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
V2X, Inc., an Indiana Corporation, formerly known as Vectrus, Inc. (Vectrus), is a leading provider of critical mission solutions and support to defense clients globally. The Company operates as one segment and delivers a comprehensive suite of integrated solutions across the operations and logistics, aerospace, training and technology markets to national security, defense, civilian and international clients.
Vectrus was incorporated in the State of Indiana in February 2014. On September 27, 2014, Exelis Inc, an Indiana corporation, spun-off (the Spin-off) Vectrus and Vectrus became an independent, publicly traded company. References in these notes to "Exelis" or "Former Parent" refer to Exelis Inc. and its consolidated subsidiaries (other than Vectrus). Exelis was acquired by a predecessor entity of L3Harris Technologies, Inc. in May 2015.
On March 7, 2022, Vectrus entered into an Agreement and Plan of Merger (the Merger Agreement) with Vertex Aerospace Services Holding Corp., a Delaware corporation (Vertex), Andor Merger Sub Inc., a Delaware corporation (Merger Sub Inc.) and Andor Merger Sub LLC, a Delaware limited liability company (Merger Sub LLC). On July 5, 2022 (the Closing Date), Vectrus completed its merger (Merger) thereby forming V2X, Inc. For a description of the Merger, see Note 3, Merger.
Unless the context otherwise requires or unless stated otherwise, references in these notes to "V2X", "we," "us," "our," “combined company”, "the Company" and "our Company" refer to V2X, Inc. and all of its consolidated subsidiaries (including, subsequent to the Merger, Vertex and its consolidated subsidiaries), taken together as a whole.
Equity Investments
In 2011, we entered into a joint venture agreement with Shaw Environmental & Infrastructure, Inc., which is now APTIM Federal Services LLC. Pursuant to the joint venture agreement, High Desert Support Services, LLC (HDSS) was established to pursue and perform work on the Ft. Irwin Installation Support Services Contract, which was awarded to HDSS in October 2012. In 2018, we entered into a joint venture agreement with J&J Maintenance. Pursuant to the joint venture agreement, J&J Facilities Support, LLC (J&J) was established to pursue and perform work on various U.S. government contracts. In 2020, we entered into a joint venture agreement with Kuwait Resources House for Human Resources Management and Services Company. Pursuant to the joint venture agreement, ServCore Resources and Services Solutions, LLC. (ServCore) was established to operate and manage labor and life support services outside of the continental United States at designated locations serviced by V2X and other contractors around the world.
We account for our investments in HDSS, J&J, and ServCore under the equity method as we have the ability to exercise significant influence, but do not hold a controlling interest in these entities. We record our proportionate share of income or losses from HDSS, J&J, and ServCore in selling, general and administrative (SG&A) expenses in the Condensed Consolidated Statements of Income. Our investment in these joint ventures is recorded in other non-current assets in the Condensed Consolidated Balance Sheets.
When we receive cash distributions from our equity method investments, the cash distribution is compared to cumulative earnings and cumulative cash distributions. Cash distributions received are recorded as a return on investment in operating cash flows within the Condensed Consolidated Statements of Cash Flows to the extent cumulative cash distributions are less than cumulative earnings. Any cash distributions in excess of cumulative earnings are recorded as a return of investment in investing cash flows within the Condensed Consolidated Statements of Cash Flows. During the nine months ended September 30, 2022, we received a net cash distribution of $0.8 million from our joint ventures. As of September 30, 2022 and December 31, 2021 our joint venture investment balance was $6.0 million and $5.4 million, respectively. Our proportionate share of income from the HDSS, J&J, and ServCore joint ventures was $1.4 million for the first three quarters of both 2022 and 2021.
Basis of Presentation
Our quarterly financial periods end on the Friday closest to the last day of the calendar quarter (September 30, 2022 for the third quarter of 2022 and October 1, 2021 for the third quarter of 2021), 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 V2X have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Accordingly, certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles (GAAP) in the U.S. have been omitted. These unaudited interim Condensed Consolidated Financial Statements
should be read in conjunction with our audited Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2021.
It is management’s opinion that these financial statements include all normal and recurring adjustments necessary for a fair presentation of the Company’s financial position and operating results. Revenue and net income for any interim period are not necessarily indicative of future or annual results.
Restricted Cash
The Company had restricted cash of $3.3 million related to collateral security for two outstanding letters of credit at September 30, 2022 and no restricted cash as of December 31, 2021.
Reconciliation of cash, cash equivalents and restricted cash as of September 30, 2022 is presented in the following table:
| | | | | | | | |
| (In thousands) | | September 30, 2022 |
| Cash and cash equivalents | | $ | 144,061 | |
| Restricted cash | | 3,312 | |
| Total cash, cash equivalents and restricted cash | | $ | 147,373 | |
NOTE 2
RECENT ACCOUNTING STANDARDS UPDATE
Accounting Standards That Were Adopted
In October 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (ASU 2021-08). The amendment requires contract assets and contract liabilities acquired in a business combination to be recognized and measured in accordance with ASC 606, Revenue from Contracts with Customers, as if the acquirer had originated the contract. The amendment also provides certain practical expedients when applying the guidance. ASU No. 2021-08 is effective for interim and annual periods beginning after December 15, 2022, on a prospective basis, with early adoption permitted. Early adoption is to be applied to all business combinations that occur during the fiscal year that the amendment is adopted. We adopted this standard in the third quarter of 2022 and applied the guidance to our Merger.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (ASU 2020-04). To ease the burden in accounting for reference rate reform on financial reporting, the ASU provides companies with optional expedients and exceptions for applying accounting guidance to contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued because of reference rate reform. The Company adopted the standard during the first quarter of 2022. It did not have a material impact on the Company's financial statements.
NOTE 3
MERGER
On July 5, 2022, the Closing Date, Vectrus completed its previously announced Merger with Vertex, forming V2X, a global leader in aerospace and defense technologies, by acquiring all of the outstanding shares of Vertex. On the Closing Date, Vertex and its consolidated subsidiaries became wholly-owned subsidiaries of the Company.
The combined V2X entity from the Merger is a larger and more diversified Company with the ability to compete for more integrated business opportunities and generate revenue across geographies, clients, and contract types in supporting the mission of our customers.
The operating results of Vertex subsequent to the Closing Date are included in the Company's consolidated results of operations. Vertex and its consolidated subsidiaries recognized revenue of $451.6 million, operating income of $0.6 million and net loss of $12.6 million for the period from the Closing Date until September 30, 2022.
The Company recognized $28.2 million and $41.3 million of acquisition-related costs that were expensed as incurred during the three and nine months ended September 30, 2022, respectively. These costs are included in SG&A expense in the Condensed Consolidated Statements of Income.
Purchase Price Allocation
The Merger is accounted for as a business combination. As such, the assets acquired and liabilities assumed are accounted for at fair value, with the excess of the purchase price over the fair value of the net identifiable assets acquired and liabilities assumed recorded as goodwill.
