V2X, Inc. 10-Q

ITEM 1. FINANCIAL STATEMENTS VECTRUS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended Nine Months Ended October 2, September 27, October 2, September 27, (In thousands, except per share data) 2020 2019 2020 2019 Revenue $ 352,415 $ 359,873 $ 1,040,212 $ 1,017,368 Cost of revenue 320,234 327,523 951,743 923,671 Selling, general, and administrative expenses 17,344 19,934 58,718 59,697 Operating income 14,837 12,416 29,751 34,000 Interest expense, net ( 939 ) ( 1,907 ) ( 3,988 ) ( 4,811 ) Income from operations before income taxes 13,898 10,509 25,763 29,189 Income tax expense 3,507 2,668 5,593 6,657 Net income $ 10,391 $ 7,841 $ 20,170 $ 22,532 Earnings per share Basic $ 0.89 $ 0.68 $ 1.74 $ 1.97 Diluted $ 0.88 $ 0.67 $ 1.72 $ 1.95 Weighted average common shares outstanding - basic 11,621 11,506 11,590 11,420 Weighted average common shares outstanding - diluted 11,751 11,678 11,743 11,566 The accompanying notes are an integral part of these financial statements. 4 Table of Contents VECTRUS, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) Three Months Ended Nine Months Ended October 2, September 27, October 2, September 27, (In thousands) 2020 2019 2020 2019 Net income $ 10,391 $ 7,841 $ 20,170 $ 22,532 Other comprehensive income (loss), net of tax Changes in derivative instruments: Net change in fair value of interest rate swap 290 ( 194 ) ( 1,035 ) ( 1,570 ) Net change in fair value of foreign currency forward contracts 204 ( 207 ) 338 ( 123 ) Net (loss) gain reclassified to interest expense — ( 8 ) — 43 Tax (expense) benefit ( 202 ) 88 56 357 Net change in derivative instruments 292 ( 321 ) ( 641 ) ( 1,293 ) Foreign currency translation adjustments, net of tax 2,042 ( 1,526 ) 2,578 ( 1,801 ) Accounting Standards Update (ASU) 2018-02 reclassification of certain tax effects to Retained Earnings — — — ( 259 ) Other comprehensive income (loss), net of tax 2,334 ( 1,847 ) 1,937 ( 3,353 ) Total comprehensive income $ 12,725 $ 5,994 $ 22,107 $ 19,179 The accompanying notes are an integral part of these financial statements. 5 Table of Contents VECTRUS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) October 2, December 31, (In thousands, except share information) 2020 2019 Assets Current assets Cash $ 63,734 $ 35,318 Receivables 268,143 269,144 Other current assets 24,537 16,154 Total current assets 356,414 320,616 Property, plant, and equipment, net 19,256 18,844 Goodwill 262,130 261,983 Intangible assets, net 11,902 14,926 Right-of-use assets 9,970 14,654 Other non-current assets 6,256 5,366 Total non-current assets 309,514 315,773 Total Assets $ 665,928 $ 636,389 Liabilities and Shareholders' Equity Current liabilities Accounts payable $ 146,458 $ 148,015 Compensation and other employee benefits 54,216 53,155 Short-term debt 8,000 6,500 Other accrued liabilities 38,572 37,409 Total current liabilities 247,246 245,079 Long-term debt, net 57,326 63,041 Deferred tax liability 41,734 49,407 Other non-current liabilities 35,817 19,997 Total non-current liabilities 134,877 132,445 Total liabilities 382,123 377,524 Commitments and contingencies (Note 13) Shareholders' Equity Preferred stock; $ 0.01 par value; 10,000,000 shares authorized; No shares issued and outstanding — — Common stock; $ 0.01 par value; 100,000,000 shares authorized; 11,621,709 and 11,523,691 shares issued and outstanding as of October 2, 2020 and December 31, 2019, respectively 116 115 Additional paid in capital 81,589 78,757 Retained earnings 205,245 185,075 Accumulated other comprehensive loss ( 3,145 ) ( 5,082 ) Total shareholders' equity 283,805 258,865 Total Liabilities and Shareholders' Equity $ 665,928 $ 636,389 The accompanying notes are an integral part of these financial statements. 6 Table of Contents VECTRUS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended October 2, September 27, (In thousands) 2020 2019 Operating activities Net income $ 20,170 $ 22,532 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 3,001 2,395 Amortization of intangible assets 3,031 2,103 Loss on disposal of property, plant, and equipment 63 2 Stock-based compensation 6,499 5,952 Amortization of debt issuance costs 286 301 Changes in assets and liabilities: Receivables 3,584 ( 7,540 ) Other assets ( 8,826 ) ( 5,820 ) Accounts payable ( 1,988 ) ( 14,458 ) Deferred taxes ( 7,575 ) ( 4,670 ) Compensation and other employee benefits 813 17,863 Other liabilities 18,597 9,788 Net cash provided by operating activities 37,655 28,448 Investing activities Purchases of capital assets and intangibles ( 3,348 ) ( 14,440 ) Proceeds from the disposition of assets — 5,400 Acquisition of business, net of cash acquired — ( 43,963 ) Net cash (used in) investing activities ( 3,348 ) ( 53,003 ) Financing activities Repayments of long-term debt ( 4,500 ) ( 2,000 ) Proceeds from revolver 151,000 226,000 Repayments of revolver ( 151,000 ) ( 226,000 ) Proceeds from exercise of stock options 59 3,467 Payments of employee withholding taxes on share-based compensation ( 1,918 ) ( 768 ) Net cash (used in) provided by financing activities ( 6,359 ) 699 Exchange rate effect on cash 468 ( 1,239 ) Net change in cash 28,416 ( 25,095 ) Cash-beginning of year 35,318 66,145 Cash-end of period $ 63,734 $ 41,050 Supplemental disclosure of cash flow information: Interest paid $ 3,030 $ 4,363 Income taxes paid $ 12,570 $ 5,076 Non-cash investing activities: Purchase of capital assets on account $ 373 $ 394 The accompanying notes are an integral part of these financial statements. 