NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1
DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 (KRH). 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 others 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. We record our proportionate 25%, 50%, and 40% shares, respectively, of income or losses from HDSS, J&J, and ServCore in selling, general and administrative expenses in the Condensed Consolidated Statements of (Loss) 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. As of March 31, 2023 and December 31, 2022 our joint venture investment balance was $6.5 million and $7.0 million, respectively. Our proportionate share of income from the HDSS, J&J, and ServCore joint ventures was $1.8 million for the first quarter of 2023 and not material for the first quarter 2022.
Basis of Presentation
Our quarterly financial periods end on the Friday closest to the last day of the calendar quarter (March 31, 2023 for the first quarter of 2023 and April 1, 2022 for the first quarter of 2022), 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, 2022.
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.
NOTE 2
RECENT ACCOUNTING STANDARDS UPDATE
There have been no accounting standards issued or adopted during the first quarter of 2023 that are expected to have a material impact on the Company's financial statements.
NOTE 3
MERGER
In accordance with ASC Topic 805, Business Combinations, we accounted for the below transaction using the acquisition method. We conducted valuations of certain acquired assets and liabilities for inclusion in our Condensed Consolidated Balance Sheets as of the date of the Merger. Assets that normally would not be recorded in ordinary operations, such as intangibles related to contractual relationships, were recorded at their estimated fair values. The excess purchase price over the estimated fair value of the net assets acquired was recorded as goodwill.
On the Closing Date, Vectrus completed its previously announced Merger with Vertex, forming V2X 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.
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 March 31, 2023, we considered these amounts to be preliminary because we are still in the process of gathering and reviewing information to support the details surrounding tax matters and assumptions underlying certain existing or potential reserves. The final determination could result in further adjustments.
| | | | | | | | |
| (In thousands) | | Preliminary Fair Value |
| Cash and cash equivalents | | $ | 196,993 | |
| Receivables | | 334,655 | |
| Prepaid expenses | | 49,172 | |
| Property, plant, and equipment | | 53,618 | |
| Intangible assets | | 480,000 | |
| Other non-current assets | | 18,895 | |
| Right-of-use assets | | 21,062 | |
| Accounts payable | | (121,515) | |
| Debt | | (1,352,303) | |
| Compensation and other employee benefits | | (45,968) | |
| Other current and non-current liabilities | | (334,469) | |
| Total identifiable net assets | | (699,860) | |
| Goodwill | | 1,333,811 | |
| Total purchase consideration | | $ | 633,951 | |
As a result of the Merger, the Company recognized $1,333.8 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, we recognized two intangible assets related to backlog and customer contracts arising from the Merger. The fair value of backlog was $316.0 million, and the fair value of the customer contracts was $164.0 million with amortization periods of 4.5 years and 14.0 years, respectively. The receivables of $334.7 million represent fair value and are considered fully collectible.
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 March 31, 2023, the Company recorded $0.7 million of income related to the TSA with Crestview, which was recorded as a reduction in cost of sales. AIP held approximately 60.0% of V2X common stock as of March 31, 2023.
The following unaudited information shows the combined actual results of our operations for the three months ended March 31, 2023 and pro forma results for the three months ended April 1, 2022 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 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 |
| | March 31, 2023 | | April 1, 2022 |
| (Unaudited, in thousands) | | Actual | | Pro forma |
| Revenue | | $ | 943,460 | | | $ | 842,741 | |
| Net (loss) income | | $ | (17,480) | | | $ | 11,953 | |
NOTE 4
REVENUE
Performance Obligations
Performance obligations represent firm orders by the customer and excludes potential orders under indefinite delivery and indefinite quantity (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 (COFC). 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.
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 contract terms 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.
Performance obligations as of March 31, 2023 and December 31, 2022 are presented in the following table:
| | | | | | | | | | | | | | |
| | |
| | March 31, | | December 31, |
| (In millions) | | 2023 | | 2022 |
| Performance Obligations | | $ | 3,425 | | | $ | 2,997 | |
We expect to recognize approximately 62% of the performance obligations as of March 31, 2023 as revenue in 2023 and the remaining 38% during 2024.
Contract Estimates
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 for the three months ended March 31, 2023 and April 1, 2022 increased operating income by $13.1 million and $0.6 million, respectively.
