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Section 1: 10-K (10-K)

Document
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
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.)

 
655 Space Center Drive, Colorado Springs, Colorado 80915
(Address of Principal Executive Offices) (Zip Code)
Registrant’s telephone number, including area code:
(719) 591-3600
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of Each Class 
 
Name of Exchange on Which Registered 
Common Stock, Par Value $.01 Per Share
 
New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  ¨   No  þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  ¨   No  þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ   No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨
Accelerated filer þ
Non-accelerated filer ¨
Smaller reporting company ¨
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨ No  þ
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant computed by reference to the closing price at which the common equity was last sold as of July 1, 2016, the last business day of the registrant’s most recently completed second quarter, was $308,908,348.
As of February 22, 2017, there were 10,894,924 shares of common stock ($0.01 par value per share) outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A relating to the registrant's Annual Meeting of Shareholders, to be held on May 12, 2017 will be incorporated by reference in this Form 10-K in response to Items 10,11,12,13 and 14 of Part III.




VECTRUS, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS



Page No.
 
 
 
 
 
 








 
 
 
 
 
 


 

 

 
 



 
 








    
PART I
ITEM 1. BUSINESS
Overview
Vectrus, Inc. (Vectrus, the Company, our company, we, us or our) is a leading provider of services to the United States (U.S.) government worldwide. Leveraging a history of more than 70 years, we provide global service solutions in 143 locations and 18 countries across three continents in both stable and unstable political and economic environments. We have a proven history of deploying resources rapidly and with precision to support the mission success of our customers.
We operate our business based on three core values of Integrity, Respect and Responsibility. We operate in one segment and offer the following services: 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 each of the three years ended December 31, 2016, 2015, and 2014, we had total revenue of $1.2 billion, all of which was derived from U.S. government customers.
We employ approximately 5,600 people and engage approximately 7,000 subcontractor personnel around the world. This includes an experienced management team with an average of 27 years of experience in the military, industry, and a wide range of U.S. government agencies. Our management team has experience winning new contracts, driving premier operating efficiency, and managing all aspects of the demanding compliance culture required to do business with the U.S. government worldwide. We are also a leading employer of veterans with more than 35% of our employees reporting a military background, and we have been recognized numerous times in recent years by veteran-focused organizations as a military-friendly employer.
Vectrus was incorporated as an Indiana corporation on February 4, 2014. On September 27, 2014, Exelis Inc. (Exelis) completed the spin-off (the Spin-off) of Vectrus. Prior to the Spin-off, we were a subsidiary of Exelis that constituted Exelis' Mission Systems business, which was part of Exelis' Information and Technical Services segment. As a result of the Spin-off, Vectrus became an independent, publicly traded company. Exelis was acquired by Harris Corporation in May 2015.
Our Business Strategy
We recently initiated a strategic process that will leverage the capabilities of our facility and logistics service offerings with our information technology and network communications service offerings. 
Vectrus will drive growth through strategic imperatives aligned to the following three core strategies: Enhance the Foundation, Expand the Portfolio and Add More Value. These strategies will evolve to include more innovative, technology-enabled methods, capabilities and business models. Key components of our core strategies include:
Enhance the Foundation. We will enhance our business by strengthening our existing approaches to deliver high value, high impact services to our clients. We cultivate a global Vectrus Improvement Project (VIP) culture that encourages every Vectrus employee to implement measurable improvements. The VIPs align with our business objectives, benefiting our clients, employees, and overall performance. We support this VIP culture with an internal reward and recognition program and a robust internal training program, equipping our leaders with the tools to sustain our daily approach to continuous improvement. We will expand our VIP program to become an enterprise-wide program and infuse new technologies and enhanced operational capabilities into our current operations and programs wherever possible. 
Expand the Portfolio. We are focused on creating a higher-value, technology-enabled and differentiated platform through strengthening our IT competencies and fusing the physical and digital aspects of our client’s facility and logistics missions. We will package our capabilities by leveraging our strong foundation in facilities, logistics and IT. In addition, we will seek to partner with highly innovative third parties. The result will be a more technology-enabled, differentiated and higher value portfolio.
Add More Value. The convergence of our clients' physical and digital infrastructure and supply chains represents an opportunity to improve the outcomes of our clients' missions while creating a higher value, growth oriented platform. We are evolving our long-term strategy in order to take advantage of this opportunity and to shape our future. While we are in the early stages of this strategic journey, the essence of these imperatives will be to, with our clients, create more predictive, agile and responsive infrastructures and supply chains to create a significantly differentiated, growth oriented business.