7 Table of Contents VECTRUS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES TO SHAREHOLDERS' EQUITY (UNAUDITED) Common Stock Issued Additional Paid-in Capital Accumulated Other Comprehensive Loss Total Shareholders' Equity (In thousands) Shares Amount Retained Earnings Balance at December 31, 2018 11,267 $ 113 $ 71,729 $ 151,640 $ ( 3,158 ) $ 220,324 Net income 7,074 7,074 Cumulative effects of adoption of ASU 2018-02 reclassification of certain tax effects from AOCI 259 ( 259 ) — Foreign currency translation adjustments ( 823 ) ( 823 ) Unrealized loss on cash flow hedge ( 360 ) ( 360 ) Employee stock awards and stock options 85 1 601 602 Taxes withheld on restricted stock unit compensation awards ( 683 ) ( 683 ) Stock-based compensation 1,117 1,117 Balance at March 29, 2019 11,352 $ 114 $ 72,764 $ 158,973 $ ( 4,600 ) $ 227,251 Net income 7,617 7,617 Foreign currency translation adjustments 547 547 Unrealized loss on cash flow hedge ( 611 ) ( 611 ) Employee stock awards and stock options 154 1 2,864 2,865 Taxes withheld on restricted stock unit compensation awards ( 85 ) ( 85 ) Stock-based compensation 1,099 1,099 Balance at June 28, 2019 11,506 $ 115 $ 76,642 $ 166,590 $ ( 4,664 ) $ 238,683 Net income 7,841 7,841 Foreign currency translation adjustments ( 1,526 ) ( 1,526 ) Unrealized loss on cash flow hedge ( 321 ) ( 321 ) Stock-based compensation 1,124 1,124 Balance at September 27, 2019 11,506 $ 115 $ 77,766 $ 174,431 $ ( 6,511 ) $ 245,801 Balance at December 31, 2019 11,524 $ 115 $ 78,757 $ 185,075 $ ( 5,082 ) $ 258,865 Net income 8,668 8,668 Foreign currency translation adjustments ( 1,934 ) ( 1,934 ) Unrealized loss on cash flow hedge ( 1,290 ) ( 1,290 ) Employee stock awards and stock options 64 1 — 1 Taxes withheld on stock compensation awards ( 1,787 ) ( 1,787 ) Stock-based compensation 1,720 1,720 Balance at April 3, 2020 11,588 $ 116 $ 78,690 $ 193,743 $ ( 8,306 ) $ 264,243 Net income 1,111 1,111 Foreign currency translation adjustments 2,470 2,470 Unrealized gain on cash flow hedge 357 357 8 Table of Contents Employee stock awards and stock options 32 — 58 58 Taxes withheld on restricted stock unit compensation awards ( 86 ) ( 86 ) Stock-based compensation 1,282 1,282 Balance at July 3, 2020 11,620 $ 116 $ 79,944 $ 194,854 $ ( 5,479 ) $ 269,435 Net income 10,391 10,391 Foreign currency translation adjustments 2,042 2,042 Unrealized gain on cash flow hedge 292 292 Employee stock awards and stock options 2 — — — Conversion of liability-based stock compensation awards to equity-based stock compensation awards 405 405 Taxes withheld on restricted stock unit compensation awards ( 44 ) ( 44 ) Stock-based compensation 1,284 1,284 Balance at October 2, 2020 11,622 $ 116 $ 81,589 $ 205,245 $ ( 3,145 ) $ 283,805 The accompanying notes are an integral part of these financial statements. 9 Table of Contents NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business and Basis of Presentation Our Business Vectrus, Inc. is a leading provider of services to the United States Government (U.S. Government) worldwide. The Company operates as one segment and provides the following services and offerings: facility and base operations; supply chain and logistics services; information technology mission support; and engineering and digital technology services. Vectrus was incorporated in the State of Indiana on February 4, 2014. On September 27, 2014, Exelis Inc. (Exelis) completed a spin-off (the Spin-off) of Vectrus, and Vectrus became an independent, publicly traded company. Unless the context otherwise requires, references in these notes to "Vectrus", "we," "us," "our," "the Company" and "our Company" refer to Vectrus, Inc. References in these notes to Exelis or "Former Parent" refer to Exelis Inc. and its consolidated subsidiaries (other than Vectrus) or successor entities. Basis of Presentation Our quarterly financial periods end on the Friday closest to the last day of the calendar quarter (October 2, 2020 for the third quarter of 2020 and September 27, 2019 for the third quarter of 2019), except for the last quarter of the fiscal year, which ends on December 31. For ease of presentation, the quarterly financial statements included herein are described as three months ended. The unaudited interim Condensed Consolidated Financial Statements of Vectrus have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Accordingly, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the U.S. (GAAP) have been omitted. These unaudited interim Condensed Consolidated Financial Statements should be read in conjunction with our audited Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2019. 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. Immaterial Restatement of Prior Period Balances Subsequent to the issuance of our Annual Report on Form 10-K for the year ended December 31, 2019, we identified an error in our historical financial statements related to estimated contract costs for the year ended December 31, 2019 as well as an error in our historical financial statements related to overbilling for a separate contract dating back to 2013, prior to the Spin-off. In the first instance, management determined that additional subcontractor costs should have been included as part of estimated contract costs, resulting in a misstatement in other accrued liabilities and cost of revenue as well as revenue and accounts receivable to a lesser extent. In the second instance, management identified that certain contract costs were incorrectly included in customer billings for one contract, resulting in a misstatement in revenue and other accrued liabilities . The cumulative impact of the errors was a $ 2.5 million decrease in retained earnings as of December 31, 2019. The impact of the errors on net income for the year ended December 31, 2019 is $ 1.5 million. The impact on diluted earnings per share is a decrease of $ 0.13 for the year ended December 31, 2019. The impact to diluted earnings per share in the first, second, third, and fourth quarters of 2019 is a decrease of $ 0.00 , $ 0.00 , $ 0.13 , and $ 0.00 , respectively. The impact on diluted earnings per share is a decrease of $ 0.02 and $ 0.01 for the years ended December 31, 2018 and 2017, respectively. Accordingly, the Company is restating the relevant financial statements and related footnotes for all applicable periods for these errors and related tax effect and will correct the respective financial statements as they appear in future filings. Management has evaluated the materiality of these misstatements and concluded they were not material to prior periods, individually or in aggregate. 