The Closing Date fair value of the consideration transferred totaled $634.0 million, which was comprised of the following:
| | | | | | | | |
| ($ in thousands, except share and per share amounts) | | Purchase Price |
| Shares of V2X common stock issued | | 18,591,866 | |
| Market price per share of V2X as of Closing Date | | $ | 33.92 | |
| Fair value of common shares issued | | $ | 630,636 | |
| Fair value of cash consideration | | 3,315 | |
| Total consideration transferred | | $ | 633,951 | |
The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed in the Merger as of the Closing Date. The estimated fair value of Vertex’s assets acquired and liabilities assumed at the acquisition date are determined based on preliminary valuations and analyses. As of September 30, 2022, we considered these amounts to be preliminary because we are still in the process of gathering and reviewing information to support the valuations of certain contractual and operational factors underlying the customer related intangible assets, details surrounding tax matters and assumptions underlying certain existing or potential reserves, such as those for legal matters. The final determination could result in material adjustments.
| | | | | | | | |
| (In thousands) | | Preliminary Fair Value |
| Cash and cash equivalents | | $ | 197,747 | |
| Receivables | | 336,169 | |
| | |
| Prepaid expenses | | 49,531 | |
| | |
| Property, plant, and equipment, net | | 53,618 | |
| | |
| Intangibles assets, net | | 522,000 | |
| Other assets | | 18,670 | |
| | |
| | |
| Accounts payable | | (122,269) | |
| Net debt | | (1,352,304) | |
| Accrued payroll | | (49,282) | |
| | |
| | |
| | |
| | |
| | |
| Other liabilities | | (235,905) | |
| Total identifiable net assets | | (582,025) | |
| Goodwill | | 1,215,976 | |
| Total purchase consideration | | $ | 633,951 | |
As a result of the Merger, the Company recognized $1,216.0 million of goodwill. The goodwill recognized is attributable to operational and general and administrative cost synergies, expanded market opportunities and other benefits that do not qualify for separate recognition. None of the goodwill is expected to be deductible for tax purposes. In addition, $522.0 million was recognized for customer related amortizable intangible assets with a weighted average life of 7.4 years.
As part of the Merger, V2X acquired certain contracts, including a Transition Services Agreement (TSA) with Crestview Aerospace LLC (Crestview), which was previously divested to American Industrial Partners Capital Fund VI, L.P. (AIP). As of September 30, 2022, the Company recorded $0.9 million of income related to the TSA with Crestview, which was recorded as a reduction in cost of sales. AIP currently holds approximately 62% of V2X common stock.
The following unaudited pro forma information shows the combined results of our operations for the three and nine months ended September 30, 2022 and 2021 as if the Merger had occurred on January 1, 2021. The unaudited pro forma information reflects the effects of applying our accounting policies and certain pro forma adjustments to the combined historical financial information of Vertex. The pro forma adjustments include: a) incremental amortization expense associated with identified intangible assets; b) incremental interest expense resulting from fair value adjustments applied to the Vertex debt that we assumed; and c) a reduction of revenues and operating expenses associated with fair value adjustments made to acquire assets and assumed liabilities, such as contract cost assets and contract liabilities.
This unaudited pro forma information is presented for informational purposes only and may not necessarily reflect the actual results of operations that would have been achieved, nor are they necessarily indicative of future results of operations.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | Nine Months Ended |
| | September 30, | | October 1, | | September 30, | | October 1, |
| In thousands | | 2022 | | 2021 | | 2022 | | 2021 |
| Pro forma Revenue | | $ | 961,281 | | | $ | 876,267 | | | $ | 2,691,399 | | | $ | 2,555,502 | |
| Pro forma Net Income (Loss) | | $ | 9,576 | | | $ | 19,476 | | | $ | 5,583 | | | $ | (4,645) | |
NOTE 4
REVENUE
Performance Obligations
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account for revenue in ASC Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. To determine the proper revenue recognition method, consideration is given as to whether a single contract should be accounted for as more than one performance obligation. For most of our contracts, the customer contracts with us to perform an integrated set of tasks and deliverables as a single service solution, whereby each service is not separately identifiable from other promises in the contract and therefore is not distinct. As a result, when this integrated set of tasks exists, the contract is accounted for as one performance obligation. The vast majority of our contracts have a single performance obligation. Unexercised contract options and indefinite delivery and indefinite quantity (IDIQ) contracts are considered to be separate performance obligations when the option or IDIQ task order is exercised or awarded.
Contracts are often modified to account for changes in contract specifications and requirements. If the modification either creates new enforceable rights and obligations or changes the existing enforceable rights and obligations, the modification will be treated as a separate contract. Our contract modifications, except for those to exercise option years, have historically not been distinct from the existing contract and have been accounted for as if they were part of that existing contract.
The Company's performance obligations are satisfied over time as services are provided throughout the contract term. We recognize revenue over time using the input method (e.g., costs incurred to date relative to total estimated costs at completion) to measure progress. Our over time recognition is reinforced by the fact that our customers simultaneously receive and consume the benefits of our services as they are performed. For most U.S. government contracts, this continuous transfer of control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. This continuous transfer of control requires that we track progress towards completion of performance obligations in order to measure and recognize revenue.
The Company's contracts are multi-year contracts and typically include an initial period of one year or less with annual one-year or less option periods. The number of option periods varies by contract, and there is no guarantee that an option period will be exercised. The right to exercise an option period is at the sole discretion of the U.S. government when we are the prime contractor or of the prime contractor when we are a subcontractor. We expect to recognize a substantial portion of our performance obligations as revenue within the next 12 months. However, the U.S. government or the prime contractor may cancel any contract at any time through a termination for convenience or for cause. Substantially all of our contracts have terms that would permit us to recover all or a portion of our incurred costs and fees for work performed in the event of a termination for convenience.
Remaining performance obligations as of September 30, 2022 and December 31, 2021 are presented in the following table:
| | | | | | | | | | | | | | |
| | |
| | September 30, | | December 31, |
| (In millions) | | 2022 | | 2021 |
| Performance Obligations | | $ | 3,362 | | | $ | 1,398 | |
As of September 30, 2022, we expect to recognize approximately 26% of the remaining performance obligations as revenue in 2022 and the remaining 74% during 2023.
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 negotiations with the customer on contract modifications. When the estimates of total costs to be incurred on a contract exceed total estimates of the transaction price, a provision for the entire loss is determined at a contract level and is recognized in the period in which the loss was determined.
The impact of adjustments in contract estimates on our operating income can be reflected in either revenue or cost of revenue. Cumulative catch-up adjustments are driven by changes in contract terms, program performance, customer scope changes, and changes to estimates in the reported period. These changes can increase or decrease operating income depending on the dynamics of each contract. Cumulative catch-up adjustments for the three and nine months ended September 30, 2022 decreased operating income by $1.5 million and increased operating income $5.9 million, respectively. For the three and nine months ended October 1, 2021, the adjustments increased operating income by $2.6 million and decreased operating income by $0.4 million, respectively.
For the three and nine months ended September 30, 2022, the cumulative catch-up adjustments to operating income decreased revenue by $1.7 million and increased revenue by $6.1 million, respectively. For the three and nine months ended October 1, 2021, the cumulative catch-up adjustments to operating income increased revenue by $3.0 million and $1.4 million, respectively.
