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Section 1: 10-Q (10-Q)

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 27, 2019
or
¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to    
Commission File Number: 001-36341        
Vectrus, Inc.
(Exact name of registrant as specified in its charter)
Indiana
 
38-3924636
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

 
2424 Garden of the Gods Road, Colorado Springs, Colorado 80919
(Address of Principal Executive Offices) (Zip Code)
Registrant’s telephone number, including area code:
(719) 591-3600
Securities Registered Under Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common Stock, Par Value $0.01 Per Share
VEC
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ   No  ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
Accelerated filer þ
Non-accelerated filer ¨
 
Smaller reporting company ¨
Emerging growth company ¨
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨


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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨
No  þ
As of November 1, 2019, there were 11,509,088 shares of common stock ($0.01 par value per share) outstanding.


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VECTRUS, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
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Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VECTRUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 27,
 
September 28,
 
September 27,
 
September 28,
(In thousands, except per share data)
 
2019
 
2018
 
2019
 
2018
Revenue
 
$
359,854

 
$
308,095

 
$
1,017,371

 
$
949,744

Cost of revenue
 
325,537

 
278,964

 
921,685

 
865,078

Selling, general and administrative expenses
 
19,934

 
15,125

 
59,697

 
48,990

Operating income
 
14,383

 
14,006

 
35,989

 
35,676

Interest expense, net
 
(1,907
)
 
(1,314
)
 
(4,811
)
 
(3,619
)
Income from operations before income taxes
 
12,476

 
12,692

 
31,178

 
32,057

Income tax expense
 
3,094

 
2,826

 
7,088

 
6,884

Net income
 
$
9,382

 
$
9,866

 
$
24,090

 
$
25,173

 
 
 
 
 
 
 
 
 
Earnings per share
 
 
 
 
 
 
 
 
Basic
 
$
0.82

 
$
0.88

 
$
2.11

 
$
2.25

Diluted
 
$
0.80

 
$
0.86

 
$
2.08

 
$
2.21

Weighted average common shares outstanding - basic
 
11,506

 
11,248

 
11,420

 
11,210

Weighted average common shares outstanding - diluted
 
11,678

 
11,406

 
11,566

 
11,380

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

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VECTRUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 27,
 
September 28,
 
September 27,
 
September 28,
(In thousands)
 
2019
 
2018
 
2019
 
2018
Net income
 
$
9,382

 
$
9,866

 
$
24,090

 
$
25,173

Other comprehensive income, net of tax
 
 
 
 
 
 
 
 
Changes in derivative instruments:
 
 
 
 
 
 
 
 
Net change in fair value of interest rate swap
 
(194
)
 
296

 
(1,570
)
 
1,177

Net change in fair value of foreign currency forward contracts
 
(207
)
 
(34
)
 
(123
)
 
(196
)
Net (loss) gain reclassified to interest expense
 
(8
)
 

 
43

 

Tax benefit (expense)
 
88

 
(64
)
 
357

 
(254
)
Net change in derivative instruments
 
(321
)
 
198

 
(1,293
)
 
727

Foreign currency translation adjustments, net of tax
 
(1,526
)
 
(43
)
 
(1,801
)
 
(943
)
Accounting Standards Update (ASU) 2018-02 reclassification of certain tax effects to retained earnings
 

 

 
(259
)
 

Other comprehensive (loss) income, net of tax
 
(1,847
)
 
155

 
(3,353
)
 
(216
)
Total comprehensive income
 
$
7,535

 
$
10,021

 
$
20,737

 
$
24,957

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


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VECTRUS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
 
September 27,
 
December 31,
(In thousands, except share information)
 
2019
 
2018
Assets
 
 
 
 
Current assets
 
 
 
 
Cash
 
$
41,050

 
$
66,145

Receivables
 
254,796

 
232,119

Other current assets
 
22,588

 
15,063

Total current assets
 
318,434

 
313,327

Property, plant, and equipment, net
 
18,159

 
13,419

Goodwill
 
260,872

 
233,619

Intangible assets, net
 
15,934

 
8,630

Right-of-use assets
 
18,233

 

Other non-current assets
 
3,803

 
3,248

Total non-current assets
 
317,001

 
258,916

Total Assets
 
$
635,435

 
$
572,243

Liabilities and Shareholders' Equity
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
144,828

 
$
156,393

Compensation and other employee benefits
 
60,897

 
41,790

Short-term debt
 
5,500

 
4,500

Other accrued liabilities
 
39,524

 
22,303

Total current liabilities
 
250,749

 
224,986

Long-term debt, net
 
66,438

 
69,137

Deferred tax liability
 
50,560

 
55,358

Other non-current liabilities
 
19,353

 
1,462

Total non-current liabilities
 
136,351

 
125,957

Total liabilities
 
387,100

 
350,943

Commitments and contingencies (Note 13)
 

 

Shareholders' Equity
 

 

Preferred stock; $0.01 par value; 10,000,000 shares authorized; No shares issued and outstanding
 

 

Common stock; $0.01 par value; 100,000,000 shares authorized; 11,506,228 and 11,266,906 shares issued and outstanding as of September 27, 2019 and December 31, 2018, respectively
 
115

 
113

Additional paid in capital
 
77,766

 
71,729

Retained earnings
 
176,965

 
152,616

Accumulated other comprehensive loss
 
(6,511
)
 
(3,158
)
Total shareholders' equity
 
248,335

 
221,300

Total Liabilities and Shareholders' Equity
 
$
635,435

 
$
572,243

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

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VECTRUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
 
Nine Months Ended
 
 
September 27,
 
September 28,
(In thousands)
 
2019
 
2018
Operating activities
 
 
 
 
Net income
 
$
24,090

 
$
25,173

Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense
 
2,395

 
1,078

Amortization of intangible assets
 
2,103

 
1,468

Loss on disposal of property, plant, and equipment
 
2

 
315

Stock-based compensation
 
5,952

 
3,410

Amortization of debt issuance costs
 
301

 
318

Changes in assets and liabilities:
 
 
 
 
Receivables
 
(7,521
)
 
(15,179
)
Other assets
 
(5,820
)
 
(5,669
)
Accounts payable
 
(14,458
)
 
(5,259
)
Deferred taxes
 
(4,240
)
 
(2,101
)
Compensation and other employee benefits
 
17,863

 
5,002

Other liabilities
 
7,781

 
98

Net cash provided by operating activities
 
28,448

 
8,654

Investing activities
 
 
 
 
Purchases of capital assets and intangibles
 
(14,440
)
 
(6,115
)
Proceeds from the disposition of assets
 
5,400

 
33

Acquisition of business, net of cash acquired
 
(43,963
)
 
(36,855
)
Net cash used in investing activities
 
(53,003
)
 
(42,937
)
Financing activities
 
 
 
 
Repayments of long-term debt
 
(2,000
)
 
(3,000
)
Proceeds from revolver
 
226,000

 
138,000

Repayments of revolver
 
(226,000
)
 
(138,000
)
Proceeds from exercise of stock options
 
3,467

 
1,388

Payments of employee withholding taxes on share-based compensation
 
(768
)
 
(803
)
Net cash provided by (used in) financing activities
 
699

 
(2,415
)
Exchange rate effect on cash
 
(1,239
)
 
(1,171
)
Net change in cash
 
(25,095
)
 
(37,869
)
Cash-beginning of year
 
66,145

 
77,453

Cash-end of period
 
$
41,050

 
$
39,584

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Interest paid
 
$
4,363

 
$
3,241

Income taxes paid
 
$
5,076

 
$
11,222

Non-cash investing activities:
 
 
 
 
Purchase of capital assets on account
 
$
394

 
$
1,374

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

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VECTRUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES TO SHAREHOLDERS' EQUITY
 
 
Common Stock Issued
 
Additional Paid-in Capital
 
 
 
Accumulated Other Comprehensive Loss
 
Total Shareholders' Equity
(In thousands)
 
Shares
 
Amount
 
 
Retained Earnings
 
 
Balance at December 31, 2017
 
11,121

 
$
111

 
$
67,526

 
$
117,415

 
$
(1,680
)
 