10 Table of Contents The effects of the corrections to each of the individual affected line items in our Condensed Consolidated Statements of Income were as follows: Three Months Ended September 27, 2019 Nine Months Ended September 27, 2019 (In thousands, except per share data) As Previously Reported Correction As Corrected As Previously Reported Correction As Corrected Revenue $ 359,854 $ 19 $ 359,873 $ 1,017,371 $ ( 3 ) $ 1,017,368 Cost of revenue 325,537 1,986 327,523 921,685 1,986 923,671 Operating income 14,383 ( 1,967 ) 12,416 35,989 ( 1,989 ) 34,000 Income from operations before income taxes 12,476 ( 1,967 ) 10,509 31,178 ( 1,989 ) 29,189 Income tax expense 3,094 ( 426 ) 2,668 7,088 ( 431 ) 6,657 Net income $ 9,382 $ ( 1,541 ) $ 7,841 $ 24,090 $ ( 1,558 ) $ 22,532 Earnings per share Basic $ 0.82 $ ( 0.14 ) $ 0.68 $ 2.11 $ ( 0.14 ) $ 1.97 Diluted $ 0.80 $ ( 0.13 ) $ 0.67 $ 2.08 $ ( 0.13 ) $ 1.95 The effects of the corrections to each of the individual affected line items on our Condensed Consolidated Statements of Comprehensive Income were as follows: Three Months Ended September 27, 2019 Nine Months Ended September 27, 2019 (In thousands) As Previously Reported Correction As Corrected As Previously Reported Correction As Corrected Net income $ 9,382 $ ( 1,541 ) $ 7,841 $ 24,090 $ ( 1,558 ) $ 22,532 Total comprehensive income $ 7,535 $ ( 1,541 ) $ 5,994 $ 20,737 $ ( 1,558 ) $ 19,179 The effects of the corrections to each of the individual affected line items on our Condensed Consolidated Balance Sheet were as follows: December 31, 2019 (In thousands) As Previously Reported Correction As Corrected Receivables $ 269,239 $ ( 95 ) $ 269,144 Total current assets 320,711 ( 95 ) 320,616 Total Assets 636,484 ( 95 ) 636,389 Other accrued liabilities 34,587 2,822 37,409 Total current liabilities 242,257 2,822 245,079 Deferred tax liability 49,808 ( 401 ) 49,407 Total non-current liabilities 132,846 ( 401 ) 132,445 Total Liabilities 375,103 2,421 377,524 Retained earnings 187,591 ( 2,516 ) 185,075 Total shareholders' equity 261,381 ( 2,516 ) 258,865 Total Liabilities and Shareholders' Equity $ 636,484 $ ( 95 ) $ 636,389 11 Table of Contents The effects of the corrections to each of the individual affected line items on our Condensed Consolidated Statements of Cash Flows were as follows: Nine Months Ended September 27, 2019 (In thousands) As Previously Reported Correction As Corrected Net income $ 24,090 $ ( 1,558 ) $ 22,532 Changes in receivables ( 7,521 ) ( 19 ) ( 7,540 ) Changes in deferred taxes ( 4,240 ) ( 430 ) ( 4,670 ) Changes in other liabilities 7,781 2,007 9,788 Net cash provided in operating activities $ 28,448 $ — $ 28,448 The effects of the corrections to each of the individual affected line items on our Condensed Consolidated Statements of Changes in Shareholders' Equity were as follows: Retained Earnings Total Shareholders' Equity (In thousands) As Previously Reported Correction As Corrected As Previously Reported Correction As Corrected Balance at December 31, 2018 $ 152,616 $ ( 976 ) $ 151,640 $ 221,300 $ ( 976 ) $ 220,324 Net income 7,091 ( 17 ) 7,074 7,091 ( 17 ) 7,074 Balance at March 29, 2019 159,966 ( 993 ) 158,973 228,244 ( 993 ) 227,251 Net income 7,617 — 7,617 7,617 — 7,617 Balance at June 28, 2019 167,583 ( 993 ) 166,590 239,676 ( 993 ) 238,683 Net income 9,382 ( 1,541 ) 7,841 9,382 ( 1,541 ) 7,841 Balance at September 27, 2019 $ 176,965 $ ( 2,534 ) $ 174,431 $ 248,335 $ ( 2,534 ) $ 245,801 NOTE 2 RECENT ACCOUNTING STANDARDS UPDATE Accounting Standards Issued but Not Yet Effective In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740) Simplifying the Accounting for Income Taxes (ASU 2019-12). The objectives of ASU 2019-12 are (i) to simplify the accounting for income taxes by removing certain exceptions, (ii) to update certain requirements to simplify the accounting for income taxes, and (iii) to make minor codification improvements for income taxes. The guidance is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of this standard to have a material impact on the Company’s financial statements. Accounting Standards That Were Adopted In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) (ASU 2018-15). The objective of ASU 2018-15 is to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with those incurred to develop or obtain internal-use software. The guidance is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The amendments can be applied either retrospectively or prospectively. We adopted ASU 2018-15 on January 1, 2020 using the retrospective method. As a result of the adoption, $ 0.3 million was reclassified from 2019 year-end property, plant and equipment, net, to other non-current assets on our Condensed Consolidated Balance Sheet. In addition, $ 0.3 million of cash outflows from investing activities incurred during the third and fourth quarters of 2019 was reclassified to cash outflows from operating activities. In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment (ASU 2017-04). The objective of ASU 2017-04 is to simplify the subsequent measurement of goodwill by entities performing their annual goodwill impairment tests by comparing the fair value of a reporting unit, including income tax effects from any tax-deductible goodwill, with its carrying amount and recognizing an impairment charge for the amount by which the carrying amount exceeds fair value. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. ASU 2017-04 should be applied on a prospective basis. We adopted ASU 2017-04 on January 1, 2020. The adoption of the standard did not have a material impact on our financial statements. In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (ASU 2016-13). The objective of ASU 2016-13 is to provide financial statement users with more useful information about the expected credit losses 12 Table of Contents on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. Under the new guidance, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. We adopted the standard on January 1, 2020. The adoption of the standard did not have a material impact on our financial statements. NOTE 3 REVENUE Performance Obligations A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and 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. Contract modifications are routine in the performance of our contracts. Contracts are often modified to account for changes in contract specifications or requirements. In most instances, contract modifications are for goods or services that are not distinct, and therefore, are