For the three months ended March 31, 2023 and April 1, 2022, the cumulative catch-up adjustments to operating income increased revenue by $13.9 million and $0.6 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, time-and-materials and firm-fixed-price contracts on a single contract. On a cost-plus 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 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 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 time-and-materials 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 that our labor costs and allocable indirect expenses are greater than the fixed hourly rate defined within the contract.
On a firm-fixed-price contract, we agree to perform the contractual statement of work for a predetermined contract price. A firm-fixed-price contract typically offers higher profit margin potential than a cost-plus contract, which is commensurate with the greater levels of risk we assume on a firm-fixed-price contract. Although a firm-fixed-price 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 various revenue disaggregations.
Revenue by contract type for the three months ended March 31, 2023 and April 1, 2022 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, | | April 1, | | % | | | | | | |
| (In thousands) | | 2023 | | 2022 | | Change | | | | | | |
| Cost-plus and cost-reimbursable | | $ | 523,030 | | | $ | 311,094 | | | 68.1 | % | | | | | | |
| Firm-fixed-price | | 385,112 | | | 128,004 | | | 200.9 | % | | | | | | |
| Time-and-materials | | 35,318 | | | 17,373 | | | 103.3 | % | | | | | | |
| Total revenue | | $ | 943,460 | | | $ | 456,471 | | | | | | | | | |
Revenue by geographic region in which the contract is performed for the three months ended March 31, 2023 and April 1, 2022 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, | | April 1, | | % | | | | | | |
| (In thousands) | | 2023 | | 2022 | | Change | | | | | | |
| United States | | $ | 548,770 | | | $ | 167,980 | | | 226.7 | % | | | | | | |
| Middle East | | 281,121 | | | 235,754 | | | 19.2 | % | | | | | | |
| Asia | | 64,317 | | | 16,206 | | | 296.9 | % | | | | | | |
| Europe | | 49,252 | | | 36,531 | | | 34.8 | % | | | | | | |
| Total revenue | | $ | 943,460 | | | $ | 456,471 | | | | | | | | | |
Revenue by contract relationship for the three months ended March 31, 2023 and April 1, 2022 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, | | April 1, | | % | | | | | | |
| (In thousands) | | 2023 | | 2022 | | Change | | | | | | |
| Prime contractor | | $ | 879,179 | | | $ | 427,093 | | | 105.9 | % | | | | | | |
| Subcontractor | | 64,281 | | | 29,378 | | | 118.8 | % | | | | | | |
| Total revenue | | $ | 943,460 | | | $ | 456,471 | | | | | | | | | |
Revenue by customer for the three months ended March 31, 2023 and April 1, 2022 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, | | April 1, | | % | | | | | | |
| (In thousands) | | 2023 | | 2022 | | Change | | | | | | |
| Army | | $ | 390,503 | | | $ | 280,113 | | | 39.4 | % | | | | | | |
| Navy | | 292,690 | | | 75,217 | | | 289.1 | % | | | | | | |
| Air Force | | 129,981 | | | 61,474 | | | 111.4 | % | | | | | | |
| Other | | 130,286 | | | 39,667 | | | 228.4 | % | | | | | | |
| Total revenue | | $ | 943,460 | | | $ | 456,471 | | | | | | | | | |
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) on the 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 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 March 31, 2023 and December 31, 2022, we had contract assets of $559.3 million and $487.8 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. Refer to Note 5, Receivables for additional information regarding the composition of our receivable balances. As of March 31, 2023 and December 31, 2022, our contract liabilities, included in other accrued liabilities in the Condensed Consolidated Balance Sheets, were $73.1 million and $76.4 million, respectively. NOTE 5
RECEIVABLES
Receivables were comprised of the following:
| | | | | | | | | | | | | | |
| (In thousands) | | March 31, 2023 | | December 31, 2022 |
| Billed receivables | | $ | 189,247 | | | $ | 227,718 | |
| Unbilled receivables (contract assets) | | 559,341 | | | 487,758 | |
| Other | | 11,225 | | | 13,106 | |
| Total receivables | | $ | 759,813 | | | $ | 728,582 | |
As of March 31, 2023 and December 31, 2022, 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 a 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 March 31, 2023 contract assets during 2023. Changes in the balance of receivables are primarily due to the timing differences between our performance and customers' payments.
