefit costs - executive separations	468
Payments	(1,260		)
Adjustments	(46		)
Balance, September 29, 2017	$	1,176

(In thousands)

Fair Value

Balance sheet caption

Foreign currency forward designated as cash flow hedge

Other accrued liabilities

Foreign currency forward designated as cash flow hedge

Other non-current assets