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We focus on the following service offerings in support of the U.S. government: facility and logistics services and information technology and network communications services. Our primary geographic areas of operation include Asia, Europe, the Middle East and the U.S.
Facility and Logistics Services
Our facility and logistics services support the U.S. Army, Air Force and Navy in both domestic and international environments, geographically ranging from the U.S. to Europe and Southwest Asia.
For the three years ending December 31, 2016, 2015, and 2014, facility and logistics services, which is a recent consolidation of our infrastructure asset management and logistics and supply chain management service offerings, had revenue of $925.7 million or 78% of total revenue, $942.1 million or 80% of total revenue, and $1,013.4 million or 84% of total revenue, respectively.
Facility and logistics capabilities consist of:
Airfield Management: These services include flight line operations and scheduling; runway maintenance and sweeping; air traffic control; Aerospace Ground Equipment (AGE) operation and maintenance; and navigation aids operation and maintenance.
Ammunition Management: These services include inventory control, accountability, security and shelf-life management of all ammunition categories, including small arms, explosives, mortars, artillery and missiles.
Civil Engineering: These services include designing, building, supervising, operating and maintaining construction projects and systems.
Communications: These services include classified and unclassified email; voice; Voice over Internet Protocol (VoIP) services; video teleconferencing; help desk operations; data and information management and analysis; and electronic repair.
Emergency Services: These services include fire, medical and emergency services operations and inspections.
Equipment Maintenance, Repair and Services: These services include the repair and sustainment of military and commercial wheeled and tracked vehicles; ground support equipment; communications and electronics equipment; weapons; emergency service vehicles and equipment; and subassemblies. We perform various repair functions including Line Replaceable Unit (LRU) testing and repair; small and heavy weapons repair; canvas and component repair; and Test, Measurement and Diagnostic Equipment (TMDE) repair.
Life Support Activities: These services include postal operations; housing management; lodging management; Morale, Welfare and Recreation (MWR) services; travel office support; and food service operations.
Public Works: These services include utilities; power production and distribution; roads and grounds maintenance; water treatment; potable water production and distribution; solid waste disposal and recycling; and facilities operations, maintenance and repair, which consists of plumbing, electrical, carpentry, vector control and HVAC-R.
Security: These services include static and mobile security including entry and exit points to U.S. or coalition bases; installation security; residential security; personal security detachment operations in contingency environments; and management of biometric screening, interviews, and security badging.
Transportation Operations: These services include ground transportation of all commodities; shuttle bus services; operational movement of personnel and household goods and supplies; support for military unit movements by air, rail and ship; and Transportation Motor Pool (TMP) operations.
Warehouse Management and Distribution: These services include warehouse management and inventory control for various equipment and commodities ranging from vehicles, weapons and ground support equipment to repair parts, general supplies, barrier material, packaged petroleum products, organization clothing and individual equipment, medical supplies equipment and rations. We also operate various storage distribution activities including Supply Support Activities (SSA); weapons storage sites; fuel distribution points; subsistence storage and distribution points; central receiving and shipping points; Care of Supplies in Storage (COSIS) operations; container storage and distribution points; and Contractor Operated and Maintained Base Supply (COMBS) points.