NOTE 6
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).
On February 28, 2023, Vertex Borrower entered into a credit agreement (the 2023 Credit Agreement) among the lenders identified therein and Bank of America, N.A., as administrative agent, collateral agent, swingline lender and letter of credit issuer. The 2023 Credit Agreement provides for $750.0 million in senior secured financing, with a first lien on substantially all the Borrower’s assets, consisting of a $500.0 million five-year Revolving Credit Facility (2023 Revolver) and a five-year $250.0 million Term Loan. The proceeds of these Credit Facilities were used to, among other things, (i) repay the First Lien Incremental Term Tranche (as defined below), (ii) repay the entire outstanding amount of the Second Lien Credit Agreement, and (iii) repay the entire outstanding ABL Credit Facility.
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.
On February 28, 2023, the outstanding balance of the First Incremental Term Tranche of $258.7 million was repaid. The balance of unamortized deferred financing costs related to the First Incremental Term Tranche of $11.9 million was recorded as a loss on extinguishment of debt in the Condensed Consolidated Statements of (Loss) Income for the three months ended March 31, 2023.
The remaining loans under the First Lien Term Facility (consisting solely of the Initial Term Loan Tranche) amortize in an amount equal to approximately $2.3 million per quarter for the fiscal quarters ending March 31, 2023, through September 30, 2028, with the balance of $864.9 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 Guarantors), subject to customary exceptions and limitations. The Vertex Borrower’s obligations under the First Lien Term Facility and the Guarantors’ obligations under the related guarantees are secured by a first-lien on substantially all of the Vertex Borrower’s and the Guarantors’ assets which exists on a pari passu basis with the lien held by the 2023 Credit Agreement lenders.
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 greater of (a) the federal funds rate plus 0.50%, (b) the prime lending
rate, or (c) an adjusted Eurodollar rate plus 1.00%, plus a margin of 2.50% to 2.75% 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 March 31, 2023, the effective interest rate for the First Lien Initial Term Tranche was 9.11%.
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 March 31, 2023, the carrying value of the First Lien Credit Agreement was $915.8 million, excluding deferred discount and unamortized deferred financing costs of $40.8 million. The estimated fair value of the First Lien Credit Agreement as of March 31, 2023 was $910.0 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 (Level 2).
Vertex Second Lien Credit Agreement
The Vertex Second Lien Credit Agreement provided 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 Company voluntarily prepaid $25.0 million of the Second Lien Term Facility on December 30, 2022 (the Voluntary Prepayment). On February 28, 2023, the remaining Second Lien Term Facility balance of $160.0 million was repaid (the 2023 Payoff) and related guarantees and liens were discharged and released. The balance of unamortized deferred financing costs related to the Second Lien Term Facility of $7.1 million was recorded as a loss on extinguishment of debt in the Condensed Consolidated Statements of (Loss) Income for the three months ended March 31, 2023.
Under the terms of the Vertex Second Lien Credit Agreement, the Vertex Borrower was required to remit a prepayment premium of $1.6 million with the 2023 Payoff which was recorded as a loss on extinguishment of debt in the Condensed Consolidated Statements of (Loss) Income for the three months ended March 31, 2023.
Vertex ABL Credit Agreement
The Vertex ABL Credit Agreement provided 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 provided 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. On February 28, 2023, the outstanding ABL Facility borrowings of $67.5 million were repaid and related guarantees and liens were discharged and released. The balance of unamortized deferred financing costs related to the Vertex ABL Credit Agreement of $1.5 million which was recorded as a loss on extinguishment of debt in the Condensed Consolidated Statements of (Loss) Income for the three months ended March 31, 2023.
2023 Credit Agreement
The 2023 Credit Agreement provides for $750.0 million in senior secured financing, with a first lien on substantially all the Borrower’s assets and consists of (a) a $500.0 million five-year Revolving Credit Facility (which includes (i) a $50.0 million sublimit of availability for letters of credit, and (ii) a $50.0 million sublimit for short-term borrowings on a swingline basis) and (b) a five-year $250.0 million Term Loan.