Revenue by Category
Generally, the sales price elements for our contracts are cost-plus, cost-reimbursable or firm-fixed-price. We commonly have elements of cost-plus, cost-reimbursable and firm-fixed-price contracts on a single contract. On a cost-plus type contract, we are paid our allowable incurred costs plus a profit, which can be fixed or variable depending on the contract’s fee arrangement, up to funding levels predetermined by our customers. On cost-plus type contracts, we do not bear the risks of unexpected cost overruns, provided that we do not incur costs that exceed the predetermined funded amounts. Most of our cost-plus contracts also contain a firm-fixed price element. Cost-plus type contracts with award and incentive fee provisions are our primary variable contract fee arrangement. Award fees provide for a fee based on actual performance relative to contractually specified performance criteria. Incentive fees provide for a fee based on the relationship between total allowable and target cost. On most of our contracts, a cost-reimbursable element captures consumable materials required for the contract. Typically, these costs do not bear fees.
On a firm-fixed-price type contract, we agree to perform the contractual statement of work for a predetermined contract price. A firm-fixed-price type contract typically offers higher profit margin potential than a cost-plus type contract, which is commensurate with the greater levels of risk we assume on a firm-fixed-price type contract. Although a firm-fixed-price type contract generally permits us to retain profits if the total actual contract costs are less than the estimated contract costs, we bear the risk that increased or unexpected costs may reduce our profit or cause us to sustain losses on the contract. Although the overall scope of work required under the contract may not change, profit may be adjusted as experience is gained and as efficiencies are realized or costs are incurred.
On a time-and-materials type contract, we are reimbursed for labor at fixed hourly rates and generally reimbursed separately for allowable materials, costs, and expenses at cost. For this contract type, we bear the risk when our labor costs and allocable indirect expenses exceed the fixed hourly rate specified within the contract.
Revenue by contract type for the three and nine months ended September 30, 2022 and October 1, 2021 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | September 30, | | October 1, | | % | | September 30, | | October 1, | | % |
| (In thousands) | | 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change |
| Cost-plus and cost-reimbursable | | $ | 505,743 | | | $ | 338,007 | | | 49.6 | % | | $ | 1,172,397 | | | $ | 972,426 | | | 20.6 | % |
| Firm-fixed-price | | 416,618 | | | 105,619 | | | 294.5 | % | | 672,970 | | | 345,792 | | | 94.6 | % |
| Time and material | | 35,795 | | | 15,782 | | | 126.8 | % | | 67,326 | | | 46,039 | | | 46.2 | % |
| Total revenue | | $ | 958,156 | | | $ | 459,408 | | | | | $ | 1,912,693 | | | $ | 1,364,257 | | | |
Revenue by geographic region in which the contract is performed for the three and nine months ended September 30, 2022 and October 1, 2021 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | September 30, | | October 1, | | % | | September 30, | | October 1, | | % |
| (In thousands) | | 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change |
| United States | | $ | 582,817 | | | $ | 139,357 | | | 318.2 | % | | $ | 908,271 | | | $ | 435,717 | | | 108.5 | % |
| Middle East | | 261,997 | | | 263,257 | | | (0.5) | % | | 747,310 | | | 761,758 | | | (1.9) | % |
| Europe | | 62,669 | | | 34,902 | | | 79.6 | % | | 143,847 | | | 111,604 | | | 28.9 | % |
| Asia | | 50,673 | | | 21,892 | | | 131.5 | % | | 113,265 | | | 55,178 | | | 105.3 | % |
| Total revenue | | $ | 958,156 | | | $ | 459,408 | | | | | $ | 1,912,693 | | | $ | 1,364,257 | | | |
Revenue by contract relationship for the three and nine months ended September 30, 2022 and October 1, 2021 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | September 30, | | October 1, | | % | | September 30, | | October 1, | | % |
| (In thousands) | | 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change |
| Prime contractor | | $ | 886,415 | | | $ | 429,370 | | | 106.4 | % | | $ | 1,781,961 | | | $ | 1,272,671 | | | 40.0 | % |
| Subcontractor | | 71,741 | | | 30,038 | | | 138.8 | % | | 130,732 | | | 91,586 | | | 42.7 | % |
| Total revenue | | $ | 958,156 | | | $ | 459,408 | | | | | $ | 1,912,693 | | | $ | 1,364,257 | | | |
Revenue by customer for the three and nine months ended September 30, 2022 and October 1, 2021 is as follows:
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| | Three Months Ended | | Nine Months Ended |
| | September 30, | | October 1, | | % | | September 30, | | October 1, | | % |
| (In thousands) | | 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change |
| Army | | $ | 352,923 | | | $ | 304,341 | | | 16.0 | % | | $ | 959,792 | | | $ | 869,690 | | | 10.4 | % |
| Air Force | | 165,085 | | | 63,569 | | | 159.7 | % | | 295,015 | | | 207,565 | | | 42.1 | % |
| Navy | | 270,071 | | | 52,556 | | | 413.9 | % | | 410,173 | | | 165,391 | | | 148.0 | % |
| Other | | 170,077 | | | 38,942 | | | 336.7 | % | | 247,713 | | | 121,611 | | | 103.7 | % |
| Total revenue | | $ | 958,156 | | | $ | 459,408 | | | | | $ | 1,912,693 | | | $ | 1,364,257 | | | |
Contract Balances
The timing of revenue recognition, billings, and cash collections results in billed and unbilled accounts receivable (contract assets) and customer advances and deposits (contract liabilities). 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 fund current operating expenses under the contract. 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 September 30, 2022 and December 31, 2021, we had contract assets of $490.1 million and $240.0 million, respectively. Contract assets primarily consist of unbilled receivables, which represent rights to consideration for work completed but not billed as of the reporting date. The balance of unbilled receivables consists of costs and fees that are: (i) billable immediately; (ii) billable on contract completion; or (iii) billable upon other specified events, such as the resolution of a request for equitable adjustment (REA). For additional information regarding the composition of our receivables, see Note 5, Receivables. As of both September 30, 2022 and December 31, 2021, our contract liabilities were $80.7 million and $5.5 million, respectively.
NOTE 5
RECEIVABLES
Receivables were comprised of the following:
| | | | | | | | | | | | | | |
| | | | |
| (In thousands) | | September 30, 2022 | | December 31, 2021 |
| Billed receivables | | $ | 190,358 | | | $ | 104,074 | |
| Unbilled receivables (contract assets) | | 490,101 | | | 239,979 | |
| Other | | 10,484 | | | 4,552 | |
| Total receivables | | $ | 690,943 | | | $ | 348,605 | |
As of September 30, 2022 and December 31, 2021, substantially all billed receivables are due from the U.S. government, either directly as prime contractor to the U.S. government or as subcontractor to another prime contractor to the U.S. government. Because the Company's billed receivables are with the U.S. government, the Company does not believe it has material credit risk exposure.
Unbilled receivables are contract assets that represent revenue recognized on long-term contracts in excess of amounts billed as of the balance sheet date.