accounted for as part of the existing contract. Modifications to exercise option years create new enforceable rights and obligations and therefore are treated as separate performance obligations. The Company's performance obligations are typically 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. This continuous transfer of control requires that we track progress towards completion of performance obligations in order to measure and recognize revenue. Determining progress on performance obligations requires us to make judgments that affect the timing of revenue recognition. Remaining performance obligations represent firm orders by the customer and excludes potential orders under IDIQ contracts, unexercised contract options, and contracts awarded to us that are being protested by competitors with the U.S. Government Accountability Office (GAO) or in the U.S. Court of Federal Claims. The level of order activity related to contracts 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. 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. 13 Table of Contents Remaining performance obligations increased by $ 306.4 million as of October 2, 2020 as compared to December 31, 2019. We expect to recognize approximately 30 % of the remaining performance obligations as of October 2, 2020 as revenue in 2020, and the remaining 70 % during 2021. Remaining performance obligations as of October 2, 2020 and December 31, 2019 are presented in the following table: October 2, December 31, (In thousands) 2020 2019 Performance Obligations $ 1,155,742 $ 849,389 Contract Estimates Accounting for contracts involves the use of various techniques to estimate total contract revenue and costs. We estimate the profit on our contracts as the difference between the total estimated revenue and expected costs to complete a contract and recognize that profit over the life of the contract. Contract estimates are based on various assumptions to project the outcome of future events. These assumptions include labor productivity and availability; the complexity of the services being performed; the cost and availability of materials; the performance of subcontractors; and the availability and timing of funding from the customer. The impact of adjustments in contract estimates on our operating income can be reflected in either revenue or cost of revenue. Cumulative catch-up adjustments for the three and nine months ended October 2, 2020 were favorable to operating income by less than $ 0.1 million and unfavorable to operating income by $ 3.8 million, respectively. For the three and nine months ended September 27, 2019, the net favorable adjustments to operating income were $ 0.7 million and $ 1.5 million, respectively. For the three and nine months ended October 2, 2020 the cumulative catch-up adjustments to operating income decreased revenue by $ 1.1 million and $ 0.5 million, respectively. For the three and nine months ended September 27, 2019, the cumulative catch-up adjustments to operating income increased revenue by $ 4.0 million and $ 4.2 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. 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. The following tables present our revenue disaggregated by several categories. Revenue by contract type for the three and nine months ended October 2, 2020 and September 27, 2019 is as follows: Three Months Ended Nine Months Ended October 2, September 27, % October 2, September 27, % (In thousands) 2020 2019 Change 2020 2019 Change Cost-plus and cost-reimbursable ¹ $ 249,484 $ 272,810 ( 8.6 ) % $ 748,543 $ 781,024 ( 4.2 ) % Firm-fixed-price 102,931 87,063 18.2 % 291,669 236,344 23.4 % Total revenue $ 352,415 $ 359,873 $ 1,040,212 $ 1,017,368 ¹ Includes time and material contracts 14 Table of Contents Revenue by geographic region in which the contract is performed for the three and nine months ended October 2, 2020 and September 27, 2019 is as follows: Three Months Ended Nine Months Ended October 2, September 27, % October 2, September 27, % (In thousands) 2020 2019 Change 2020 2019 Change Middle East $ 224,934 $ 244,142 ( 7.9 ) % $ 679,633 $ 695,626 ( 2.3 ) % United States 89,400 77,228 15.8 % 254,640 219,512 16.0 % Europe 38,081 38,503 ( 1.1 ) % 105,939 102,230 3.6 % Total revenue $ 352,415 $ 359,873 $ 1,040,212 $ 1,017,368 Revenue by contract relationship for the three and nine months ended October 2, 2020 and September 27, 2019 is as follows: Three Months Ended Nine Months Ended October 2, September 27, % October 2, September 27, % (In thousands) 2020 2019 Change 2020 2019 Change Prime contractor $ 332,564 $ 334,402 ( 0.5 ) % $ 980,301 $ 954,191 2.7 % Subcontractor 19,851 25,471 ( 22.1 ) % 59,911 63,177 ( 5.2 ) % Total revenue $ 352,415 $ 359,873 $ 1,040,212 $ 1,017,368 Revenue by customer for the three and nine months ended October 2, 2020 and September 27, 2019 is as follows: Three Months Ended Nine Months Ended October 2. September 27, % October 2. September 27, % (In thousands) 2020 2019 Change 2020 2019 Change Army $ 236,267 $ 245,817 ( 3.9 ) % $ 711,173 $ 698,377 1.8 % Air Force 79,425 86,576 ( 8.3 ) % 231,088 227,100 1.8 % Navy 18,785 13,344 40.8 % 48,564 45,227 7.4 % Other 17,938 14,136 26.9 % 49,387 46,664 5.8 % Total revenue $ 352,415 $ 359,873 $ 1,040,212 $ 1,017,368 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 October 2, 2020 and December 31, 2019, we had contract assets of $ 199.3 million and $ 186.4 million, respectively. Refer to Note 8, "Receivables" for additional information regarding the composition of our receivable balances. As of both October 2, 2020 and December 31, 2019, our contract liabilities were insignificant. 