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Facility and Logistics Services Key Contracts:
Kuwait Base Operations and Security Support Services in Kuwait (K-BOSSS). Our largest base operations support services contract supports geographically-dispersed primary operating locations within the State of Kuwait, including several camps and a range training complex. K-BOSSS provides full spectrum services that include: army postal operations; range operations and maintenance; logistics; information management; engineering services; medical administrative support services; installation services; security, fire and emergency services; and professional program management services. On September 29, 2016, we announced that we were not awarded the renewal of the K-BOSSS contract. We filed a post-award protest with the U.S. Government Accountability Office (GAO) on the K-BOSSS award on October 11, 2016. On November 7, 2016, we were notified by the Department of the Army (Army) that it was taking corrective action to resolve the protest. As such, the solicitation was amended and re-issued to the original bidders. We are awaiting a decision on the amended solicitation as our revised proposal is currently under evaluation by the Army.
Turkey and Spain Base Management (TSBMC). We provide civil engineering, airfield support, facilities support, transportation, food services and fire emergency services support for all U.S. Air Force bases in Turkey and Spain. TSBMC is the largest service contract in U.S. Air Force Europe and Africa. Our Spain operations support U.S. Marine Corps presence throughout Africa, while our Turkey operations are in direct support of coalition forces efforts in Syria and Iraq. We also provide support to the Office of Defense Cooperation in Ankara Turkey and the North Atlantic Treaty Organization's (NATO) Allied Land Command in Izmir, Turkey.  
Maxwell Air Force Base Operations Support in Montgomery, Alabama (MAXWELL). We operate and maintain the key facilities at the Air University, which provides the full spectrum of Air Force education, from pre-commissioning to the highest levels of professional military education such as the Air War College. We perform facility maintenance, air base and equipment maintenance, communication architecture support and minor construction.
Kaiserslautern Facilities Engineering Services in Germany (K-TOWN). We have provided facility engineering services for the Kaiserslautern Military Community for over 30 years. Work consists of maintenance and repair of installed building equipment, utility services, construction, and a number of ancillary support functions.
Information Technology and Network Communications Services
Our information technology and network communications services consist of sustainment of communications systems, network security, systems installation and full life cycle management of information technology systems for the U.S. Army, Air Force and Navy. Since 1965, we have provided information technology and command, control, communications and computer (C4) support services for the U.S. government's worldwide communications and network systems. The support ranges from legacy World War II era and emerging communications systems in Europe to dynamic state-of-the-art communications systems in remote and hostile locations like Iraq and Afghanistan. We have demonstrated our capacity to effectively operate, maintain, supply, staff, sustain, and modernize a wide array of information technology and communications systems. We perform information technology and network communications services in Europe, the Middle East, Asia, throughout the U.S., and at sea. To support high standards and performance excellence in this area, our company applies the principles of Information Technology Infrastructure Library (ITIL), is certified to the ISO 9001, ISO 20000 and Capability Maturity Model Integration (CMMI) level III standards and maintains important information assurance, network protection, project management and design credentials for providing these services. For the three years ending December 31, 2016, 2015, and 2014, information technology and network communications services had revenue of $264.8 million or 22% of total revenue, $238.6 million or 20% of total revenue, and $189.9 million or 16% of total revenue, respectively.
Our information technology and network communications capabilities consist of:
Communications: These services include complete 24/7/365 communications systems operations and maintenance, including systems administration, network administration, operations and maintenance of technical control facilities, secure and non-secure telephone switch operations, VoIP, multi-media networks, cabling and distribution infrastructure and video information systems. Our support also includes contingency and backup site operations.
Engineering and Design: We provide engineering and technical support services required to design, model, test, pilot, and implement the IT systems and infrastructure required to deliver voice, video, and data services across the enterprise. We provide a structured and disciplined life cycle systems engineering approach to manage and document the enterprise architecture.