$
183,372

Net income
 
 
 
 
 
 
 
6,111

 
 
 
6,111

Cumulative effects of adoption of Accounting Standards Codification (ASC) Topic 606 revenue recognition guidance
 
 
 
 
 
 
 
(77
)
 
 
 
(77
)
Foreign currency translation adjustments
 
 
 
 
 
 
 
 
 
487

 
487

Unrealized gain on cash flow hedge
 
 
 
 
 
 
 
 
 
403

 
403

Employee stock awards and stock options
 
101

 
1

 
522

 
 
 
 
 
523

Stock-based compensation
 
 
 
 
 
867

 
 
 
 
 
867

Balance at March 30, 2018
 
11,222

 
$
112

 
$
68,915

 
$
123,449

 
$
(790
)
 
$
191,686

Net income
 
 
 
 
 
 
 
9,195

 
 
 
9,195

Foreign currency translation adjustments
 
 
 
 
 
 
 
 
 
(1,388
)
 
(1,388
)
Unrealized gain on cash flow hedge
 
 
 
 
 
 
 
 
 
127

 
127

Employee stock awards and stock options
 
26

 
 
 
32

 
 
 
 
 
32

Stock-based compensation
 
 
 
 
 
908

 
 
 
 
 
908

Balance at June 28, 2018
 
11,248

 
$
112

 
$
69,855

 
$
132,644

 
$
(2,051
)
 
$
200,560

Net income
 
 
 
 
 
 
 
9,866

 
 
 
9,866

Foreign currency translation adjustments
 
 
 
 
 
 
 
 
 
(43
)
 
(43
)
Unrealized gain on cash flow hedge
 
 
 
 
 
 
 
 
 
198

 
198

Employee stock awards and stock options
 
1

 
1

 
30

 
 
 
 
 
31

Stock-based compensation
 
 
 
 
 
874

 
 
 
 
 
874

Balance at September 28, 2018
 
11,249

 
$
113

 
$
70,759

 
$
142,510

 
$
(1,896
)
 
$
211,486

 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
 
11,267

 
$
113

 
$
71,729

 
$
152,616

 
$
(3,158
)
 
$
221,300

Net income
 
 
 
 
 
 
 
7,091

 
 
 
7,091

Cumulative effects of adoption of ASU 2018-02 reclassification of certain tax effects from accumulated other comprehensive loss
 
 
 
 
 
 
 
259

 
(259
)
 

Foreign currency translation adjustments
 
 
 
 
 
 
 
 
 
(823
)
 
(823
)
Unrealized loss on cash flow hedge
 
 
 
 
 
 
 
 
 
(360
)
 
(360
)
Employee stock awards and stock options
 
85

 
1

 
(82
)
 
 
 
 
 
(81
)
Stock-based compensation
 
 
 
 
 
1,117

 
 
 
 
 
1,117

Balance at March 29, 2019
 
11,352

 
$
114

 
$
72,764

 
$
159,966

 
$
(4,600
)
 
$
228,244


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Net income
 
 
 
 
 
 
 
7,617

 
 
 
7,617

Foreign currency translation adjustments
 
 
 
 
 
 
 
 
 
547

 
547

Unrealized loss on cash flow hedge
 
 
 
 
 
 
 
 
 
(611
)
 
(611
)
Employee stock awards and stock options
 
154

 
1

 
2,779

 
 
 
 
 
2,780

Stock-based compensation
 
 
 
 
 
1,099

 
 
 
 
 
1,099

Balance at June 27, 2019
 
11,506

 
$
115

 
$
76,642

 
$
167,583

 
$
(4,664
)
 
$
239,676

Net income
 
 
 
 
 
 
 
9,382

 
 
 
9,382

Foreign currency translation adjustments
 
 
 
 
 
 
 
 
 
(1,526
)
 
(1,526
)
Unrealized loss on cash flow hedge
 
 
 
 
 
 
 
 
 
(321
)
 
(321
)
Employee stock awards and stock options
 

 

 

 
 
 
 
 

Stock-based compensation
 
 
 
 
 
1,124

 
 
 
 
 
1,124

Balance at September 27, 2019
 
11,506

 
$
115

 
$
77,766

 
$
176,965

 
$
(6,511
)
 
$
248,335

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




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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 (U.S.) government worldwide. The Company operates as one segment and offers facility and logistics services and information technology and network communications services.
Vectrus was incorporated in the State of Indiana on February 4, 2014. On September 27, 2014, Exelis Inc. (Exelis) completed a spin-off (the Spin-off) of Vectrus, and Vectrus became an independent, publicly traded company. Unless the context otherwise requires, references in these notes to "Vectrus", "we," "us," "our," "the Company" and "our Company" refer to Vectrus, Inc. References in these notes to Exelis or "Former Parent" refer to Exelis Inc. and its consolidated subsidiaries (other than Vectrus).
Basis of Presentation
Our quarterly financial periods end on the Friday closest to the last day of the calendar quarter (September 27, 2019 for the third quarter of 2019 and September 28, 2018 for the third quarter of 2018), except for the last quarter of the fiscal year, which ends on December 31. For ease of presentation, the quarterly financial statements included herein are described as three and nine 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, 2018.
It is management’s opinion that these financial statements include all normal and recurring adjustments necessary for a fair presentation of the Company’s financial position and operating results. Net sales and net earnings for any interim period are not necessarily indicative of future or annual results.
Leases
On January 1, 2019, the Company adopted the new lease accounting standard Accounting Standards Codification Topic 842, Leases (ASC Topic 842). Operating leases are included on our Condensed Consolidated Balance Sheets as right-of-use (“ROU”) assets, other accrued liabilities and other non-current liabilities.
ROU assets represent the Company's right to use an underlying asset for the lease term and lease liabilities represent the Company's obligation to make lease payments arising from the lease. Lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit interest rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The incremental borrowing rate as of January 1, 2019 was applied to operating leases in effect as of that date. The operating lease ROU asset also includes any prepaid lease payments and excludes lease incentives. Many of our leases include one or more options to renew or terminate the lease, solely at our discretion. Such options are factored into the lease term when it is reasonably certain that we will exercise the option. Lease expense for lease payments is recognized on a straight-line basis over the term of the lease.
As allowed under ASC Topic 842, the Company elected the package of practical expedients permitted under the transition guidance which allowed the Company to carry forward the historical lease classification, assessment of whether a contract was or contained a lease and assessment of initial direct costs. In addition, we have made policy elections to apply the short-term leases practical expedient, whereby leases with a term of 12 months or less are not capitalized and recorded on our balance sheet, and the practical expedient to not separate lease components from non-lease components. The latter expedient is applied to all of our leases. We did not elect to apply the hindsight practical expedient in determining lease terms and assessing impairment of ROU assets. See Note 2, "Recent Accounting Pronouncements" and Note 10, "Leases" for further information.