15 Table of Contents NOTE 4 INCOME TAXES Effective Tax Rate Income tax expense during interim periods is based on an estimated annual effective income tax rate, plus any significant unusual or infrequently occurring items recorded in 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 quarters ended October 2, 2020 and September 27, 2019, we recorded an income tax provision of $ 3.5 million and $ 2.7 million, respectively, representing effective income tax rates of 25.2 % and 25.4 %. For the nine months ended October 2, 2020 and September 27, 2019, we recorded income tax provisions of $ 5.6 million and $ 6.7 million, representing effective income tax rates of 21.7 % and 22.8 %, respectively. The effective income tax rates vary from the federal statutory rate of 21.0% due to state and foreign taxes, required tax income exclusions, nondeductible expenses and available deductions not reflected in book income. Uncertain Tax Provisions As of October 2, 2020, and December 31, 2019, unrecognized tax benefits from uncertain tax positions were $ 12.5 million and $ 7.9 million, respectively. The increase in the uncertain tax positions was principally the result of the additional Foreign Derived Intangible Income (FDII) deduction. NOTE 5 ACQUISITIONS Advantor On July 8, 2019, we acquired Advantor from Infrasafe Holding, Inc. and Infrasafe, LLC (collectively, Infrasafe). Advantor is a leading provider of integrated electronic security systems to the U.S. Government. In accordance with ASC Topic 805, Business Combinations , we accounted for this 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 acquisition. Assets that normally would not be recorded in ordinary operations (i.e. intangibles related to contractual relationships) were recorded at their estimated fair values. The excess purchase price over the estimated fair value of the net assets acquired was recorded as goodwill. The total net consideration paid for the acquisition was $ 45.1 million, consisting of the purchase price of $ 44.0 million, net of cash acquired, and $ 1.1 million for working capital in excess of the working capital requirement agreed upon in the stock purchase agreement. The acquisition was funded by utilizing cash on hand and available capacity from our Amended Revolver (as defined in Note 9, “Debt”). A breakdown of the purchase price allocation, net of cash acquired, is as follows: (In thousands) Allocation of Purchase Price Receivables $ 11,388 Other current assets 2,719 Property, plant and equipment 155 Goodwill 28,511 Intangible assets 8,300 Other non-current assets 1,868 Accounts payable ( 4,223 ) Other current liabilities ( 1,519 ) Accrued compensation ( 907 ) Other non-current liabilities ( 1,218 ) Purchase price, net of cash acquired $ 45,074 We completed purchase accounting for the acquisition as of July 3, 2020 with no material adjustments. The Company recognized two intangible assets related to customer contracts (backlog) and the Advantor trade name arising from the acquisition. The fair value of the customer contracts was $ 7.2 million, and the fair value of the Advantor trade name was $ 1.1 million with amortization periods of 5.0 years and 4.5 years, respectively. As of October 2, 2020, the remaining weighted-average amortization period for these intangible assets was 3.7 years. The Company recorded amortization expense of $ 1.3 16 Table of Contents million during the first nine months of 2020. The amortization expense is included in cost of revenue in our Condensed Consolidated Statements of Income. Additionally, the Company recognized goodwill of $ 28.5 million arising from the acquisition, which relates primarily to acquired product and services strengthening our advance into a higher value, technology-enabled and differentiated platform, as well as extending our facilities and logistics services to include the electronic protection and security of facilities. Goodwill also includes other intangibles that do not qualify for separate recognition. The goodwill recognized for the Advantor acquisition is fully deductible for income tax purposes. Advantor's operating results have been included in our reported results since the date of acquisition. NOTE 6 GOODWILL AND INTANGIBLE ASSETS As of October 2, 2020 and December 31, 2019 the carrying amount of goodwill was $ 262.1 million and $ 262.0 million, respectively. The $ 0.1 million increase during the first nine months of 2020 is due to a final adjustment to the Advantor purchase price allocation. The Company tests goodwill for impairment as of the beginning of the fourth 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. Due to the COVID-19 pandemic and the negative effect on the U.S. and global economy, the Company completed a qualitative assessment to evaluate whether or not it is more likely than not that the fair value of goodwill is less than its carrying amount. Based on our assessment of the totality of events and circumstances as of October 2, 2020, including the estimated impact of the COVID-19 pandemic on our business forecast and the Company's market capitalization, we determined that it is not more likely than not that the fair value of our reporting unit is below its carrying amount. Identifiable intangible assets consist of the following: October 2, 2020 December 31, 2019 (In thousands) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Contract backlogs and recompetes $ 11,600 $ ( 6,053 ) $ 5,547 $ 11,600 $ ( 4,300 ) $ 7,300 Customer contracts 7,200 ( 1,773 ) 5,427 7,200 ( 692 ) 6,508 Trade names and other 1,243 ( 315 ) 928 1,236 ( 118 ) 1,118 Balance $ 20,043 $ ( 8,141 ) $ 11,902 $ 20,036 $ ( 5,110 ) $ 14,926 Identifiable intangible asset amortization expense was $ 1.0 million and $ 3.0 million for the three and nine months ended October 2, 2020, respectively. Intangible amortization expense for the three and nine months ended September 27, 2019 was $ 0.8 million and $ 2.1 million, respectively. As of October 2, 2020, the remaining average intangible asset amortization period was 3.6 years. The estimated amortization expense for the next five years is as follows (in thousands): Period Amortization 2020 (excluding the nine months ended October 2, 2020) $ 998 2021 $ 4,029 2022 $ 2,501 2023 $ 2,404 2024 $ 1,297 After 2024 $ 673 17 Table of Contents NOTE 7 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. Three Months Ended Nine Months Ended October 2, September 27, October 2, September 27, (In thousands, except per share data) 2020 2019 2020 2019 Net income $ 10,391 $ 7,841 $ 20,170 $ 22,532 Weighted average common shares outstanding 11,621 11,506 11,590 11,420 Add: Dilutive impact of stock options 34 37 38 45 Add: Dilutive impact of restricted stock units 96 135 115 101 Diluted weighted average common shares outstanding 11,751 11,678 11,743 11,566 