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Management and Service Support: These services include full life cycle management and service delivery support functions, including preventative maintenance scheduling, material supply control functions, help desk support, training, electronic repair, logistics trend analysis, configuration control, project support agreements, technical reports, parts lists, site survey reports, systems as-built documentation and computer-aided design and drafting.
Network and Cybersecurity: These services include network cyber-center operations, information assurance, and data and information management and analysis.
Systems Installation and Activation: These services include engineering and technical support to identify and define systems requirements, determine capabilities and delineate and define interfaces, protocols, required upgrades, installation/de-installation, testing, integration, modification, documentation, troubleshooting, and training pertaining to information technology and C4 systems.
Information Technology and Network Communications Services Key Contracts:
Operations, Maintenance and Defense of Army Communications in Southwest Asia and Central Asia (OMDAC-SWACA). We provide the operations, maintenance and defense of the Army’s communications network across multiple locations in the Middle East and Central Asia. Technical support activities include the Southwest Asia Cyber-Center operations, regional network operations and security centers (RNOSC), local area and wide area network administration, systems administration, service desk administration, computer repair (ADPE), email administration, Defense Red Switch, 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 plant, prime power and backup power generators, HVAC systems, uninterruptible power supplies, logistics support services, and other contingency requirements for the warfighter.
U.S. Army Corps of Engineers Information Technology (ACE-IT). We provide information management, information technology and cybersecurity support services to more than 37,000 U.S. Army Corps of Engineers (USACE) customers throughout the U.S., including USACE headquarters in Washington D.C.; nine divisions; 44 districts and their associated field and area project offices; and two data centers located in Vicksburg, Mississippi and Portland, Oregon. We provide comprehensive enterprise and transport services including IT service management (ITSM); custom applications development and software integration services; engineering design and support services; network operations and infrastructure management; and cybersecurity configuration and management services. This contract also includes rapid response and flexible support for emergency operations.
Fleet Systems Engineering Team (FSET). We provide on-site technical and end-to-end systems engineering support for command, control, communications, computer and intelligence (C4I) systems for the U.S. Navy. FSET assures effective operations for all afloat and ashore C4I systems throughout the deployment cycle and provides systems engineering and technical support for rapid introduction of new capabilities into the fleet. Our engineers conduct on-site troubleshooting and maintenance assistance for problems that cross multiple C4I systems, provide over-the-shoulder training on C4I systems, and develop and implement technical processes crossing multiple C4I systems.
Customers
We attribute the strength of our relationship with the DoD and other branches of the U.S. government to our focus on program performance, global responsiveness and operational excellence, as well as our core values of Integrity, Respect and Responsibility. We treat sales to our U.S. government customers as sales within the U.S. regardless of where the services are performed. Our revenue from the U.S. government for the periods presented below was as follows:


Year Ending December 31,
(In thousands)

2016

2015

2014
DoD

$
1,190,519

 
$
1,180,684

 
$
1,171,954

Other U.S. government¹


 

 
31,315

Total Revenue

$
1,190,519

 
$
1,180,684

 
$
1,203,269

¹ Tethered Aerostat Radar System (TARS) program, which was retained by Exelis.
 
 
 
 
 
 

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Revenue by military branch for the periods presented below was as follows:
 
 
Year Ending December 31,
(In thousands)
 
2016
 
2015
 
2014
Army
 
$
1,004,842

 
$
1,007,648

 
$
1,054,344

Navy
 
20,066

 
25,561

 
26,163

Air Force
 
165,611

 
145,854

 
87,799

Marines
 

 
1,621

 
3,648

Other U.S. government¹
 

 

 
31,315

Total Revenue
 
$
1,190,519

 
$
1,180,684

 
$
1,203,269

¹ TARS program, which was retained by Exelis.
 
 
 
 
 
 
Competition
Our competition varies depending on our service offerings. In facility and logistics services, our primary competitors are PAE Facilities Management (PAE), Delta Tucker Holdings, Inc. (DynCorp), KBR Inc., Fluor Corporation and AECOM. Our principal competitors in information technology and network communications services include divisions of Leidos, Harris Corporation (which acquired Exelis in May 2015), Science Applications International Corporation (SAIC), CSRA, Inc. and General Dynamics Information Technology (GDIT).
The U.S. government has implemented policies designed to protect small businesses and under-represented minority contractors. Certain U.S. government work in the U.S. has been restricted to small businesses, including Alaska native companies, from time to time. We participate with these small businesses as a subcontractor for select opportunities, as appropriate. In addition, we rely on our teaming relationships with other prime contractors and subcontractors in order to submit bids for large procurements or other opportunities where we believe the combination of services will help us to win and perform the contract. Our competitors may consolidate or establish teaming or other relationships among themselves or with third parties to increase their ability to address customers’ needs.
Competitive bids for the work that Vectrus pursues are based on technical qualifications and corporate experience in performing contracts of similar size and scope, and are highly price sensitive. While not every contract is procured via selection of the lowest priced bidder, customers are sensitive to cost based on their budget allocations. Acquisition cycles are long (generally 12 to 24 months), and contracts are typically multi-year contracts that include an initial period of one year or less with annual one year (or less) option periods for the remaining contract period.
Some U.S. government customers have shown a strong preference for multiple award indefinite delivery, indefinite quantity (IDIQ) contracts. These contracts offer awards to a pool of contractors, followed by competition within the pool for individual programs via task orders under each IDIQ over the period of performance. Period of performance under IDIQ contracts follows a traditional three-to-ten-year performance cycle. The governing IDIQ contracts often have multi-billion dollar ceiling values.
There are typically fewer competitors in the overseas market for each of our services capabilities. We believe that a primary strength of our company is our expeditionary nature that is grounded in our ability to recruit U.S. and international personnel with appropriate expertise, as well as navigate the logistical, legal, and other challenges of operating in multiple, challenging overseas locations.
Our company closely monitors costs to foster highly competitive pricing and uses an in-house business development model both to manage the cost of revenue and capture opportunities for future bids.
Seasonality
We do not consider any material portion of our business to be seasonal. However, various factors can affect the distribution of our revenue between accounting periods, including the timing of awards, product deliveries, customer acceptance of products and services, contract phase-in durations, contract completions, and the availability of customer funding.
Regulatory Environment
The U.S. government markets in which we serve are highly regulated. We market our services to the DoD and equivalent foreign agencies, National Aeronautics and Space Administration (NASA), and intelligence and other civilian agencies. When working with U.S. agencies and entities, we comply with laws and regulations relating to the creation, administration and performance of contracts. Among other things, these laws and regulations:

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Require compliance with government standards for contract administration, accounting and management internal control systems;
Define allowable and unallowable costs and otherwise govern our right to reimbursement under various flexibly priced U.S. government contracts;
Require certification and disclosure of all cost and pricing data in connection with certain contract negotiations;
Require us not to compete for, or to divest ourselves of, work if an organizational conflict of interest exists related to such work that cannot be appropriately mitigated; and
Restrict the use and dissemination of information classified for national security purposes and the exportation of certain products and technical data.
U.S. government contracts generally are subject to the Federal Acquisition Regulation (FAR), which sets forth policies, procedures and requirements for the acquisition of goods and services by the U.S. government, agency-specific regulations that implement or supplement FAR, such as the DoD’s Defense Federal Acquisition Regulation Supplement (DFARS), and other applicable laws and regulations. These regulations impose a broad range of requirements, many of which are unique to government contracting, including various rules regarding procurement, import and export, security, contract pricing and cost, allowable costs, contract performance, contract termination and adjustment, audits, and IT system security and privacy controls. In addition, as government contractors, we are also subject to routine audits and investigations by U.S. government agencies, such as the Defense Contract Audit Agency (DCAA) and the Defense Contract Management Agency (DCMA). These agencies review our performance, cost structure, incurred costs, forward pricing rates and compliance with applicable laws, regulations and standards under our contracts. The DCAA also reviews the adequacy of and our compliance with our internal control systems and policies, including our accounting, purchasing, government property, estimating, and related business systems.
The U.S. government may revise its procurement practices or adopt new or revised contract rules and regulations at any time. In order to help ensure compliance with these complex laws and regulations, all of our employees are required to complete ethics and other compliance training relevant to their respective positions.
We are subject to other U.S. government laws, regulations and policies, including the International Traffic in Arms Regulations, the Foreign Corrupt Practices Act and the False Claims Act. When working overseas, we must comply not only with applicable U.S. laws and regulations, but also with foreign government laws, regulations and procurement policies and practices, which may differ from U.S. laws, including regulations relating to import-export control, foreign tax considerations, foreign labor and environmental law, and anti-corruption.
Contracts
U.S. government programs generally are implemented by the award of individual contracts to a prime contractor, which may utilize one or more subcontractors. We were the prime contractor on contracts representing 95%, 90% and 86% of our revenue for the three years ended December 31, 2016, 2015, and 2014, respectively. Our company usually is a prime contractor on long-term contracts that are of a finite duration of between three and ten years. The U.S. Congress usually appropriates funds on a fiscal year basis even though a program may extend across several fiscal years. Consequently, programs are often only partially funded initially, and additional funds are committed only as Congress makes further appropriations. The contracts and subcontracts under a program generally are subject to termination for convenience or adjustment if appropriations for such programs are not available or if they change. The U.S. government is required to equitably adjust a contract price for additions to or reductions in scope or other changes that it directs.
Generally, the sales price elements for our contracts are cost-plus, cost-reimbursable or firm-fixed-price. We commonly have elements of cost-plus, cost-reimbursable and firm-fixed price contracts on a single contract.
On a cost-plus type contract, we are paid our allowable incurred costs plus a profit, which can be fixed or variable depending on the contract’s fee arrangement, up to funding levels predetermined by our customers. On cost-plus type contracts, we do not bear the risks of unexpected cost overruns, provided that we do not incur costs that exceed the predetermined funded amounts. Most of our cost-plus contracts also contain a firm-fixed-price element. Cost-plus type contracts with award and incentive fee provisions are our primary variable contract fee arrangement. Award fees provide for a fee based on actual performance relative to contractually specified performance criteria. Incentive fees provide for a fee based on the relationship between total allowable and target cost.
On most of our contracts, a cost-reimbursable element captures consumable materials required for the program. Typically these costs do not bear fees.