The Term Loan portion of the 2023 Credit Agreement amortizes at approximately $1.6 million per quarter for the fiscal quarters ending June 30, 2023 through March 31, 2025, increasing to $3.1 million per quarter for the fiscal quarters ending June 30, 2025 through December 31, 2027, with the balance of $203.1 million due on February 28, 2028.
The Vertex Borrower’s obligations under the 2023 Credit Agreement are guaranteed by the Guarantors, subject to customary exceptions and limitations. The Vertex Borrower’s obligations under the 2023 Credit Agreement and the Guarantors’ obligations under the related guarantees are secured by a first priority-lien on substantially all of the Vertex Borrower’s and the Guarantors’ assets (subject to customary exceptions and limitations) which exists on a pari passu basis with the lien held by the First Lien Credit Agreement lenders.
The borrowings under the 2023 Credit Agreement bear interest at rates that, at the Vertex Borrower’s option, can be either a base rate, determined by reference to the greater of (a) the federal funds rate plus 0.50%, (b) the prime lending rate, or (c) an adjusted Eurodollar rate plus 1.00%, plus a margin of 1.00% to 2.25% per annum, or a Eurodollar rate, determined by reference to SOFR, plus a margin of 2.00% to 3.25% per annum, in each case, depending on the consolidated total net leverage ratio of the Vertex Borrower and its subsidiaries. As of March 31, 2023, the effective interest rates for the 2023 Revolver and Term Loan portion of the 2023 Credit Agreement were 8.15% and 8.35%, respectively.
Unutilized commitments under the 2023 Revolver are subject to a per annum fee ranging from 0.25% to 0.50% depending on the consolidated total net leverage ratio of the Vertex Borrower and its subsidiaries.
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 to SOFR of Revolving Credit loans times the average daily amount available to be drawn under all outstanding letters of credit.
The 2023 Credit Agreement contains customary representations and warranties, which must be accurate for the Vertex Borrower to borrow under the 2023 Credit Agreement, and affirmative covenants. The 2023 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 2023 Credit Agreement contains financial covenants requiring (a) the consolidated total net leverage ratio not to exceed 5.00 to 1.00 for the reporting periods ending on or after June 30, 2023, and on or prior to June 30, 2024, with further step downs thereafter, and (b) the consolidated interest coverage ratio be at least 2.00 to 1.00 commencing with the reporting period ending on June 30, 2023.
The 2023 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 2023 Credit Agreement 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 2023 Credit Agreement.
As of March 31, 2023, there were $185.0 million of outstanding borrowings and $14.9 million of outstanding letters of credit under the 2023 Revolver. Availability under the 2023 Revolver was $300.1 million as of March 31, 2023. Unamortized deferred financing costs related to the 2023 Revolver of $4.9 million are included in other non-current assets in the Condensed Consolidated Balance Sheets. As of March 31, 2023, the fair value of the 2023 Revolver approximated the carrying value because the debt bears a floating interest rate.
As of March 31, 2023, the carrying value of the Term Loan portion of the 2023 Credit Agreement was $250.0 million, excluding unamortized deferred financing costs of $2.5 million. The estimated fair value of the Term Loan portion of the 2023 Credit Agreement as of March 31, 2023 was $246.3 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 (Level 2).
The aggregate scheduled maturities of the First Lien Credit Agreement and 2023 Credit Agreement as of March 31, 2023 are as follows:
| | | | | | | | |
| (In thousands) | | Payments due |
| 2023 (remainder of the year) | | $ | 11,625 | |
| 2024 | | 15,500 | |
| 2025 | | 20,188 | |
| 2026 | | 21,750 | |
| 2027 | | 21,750 | |
| After 2027 | | 1,259,937 | |
| Total | | $ | 1,350,750 | |
As of March 31, 2023 we were in compliance with all covenants related to the First Lien Credit Agreement and the 2023 Credit Agreement.
NOTE 7
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
The Company is exposed to the risk that the earnings and cash flows could be adversely impacted due to fluctuations in interest rates. To mitigate this risk, the Company entered into interest rate swap contracts in the amount of $300 million in March 2023. These contracts are designated and qualify as effective cash flow hedges.