We expect to bill customers for the majority of the September 30, 2022 contract assets during 2022. Changes in the balance of receivables are primarily due to the timing differences between our performance and customers' payments.
NOTE 6
GOODWILL AND INTANGIBLE ASSETS
As of September 30, 2022 and December 31, 2021 the carrying amount of goodwill was $1,537.7 million and $321.7 million respectively. The $1,216.0 million increase for the nine months ended September 30, 2022 relates to the Merger. For a description of the Merger, see Note 3, Merger.
The Company tests goodwill for impairment on the first day of the Company's fourth fiscal quarter each year, or more frequently should circumstances change or events occur that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
Identifiable intangible assets consist of the following:
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| | September 30, 2022 | | December 31, 2021 |
| (In thousands) | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount |
| Contract backlogs | | $ | 441,300 | | | $ | (39,621) | | | $ | 401,679 | | | $ | 77,300 | | | $ | (14,988) | | | $ | 62,312 | |
| Customer contracts | | 165,200 | | | (7,353) | | | 157,847 | | | 7,200 | | | (3,572) | | | 3,628 | |
| Trade names and other | | 1,249 | | | (790) | | | 459 | | | 1,249 | | | (607) | | | 642 | |
| Balance | | $ | 607,749 | | | $ | (47,764) | | | $ | 559,985 | | | $ | 85,749 | | | $ | (19,167) | | | $ | 66,582 | |
Identifiable intangible asset amortization expense was $24.2 million and $28.6 million for the three and nine months ended September 30, 2022, respectively. Intangible asset amortization for the three and nine months ended October 1, 2021 was $2.6 million and $7.5 million, respectively. As of September 30, 2022, the remaining average intangible asset amortization period was 7.43 years.
Future estimated amortization expense is as follows (in thousands):
| | | | | | | | | | | | | | |
| Period | | | | Amortization |
| 2022 (remainder of the year) | | $ | 25,165 | |
| 2023 | | $ | 100,661 | |
| 2024 | | $ | 99,554 | |
| 2025 | | $ | 98,757 | |
| 2026 | | $ | 98,286 | |
| After 2026 | | $ | 137,562 | |
NOTE 7
DEBT
Senior Secured Credit Facilities
In September 2014, Vectrus and its wholly-owned subsidiary, Vectrus Systems Corporation (VSC), entered into a senior secured credit agreement. The credit agreement was subsequently amended on December 24, 2020 and January 24, 2022 and is collectively referred to as the Prior Credit Agreement. The credit agreement consisted of a term loan (Amended Term Loan) and a $270.0 million revolving credit facility (Amended Revolver).
On the Closing Date, the outstanding debt from the Amended Term Loan and the Amended Revolver, $50.2 million and $40.0 million, respectively, was repaid and related guarantees and liens were discharged and released. Repayment was made using proceeds from the Vertex First Lien Credit Agreement described below. As of December 31, 2021, the balance outstanding under the Amended Term Loan and the Amended Revolver, was $55.4 million and $50.0 million, respectively
On the Closing Date, certain of our subsidiaries, including VSC (and together with VSC, the Company Guarantor Subsidiaries), that became direct or indirect subsidiaries of Vertex Aerospace Service Corp., a Delaware corporation and wholly-owned indirect subsidiary of Vertex (Vertex Borrower), have provided guarantees of the indebtedness under each of:
(i) the First Lien Credit Agreement, dated as of December 6, 2021 (as amended by the Amendment No. 1 to First Lien Credit Agreement, dated as of the Closing Date, and as further amended, restated, amended and restated, supplemented and otherwise modified from time to time, the Vertex First Lien Credit Agreement), by and among
Vertex Borrower, as borrower, Vertex Aerospace Intermediate LLC, a Delaware limited liability company, direct parent entity of Vertex Borrower and wholly-owned indirect subsidiary of Vertex (Vertex Holdings), the lenders from time to time party thereto and Royal Bank of Canada, as administrative agent;
(ii) the Second Lien Credit Agreement, dated as of December 6, 2021 (as amended, restated, amended and restated, supplemented and otherwise modified from time to time, the Vertex Second Lien Credit Agreement), Vertex Borrower, as borrower, Vertex Holdings, the lenders from time to time party thereto and Royal Bank of Canada, as administrative agent; and
(iii) the ABL Credit Agreement, dated as of June 29, 2018 (as amended by the First Amendment to ABL Credit Agreement, dated as of May 17, 2019, as further amended by the Second Amendment to ABL Credit Agreement, dated as of May 17, 2021, and as further amended by the Third Amendment to ABL Credit Agreement, dated as of December 6, 2021, as further amended by the Fourth Amendment to ABL Credit Agreement, dated as of the Closing Date, and as further amended, restated, amended and restated, supplemented and otherwise modified from time to time, the Vertex ABL Credit Agreement), by and among Vertex Borrower, Vertex Holdings, certain other subsidiaries of Vertex Borrower from time to time party thereto as co-borrowers, the lenders from time to time party thereto and Ally Bank, as administrative agent (in such capacity, the ABL Agent).
Vertex First Lien Credit Agreement.
The Vertex First Lien Credit Agreement provides for senior secured first lien term loans in an aggregate principal amount of $1,185.0 million, consisting of a $925.0 million term loan “B” tranche, (the First Lien Initial Term Tranche) and a $260.0 million incremental term loan “B” tranche (the First Lien Incremental Term Tranche and, together with the First Lien Initial Term Tranche, collectively, the First Lien Term Facility). The entire amount of the proceeds from the (i) First Lien Initial Term Tranche were previously used to finance the acquisition of certain subsidiaries of Raytheon Company, a Delaware corporation, and related transaction costs (the Sky Acquisition in December 2021). As provided in the Merger Agreement, the proceeds of the First Incremental Term Tranche were used by the Vertex Borrower to redeem all of the shares of previously issued preferred stock on the Closing Date (but prior to the Merger). The remaining First Lien Incremental Term Tranche proceeds were used to repay in full all outstanding indebtedness under the Prior Credit Agreement, and other transaction costs. Approximately $54.0 million of cash remained after funding the preferred stock redemption, repayment of the Prior Credit Agreement and other transaction costs. The loans under the First Lien Term Facility will be payable in full on December 6, 2028.
The First Lien Term Facility amortizes in an amount equal to approximately $3.0 million per quarter for the fiscal quarters ending September 30, 2022, through September 30, 2028, with the balance of $1,108.6 million due on December 6, 2028.
The Vertex Borrower’s obligations under the First Lien Term Facility, which were assumed in the Merger, are guaranteed by Vertex Holdings and Vertex Borrower’s wholly-owned domestic subsidiaries (including the Company Guarantor Subsidiaries, collectively, the First Lien Guarantors), subject to customary exceptions and limitations. The Vertex Borrower’s obligations under the First Lien Term Facility and the First Lien Guarantors’ obligations under the related guarantees are secured by (i) a first priority-lien on substantially all of the Vertex Borrower’s and the First Lien Guarantors’ assets other than the ABL Priority Collateral, as defined below (subject to customary exceptions and limitations), and (ii) a second-priority lien on substantially all of the Vertex Borrower’s and the First Lien Guarantors’ accounts receivable, inventory and certain other assets arising therefrom or related thereto (collectively, the ABL Priority Collateral) (subject to customary exceptions and limitations).