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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. On a firm-fixed-price type contract, we agree to perform the contractual statement of work for a predetermined contract price. 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. Accounting for revenue on a firm-fixed-price type contract is covered by contract accounting standards, which require the preparation of estimates of (1) the total contract revenue, (2) the total costs at completion, which is equal to the sum of the actual incurred costs to date on the contract and the estimated costs to complete the contract’s statement of work, and (3) the measurement of progress towards completion. Adjustments to original estimates for a firm-fixed-price type contract’s revenue are often required as work progresses under a 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 percentage of our total revenue generated from each contract type for the periods presented was as follows:


Year Ending December 31,
Contract type

2016

2015

2014
Cost-Plus and Cost-Reimbursable

75
%
 
73
%
 
76
%
Firm-Fixed-Price

25
%
 
27
%
 
24
%
Total Revenue

100
%
 
100
%
 
100
%
Backlog
Total backlog includes both 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 represents firm orders and potential options on multi-year contracts. Total backlog excludes potential orders under IDIQ contracts. The value of the backlog is based on anticipated revenue levels over the anticipated life of the contract. Actual volumes 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.
We expect to recognize a substantial portion of our funded backlog as revenue within the next 12 months. However, the U.S. government 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.
Total backlog decreased by $56.3 million in the year ended December 31, 2016 as compared to the year ended December 31, 2015. As of December 31, 2016, total backlog (funded and unfunded) was $2.4 billion.
 
 
As of December 31,
(In millions)
 
2016
 
2015
Funded backlog
 
$
665

 
$
685

Unfunded backlog
 
1,691

 
1,727

Total backlog
 
$
2,356

 
$
2,412

Funded orders, which are different from funded backlog, represent orders for which funding was received during the period. We received funded orders of $1.2 billion during the year ended December 31, 2016, which was an increase of $118.9 million compared to the year ended December 31, 2015 due to the timing of funded orders for some of our contracts.
Environmental, Health and Safety
We are subject to federal, state, local, and foreign environmental protection laws and regulations, including those governing the management and disposal of hazardous substances, the cleanup of contaminated sites, and the maintenance of a safe and healthy workplace for our employees, contractors, and visitors. Environmental laws and regulations are subject to change, the nature of which is inherently unpredictable, and the timing of potential changes is uncertain. Environmental, health and safety requirements are significant factors affecting all of our operations and we have established a comprehensive program to address compliance with applicable environmental requirements.

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Employees
Integrity, Respect and Responsibility are our core values. We maintain rigorous compliance and other corporate responsibility programs that are intended to ensure a safe and secure work environment and compliance with government regulations, and allow employees to voice any concerns while knowing that matters raised will be appropriately addressed. Our company employs people of diverse backgrounds and we believe that our diversity enhances our creativity and enriches our work culture. We are committed to good corporate citizenship and intend to always seek to maintain the trust and support of the communities in which our employees work and live.
As of December 31, 2016, our global workforce was comprised of approximately 5,600 employees and approximately 7,000 subcontracted workers, spanning 143 locations in 18 countries. Approximately 1,800 of our employees are represented under five collective bargaining agreements with labor unions. Three of the five collective bargaining agreements are due to be negotiated in 2017. Our Turkey Collective Labor Agreement on our TSBMC contract is presently being negotiated by the U.S. Air Force. This negotiation is now with the Turkish High Arbitration Board and we expect will be concluded during 2017. The TSBMC Spanish labor agreement and the Tariff Agreement on our K-TOWN contract will likely be negotiated during 2017. We believe that relations with our employees are positive.
Executive Officers of the Registrant
The following table sets forth certain information as of December 31, 2016, concerning our executive officers including a five-year employment history and any directorships held in public companies.
Name
 