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Reclassifications
Certain reclassifications have been made to the presentation of amounts in our Condensed Consolidated Statements of Cash Flows for the nine months ended September 28, 2018 to conform to the current year presentation. Specifically, depreciation and amortization, which were combined and disclosed as one amount are now presented separately.
NOTE 2
RECENT ACCOUNTING PRONOUNCEMENTS
Accounting Standards Issued But Not Yet Effective
In August 2018, the Financial Accounting Standards Board (FASB) issued ASU 2018-15 to provide guidance on accounting for implementation costs incurred in a cloud computing arrangement (CCA) hosted by the vendor - that is a service contract. Under the new guidance, a customer will apply the same criteria for capitalizing implementation costs of a CCA as it would for an on-premises internal-use software license. Presentation of such costs, however, will vary from those required for licensed internal-use software. ASU 2018-15 is effective January 1, 2020 and can be adopted prospectively or retrospectively. Early adoption is permitted. The standard is not expected to have a material impact on the Company's consolidated financial statements.
ASU 2016-13 was issued in June 2016 with the intent of providing financial statement users with more useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. Current treatment uses the incurred loss methodology for recognizing credit losses that delays the recognition until it is probable a loss has been incurred. The accounting update adds a new impairment model, known as the current expected credit loss model, which is based on expected losses rather than incurred losses. Under the new guidance, an entity will recognize as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. The standard is not expected to have a material impact on our consolidated financial statements.
For a discussion of other accounting standards that have been issued by the FASB but are not yet effective, refer to the Accounting Standards Updates section in our Annual Report on Form 10-K for the year ended December 31, 2018. These standards are not expected to have a material impact on our results of operations or cash flows.
Accounting Standards That Were Adopted
In February 2018, the FASB issued ASU 2018-02, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (Tax Act). The Company adopted the provisions of ASU 2018-02 during the first quarter of 2019 and recorded a $0.3 million decrease to accumulated other comprehensive income and a corresponding increase to beginning retained earnings to reflect the changes in the U.S. federal corporate income tax rate as a result of the Tax Act. As a result of the adoption of ASU 2018-02, the Company's policy to release income tax effects in accumulated other comprehensive income is consistent with the underlying book method.
In February 2016, the FASB issued ASU 2016-02, with amendments issued in 2018. The objective of ASU 2016-02 is to recognize lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The standard requires lessees to recognize most leases on the Condensed Consolidated Balance Sheets but does not change the manner in which expenses are recorded in the income statement. We adopted the standard during the first quarter of 2019 using the cumulative-effect adjustment transition method, which applies the provisions of the standard at the effective date without adjusting comparative periods presented.
See Note 1, "Description of Business and Summary of Significant Accounting Policies" and Note 10,"Leases" for further information.
Other new accounting pronouncements issued but not yet effective until after September 27, 2019 are not expected to have a material impact on our financial position, results of operations or cash flows.
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 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

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a single service solution, whereby each service is not separately identifiable from other promises in the contract. 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 contracts 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.
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 the services are performed. This continuous transfer of control requires that the Company tracks progress towards completion of performance obligations in order to measure and recognize revenue. Determining progress on performance obligations requires the Company to make judgments that affect the timing of revenue recognition. Remaining performance obligations represent firm orders by the customer and exclude potential orders under IDIQ contracts, unexercised contract options and contracts awarded to us that are being protested by competitors with the U.S. Government Accountability Office (GAO) or in the U.S. Court of Federal Claims. The level of order activity related to programs can be affected by the timing of government funding authorizations and 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. Most of our contracts have terms that would permit us to recover all or a portion of our incurred costs and fees for work performed in the event of a termination for convenience.
Remaining performance obligations increased by $101.3 million to $959 million as of September 27, 2019 as compared to $858 million as of December 31, 2018. The Company expects to recognize approximately 34% of the remaining performance obligations as revenue in 2019, and the remaining 66% during 2020. Remaining performance obligations as of September 27, 2019 and December 31, 2018 are presented in the following table:
 
 
September 27,
 
December 31,
(In millions)
 
2019
 
2018
Performance Obligations
 
$
959

 
$
858


Contract Estimates
Accounting for contracts and programs involves the use of various techniques to estimate total contract revenue and costs. For contracts, we estimate the profit on a contract as the difference between the total estimated revenue and expected costs to complete a contract and recognize that profit over the life of the contract.
Contract estimates are based on various assumptions to project the outcome of future events. These assumptions include labor productivity and availability; the complexity of the services being performed; the cost and availability of materials; the performance of subcontractors; and the availability and timing of funding from the customer.
The impact of adjustments in contract estimates on our operating income can be reflected in either revenue or cost of revenue. Cumulative adjustments for the three and nine months ended September 27, 2019 were favorable by $0.7 million and $1.5 million, respectively. Cumulative adjustments for the three and nine months ended September 28, 2018 were unfavorable by $1.6 million and favorable by $4.9 million, respectively.
For the three and nine months ended September 27, 2019, the net favorable adjustments to operating income increased revenue by $4.0 million and $4.2 million, respectively. For the three months ended September 28, 2018, the net unfavorable adjustments to operating income decreased revenue by $2.0 million. For the nine months ended September 28, 2018, the net favorable adjustments to operating income increased revenue by $4.7 million.
Revenue by Category
Generally, the sales price elements for the Company's contracts are cost-plus, cost-reimbursable or firm-fixed-price. The Company commonly has elements of cost-plus, cost-reimbursable and firm-fixed-price contracts in a single contract. On a cost-plus type contract, the Company is 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

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contracts, we do not bear the risks of unexpected cost overruns, provided that we do not incur costs that exceed the predetermined funded amounts. Most of our cost-plus contracts also contain a firm-fixed-price element. Cost-plus type contracts with award and incentive fee provisions are our primary variable contract fee arrangement. Award fees provide for a fee based on actual performance relative to contractually specified performance criteria. Incentive fees provide for a fee based on the relationship between total allowable and target cost. On most of our contracts, a cost-reimbursable element captures consumable materials required for the program. Typically, these costs do not bear fees.
On a firm-fixed-price type contract, we agree to perform the contractual statement of work for a predetermined contract price. A firm-fixed-price type contract typically offers higher profit margin potential than a cost-plus type contract, which is commensurate with the greater levels of risk we assume on a firm-fixed-price type contract. Although a firm-fixed-price type contract generally permits us to retain profits if the total actual contract costs are less than the estimated contract costs, we bear the risk that increased or unexpected costs may reduce our profit or cause us to sustain losses on the contract. Although the overall scope of work required under the contract may not change, profit may be adjusted as experience is gained and as efficiencies are realized or costs are incurred.
The following tables present our revenue disaggregated by several categories. Revenue by contract type for the three and nine months ended September 27, 2019 and September 28, 2018 is as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 27,
 
September 28,
 
September 27,
 
September 28,
(In thousands)
 
2019
 
2018
 
2019
 
2018
Cost-plus and cost-reimbursable ¹
 
$
272,810

 
$
240,338

 
$
781,024

 
$
713,289

Firm-fixed-price
 
87,044

 
67,757

 
236,347

 
236,455

Total revenue
 
$
359,854

 
$
308,095

 
$
1,017,371

 
$
949,744


 
 
 
 
 
 
 
 
¹ Includes time and material contracts
 
 
 
 
 
 
 
 
Revenue by geographic region in which the contract is performed for the three and nine months ended September 27, 2019 and September 28, 2018 is as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 27,
 
September 28,
 
September 27,
 
September 28,
(In thousands)
 
2019
 
2018
 
2019
 
2018
Middle East
 
$
244,142

 
$
223,636

 
$
695,626

 
$
662,734

United States
 
77,228

 
54,379

 
219,534

 
203,015

Europe
 
38,484

 
30,080

 
102,211

 
83,995

Total revenue
 
$
359,854

 
$
308,095

 
$
1,017,371

 
$
949,744


Revenue by contract relationship for the three and nine months ended September 27, 2019 and September 28, 2018 is as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 27,
 
September 28,
 
September 27,
 
September 28,
(In thousands)
 
2019
 
2018
 
2019
 
2018
Prime contractor
 
$
334,383

 
$
290,090

 
$
954,172

 
$
892,206

Subcontractor
 
25,471

 
18,005

 
63,199

 
57,538

Total revenue
 
$
359,854

 
$
308,095

 
$
1,017,371

 
$
949,744



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Revenue by customer for the three and nine months ended September 27, 2019 and September 28, 2018 is as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 27,
 
September 28,
 
September 27,
 
September 28,
(In thousands)
 
2019
 
2018
 
2019
 
2018
Army
 
$
245,817

 
$
224,038

 
$
698,377

 
$
700,265

Air Force
 
86,557

 
64,278

 
227,081

 
189,954

Navy
 
13,344

 
8,567

 
45,249

 
26,912

Other
 
14,136

 
11,212

 
46,664

 
32,613

Total revenue
 
$
359,854

 
$
308,095

 
$
1,017,371

 
$
949,744

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 September 27, 2019, we had contract assets of $194.7 million. Refer to Note 7, "Receivables" for additional information regarding the composition of our receivables balances. As of September 27, 2019, our contract liabilities were $0.9 million.
NOTE 4
ACQUISITIONS
Advantor
On July 8, 2019, we acquired Advantor Systems Corporation and Advantor Systems, LLC (collectively, Advantor) from Infrasafe Holding, Inc. and Infrasafe, LLC (collectively, Infrasafe). Advantor 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 $44.0 million, consisting of the purchase price, net of cash acquired, and $0.3 million estimated 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 8, “Debt”).