Earnings per share Basic $ 0.89 $ 0.68 $ 1.74 $ 1.97 Diluted $ 0.88 $ 0.67 $ 1.72 $ 1.95 The following table provides a summary of securities that could potentially dilute basic earnings per share in the future that were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented: Three Months Ended Nine Months Ended October 2, September 27, October 2, September 27, (In thousands) 2020 2019 2020 2019 Anti-dilutive stock options — — — 1 Anti-dilutive restricted stock units 3 — 2 3 Total 3 — 2 4 NOTE 8 RECEIVABLES Receivables were comprised of the following: (In thousands) October 2, 2020 December 31, 2019 Billed receivables $ 59,445 $ 71,068 Unbilled receivables (contract assets) 199,301 186,365 Other 9,397 11,711 Total receivables $ 268,143 $ 269,144 As of October 2, 2020 and December 31, 2019, 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 our billed receivables are with the U.S. Government, we do not believe they represent 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 estimate that approximately $ 6.1 million of our unbilled receivables as of October 2, 2020 may not be collected within the next 12 months. These amounts relate to the timing of the U.S. Government review of indirect rates and contract line item realignments with our customers. Changes in the balance of receivables are primarily due to the timing differences between our performance and customers' payments. 18 Table of Contents NOTE 9 DEBT Senior Secured Credit Facilities Term Loan and Revolver . In September 2014, we and our wholly-owned subsidiary, VSC, entered into a credit agreement with a group of lenders, including JPMorgan Chase Bank, N.A. as administrative agent. The credit agreement was subsequently amended in November 2017 by the Amendment and Restatement Agreement (the Amendment Agreement) with a group of lenders, including JPMorgan Chase Bank, N.A., as administrative agent. The Amendment Agreement provides for $ 200.0 million in senior secured financing, consisting of a $ 80.0 million five-year term loan facility (the Amended Term Loan) and a $ 120.0 million five-year senior secured revolving credit facility (the Amended Revolver, and together with the Amended Term Loan, the Amended Credit Facilities). Additionally, the Amendment Agreement includes an accordion feature that allows the Company to draw up to an additional $ 100.0 million, subject to the lender's consent. The Amendment Agreement also permits the Company to borrow up to $ 75.0 million in unsecured debt as long as the aggregated sum of both the unsecured debt and the accordion does not exceed $ 100.0 million. The Amended Revolver is available for working capital, capital expenditures, and other general corporate purposes. Up to $ 25.0 million of the Amended Revolver is available for the issuance of letters of credit. As of October 2, 2020, there were two letters of credit outstanding in the aggregate amount of $ 2.4 million, and no outstanding borrowings under the Amended Revolver resulting in borrowing capacity of $ 117.6 million under the Amended Revolver. The Amended Revolver will mature and the commitments thereunder will terminate on November 15, 2022 . The aggregate scheduled maturities of the Amended Term Loan, are as follows: (In thousands) Payments due 2020 (excluding the nine months ended October 2, 2020) $ 2,000 2021 8,600 2022 55,400 Total $ 66,000 Voluntary Prepayments. We may voluntarily prepay the Amended Term Loan in whole or in part at any time without premium or penalty, subject to the payment of customary breakage costs under certain conditions. Amounts borrowed under the Amended Term Loan that are repaid or prepaid may not be re-borrowed. Covenants . The Amended Credit Facilities contain customary covenants, including covenants that, under certain circumstances and subject to certain qualifications and exceptions: limit or restrict our ability to incur additional indebtedness; merge, dissolve, liquidate or consolidate; make acquisitions, investments, advances or loans; dispose of or transfer assets; pay dividends; redeem or repurchase certain debt; and enter into certain restrictive agreements. In addition, we are required to comply with (a) a maximum ratio of total consolidated indebtedness to consolidated earnings before interest, tax, depreciation and amortization (EBITDA) of 3.00 to 1.00 ( 3.25 to 1.00 for the 12 months following a qualified acquisition), and (b) a minimum ratio of consolidated EBITDA to consolidated interest expense (net of cash interest income) of 4.50 to 1.00. As of October 2, 2020, we had a ratio of total consolidated indebtedness to EBITDA of 0.99 to 1.00 and a ratio of consolidated EBITDA to consolidated interest expense of 12.60 to 1.00. We were in compliance with all covenants related to the Amended Credit Facilities as of October 2, 2020. Interest Rates and Fees. Outstanding borrowings under the Amended Credit Facilities accrue interest, at our option, at a per annum rate of (i) LIBOR plus the applicable margin, which ranges from 1.75 % to 2.50 % depending on the leverage ratio, or (ii) a base rate plus the applicable margin, which ranges from 0.75 % to 1.50 % depending on the leverage ratio. The interest rate under the Amended Credit Facilities at October 2, 2020 was 2.15 %. Carrying Value and Fair Value. As of October 2, 2020 and December 31, 2019, the fair value of the Amended Credit Facilities approximated the carrying value because the debt bears interest at a floating rate of interest. The fair value is based on observable inputs of interest rates that are currently available to us for debt with similar terms and maturities for non-public debt. 19 Table of Contents NOTE 10 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 Our interest rate swaps are designated and qualify as effective cash flow hedges. The contracts, with expiration dates through November 2022 and notional amounts totaling $ 49.6 million at October 2, 2020, are recorded at fair value. 