The borrowings under the First Lien Initial Term Tranche bear interest at rates that, at the Vertex Borrower’s option, can be either a base rate, determined by reference to the federal funds rate, plus a margin of 2.50% to 3.75% per annum, or a Eurodollar rate, determined by reference to LIBOR, plus a margin of 3.50% to 3.75% per annum, in each case, depending on the consolidated first lien net leverage ratio of the Vertex Borrower and its subsidiaries. As of September 30, 2022, the effective interest rate for the First Lien Initial Term Tranche was 7.63%. The borrowings under the First Lien Incremental Term Tranche bear interest at rates that, at the Vertex Borrower’s option, can be either a base rate, determined by reference to the federal funds rate, plus a margin of 3.00% per annum, or a term benchmark rate, determined by reference to Term SOFR, plus a margin of 4.00% per annum. As of September 30, 2022, the effective interest rate for the First Lien Incremental Term Tranche was 7.90%
The Vertex First Lien Credit Agreement contains customary representations and warranties and affirmative covenants. The Vertex First Lien Credit Agreement also includes negative covenants that limit, among other things, additional indebtedness, additional liens, sales of assets, dividends, investments and advances, prepayments of debt and mergers and acquisitions.
The Vertex First Lien Credit Agreement contains customary events of default, including, but not limited to, payment defaults, breaches of representations and warranties, covenant defaults, events of bankruptcy and insolvency, failure of any guaranty or security document supporting the First Lien Term Facility to be in full force and effect, and a change of control. If
an event of default occurs and is continuing, the Vertex Borrower may be required immediately to repay all amounts outstanding under the Vertex First Lien Credit Agreement.
As of September 30, 2022, the carrying value of the First Lien Credit Agreement was $1,122.8 million, net of deferred discount and unamortized deferred financing costs of $56.9 million. The estimated fair value of the First Lien Credit Agreement as of September 30, 2022 was $1,138.4 million. 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.
Vertex Second Lien Credit Agreement.
The Vertex Second Lien Credit Agreement provides for senior secured second lien term loans in an aggregate principal amount of $185.0 million (the Second Lien Term Facility). The entire amount of the proceeds from the Second Lien Term Facility were previously used to finance the Sky Acquisition in December 2021. The loans under the Second Lien Term Facility will be payable in full on December 6, 2029.
The Vertex Borrower’s obligations under the Second Lien Term Facility are guaranteed by Vertex Holdings and the Vertex Borrower’s wholly-owned domestic subsidiaries (including the Company Guarantor Subsidiaries, collectively, the Second Lien Guarantors), subject to customary exceptions and limitations. The Vertex Borrower’s obligations under the Second Lien Term Facility and the Second Lien Guarantors’ obligations under the related guarantees are secured by (i) a second priority-lien on substantially all of the Vertex Borrower’s and Second Lien Guarantors’ assets other than the ABL Priority Collateral (subject to customary exceptions and limitations), and (b) a third-priority lien on substantially all of the Vertex Borrower’s and Second Lien Guarantors’ assets ABL Priority Collateral (subject to customary exceptions and limitations).
The borrowings under the Second Lien Term Facility bear interest at rates that, at the Vertex Borrower’s option, can be either a base rate, determined by reference to the federal funds rate, plus a margin of 6.50% per annum, or a Eurodollar rate, determined by reference to LIBOR, plus a margin of 7.50% per annum. As of September 30, 2022, the effective interest rate for Second Lien Term Facility was 11.28%.
The Vertex Second Lien Credit Agreement contains customary representations and warranties and affirmative covenants. The Vertex Second Lien Credit Agreement also includes negative covenants that limit, among other things, additional indebtedness, additional liens, sales of assets, dividends, investments and advances, prepayments of debt and mergers and acquisitions.
The Vertex Second Lien Credit Agreement contains customary events of default, including, but not limited to, payment defaults, breaches of representations and warranties, covenant defaults, events of bankruptcy and insolvency, failure of any guaranty or security document supporting the First Lien Term Facility to be in full force and effect, and a change of control. If an event of default occurs and is continuing, the Vertex Borrower may be required immediately to repay all amounts outstanding under the Vertex Second Lien Credit Agreement.
As of September 30, 2022, the carrying value of the Second Lien Credit Agreement was $176.0 million, net of a deferred discount of $9.0 million. The estimated fair value of the Second Lien Credit Agreement as of September 30, 2022 was $173.0 million. 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.
Vertex ABL Credit Agreement
The Vertex ABL Credit Agreement provides for a senior secured revolving loan facility (the ABL Facility) of up to an aggregate amount of $200.0 million (the loans thereunder, the ABL Loans). The Vertex ABL Credit Agreement also provides for (i) a $30.0 million sublimit of availability for letters of credit, and (ii) a $10.0 million sublimit for short-term borrowings on a swingline basis. The commitments under the ABL Facility expire on June 29, 2026, and any ABL Loans then outstanding will be payable in full at that time.
Availability under the ABL Facility is subject to a borrowing base (the Borrowing Base), which is based on 85% of eligible accounts receivable, eligible government account receivable and eligible government subcontract accounts receivable, plus 50% of eligible unbilled accounts receivable, plus the lesser of (x) 65% of the book value of eligible inventory, and (y) 85% of the net orderly liquidation value of eligible inventory of the Vertex Borrower, Vertex Holdings and most of the Vertex Borrower’s wholly-owned domestic subsidiaries (including the Company Guarantor Subsidiaries, collectively, the ABL Guarantors), after adjusting for customary reserves that are subject to the ABL Agent’s discretion. The aggregate amount of the ABL Loans made and letters of credit issued under the ABL Facility shall at no time exceed the lesser of the aggregate commitments under the ABL Facility (currently $200.0 million) or the Borrowing Base. To the extent that the Vertex Borrower’s and ABL Guarantors’ eligible accounts receivable, eligible government account receivable, eligible government subcontract accounts receivable, eligible unbilled accounts receivable, and eligible inventory, decline, the Borrowing Base will decrease, and the availability under the ABL Facility may decrease below $200.0 million. Any ABL Loans requested are subject to a number of customary conditions, including accuracy of representations and warranties and no default. The proceeds from the ABL Loans may be used to finance the working capital needs and general corporate purposes of the Vertex Borrower and its subsidiaries.
The Vertex Borrower’s obligations under the ABL Term Facility are guaranteed by the ABL Guarantors, subject to customary exceptions and limitations. The Vertex Borrower’s obligations under the ABL Facility and the ABL Subsidiary Guarantors’ obligations under the related guarantees are secured by (a) a first priority-lien on substantially all of the Vertex Borrower’s and the ABL Guarantors’ ABL Priority Collateral (subject to customary exceptions and limitations), and (b) a third priority-lien on substantially all of the Vertex Borrower’s and the ABL Guarantors’ assets other than the ABL Priority Collateral (subject to customary exceptions and limitations).