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A breakdown of the preliminary purchase price allocation, net of cash acquired, is as follows:
(In thousands)
 
Allocation of Purchase Price
Receivables
 
$
11,535

Other current assets
 
2,719

Property, plant and equipment
 
155

Goodwill
 
27,253

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
 
$
43,963

The Company is in the process of finalizing the details related to the amounts allocated to receivables, prepaid assets, property, plant and equipment and accounts payables. The amount paid relating to working capital was based on an estimate at the closing of the acquisition. Any differences between the estimate and the actual amount at closing will be finalized subsequent to September 27, 2019. Adjustments to the initial purchase accounting for the acquired net assets will be completed, as needed, up to one year from the acquisition date as we obtain additional information regarding facts and circumstances that existed as of the acquisition date.
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. The weighted-average remaining useful life of these two intangible assets is 4.7 years. Accordingly, the Company recorded amortization expense of $0.4 million during the three months and nine months ended September 27, 2019. The amortization expense is included in cost of revenue in our Condensed Consolidated Statements of Income.
Additionally, the Company recognized goodwill of $27.3 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.
Through September 27, 2019, the Company recorded acquisition-related costs of $1.0 million. These costs are included in selling, general and administrative expenses in our Condensed Consolidated Statements of Income and do not reflect any other one-time internal non-recurring integration costs.
Advantor's results of operations have been included in our Condensed Consolidated Statements of Income for the period subsequent to acquisition on July 8, 2019. For the three and nine months ended September 27, 2019, Advantor contributed $10.2 million of revenue and an insignificant amount of income from operations before income taxes. For the three months and nine months ended September 28, 2018, the acquired business recognized revenue of $8.4 million and $24.1 million, respectively. Income from operations before income taxes for the acquired business was insignificant during the same prior year periods.
SENTEL
On January 23, 2018, the Company acquired 100% of the outstanding common stock of SENTEL Corporation (SENTEL). 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 of the purchase price over the estimated fair value of the net assets acquired was recorded as goodwill.
The total net consideration paid for the acquisition was $36.9 million, consisting of the purchase price of $36.0 million and $0.9 million in excess of the working capital requirement agreed upon in the stock purchase agreement entered into among our wholly-owned subsidiary Vectrus Systems Corporation (VSC), SENTEL, R&R Enterprises, Inc. and Russell T. Wright. The acquisition was funded by utilizing cash on hand and available capacity from our Amended Revolver (as defined in Note 8, "Debt").

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A breakdown of the purchase price allocation, net of cash acquired, is as follows:
(In thousands)
Allocation of Purchase Price
Receivables
$
23,339

Property, plant and equipment
810

Goodwill
16,689

Intangible assets
10,500

Other current assets
975

Accounts payable
(10,012
)
Other current liabilities
(5,446
)
Purchase price, net of cash acquired
$
36,855

With the acquisition of SENTEL, the Company recognized two intangible assets relating to customer contracts, backlog and contract re-competes. The fair value of the backlog was $6.5 million, and the fair value of the contract re-competes was $4.0 million with an amortization period of 4.0 years and 8.0 years, respectively.
Additionally, the Company recognized goodwill of $16.7 million arising from the acquisition, which relates primarily to growth opportunities resulting from a broader service offering in the converging physical and digital infrastructure market, enhancing our information technology, technical solutions and logistics capabilities, and expanding our client base to customers in the U.S. intelligence community. The goodwill recognized for the SENTEL acquisition is fully deductible for income tax purposes.
SENTEL’s operating results have been included in our reported results since the date of acquisition.
NOTE 5
INCOME TAXES
Effective Tax Rate
Our quarterly income tax expense is measured using an estimated annual effective income tax rate. The comparison of effective income tax rates between periods may be significantly affected by discrete items recognized during the periods, the level and mix of earnings by tax jurisdiction and permanent differences.
For the three months ended September 27, 2019 and September 28, 2018, we recorded income tax provisions of $3.1 million and $2.8 million, respectively, representing effective income tax rates of 24.8% and 22.3%, respectively. For the nine months ended September 27, 2019 and September 28, 2018, we recorded income tax provisions of $7.1 million and $6.9 million, respectively, representing effective income tax rates of 22.7% and 21.5%, respectively. The higher effective income tax rates for the 2019 periods are the result of an increase in state taxes due to additional continental United States (CONUS) activity, the impact of foreign taxes due to additional guidance on the implementation of the Tax Act and a reduction in employment tax credits. The effective income tax rates vary from the federal statutory rate of 21.0% due to state taxes, required tax income exclusions, nondeductible expenses and available deductions not reflected in book income.
Uncertain Tax Positions
As of September 27, 2019 and December 31, 2018, unrecognized tax benefits from uncertain tax positions were $6.7 million and $1.8 million, respectively. The increase in the uncertain tax positions was principally the result of the additional Foreign Derived Intangible Income (FDII) deduction.

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NOTE 6
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 the potential dilution that could occur if securities such as stock options and restrictive stock units 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
 
 
September 27,
 
September 28,
 
September 27,
 
September 28,
(In thousands, except per share data)
 
2019
 
2018
 
2019
 
2018
Net income
 
$
9,382

 
$
9,866

 
$
24,090

 
$
25,173

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
11,506

 
11,248

 
11,420

 
11,210

Add: Dilutive impact of stock options
 
37

 
68

 
45

 
75

Add: Dilutive impact of restricted stock units
 
135

 
90

 
101

 
95

Diluted weighted average common shares outstanding
 
11,678

 
11,406

 
11,566

 
11,380

 
 
 
 
 
 
 
 
 
Earnings per share
 
 
 
 
 
 
 
 
Basic
 
$
0.82

 
$
0.88

 
$
2.11

 
$
2.25

Diluted
 
$
0.80

 
$
0.86

 
$
2.08

 
$
2.21


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
 
 
September 27,
 
September 28,
 
September 27,
 
September 28,
(In thousands)
 
2019
 
2018
 
2019
 
2018
Anti-dilutive stock options
 

 
1

 
1

 
2

Anti-dilutive restricted stock units
 

 

 
3

 

Total
 

 
1

 
4

 
2


NOTE 7
RECEIVABLES
Receivables were comprised of the following:
 
 
September 27,
 
December 31,
(In thousands)
 
2019
 
2018
Billed receivables
 
$
48,297

 
$
44,868

Unbilled receivables (contract assets)
 
194,729

 
181,009

Other
 
11,770

 
6,242

Total receivables
 
$
254,796

 
$
232,119

As of September 27, 2019 and December 31, 2018, all billed receivables are due from the U.S. government, either directly as prime contractor to the U.S. government or as subcontractor to another prime contractor to the U.S. government. Because our billed receivables are with the U.S. government, we do not believe the Company 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 estimate that approximately $3.7 million of our unbilled receivables as of September 27, 2019 may not be collected within the next 12 months. These amounts relate to the timing of the U.S.

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government review of indirect rates and contract line item realignments with our customers. Changes in the balance of receivables are primarily due to the timing differences between our performance and customers' payments.
NOTE 8
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 request up to an additional $100.0 million subject to the lender's consent on the same terms and conditions as the existing Amended Term Loan.  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. There were no outstanding borrowings under the Amended Revolver at September 27, 2019. As of September 27, 2019, there were seven letters of credit outstanding in the aggregate amount of $8.1 million, which reduced our borrowing availability to $111.9 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
2019 (excluding the nine months ended September 27, 2019)
 
$
2,500

2020
 
6,500

2021
 
8,600

2022
 
55,400

Total
 
$
73,000

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.
The Amended Credit Facilities contain customary covenants, including covenants that, under certain circumstances are 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 September 27, 2019, the Company had a ratio of total consolidated indebtedness to EBITDA of 1.04 to 1.00 and a ratio of consolidated EBITDA to consolidated interest expense of 11.02 to 1.00 and was in compliance with all covenants related to the Amended Credit Facilities.
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 September 27, 2019 was 4.12%.
Carrying Value and Fair Value. As of September 27, 2019 and December 31, 2018, the fair value of the Amended Credit Facilities approximated the carrying value since 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.