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 October 2, 2020: (In thousands) Fair Value Balance sheet caption Amount Interest rate swap designated as cash flow hedge Other accrued liabilities $ 1,037 Interest rate swap designated as cash flow hedge Other non-current liabilities $ 1,007 The following table summarizes the amount at fair value and location of the derivative instruments used for our interest rate hedges in the Condensed Consolidated Balance Sheets as of December 31, 2019: (In thousands) Fair Value Balance sheet caption Amount Interest rate swap designated as cash flow hedge Other accrued liabilities $ 323 Interest rate swap designated as cash flow hedge Other non-current liabilities $ 686 We regularly assess the creditworthiness of the counterparty. As of October 2, 2020, 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 losses of $ 0.7 million and net interest rate derivative gains of less than $ 0.1 million were recognized in interest expense, net in our Condensed Consolidated Statements of Income during the first three quarters of 2020 and 2019, respectively. We expect $ 1.0 million of existing interest rate swap losses reported in accumulated other comprehensive loss as of October 2, 2020 to be recognized in earnings within the next 12 months. Foreign Currency Derivative Instruments The following table summarizes the amount at fair value and location of the derivative instruments used for our forward contract hedges in the Condensed Consolidated Balance Sheets as of October 2, 2020: (In thousands) Fair Value Balance sheet caption Amount Foreign currency forward designated as cash flow hedge Other current assets $ 197 Foreign currency forward designated as cash flow hedge Other accrued liabilities $ 44 The following table summarizes the amount at fair value and location of the derivative instruments used for our forward contract hedges in the Condensed Consolidated Balance Sheets as of December 31, 2019: (In thousands) Fair Value Balance sheet caption Amount Foreign currency forward designated as cash flow hedge Other accrued liabilities $ 185 At October 2, 2020, we had outstanding foreign currency forward contracts, for the exchange of U.S. dollars and Euros, with a notional amount of $ 9.5 million and expiration dates through September 2021. Counterparty default risk is considered low because the forward contracts that we entered into are over-the-counter instruments transacted with highly-rated financial institutions. We were not required to, and did not, post collateral as of October 2, 2020. Net foreign currency derivative losses of $ 0.2 million and $ 0.4 million were recognized in selling, general and administrative expenses during the first three quarters of 2020 and 2019, respectively. We expect $ 0.2 million of existing 20 Table of Contents foreign currency forward contract gains reported in accumulated other comprehensive loss as of October 2, 2020 to be recognized in earnings within the next 12 months. NOTE 11 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) October 2, 2020 September 27, 2019 October 2, 2020 September 27, 2019 Operating lease expense $ 1,349 $ 3,827 $ 5,621 $ 10,890 Variable lease expense 191 196 546 594 Short-term lease expense 14,323 12,436 40,483 35,055 Total lease expense $ 15,863 $ 16,459 $ 46,650 $ 46,539 Supplemental balance sheet information related to our operating leases is as follows: (In thousands) October 2, 2020 December 31, 2019 Right-of-use assets $ 9,970 $ 14,654 Current lease liabilities (recorded in other accrued liabilities) $ 3,449 $ 5,743 Long-term lease liabilities (recorded in other non-current liabilities) 7,553 9,811 Total operating lease liabilities $ 11,002 $ 15,554 Additional right-of-use assets of $ 1.5 million were recognized as non-cash asset additions that resulted from new operating lease liabilities during the first nine months of 2020. The weighted average remaining lease term and discount rate for our operating leases at October 2, 2020 were 5.2 years and 6.3 %, respectively. Maturities of lease liabilities at October 2, 2020 were as follows: (In thousands) Payments due 2020 (excluding the nine months ended October 2, 2020) $ 4,014 2021 2,002 2022 1,720 2023 1,483 2024 1,226 2025 and beyond 2,843 Total lease payments 13,288 Less: Imputed interest ( 2,286 ) Total operating lease liabilities $ 11,002 21 Table of Contents NOTE 12 STOCK-BASED COMPENSATION We maintain an equity incentive plan (the 2014 Omnibus Plan) to govern awards granted to Vectrus employees and directors, including nonqualified stock options (NQOs), restricted stock units (RSUs), total shareholder return (TSR) awards and other awards. We account for NQOs and stock-settled RSUs as equity-based compensation awards. TSR awards, described below, and cash-settled RSUs are accounted for as liability-based compensation awards and 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 Income were as follows: Three Months Ended Nine Months Ended (In thousands) October 2, 2020 September 27, 2019 October 2, 2020 September 27, 2019 Compensation costs for equity-based awards $ 1,284 $ 1,124 $ 4,286 $ 3,339 Compensation costs for liability-based awards ( 196 ) 798 2,213 2,613 Total compensation costs, pre-tax $ 1,088 $ 1,922 $ 6,499 $ 5,952 Future tax benefit $ 235 $ 416 $ 1,404 $ 1,288 As of October 2, 2020, total unrecognized compensation costs related to equity-based awards and liability-based awards were $ 6.7 million and $ 3.3 million, respectively, which are expected to be recognized ratably over a weighted average period of 1.68 years and 1.96 years, respectively. The following table provides a summary of the activities for NQOs and RSUs for the nine months ended October 2, 2020: 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, 2020 77 $ 23.30 301 $ 30.30 Granted — $ — 129 $ 51.98 Exercised ( 3 ) $ 21.43 — $ — Vested — $ — ( 147 ) $ 30.55 Issued in exchange — $ — 16 $ 52.28 Cancelled in exchange — $ — ( 16 ) $ 29.00 Forfeited or expired — $ — ( 18 ) $ 40.67 Outstanding at October 2, 2020 74 $ 23.37 265 $ 41.41 During the nine months ended October 2, 2020, we granted long term incentive awards to employees consisting of 108,490 RSUs with a weighted average grant date fair value per share of $ 52.76 and to our directors consisting of 20,311 RSUs with a weighted average grant date fair value per share of $ 47.76 . On August 11, 2020, our total outstanding 15,839 CRSUs were exchanged for 15,839 RSUs. As of the exchange date, both the CRSUs and