The borrowings under the ABL Facility bear interest at rates that, at the Vertex Borrower’s option, can be either a base rate, determined by reference to the federal funds rate, plus a margin of 0.75% to 1.25% per annum, or a term benchmark rate, determined by reference to Term SOFR, plus a margin of 1.75% to 2.25% per annum, in each case, depending on the aggregate availability under the ABL Facility.
Unutilized commitments under the ABL Facility are subject to a per annum fee of (x) 0.375% if the total outstandings were equal to or less than 50% of the aggregate commitments, or (y) 0.25% if such total outstandings were more than 50% of the aggregate commitments.
The Vertex Borrower is also required to pay a letter of credit fronting fee to each letter of credit issuer equal to 0.125% per annum of the amount available to be drawn under each such letter of credit (or such other amount as may be mutually agreed by the Vertex Borrowers and the applicable letter of credit issuer), as well as a fee to all lenders equal to the applicable margin for Term SOFR ABL Loans times the average daily amount available to be drawn under all outstanding letters of credit.
The Vertex ABL Credit Agreement contains customary representations and warranties, that must be accurate in order for the Vertex Borrower to borrow under the ABL Facility, and affirmative covenants. The Vertex ABL Credit Agreement also includes negative covenants that limit, among other things, additional indebtedness, transactions with affiliates, additional liens, sales of assets, dividends, investments and advances, prepayments of debt, mergers and acquisitions. The Vertex ABL Credit Agreement also includes a financial covenant that requires the fixed charge coverage ratio to be at least 1.00 to 1.00 as of the end of any period of four fiscal quarters while aggregate availability is less than the greater of (i) $10.0 million and (ii) 10% of the aggregate borrowing base.
The Vertex ABL Credit Agreement contains customary events of default, including, but not limited to, payment defaults, breaches of representations and warranties, covenant defaults, events of bankruptcy and insolvency, failure of any guaranty or security document supporting the ABL Facility to be in full force and effect, and a change of control. If an event of default occurs and is continuing, the Borrowers may be required immediately to repay all amounts outstanding under the Vertex ABL Credit Agreement.
As of September 30, 2022, there was no outstanding balance under the ABL Credit Facility and $14.0 million outstanding for letters of credit. Unamortized deferred financing fees related to the ABL Credit Agreement of $1.7 million are included in Other Non-Current Assets in the Condensed Consolidated Balance Sheets. As of September 30, 2022, the fair value of the ABL Credit Agreement approximated the carrying value because the debt bears a floating interest rate.
The aggregate scheduled maturities of the First Lien Credit Agreement, Second Lien Credit Agreement and ABL Credit Agreement as of September 30, 2022, are as follows:
| | | | | | | | |
| (In thousands) | | Payments Due |
| | |
| 2022 (remainder of the year) | | $ | 2,962 | |
| 2023 | | 11,850 | |
| 2024 | | 11,850 | |
| 2025 | | 11,850 | |
| 2026 | | 11,850 | |
| After 2026 | | 1,314,363 | |
| Total | | $ | 1,364,725 | |
As of September 30, 2022, we were in compliance with all covenants related to the First Lien Term Facility, the Second Lien Term Facility and the ABL Facility.
NOTE 8
DERIVATIVE INSTRUMENTS
During the periods covered by this report, we have made no changes to our policies or strategies for the use of derivative instruments and there has been no change in our related accounting methods. For our derivative instruments, which are designated as cash flow hedges, gains and losses are initially reported as a component of accumulated other comprehensive loss and subsequently recognized in earnings with the corresponding hedged item.
Interest Rate Derivative Instruments
On June 29, 2022, in conjunction with our planned extinguishment of the related hedged debt interest expense, we terminated our remaining interest rate swaps that were designated and qualified as effective cash flow hedges. Interest rate swap losses in accumulated other comprehensive loss upon termination were immaterial.
The following table summarizes the amount at fair value and balance sheet caption of the derivative instruments used for our interest rate hedges in the Condensed Consolidated Balance Sheets as of December 31, 2021:
| | | | | | | | | | | | | | |
| | Fair Value |
| (In thousands) | | Balance sheet caption | | Amount |
| Interest rate swap designated as cash flow hedge | | Other accrued liabilities | | $ | 666 | |
| | | | |
Net interest rate derivative losses of $0.4 million and $0.8 million were recognized in interest expense, net, in our Condensed Consolidated Statements of Income during the first nine months of 2022 and 2021, respectively.
Foreign Currency Derivative Instruments
The Company had no outstanding foreign currency forward contracts at September 30, 2022 and had outstanding forward contracts with a current liability value of less than $0.1 million at December 31, 2021.
Net foreign currency derivative gains and losses recognized in SG&A expenses during the first nine months of 2022 and 2021 were immaterial.
NOTE 9
LEASES
We determine whether an arrangement contains a lease at inception. We have operating leases for office space, apartments, vehicles, and machinery and equipment. Our operating leases have lease terms of less than one year to ten years.
We do not separate lease components from non-lease components (e.g., common area maintenance, property taxes and insurance) but account for both components in a contract as a single lease component.
The components of lease expense are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| (In thousands) | | September 30, 2022 | | October 1, 2021 | | September 30, 2022 | | October 1, 2021 |
| | | | | | | | |
| Operating lease expense | | $ | 4,390 | | | $ | 3,307 | | | $ | 11,671 | | | $ | 7,372 | |
| Variable lease expense | | 130 | | | 184 | | | 389 | | | 599 | |
| Short-term lease expense | | 21,862 | | | 16,630 | | | 59,993 | | | 47,367 | |
| Total lease expense | | $ | 26,382 | | | $ | 20,121 | | | $ | 72,053 | | | $ | 55,338 | |
Supplemental balance sheet information related to our operating leases is as follows:
| | | | | | | | | | | | | | |
| | | | |
| | | | |
| (In thousands) | | September 30, 2022 | | December 31, 2021 |
| Right-of-use assets | | $ | 51,968 | | | $ | 43,651 | |
| | | | |
| Current lease liabilities (recorded in Other accrued liabilities) | | $ | 15,302 | | | $ | 11,983 | |
| Long-term lease liabilities (recorded in Operating lease liability) | | 40,234 | | | 34,536 | |
| Total operating lease liabilities | | $ | 55,536 | | | $ | 46,519 | |
During the first nine months of 2022, we recognized additional right-of-use assets of $3.6 million from newly executed operating leases and $15.2 million from the Merger.
The weighted average remaining lease term and discount rate for our operating leases at September 30, 2022 was 5.2 years and 4.1%, respectively.