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NOTE 9
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.
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 $54.9 million at September 27, 2019, are recorded at fair value.
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 September 27, 2019:
(In thousands)
 
Fair Value
 
 
Balance sheet caption
 
Amount
Interest rate swap designated as cash flow hedge
 
Other accrued liabilities
 
$
315

Interest rate swap designated as cash flow hedge
 
Other non-current liabilities
 
$
995

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, 2018:
(In thousands)
 
Fair Value
 
 
Balance sheet caption
 
Amount
Interest rate swap designated as cash flow hedge
 
Other current assets
 
$
121

Interest rate swap designated as cash flow hedge
 
Other non-current assets
 
$
104

We regularly assess the creditworthiness of the counterparty. As of September 27, 2019, the counterparty to the interest rate swaps had performed in accordance with its contractual obligations. Both the counterparty credit risk and our credit risk were considered in the fair value determination.
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 September 27, 2019:
(In thousands)
 
Fair Value
 
 
Balance sheet caption
 
Amount
Foreign currency forward designated as cash flow hedge
 
Other accrued liabilities
 
$
423

Foreign currency forward designated as cash flow hedge
 
Other non-current liabilities
 
$
58

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, 2018:
(In thousands)
 
Fair Value
 
 
Balance sheet caption
 
Amount
Foreign currency forward designated as cash flow hedge
 
Other accrued liabilities
 
$
351

Foreign currency forward designated as cash flow hedge
 
Other non-current liabilities
 
$
7

At September 27, 2019, we had outstanding foreign currency forward contracts, for the exchange of U.S. dollars and Euros, with a notional amount of $9.2 million and expiration dates through December 2020.
Counterparty default risk is considered low because the forward contracts that we entered into are over-the-counter instruments transacted with highly-rated financial institutions. We were not required to, and did not, post collateral as of September 27, 2019.
The current estimated value of net losses for the above derivative instruments anticipated to be transferred from accumulated other comprehensive income into earnings over the next 12 months is $0.7 million.

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NOTE 10
Leases
We determine whether an arrangement contains a lease at inception. We have operating leases for office space, apartments, vehicles, and machinery and equipment. Our operating leases have lease terms of less than one year to ten years.
We do not separate lease components from non-lease components (e.g., common area maintenance, property taxes, and insurance) but account for both components in a contract as a single lease component.
The components of lease expense are as follows:

 
Three Months Ended
 
Nine Months Ended
(In thousands)
 
September 27, 2019
 
September 27, 2019
Operating lease expense
 
$
3,827

 
$
10,890

Variable lease expense
 
196

 
594

Short-term lease expense
 
12,436

 
35,055

Total lease expense
 
$
16,459

 
$
46,539

Supplemental balance sheet information related to our operating leases is as follows:
(In thousands)
 
 
September 27, 2019
Right-of-use assets
 
 
$
18,233

 
 
 
 
Current lease liabilities (recorded in other accrued liabilities)
 
 
$
8,402

Long-term lease liabilities (recorded in other non-current liabilities)
 
 
10,683

Total operating lease liabilities
 
 
$
19,085

Initial ROU assets of $19.2 million were recognized as non-cash asset additions when the new lease accounting standard was adopted on January 1, 2019. Additional ROU assets from operating lease arrangements of $7.1 million were recognized as non-cash asset additions during the nine months ended September 27, 2019, and; ROU assets of $1.9 million were recognized with the Advantor acquisition.
The weighted average remaining lease term and discount rate for our operating leases at September 27, 2019 were 4.1 years and 5.9%, respectively.
Maturities of lease liabilities at September 27, 2019 were as follows:
(In thousands)
 
 
2019 (excluding the nine months ended September 27, 2019)
 
$
3,832

2020
 
6,445

2021
 
3,315

2022
 
2,589

2023
 
1,426

2024 and beyond
 
4,537

    Total lease payments
 
22,144

Less: Imputed interest
 
3,059

   Total
 
$
19,085


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NOTE 11
GOODWILL AND INTANGIBLE ASSETS
As of September 27, 2019 and December 31, 2018, the carrying amount of goodwill was $260.9 million and $233.6 million, respectively. The increase during the first nine months of 2019 is due to the acquisition of Advantor.
Other identifiable intangible assets were as follows:

 
September 27, 2019

December 31, 2018
(In thousands)
 
Gross Carrying Amount

Accumulated Amortization

Gross Carrying Amount

Accumulated Amortization
Amortizing intangible assets
 
$
19,900


$
4,102


$
10,500


$
1,999

Non-amortizing intangible assets
 
136




129



Balance
 
$
20,036


$
4,102


$
10,629


$
1,999

As of September 27, 2019 and December 31, 2018, the carrying amount of intangible assets was approximately $15.9 million and $8.6 million, respectively. The increase during the first nine months of 2019 was due to $8.3 million from the acquisition of Advantor and $1.1 million of amortizable intangible assets purchased during the first quarter of 2019. This increase was offset by intangible amortization expense of approximately $0.8 million and $2.1 million for the three and nine months ended September 27, 2019, respectively. Intangible amortization expense for the three and nine months ended September 28, 2018 was $0.6 million and $1.5 million, respectively.
During the third quarter ending September 27, 2019, the Company received $5.4 million from the seller of a contract acquired by the Company in the first quarter of 2019 due to the inability to have this contract novated to the Company.  The Company eliminated the previously established intangible asset during the third quarter of 2019.
Amortizing intangible assets, which carry a remaining average life of approximately four years, are principally composed of customer contracts and related backlogs, re-competes and trade names.
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.
Stock-based compensation expense and the associated tax benefits impacting our Condensed Consolidated Statements of Income were as follows:
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
 
September 27, 2019
 
September 28, 2018
 
September 27, 2019
 
September 28, 2018
Compensation costs for equity-based awards
 
$
1,124

 
$
874

 
$
3,339

 
$
2,650

Compensation costs for liability-based awards
 
798

 
14

 
2,613

 
760

Total compensation costs, pre-tax
 
$
1,922

 
$
888

 
$
5,952

 
$
3,410

Future tax benefit
 
$
416

 
$
192

 
$
1,288

 
$
737

Liability-based awards are revalued at the end of each reporting period to reflect changes in fair value.
As of September 27, 2019, total unrecognized compensation costs related to equity-based awards and liability-based awards were $5.6 million and $3.9 million, respectively, which are expected to be recognized ratably over a weighted average period of 1.81 years and 1.97 years, respectively.

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The following table provides a summary of the activities for NQOs and RSUs for the nine months ended September 27, 2019:
 
 
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, 2019
 
251

 
$
23.00

 
257

 
$
28.90

Granted
 

 

 
205

 
$
30.03

Exercised
 
152

 
$
22.89

 

 

Vested
 

 

 
126

 
$
27.66

Forfeited or expired
 
12

 
$
24.47

 
21

 
$
29.04

Outstanding at September 27, 2019
 
87

 
$
22.98

 
315

 
$
30.14

During the nine months ended September 27, 2019, we granted long term incentive awards to employees consisting of 180,409 RSUs with a weighted average grant date fair value per share of $28.85 and to our directors consisting of 25,246 RSUs with a weighted average grant date fair value per share of $38.42.
For employee RSUs, one-third of the award vests on each of the three anniversary dates following the grant date. Director RSUs are granted on the date of an annual meeting of shareholders and vest on the business day immediately prior to the next annual meeting. The fair value of each RSU grant was determined based on the closing price of Vectrus common stock on the date of grant. Stock compensation expense will be recognized ratably over the vesting period of the awards.
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 September 27, 2019, we granted TSR awards with an aggregate target TSR value of $2.5 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.
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 $12.0 million and $7.8 million as of September 27, 2019 and December 31, 2018, 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.