The following table summarizes the amount at fair value and location of the derivative instruments in our balance sheet for our interest rate hedges in the Condensed Consolidated Balance Sheets as of March 31, 2023:
| | | | | | | | | | | | | | |
| (In thousands) | | Fair Value (level 2) |
| | Balance sheet caption | | Amount |
| Interest rate swap designated as cash flow hedge | | Other current assets | | $ | 2,839 | |
| Interest rate swap designated as cash flow hedge | | Other non-current liabilities | | $ | 5,186 | |
There were no interest rate swaps designated as cash flow hedges for the period ended December 31, 2022.
We regularly assess the creditworthiness of the counterparty. As of March 31, 2023, 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.
Net interest rate derivative gains and losses of a nominal amount and $0.2 million were recognized in interest expense, net, in our Condensed Consolidated Statements of (Loss) Income during the first three months of 2023 and 2022, respectively. We expect $2.8 million of existing interest rate swap gains reported in accumulated other comprehensive loss as of March 31, 2023 to be recognized in earnings within the next 12 months.
NOTE 8
COMMITMENTS AND CONTINGENCIES
General
From time to time, we are involved in various investigations, lawsuits, arbitration, claims, enforcement actions and other legal proceedings, including government investigations and claims, which 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 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.
The Company estimated and accrued $27.6 million as of March 31, 2023 and December 31, 2022 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 flows, 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 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 non-reimbursable 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, the Defense Contract Management Agency 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.
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 requests for equitable adjustments (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 recently reached a final settlement with them on this matter.
NOTE 9
STOCK-BASED COMPENSATION
The Company maintains an equity incentive plan, the 2014 Omnibus Incentive Plan, as amended and restated effective as of October 27, 2022 (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, performance share units (PSUs) and other awards. We account for NQOs, stock-settled RSUs and PSUs as equity-based compensation awards. TSR awards, described below, are accounted for as liability-based compensation awards. Liability-based awards are revalued at the end of each reporting period to reflect changes in fair value.
Stock-based compensation expense and the associated tax benefits impacting our Condensed Consolidated Statements of (Loss) Income were as follows:
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| (In thousands) | | March 31, 2023 | | April 1, 2022 | | | | |
| Compensation costs for equity-based awards | | $ | 12,066 | | | $ | 3,100 | | | | | |
| Compensation costs for liability-based awards | | 806 | | | (542) | | | | | |
| Total compensation costs, pre-tax | | $ | 12,872 | | | $ | 2,558 | | | | | |
| Future tax benefit | | $ | 2,971 | | | $ | 555 | | | | | |
Compensation costs for equity-based awards for the three months ended March 31, 2023, included $5.6 million related to RSUs issued in connection with the Merger.
As of March 31, 2023, total unrecognized compensation costs related to equity-based awards and liability-based awards were $34.4 million and $1.7 million, respectively, which are expected to be recognized ratably over a weighted average period of 1.85 years and 1.59 years, respectively. Total unrecognized compensation costs included $15.6 million of expense related to RSUs granted in connection with the Merger.
The following table provides a summary of the activities for NQOs, RSUs and PSUs for the three months ended March 31, 2023: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | NQOs | | RSUs | | PSUs |
| (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 Grant Date Fair Value Per Share |
| Outstanding at January 1, 2023 | | 42 | | | $ | 22.86 | | | 1,628 | | | $ | 35.47 | | | — | | | $ | — | |
| Granted | | — | | | $ | — | | | 278 | | | $ | 39.39 | | | 254 | | | $ | 35.86 | |
| Exercised | | — | | | $ | — | | | — | | | $ | — | | | — | | | $ | — | |
| Vested | | — | | | $ | — | | | (839) | | | $ | 41.86 | | | — | | | $ | — | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Forfeited or expired | | — | | | $ | — | | | (6) | | | $ | 40.59 | | | — | | | $ | — | |
| Outstanding at March 31, 2023 | | 42 | | | $ | 22.86 | | | 1,061 | | | $ | 36.41 | | | 254 | | | $ | 35.86 | |
Restricted Stock Units
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 have been or 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 or having vested 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.