Maturities of lease liabilities at September 30, 2022 were as follows:
| | | | | | | | |
| (In thousands) | | Payments Due |
| | |
| 2022 (remainder of the year) | | $ | 4,295 | |
| 2023 | | 16,959 | |
| 2024 | | 12,251 | |
| 2025 | | 7,526 | |
| 2026 | | 6,094 | |
| After 2026 | | 15,128 | |
| Total minimum lease payments | | 62,253 | |
| Less: Imputed interest | | (6,717) | |
| Total operating lease liabilities | | $ | 55,536 | |
| | |
| | |
NOTE 10
COMMITMENTS AND CONTINGENCIES
General
From time to time, we are involved in legal proceedings that are incidental to the operation of our business. Some of these proceedings seek remedies relating to employment matters, matters in connection with our contracts and matters arising under laws relating to the protection of the environment. Additionally, U.S. government customers periodically advise the Company of claims and penalties concerning certain potential disallowed costs. When such findings are presented, V2X and the U.S. government representatives engage in discussions to enable V2X 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 $39.6 million and $9.6 million as of September 30, 2022 and December 31, 2021, respectively, in "Other accrued liabilities" in the Condensed Consolidated Balance Sheets for legal proceedings and for claims with respect to our U.S. government contracts as discussed below, including years where the U.S. government has not completed its incurred cost audits. Although the ultimate outcome of any legal matter or claim cannot be predicted with certainty, based on present information, including our assessment of the merits of the particular claim, we do not expect that any asserted or unasserted legal or contractual claims or proceedings, individually or in the aggregate, including the lawsuit discussed below, will have a material adverse effect on our cash flow, results of operations or financial condition.
U.S. Government Contracts, Investigations and Claims
We have U.S. government contracts that are funded incrementally on a year-to-year basis. Changes in U.S. government policies, priorities or funding levels through agency or program budget reductions by the U.S. Congress or executive agencies could have a material adverse effect on our financial condition or results of operations. Furthermore, our contracts with the U.S. government may be terminated or suspended by the U.S. government at any time, with or without cause. Such contract suspensions or terminations could result in unreimbursable expenses or charges or otherwise adversely affect our financial condition and results of operations.
Departments and agencies of the U.S. government have the authority to investigate various transactions and operations of the Company, and the results of such investigations may lead to administrative, civil or criminal proceedings, the ultimate outcome of which could be fines, penalties, repayments, or compensatory or treble damages. U.S. government regulations provide that certain findings against a contractor may lead to suspension or debarment from future U.S. government contracts or the loss of export privileges for a company or an operating division or subdivision. Suspension or debarment could have a material adverse effect on the Company because of its reliance on U.S. government contracts.
U.S. government agencies, including the Defense Contract Audit Agency (DCAA), the Defense Contract Management Agency (DCMA) and others, routinely audit and review our performance on U.S. government contracts, indirect rates and pricing practices, and compliance with applicable contracting and procurement laws, regulations and standards. Accordingly, costs billed or billable to U.S. government customers are subject to potential adjustment upon audit by such agencies. The U.S. government agencies also review the adequacy of our compliance with U.S. government standards for our business systems, including our accounting, earned value management, estimating, materials management and accounting, purchasing, and property management systems.
In the performance of our contracts, we routinely request contract modifications that require additional funding from U.S. government customers. Most often, these requests are due to customer-directed changes in the scope of work. While we are entitled to recovery of these costs under our contracts, the administrative process with our U.S. government customer may be protracted. Based on the circumstances, we periodically file REAs that are sometimes converted into claims. In some cases, these requests are disputed by our U.S. government customer. We believe our outstanding modifications, REAs and other claims will be resolved without material adverse impact to our results of operations, financial condition or cash flows.
As a result of final indirect rate negotiations between the U.S. government and our Former Parent, we were subject to adjustments to costs previously allocated by our Former Parent to our business from 2007 through 2014. On July 7, 2022, we accepted an offer by the U.S. government to settle this legal matter involving our payment of an insignificant amount, thereby bringing closure to the matter. With respect to our Former Parent, we believe we are fully indemnified under our distribution agreement and have notified our Former Parent of the closure of our appeal of the U.S. government's decision in this matter.
COVID-19 Pandemic
On March 11, 2020, the World Health Organization designated the outbreak of COVID-19 as a global pandemic. COVID-19 has negatively impacted public health and the global economy, disrupted global supply chains, and created volatility in financial markets. Furthermore, in September 2021, the Biden Administration issued an executive order mandating a COVID-19 vaccination requirement for federal contractors, except in certain limited circumstances. Since then, multiple courts have enjoined the executive order’s implementation, although the court decisions are not uniform in their application or the states to which the injunction applies. The federal government has indicated that it will not, for the time being, enforce the vaccination mandate.
The extent of the ultimate impact of the COVID-19 pandemic on our operational and financial performance, including our ability to execute our programs in the expected timeframe, will depend on future developments, including any potential subsequent waves or variants of COVID-19, the effectiveness, distribution and acceptance of COVID-19 vaccines, the ultimate impact on financial markets and the global economy, new government regulations for defense contractors (including vaccination mandates) and other related actions taken by the U.S. government, state and local government officials, and international governments to prevent disease spread, all of which remain uncertain and cannot be predicted.
For the three and nine months ended September 30, 2022, the impact of COVID-19 was immaterial to our financial results.
NOTE 11
STOCK-BASED COMPENSATION
The Company maintains an equity incentive plan, the 2014 Omnibus Incentive Plan, as amended and restated effective as of May 13, 2016 (the 2014 Omnibus Plan), to govern awards granted to V2X 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 |
| (In thousands) | | September 30, 2022 | | October 1, 2021 | | September 30, 2022 | | October 1, 2021 |
| Compensation costs for equity-based awards | | $ | 13,681 | | | $ | 1,680 | | | $ | 18,357 | | | $ | 5,666 | |
| Compensation costs for liability-based awards | | 393 | | | 324 | | | 443 | | | 1,261 | |
| Total compensation costs, pre-tax | | $ | 14,074 | | | $ | 2,004 | | | $ | 18,800 | | | $ | 6,927 | |
| Future tax benefit | | $ | 3,029 | | | $ | 435 | | | $ | 4,046 | | | $ | 1,504 | |
Liability-based awards are revalued at the end of each reporting period to reflect changes in fair value.
As of September 30, 2022, total unrecognized compensation costs related to equity-based awards and liability-based awards were $39.9 million and $2.4 million, respectively, which are expected to be recognized ratably over a weighted average period of 1.44 years and 1.98 years, respectively.
The following table provides a summary of the activities for NQOs and RSUs for the nine months ended September 30, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | NQOs | | RSUs |
| (In thousands, except per share data) | | Shares | | Weighted Average Exercise Price Per Share | | Shares | | Weighted Average Grant Date Fair Value Per Share |
| Outstanding at January 1, 2022 | | 59 | | | $ | 23.19 | | | 245 | | | $ | 51.18 | |
| Granted | | — | | | $ | — | | | 236 | | | $ | 35.83 | |
| Replacement awards | | — | | | $ | — | | | 1,346 | | | $ | 33.92 | |
| Exercised | | (16) | | | $ | 24.43 | | | — | | | $ | — | |
| Vested | | — | | | $ | — | | | (158) | | | $ | 42.29 | |
| | | | | | | | |
| | | | | | | | |
| Forfeited or expired | | — | | | $ | — | | | (27) | | | $ | 38.84 | |
| Outstanding at September 30, 2022 | | 43 | | | $ | 22.76 | | | 1,642 | | | $ | 35.51 | |
During the nine months ended September 30, 2022, we granted long-term incentive awards to employees consisting of 213,299 RSUs with a weighted average grant date fair value per share of $36.01 and to our directors consisting of 22,309 RSUs with a weighted average grant date fair value per share of $34.07.