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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 September 2014. Because we do not participate in indirect rate negotiations between the U.S. government and our Former Parent, we cannot reasonably predict the likelihood of such adjustments or the ultimate responsible party. We have recently been in discussions with our Former Parent regarding the negotiated adjustments for 2007-2014 and believe that our potential cumulative liability for these years is insignificant. In June 2019, the U.S. government provided us with the Contracting Officer's 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). In October 2019, the ASBCA granted Vectrus’ and the U.S. government’s joint request to stay proceedings in the appeal through December 30, 2019 to enable ongoing discussions regarding the matter between Vectrus and our Former Parent. 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. government's decision in this matter.
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and notes thereto included in this Quarterly Report on Form 10-Q as well as the audited Consolidated Financial Statements and notes thereto and the information under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 31, 2018. This Quarterly Report provides additional information regarding the Company, our services, industry outlook and forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements. Refer to "Forward-Looking Information" for further information regarding forward-looking statements. Amounts presented in and throughout this Item 2 are rounded and, as such, any rounding differences could occur in period over period changes and percentages reported.
Overview
Vectrus is a leading provider of services to the U.S. government worldwide. We operate in one segment and offer facility and logistics services and information technology and network communications services.
Our primary customer is the U.S. Department of Defense (DoD), with a high concentration in the U.S. Army. For the nine months ended September 27, 2019 and September 28, 2018, we had total revenue of $1,017.4 million and $949.7 million, respectively, essentially all of which was derived from U.S. government customers. For the nine months ended September 27, 2019 and September 28, 2018, we generated approximately 69% and 74%, respectively, of our total revenue from the U.S. Army.
Executive Summary
Our revenue increased by $51.8 million, or 16.8%, for the three months ended September 27, 2019 compared to the three months ended September 28, 2018. The increase in revenue was attributable to increases from our U.S. programs of $22.9 million, our Middle East programs of $20.5 million, and our European programs of $8.4 million. The acquisition of Advantor contributed $10.2 million to the increase from U.S. programs.
Operating income for the three months ended September 27, 2019, was $14.4 million, an increase of $0.4 million, or 2.7%, compared to the three months ended September 28, 2018. This increase was due to increased operating income of $2.1 million from our Middle East programs offset by decreases of $1.2 million from our European programs and $0.5 million from our U.S. programs.

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During the performance of our contracts, we periodically review estimated final contract prices and costs and make revisions as required, which are recorded as changes in revenue and cost of revenue in the periods in which they are determined. Additionally, the fees under certain contracts may be increased or decreased in accordance with cost or performance incentive provisions which measure actual performance against established targets or other criteria. Such incentive fee awards or penalties are included in revenue when there is sufficient information to reasonably assess anticipated contract performance. Amounts representing contract change orders, claims, requests for equitable adjustment, or limitations in funding on contracts are recorded only if it is probable the claim will result in additional contract revenue and the amounts can be reliably estimated. Changes in estimated revenue, cost of revenue and the related effect to operating income are recognized using cumulative adjustments, which recognize in the current period the cumulative effect of the changes on current and prior periods based on a contract's percentage of completion.
Further details related to our financial results for the three and nine months ended September 27, 2019, compared to the three and nine months ended September 28, 2018, are contained in the "Discussion of Financial Results" section.
Recent Developments
On April 12, 2019, the U.S. Army Contracting Command-Rock Island (ACC-RI) awarded four IDIQ, Multiple Award Task Order Contracts (MATOC), for the Logistics Civil Augmentation Program (LOGCAP) V support services in support of the U.S. military worldwide. The services are to support the Geographical Combatant Commands (GCCs) and Army Service Component Commands (ASCCs) throughout the full range of military operations. Each basic IDIQ contract Ordering Period will be an initial five-year ordering period and options for five additional one-year ordering periods.
Vectrus is one of the four award recipients of the basic IDIQ contract and received the following task orders: PACOM Setting the Theater Task Order and associated Performance Task Order; and CENTCOM Setting the Theater Task Order and associated Performance Task Order. Each task order has its own period of performance. Four of the LOGCAP V offerors filed protests of the awards with the U.S. Government Accountability Office (GAO) and, after the GAO denied two of the protests, those four offerors filed protests at the U.S. Court of Federal Claims (the Court).  At the Court’s request, the GAO issued advisory opinions that rejected the two remaining protests.  The briefings and oral arguments before the Court are scheduled to be completed by mid-November, and the Court has committed to issuing decisions by early December 2019.  We cannot predict the outcome of the protests.
Information regarding certain other significant contracts is discussed in "Significant Contracts" below.
Significant Contracts
The following table reflects contracts that accounted for more than 10% of our total revenue for the nine months ended September 27, 2019 and September 28, 2018:
 
 
% of Total Revenue
 
 
Nine Months Ended
Contract Name
 
September 27, 2019
 
September 28, 2018
Kuwait Base Operations and Security Support Services (K-BOSSS)
 
36.2%
 
40.4%
Operations, Maintenance and Defense of Army Communications in Southwest Asia and Central Asia (OMDAC-SWACA)
 
15.8%
 
14.2%
Revenue associated with a contract will fluctuate based on increases or decreases in the work being performed on the contract, award fee payments, and other contract modifications within the term of the contract resulting in changes to the total contract value. See "Backlog" below.
The K-BOSSS contract currently is exercised through March 28, 2020, with an additional six-month option through September 28, 2020. K-BOSSS, our largest base operations support services contract, supports geographically-dispersed locations within the State of Kuwait, including several camps and a range training complex. K-BOSSS provides critical base operations support and security support services, including forms, publications, and reproduction services; U.S. Army postal operations; range operations and maintenance; logistics; information management; public works; environmental services; medical administrative support; morale, welfare and recreation; and security, fire and emergency services. The K-BOSSS contract was re-competed as a task order under the LOGCAP V contract vehicle, which was awarded April 12, 2019 (see "Recent Developments" above). The K-BOSSS contract contributed $368 million and $384 million of revenue for the nine months ended September 27, 2019 and September 28, 2018, respectively.

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The OMDAC-SWACA contract is currently exercised through November 30, 2019, with a one-month option and a two-month option through February 28, 2020. The contract provides for enterprise network capabilities and services support of the U.S. Central Command. Work is based in Kuwait with additional locations throughout Southwest Asia. Technical support activities include the Southwest Asia Regional Cyber-Center (RCC-SWA) operations, regional network operations and security centers (RNOSCs), local area and wide area network administration, systems administration, service desk administration, computer repair (ADPE), email administration, the Defense Red Switch Network, satellite communications, microwave communications, tower and antenna maintenance, technical control facilities, high frequency and ultra-high frequency radios, telephone switches, telephone operations, inside and outside cable plants, prime power and backup power generators, HVAC systems, uninterruptible power supplies, logistics support services, and other contingency requirements for the warfighter. The OMDAC-SWACA contract contributed $161 million and $135 million of revenue for the nine months ended September 27, 2019 and September 28, 2018, respectively.
Backlog
Total backlog includes remaining performance obligations, consisting of funded backlog (firm orders for which funding is contractually obligated by the customer) and unfunded backlog (firm orders for which funding is not currently contractually obligated by the customer, and unexercised contract options). Total backlog excludes potential orders under IDIQ contracts and contracts awarded to the Company that are being protested by competitors with the GAO or in the U.S. Court of Federal Claims. The value of the backlog is based on anticipated revenue levels over the expected life of the contract. Actual values may be greater or less than anticipated. Total backlog is converted into revenue as work is performed. The level of order activity related to programs can be affected by the timing of government funding authorizations and their project evaluation cycles. Year-over-year comparisons could, at times, be impacted by these factors, among others.
Our contracts are multi-year contracts and typically include an initial period of one year or less with annual one-year (or less) option periods for the remaining contract period. The number of option periods vary by contract, and there is no guarantee that an option period will be exercised. The right to exercise an option period is at the sole discretion of the U.S. government when we are the prime contractor or of the prime contractor when we are a subcontractor. The U.S. government may also extend the term of a program by issuing extensions or bridge contracts, typically for periods of one year or less.
We expect to recognize a substantial portion of our funded backlog as revenue within the next 12 months. However, the U.S. government or the prime contractor may cancel any contract at any time through a termination for convenience. Most of our contracts have terms that would permit us to recover all or a portion of our incurred costs and fees for work performed in the event of a termination for convenience.
For the nine months ended September 27, 2019, total backlog increased by $33 million. As of September 27, 2019, total backlog (funded and unfunded) was $3.0 billion as set forth in the following table:

 
September 27,
 
December 31,
(In millions)
 
2019

2018
Funded backlog
 
$
807

 
$
689

Unfunded backlog
 
2,238

 
2,323

Total backlog
 
$
3,045

 
$
3,012

Funded orders (different from funded backlog) represent orders for which funding was received during the period. We received funded orders of $1,011.6 million during the nine months ended September 27, 2019, which was an increase of $96.6 million compared to the nine months ended September 28, 2018.
Economic Opportunities, Challenges and Risks
The U.S. government’s investment in services and capabilities in response to changing security challenges creates a complex and fluid business environment for Vectrus and other firms in this market segment. The pace and depth of U.S. government acquisition reform and cost savings initiatives, combined with increased industry competitiveness to win long-term positions on key programs, could add pressure to revenue levels and profit margins going forward. However, we expect the U.S. government will continue to place a high priority on national security and will continue to invest in affordable solutions for its facilities, logistics, electronic security, equipment and communication needs, which aligns with our services and strengths. Further, the DoD budget remains the largest in the world and management believes our addressable portion of the DoD budget offers substantial opportunity for growth.
We believe spending on operation and maintenance of defense assets, as well as civilian agency infrastructure and equipment, will continue to be a U.S. government priority. Our focus is on sustaining facilities, equipment and IT networks, which we believe aligns with our customers' intent to utilize existing equipment and infrastructure rather than executing new purchases. Many of the core functions we perform are mission-essential, including the following: (i) keeping communications networks operational; (ii) maintaining airfields; (iii) providing integrated electronic security services and (iv) providing emergency services. While customers may reduce the level of services required from us, we do not currently anticipate the complete elimination of these services.

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The information provided above does not represent a complete list of trends and uncertainties that could impact our business in either the near or long-term and should be considered along with the risk factors identified under the caption “Risk Factors” identified in Part 1, Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2018 and the matters identified under the caption “Forward-Looking Information" herein.
DISCUSSION OF FINANCIAL RESULTS
Three months ended September 27, 2019, compared to three months ended September 28, 2018
Selected financial highlights are presented in the following table:
 
 
Three Months Ended
 
Change
(In thousands, except for percentages)
 
September 27, 2019
 
September 28, 2018
 
$
 
%
Revenue
 
$
359,854

 
$
308,095

 
$
51,759

 
16.8
 %
Cost of revenue
 
325,537

 
278,964

 
46,573

 
16.7
 %
% of revenue
 
90.5
%
 
90.5
%
 
 
 
 
Selling, general and administrative expenses
 
19,934

 
15,125

 
4,809

 
31.8
 %
% of revenue
 
5.5
%
 
4.9
%
 
 
 
 
Operating income
 
14,383

 
14,006

 
377

 
2.7
 %
Operating margin
 
4.0
%
 
4.5
%
 
 
 
 
Interest expense, net
 
(1,907
)
 
(1,314
)
 
(593
)
 
45.1
 %
Income before taxes
 
12,476

 
12,692

 
(216
)
 
(1.7
)%
% of revenue
 
3.5
%
 
4.1
%
 
 
 
 
Income tax expense
 
3,094

 
2,826

 
268

 
9.5
 %
Effective income tax rate
 
24.8
%
 
22.3
%
 
 
 
 
Net Income
 
$
9,382

 
$
9,866

 
$
(484
)
 
(4.9
)%
Revenue
Revenue for the three months ended September 27, 2019 was $359.9 million, an increase of $51.8 million, or 16.8%, as compared to the three months ended September 28, 2018. The increase in revenue was attributable to increases from our U.S. programs of $22.9 million, our Middle East programs of $20.5 million, and our European programs of $8.4 million. The acquisition of Advantor contributed $10.2 million to the increase from U.S. programs.
Cost of Revenue
Cost of revenue as a percentage of revenue was 90.5% for both the three months ended September 27, 2019 and the three months ended September 28, 2018. The increase in cost of revenue of $46.6 million, or 16.7%, for the three months ended September 27, 2019, as compared to the three months ended September 28, 2018, was primarily due to increased revenue as described above.
Selling, General & Administrative (SG&A) Expenses
For the three months ended September 27, 2019, SG&A expenses of $19.9 million increased by $4.8 million, or 31.8%, as compared to the three months ended September 28, 2018. The increase was due primarily to increased M&A costs of $0.4 million, LOGCAP V pre-operational legal costs of $0.2 million, expenses related to internal investments in global operations of $1.5 million and Advantor SG&A expenses of $2.7 million.
Operating Income
Operating income for the three months ended September 27, 2019 increased by $0.4 million, or 2.7%, as compared to the three months ended September 28, 2018. This increase was due to increased operating income of $2.1 million from our Middle East programs offset by decreases of $1.2 million from our European programs and $0.5 million from our U.S. programs.
Operating income as a percentage of revenue was 4.0% for the three months ended September 27, 2019, compared to 4.5% for the three months ended September 28, 2018. In the three months ended September 28, 2018, we successfully closed an unresolved item on a closed contract that created a one-time $1.4 million benefit.
Aggregate cumulative adjustments increased operating income by $0.7 million for the three months ended September 27, 2019 and decreased operating income by $1.6 million for the three months ended September 28, 2018. The aggregate cumulative adjustments for the three months ended September 27, 2019 related to higher margins associated with operational efficiencies from labor and management of contract staffing and contract close-out activities. The aggregate cumulative

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adjustments for the three months ended September 28, 2018 related to lower margins associated with labor-related items partially offset by management of contract staffing.
Nine months ended September 27, 2019, compared to nine months ended September 28, 2018
Selected financial highlights are presented in the following table:
 
 
Nine Months Ended
 
Change
(In thousands, except for percentages)
 
September 27, 2019
 
September 28, 2018
 
$
 
%
Revenue
 
$
1,017,371

 
$
949,744

 
$
67,627

 
7.1
 %
Cost of revenue
 
921,685

 
865,078

 
56,607

 
6.5
 %
% of revenue
 
90.6
%
 
91.1
%
 
 
 
 
Selling, general and administrative expenses
 
59,697

 
48,990

 
10,707

 
21.9
 %
% of revenue
 
5.9
%
 
5.2
%
 
 
 
 
Operating income
 
35,989

 
35,676

 
313

 
0.9
 %
Operating margin
 
3.5
%
 
3.8
%
 
 
 
 
Interest expense, net
 
(4,811
)
 
(3,619
)
 
(1,192
)
 
(32.9
)%
Income before taxes
 
31,178

 
32,057

 
(879
)
 
(2.7
)%
% of revenue
 
3.1
%
 
3.4
%
 
 
 
 
Income tax expense
 
7,088

 
6,884

 
204

 
3.0
 %
Effective income tax rate
 
22.7
%
 
21.5
%
 
 
 
 
Net Income
 
$
24,090

 
$
25,173

 
$
(1,083
)
 