Age
 
Current Title(s)
Business Experience
Charles L. Prow
 
57

 
President and Chief Executive Officer (CEO), Director
Mr. Prow has served as President, CEO and director of the Company since December 2016. Mr. Prow has over thirty years of information technology and federal services experience, including leadership positions at IBM Corporation, PricewaterhouseCoopers, and Coopers & Lybrand. During his career, he has run large global government services organizations, delivering solutions to a wide array of DoD and other government customers. From August 2015 through August 2016, he served as President, CPS Professional Services, a service-disabled veteran-owned small business, where he provided management consulting services to U.S. government clients. Previously, Mr. Prow served in multiple roles with IBM Corporation, a multinational technology company, including: (i) from 2014 to 2015 as General Manager, Global Government Industry in connection with IBM’s technology and services competencies, where he had responsibility for global revenues exceeding $9 billion, (ii) from 2012 to 2013 as General Manager, Global Business Services, with strategic, profit and loss and operational responsibility for IBM’s over $4 billion North America consulting services unit, and (iii) from 2007 to 2012 as General Manager, Global Business Services, with strategic, profit and loss and operational responsibility for IBM’s over $2.4 billion U.S. Public Sector business unit. He currently serves on the board of directors for the Wolf Trap Foundation for the Performing Arts, the International Research and Exchange Board (IREX) and the World Affairs Council-DC.
Matthew M. Klein
 
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Senior Vice President and Chief Financial Officer (CFO)
Mr. Klein has served as Senior Vice President and CFO of the Company since the Spin-off. Prior to the Spin-off, Mr. Klein was Vice President and Chief Financial Officer of the Mission Systems business division of Exelis and had served in that position since May 2011. Prior to being named to that position, Mr. Klein was the Assistant Controller for the Electronic Systems business of ITT Communications Systems division located in Fort Wayne, Indiana. He also served as the acting Assistant Controller for ITT Electronic Systems, Radar, Reconnaissance and Acoustic Systems in Van Nuys, California. In addition, Mr. Klein served in the ITT internal audit department leading various audits for units worldwide. He joined ITT Corporation in 1996.

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Kelvin R. Coppock
 
64

 
Senior Vice President, Facility and Logistics Services and Contracts

Mr. Coppock has served as Senior Vice President, Facility and Logistics Services and Contracts since December 2016. He served as Senior Vice President, Contracts from the Spin-off to November 2016. Prior to the Spin-off, Mr. Coppock was Vice President, Contracts, of the Missions Systems business division of Exelis. Prior to assuming that position, Mr. Coppock was Division Operations Officer, Director and General Manager of the Communications and Information Systems Business Area of Exelis Mission Systems from 2005 to 2013. Mr. Coppock started with ITT Corporation in 2004 as the Director of Program Management at ITT Systems Division, where he was responsible for developing the Program Management Center of Excellence, standardizing management systems and functional processes, and leveraging best practices across the company.
Michele L. Tyler
 
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Senior Vice President, Chief Legal Officer and Corporate Secretary
Ms. Tyler has served as Senior Vice President, Chief Legal Officer and Corporate Secretary since the Spin-off. In addition to the legal function, Ms. Tyler is responsible for overseeing the Trade Compliance, Environmental, Safety & Health, Security, Facilities, and Ethics & Compliance departments. From March 2012 to September 2014, Ms. Tyler was Vice President and General Counsel of the Mission Systems business division of Exelis. Ms. Tyler was responsible for all legal support for Mission Systems. From October 2011 to March 2012, she was Associate General Counsel, primarily responsible for labor and employment matters for the Exelis Mission Systems business. Ms. Tyler joined ITT Mission Systems in January 2009 as Senior Counsel.
Francis A. Peloso
 