On July 5, 2022, pursuant to the terms of the Merger Agreement, the Company issued an additional 1,346,089 RSUs, with a grant date fair value of $33.92 per share, to certain employees of Vertex. The RSUs will be settled in shares of the Company's common stock, with 517,918 RSUs vesting on the six-month anniversary following the grant date and a quarter of the remaining 828,171 RSUs vesting on each of four six-month anniversary dates following the grant date. The fair value of each RSU grant to employees and directors was determined based on the closing price of V2X common stock on the date of grant. Stock compensation expense will be recognized ratably over the vesting period of the awards.
For employee RSUs, excluding the RSUs granted under the terms of the Merger Agreement, one-third of the award vests on each of the three anniversary dates following the grant date. Director RSUs were granted on May 13, 2022 with 3,229 vesting on the Closing Date and the balance scheduled to vest on May 12, 2023. The fair value of each RSU grant to employees and directors was determined based on the closing price of V2X common stock on the date of grant. Stock compensation expense will be recognized ratably over the vesting period of the awards.
Total Shareholder Return Awards
TSR awards are performance-based cash awards that are subject to a three-year performance period. Any payments earned are made in cash following completion of the performance period according to the achievement of specified performance goals. In concurrence with the Merger, performance achievement fair value was measured as of the Closing Date and the aggregate future award payouts were fixed at $4.6 million. As of September 30, 2022, there was $2.4 million of unrecognized TSR related compensation expense.
NOTE 12
INCOME TAXES
Effective Tax Rate
Income tax expense during interim periods is based on an estimated annual effective income tax rate, plus discrete items that may occur in any given interim periods. The computation of the estimated effective income tax rate at each interim period requires certain estimates and judgment including, but not limited to, forecasted operating income for the year, projections of the income earned and taxed in various jurisdictions, newly enacted tax rate and legislative changes, permanent and temporary differences, and the likelihood of recovering deferred tax assets generated in the current year.
For the three months ended September 30, 2022, we recorded an income tax benefit of $5.7 million and for the three months ended October 1, 2021 an income tax provision of $0.7 million, representing effective income tax rates of 25.2% and 6.2%, respectively. For the nine months ended September 30, 2022, we recorded an income tax benefit of $2.5 million and for the nine months ended October 1, 2021 an income tax provision of $7.6 million, representing effective income tax rates of 39.8% and 16.6%, respectively. The effective income tax rates vary from the federal statutory rate of 21% mainly due to state and foreign taxes, non-deductibility of transaction costs from the recent Merger, disallowed compensation deduction under Internal Revenue Code Section 162(m), and available deductions not reflected in book income, and income tax credits. The higher effective tax rate for the nine ended September 30, 2022, was primarily due to non-deductible costs related to the transaction described in Note 3, Merger.
The Merger qualified as a nontaxable, type “A” reorganization within the meaning of the IRC Section 368(a)(1)(A). The historical tax basis of the assets and liabilities, net operating losses, and other tax attributes of Vertex, including tax deductible goodwill existing as of the Closing Date from prior acquisitions of the legacy Vertex will be carried over to V2X. No additional tax-deductible goodwill was created in connection with the Merger.
Since ASC 740-10-25-3(d) prohibits recognition of a deferred tax liability relating to temporary differences for goodwill, no deferred tax liability on goodwill resulting from this Merger was recorded. In accordance with ASC 805-740-25-3, based on initial purchase accounting calculations, a net deferred tax liability of $26.9 million for the opening book versus tax basis differences was reported per valuation of assets and liabilities as of the Closing Date.
Uncertain Tax Provisions
As of September 30, 2022 and December 31, 2021, unrecognized tax benefits from uncertain tax positions were $10.8 million and $9.3 million, respectively. The increase in the uncertain tax positions was principally the result of the additional Foreign Derived Intangible Income (FDII) deduction as the Company reserves a portion of the FDII benefit claimed or expected to be claimed on its income tax return filings.
NOTE 13
EARNINGS PER SHARE
Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects potential dilution that could occur if securities to issue common stock were exercised or converted into common stock. Diluted EPS includes the dilutive effect of stock-based compensation outstanding after application of the treasury stock method.
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| | Three Months Ended | | Nine Months Ended |
| | September 30, | | October 1, | | September 30, | | October 1, |
| (In thousands, except per share data) | | 2022 | | 2021 | | 2022 | | 2021 |
| Net income (loss) | | $ | (17,039) | | | $ | 10,258 | | | $ | (3,711) | | | $ | 38,240 | |
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| Weighted average common shares outstanding | | 29,830 | | | 11,726 | | | 17,806 | | | 11,696 | |
| Add: Dilutive impact of stock options | | 15 | | | 34 | | | 20 | | | 38 | |
| Add: Dilutive impact of restricted stock units | | 327 | | | 89 | | | 194 | | | 96 | |
| Diluted weighted average common shares outstanding | | 30,172 | | | 11,849 | | | 18,020 | | | 11,830 | |
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| (Loss) earnings per share | | | | | | | | |
| Basic | | $ | (0.57) | | | $ | 0.87 | | | $ | (0.21) | | | $ | 3.27 | |
| Diluted | | $ | (0.56) | | | $ | 0.87 | | | $ | (0.21) | | | $ | 3.23 | |
The following table summarizes the weighted average of anti-dilutive securities excluded from the diluted earnings per share calculation.
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| | Three Months Ended | | Nine Months Ended |
| | September 30, | | October 1, | | September 30, | | October 1, |
| (In thousands) | | 2022 | | 2021 | | 2022 | | 2021 |
| | | | | | | | |
| Anti-dilutive restricted stock units | | 14 | | | 3 | | | 17 | | | 3 | |
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NOTE 14
DEFERRED EMPLOYEE COMPENSATION
During the first quarter of 2021, the Company established a non-qualified deferred compensation plan under which participants are eligible to defer a portion of their compensation on a tax deferred basis. The assets in the plan are held in a rabbi trust. Plan investments and obligations were recorded in other non-current assets and other non-current liabilities, respectively, in the Condensed Consolidated Balance Sheets, representing the fair value related to the deferred compensation plan. Adjustments to the fair value of the plan investments and obligations are recorded in SG&A expenses. The plan assets and liabilities were $1.3 million and $0.5 million as of September 30, 2022 and December 31, 2021, respectively.
NOTE 15
MULTI-EMPLOYER PENSION PLAN
Certain Company employees who perform work on contracts within the continental United States participate in a multiemployer pension plan of which the Company is not the sponsor. Expense recognized for this plan was $2.3 million and $2.8 million for the three and nine months ended September 30, 2022, respectively, and $0.2 million and $0.8 million for the three and nine months ended October 1, 2021, respectively.
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