RSUs had the same vesting conditions, fair value of $ 52.28 , and unrecognized compensation expense of $ 0.4 million. For employee RSUs, one-third of the award vests on each of the three anniversary dates following the grant date. Director RSUs are granted on the date of an annual meeting of shareholders and vest on the business day immediately prior to the next annual meeting. The fair value of each RSU grant was determined based on the closing price of Vectrus common stock on the date of grant. Stock compensation expense will be recognized ratably over the vesting period of the awards. Total Shareholder Return Awards TSR awards are performance-based cash awards that are subject to a three-year performance period. Any payments earned are made in cash following completion of the performance period according to the achievement of specified performance goals. During the nine months ended October 2, 2020, we granted TSR awards with an aggregate target TSR value of $ 3.1 million. The fair value of TSR awards is measured quarterly and is based on the Company’s performance relative to the performance of the Aerospace and Defense Companies in the S&P 1500 Index. Depending on the Company’s performance during the three-year performance period, payments can range from 0 % to 200 % of the target value. 22 Table of Contents NOTE 13 COMMITMENTS AND CONTINGENCIES General From time to time, we are involved in legal proceedings that are incidental to the operation of our business. Some of these proceedings seek remedies relating to employment matters, matters in connection with our contracts and matters arising under laws relating to the protection of the environment. Additionally, U.S. Government customers periodically advise the Company of claims and penalties concerning certain potential disallowed costs. When such findings are presented, Vectrus and the U.S. Government representatives engage in discussions to enable Vectrus to evaluate the merits of these claims as well as to assess the amounts being claimed. Where appropriate, provisions are made to reflect probable losses related to the matters raised by the U.S. Government representatives. Such assessments, along with any assessments regarding provisions for legal proceedings, are reviewed on a quarterly basis for sufficiency based on the most recent information available to us. We have estimated and accrued $ 11.6 million and $ 12.1 million as of October 2, 2020 and December 31, 2019, respectively, in "Other accrued liabilities" in the Condensed Consolidated Balance Sheets for legal proceedings and for claims with respect to our government contracts as discussed below, including open years subject to audit. Although the ultimate outcome of any legal matter or claim cannot be predicted with certainty, based on present information, including our assessment of the merits of the particular claim, we do not expect that any asserted or unasserted legal or contractual claims or proceedings, individually or in the aggregate, including the lawsuit discussed below, will have a material adverse effect on our cash flow, results of operations or financial condition. U.S. Government Contracts, Investigations and Claims We have U.S. Government contracts that are funded incrementally on a year-to-year basis. Changes in government policies, priorities or funding levels through agency or program budget reductions by the U.S. Congress or executive agencies could have a material adverse effect on our financial condition or results of operations. Furthermore, our contracts with the U.S. Government may be terminated or suspended by the U.S. Government at any time, with or without cause. Such contract suspensions or terminations could result in unreimbursable expenses or charges or otherwise adversely affect our financial condition and results of operations. 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. As a result of final indirect rate negotiations between the U.S. Government and our Former Parent, we may be subject to potential adjustments to costs previously allocated by our Former Parent to our business, which was formerly Exelis’ Mission Systems Business, from 2007 through 2014. We are in discussions with our Former Parent regarding the negotiated adjustments from 2007-2014 and believe that our potential cumulative liability for these years is insignificant. In June 2019, the U.S. Government provided us with the Contracting Officers Final Decision (COFD) for the years 2007-2010 related to Former Parent costs. In August 2019, we filed an appeal of the COFD with the Armed Services Board of Contract Appeals (ASBCA). Since October 2019, the ASBCA has granted Vectrus’ and the U.S. Government’s joint requests to stay proceedings in the appeal, most recently through January 11, 2021, to enable ongoing discussions regarding the matter between Vectrus and our Former Parent. In June 2020, the U.S. Government provided us with the COFD for 2013 related to Former Parent costs. In September 2020, we filed an appeal of this COFD to the ASBCA and sought a deferral of payment. In addition, we filed a motion to consolidate both appeals. The ASBCA granted our motion to consolidate. We believe we are fully indemnified under our Distribution Agreement with our Former Parent and have notified our Former Parent of our appeal of the U.S governments 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. Governments and businesses around the world have taken unprecedented actions to mitigate the spread of COVID-19, including, but not limited to, shelter-in-place orders, quarantines, significant restrictions on travel, social distancing guidelines, and restrictions on employees going to work. Uncertainty with respect to the economic impacts of the pandemic has introduced significant volatility in the financial markets. The Company has observed some disruptions on its operations due to 23 Table of Contents government delays related to the global pandemic. While the extent to which COVID-19 ultimately impacts the Company’s future results will depend on future developments, the pandemic and associated economic impacts could result in a material impact to the Company’s future financial condition, results of operations and cash flows.