RSUs awarded to employees, excluding the RSU awards awarded under the Merger Agreement, discussed above, vest in one-third increments on each of the three anniversary dates following the grant date subject to continued employment. 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 or the one-year anniversary of the grant date, if earlier. The fair value of each RSU grant 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 requisite service period of the RSU awards.
As of March 31, 2023, there was $27.8 million of unrecognized RSU related compensation expense.
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. As a result of the Merger and pursuant to the terms of the TSR awards, performance achievement fair value was measured at July 4, 2022 at $4.6 million and the aggregate future award payouts were fixed at that value. There were no cash-based TSR awards granted in the first quarter of 2023.
As of March 31, 2023, there was $1.7 million of unrecognized TSR related compensation expense.
Performance Share Units
During the first quarter of 2023, the Company granted two types of performance-based awards with market conditions. The first award will vest and the stock will be issued at the end of a three-year period based on the attainment of certain total shareholder return performance measures relative to Aerospace and Defense companies in the S&P 1500 Index and the employee's continued service through the vest date. The number of shares ultimately awarded, if any, can range up to 200% of the specified target awards. If performance is below the threshold level of performance, no shares will be issued.
The second award will vest and stock will be issued at the end of a three-year period based on achievement of certain stock price targets, shareholder return performance measures relative to certain Aerospace and Defense companies in the S&P 1500 Index and the employee's continued service through the vest date. The numbers of shares ultimately awarded, if any, can range up to the specified target awards.
As of March 31, 2023, there was $6.5 million of unrecognized PSU related compensation expense.
NOTE 10
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 March 31, 2023 and April 1, 2022, we recorded an income tax benefit of $5.7 million and a provision of $0.7 million, respectively, representing effective income tax rates of 24.7% and 19.7%, respectively. The effective income tax rates vary from the federal statutory rate of 21.0% mainly due to state and foreign taxes, disallowed compensation deduction under Internal Revenue Code Section 162(m), available deductions not reflected in book income, and income tax credits.
Uncertain Tax Positions
As of March 31, 2023 and December 31, 2022, unrecognized tax benefits from uncertain tax positions were $8.4 million and $8.6 million, respectively. The decrease in uncertain tax positions was principally the result of the release of a position for lapse of statute of limitation.
NOTE 11
(LOSS) EARNINGS PER SHARE
Basic earnings per share (EPS) is computed by dividing net income, or loss, 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.
| | | | | | | | | | | | | | | | | | |
| | | | | | | | |
| | Three Months Ended | | |
| | March 31, | | April 1, | | | | |
| (In thousands, except per share data) | | 2023 | | 2022 | | | | |
| Net (loss) income | | $ | (17,480) | | | $ | 2,855 | | | | | |
| | | | | | | | |
| Weighted average common shares outstanding | | 30,927 | | | 11,759 | | | | | |
| Add: Dilutive impact of stock options | | — | | | 27 | | | | | |
| Add: Dilutive impact of restricted stock units | | — | | | 116 | | | | | |
| Diluted weighted average common shares outstanding | | 30,927 | | | 11,902 | | | | | |
| | | | | | | | |
| (Loss) earnings per share | | | | | | | | |
| Basic | | $ | (0.57) | | | $ | 0.24 | | | | | |
| Diluted | | $ | (0.57) | | | $ | 0.24 | | | | | |
The following table summarizes the weighted average of anti-dilutive securities excluded from the diluted earnings per share calculation.
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, | | April 1, | | | | |
| (In thousands) | | 2023 | | 2022 | | | | |
| | | | | | | | |
| Anti-dilutive restricted stock units | | — | | | 5 | | | | | |
| | | | | | | | |
NOTE 12
POST-EMPLOYMENT BENEFIT PLANS
Deferred Employee Compensation
The Company sponsors two non-qualified deferred compensation plans. Under these plans, participants are eligible to defer a portion of their compensation on a tax deferred basis. 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 operating expenses. The plan assets and liabilities were $2.4 million and $1.5 million as of March 31, 2023 and December 31, 2022, respectively.
Multi-Employer Pension Plans
Certain Company employees who perform work on contracts within the continental United States participate in multi-employer pension plans of which the Company is not the sponsor. Company expenses related to these plans were $3.3 million and $0.2 million for the three months ended March 31, 2023 and April 1, 2022, respectively.
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