(4.3
)%
Revenue
Revenue for the nine months ended September 27, 2019 was $1,017.4 million, an increase of $67.6 million, or 7.1%, as compared to the nine months ended September 28, 2018. The increase in revenue was attributable to increases from our Middle East programs of $32.9 million, our U.S. programs of $16.5 million, and our European programs of $18.2 million. The acquisition of Advantor contributed $10.2 million to the increase from U.S. programs.
Cost of Revenue
Cost of revenue as a percentage of revenue was 90.6% compared to 91.1% for the nine months ended September 27, 2019 and the nine months ended September 28, 2018, respectively. The increase in cost of revenue of $56.6 million, or 6.5%, for the nine months ended September 27, 2019, as compared to the nine months ended September 28, 2018, was primarily due to increased revenue as described above.
SG&A Expenses
For the nine months ended September 27, 2019, SG&A expenses of $59.7 million increased by $10.7 million, or 21.9%, as compared to the nine months ended September 28, 2018. The increase was due primarily to increased M&A costs of $2.1 million, stock-based compensation of $1.5 million, LOGCAP V pre-operational legal costs of $0.8 million, expenses related to internal investments in global operations of $3.6 million and Advantor SG&A expenses of $2.7 million.
Operating Income
Operating income for the nine months ended September 27, 2019 increased by $0.3 million, or 0.9%, as compared to the nine months ended September 28, 2018. This increase was primarily due to higher operating income of $3.2 million from our Middle East programs offset by decreases of $2.1 million from our U.S. programs and $0.8 million from our European programs.
Operating income as a percentage of revenue was 3.5% for the nine months ended September 27, 2019, compared to 3.8% for the nine months ended September 28, 2018.
Aggregate cumulative adjustments increased operating income by $1.5 million and $4.9 million for the nine months ended September 27, 2019 and September 28, 2018, respectively. The aggregate cumulative adjustments for the nine months ended September 27, 2019 related to higher margins associated with operational efficiencies related to labor and management of contract staffing and contract close-out activities. The aggregate cumulative adjustments for the nine months ended September 28, 2018 related to higher margins associated with labor-related items and management of contract staffing.

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Interest (Expense) Income, Net
Interest (expense) income, net for the three and nine months ended September 27, 2019 and September 28, 2018 was as follows:
 
 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
(In thousands, except for percentages)
 
September 27, 2019
 
September 28, 2018
 
$
 
%
 
September 27, 2019
 
September 28, 2018
 
$
 
%
Interest income
 
$
61

 
$
98

 
$
(37
)
 
(37.8
)
 
$
169

 
$
137

 
$
32

 
23.4

Interest expense
 
(1,968
)
 
(1,412
)
 
(556
)
 
(39.4
)
 
(4,980
)
 
(3,756
)
 
(1,224
)
 
(32.6
)
Interest expense, net
 
$
(1,907
)
 
$
(1,314
)
 
$
(593
)
 
(45.1
)
 
$
(4,811
)
 
$
(3,619
)
 
$
(1,192
)
 
(32.9
)
Interest income is directly related to interest earned on our cash. Interest expense is directly related to borrowings under our senior secured credit facilities, amortization of debt issuance costs and derivative instruments used to hedge a portion of our exposure to interest rate risk. The increase in interest expense of $0.6 million and $1.2 million for the three and nine months ended September 27, 2019 compared to the three and nine months ended September 28, 2018, respectively, was due to increased use of our revolving credit facility in 2019 to finance short-term working capital requirements and the acquisition of Advantor.
Income Tax Expense
For the three months ended September 27, 2019 and September 28, 2018, we recorded income tax provisions of $3.1 million and $2.8 million, respectively, representing effective income tax rates of 24.8% and 22.3%, respectively. For the nine months ended September 27, 2019 and September 28, 2018, we recorded income tax provisions of $7.1 million and $6.9 million, respectively, representing effective income tax rates of 22.7% and 21.5%, respectively. The higher effective income tax rates for the 2019 periods are the result of an increase in state taxes due to additional CONUS activity, the impact of foreign taxes due to additional guidance on the implementation of the Tax Act and a reduction in employment tax credits.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Historically, we have generated operating cash flow sufficient to fund our working capital, capital expenditure and financing requirements. We expect to fund our ongoing working capital, capital expenditures and financing requirements through cash flows from operations, cash on hand and access to capital markets. When necessary we utilize our revolving credit facility to satisfy short-term working capital requirements.
If our cash flows from operations are less than we expect, we may need to access the long-term or short-term capital markets. Although we believe that our current financing arrangements will permit us to finance our operations on acceptable terms and conditions, our access to and the availability of financing on acceptable terms and conditions in the future will be impacted by many factors, including: (i) our credit ratings or absence of a credit rating, (ii) the liquidity of the overall capital markets and (iii) the current state of the economy. We cannot provide assurance that such financing will be available to us on acceptable terms or that such financing will be available at all.
The cash presented on our Condensed Consolidated Balance Sheets consists of U.S. and international cash from wholly owned subsidiaries. Approximately $12.7 million of our total $41.1 million in cash at September 27, 2019 is held by our foreign subsidiaries and is not available to fund U.S. operations unless repatriated. We do not currently expect that we will be required to repatriate undistributed earnings of foreign subsidiaries. We expect our U.S. domestic cash resources will be sufficient to fund our U.S. operating activities and cash commitments for financing activities.
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 amended as of April 19, 2016, to modify certain financial and negative covenants (as so amended, the Credit Agreement). On November 15, 2017, we and VSC entered into an Amendment and Restatement Agreement (the Amendment Agreement) with a group of lenders, including JPMorgan Chase Bank, N.A., as administrative agent, which provides for the amendment and restatement of the Credit Agreement. The Amendment Agreement provides for $200.0 million in senior secured 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 on the same terms and conditions as the existing commitments.  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. We used $74.6 million from the Amended Term Loan to repay principal and accrued but unpaid interest on the Credit Agreement. There were no outstanding borrowings under the Amended Revolver at September 27, 2019. At September 27, 2019, there were seven letters of credit outstanding in the aggregate amount of $8.1 million, which reduced our borrowing availability under the Amended Revolver to $111.9 million.

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Dividends
We do not currently plan to pay a regular dividend on our common stock. The declaration of any future cash dividends and if declared, the amount of any such dividends, will depend upon our financial condition, earnings, capital requirements, financial covenants, included under the Amendment Agreement, and other contractual restrictions and the discretion of our Board of Directors. In deciding whether to pay future dividends on our common stock, our Board of Directors may consider such matters as general business conditions, industry practice, our financial condition and performance, our future prospects, our cash needs and capital investment plans, income tax consequences, applicable law and such other factors as our Board of Directors may deem relevant.
Sources and Uses of Liquidity
Cash, accounts receivable, unbilled receivables, and accounts payable are the principal components of our working capital and are generally driven by our level of revenue with other short-term fluctuations related to payment practices by our customers and the timing of our billings. Our receivables reflect amounts billed to our customers, as well as the revenue that was recognized in the preceding month, which is normally billed the month following each balance sheet date.
The total amount of our accounts receivable can vary significantly over time and is sensitive to revenue levels and the timing of payments received from our customers. Days sales outstanding (DSO) is a metric used to monitor accounts receivable levels. Our DSO was 62 days as of September 27, 2019 and 63 days as of December 31, 2018.
The following table sets forth net cash used in operating activities, investing activities and financing activities:
 
 
Nine Months Ended
(In thousands)

September 27, 2019
 
September 28, 2018
Operating activities

$
28,448

 
$
8,654

Investing activities

(53,003
)
 
(42,937
)
Financing activities

699

 
(2,415
)
Foreign exchange1

(1,239
)
 
(1,171
)
Net change in cash

$
(25,095
)
 
$
(37,869
)
1 Impact on cash balances due to changes in foreign exchange rates.
 
 
 
 
Trends in our operating cash flows tend to follow trends in operating income, excluding non-cash charges. Net cash provided by operating activities for the nine months ended September 27, 2019 consisted of net income of $24.1 million plus non-cash items of $10.7 million and net changes in other long-term assets and liabilities of $1.0 million partially offset by an increase in net working capital requirements of $7.4 million.
Net cash provided by operating activities during the nine months ended September 28, 2018 consisted of net income of $25.2 million, increased by non-cash items of $6.6 million offset by net working capital changes of $23.1 million primarily due to the timing of cash collections, as reflected in an increase in receivables as of September 28, 2018.
Net cash used in investing activities for the nine months ended September 27, 2019 consisted of $44.0 million for the acquisition of Advantor and $14.4 million of capital expenditures for the purchase of intangible assets, software and hardware, leasehold improvements, and vehicles and equipment related to ongoing operations. During the third quarter of 2019, $5.4 million was received from the seller of a contract acquired by the Company in the first quarter of 2019 due to the inability to have the contract novated to the Company.
Net cash used in investing activities during the