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Senior Vice President and Chief Human Resources Officer
Mr. Peloso has served as Senior Vice President and Chief Human Resources Officer since the Spin-off. Prior to the Spin-off, Mr. Peloso was Vice President and Director, Human Resources of the Mission Systems business division of Exelis. Appointed to this role in November 2010, Mr. Peloso was responsible for all human resources activities and strategies for Mission Systems. Mr. Peloso joined ITT Corporation in 2000 and worked across a variety of business areas, including ITT Corporation's World Headquarters, ITT Mission Systems, ITT Communications Systems, and ITT Electronic Systems. From April 2010 to November 2010, Mr. Peloso served as the West Coast Regional Director for the Electronic Systems Division of ITT Corporation.
Rene (Chico) J. Moline
 
55

 
Senior Vice President, Information Technology and Network Communications Services

Mr. Moline has served as Senior Vice President, Information Technology and Network Communications Services at Vectrus since October 2016. Mr. Moline served as Corporate Vice President, Information Technology and Network Communications Services at Vectrus from October 2015 to September 2016. He is responsible for IT and network services, including all aspects of profit and loss within the portfolio, engineering, operations and maintenance, and management for a wide range of global data and communication network operations. Prior to joining Vectrus, he was General Manager of Programs with Harris IT Services, an IT services company, from November 2007 to September 2015. Mr. Moline’s experience includes management and program execution for IT services, and providing mission-critical IT support to high-profile government customers. From June 2006 to October 2007, he served as senior director at Multimax, Inc. overseeing the Navy and Marine Corps intranet program. He also has experience in systems and network engineering with the Naval District of Washington and space and naval warfare systems command (SPAWAR) contracts.
Available Information
You can read and copy any materials that we file with the U.S. Securities and Exchange Commission (SEC) at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the Public Reference Room may be obtained by calling the SEC at 1-800-732-0330. In addition, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file with the SEC at www.sec.gov.
Our website address is www.vectrus.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports are available free of charge on our website as soon as reasonably practicable after we electronically file those reports with the SEC. The information provided on our website is not part of this report, and is therefore not incorporated by reference, unless such information is otherwise specifically referenced elsewhere in this report.

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ITEM 1A. RISK FACTORS
You should carefully consider each of the following risks, which we believe are the principal risks that we face and of which we are currently aware, and all of the other information in this report. Some of the risks described below relate to our business, while others relate to the Spin-off. Other risks relate principally to the securities markets and ownership of our common stock.
Should any of the following risks and uncertainties develop into actual events, our business, financial condition or results of operations could be materially and adversely affected, the trading price of our common stock could decline, and you could lose all or part of your investment.
Risks Relating to Our Business
We face the following risks in connection with the business and industry in which we operate:
A significant portion of our revenue is derived from a few large contracts, and the loss or material reduction of any of these contracts could have a material adverse effect on our results of operations and cash flows.
Aggregate revenue from our three largest contracts amounted to approximately $0.8 billion, or 65.0%, of our revenue for the year ended December 31, 2016. As of December 31, 2016, our three largest contracts were the K-BOSSS contract for Camp Arifjan, Kuwait; the Kuwait-based Army Pre-Positioned Stocks-5 (APS-5 Kuwait) contract; and the OMDAC-SWACA contract. These contracts each accounted for more than 10% of our revenue for the year ended December 31, 2016. Our results of operations and cash flows are highly dependent on these contracts. The loss or material reduction of any of these contracts would have a material adverse effect on our results of operations and cash flows (See "Significant Contracts" in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations).
In September 2016, we announced that we were not awarded the renewal of (i) the K-BOSSS contract and (ii) the APS-5 Kuwait and APS-5 Qatar contracts, which were combined by the Army for the re-competition award as the APS-5 Kuwait/Qatar contract. We filed post-award protests with the GAO for both contracts. On November 7, 2016, we were notified by the Army that it was taking corrective action to resolve the protest of the K-BOSSS contract award. As such, the solicitation for the K-BOSSS contract award was amended and re-issued to the original bidders. We are awaiting a decision on the amended solicitation as our revised proposal is currently under evaluation by the Army. On December 21, 2016, the GAO issued its decision denying our protest of the APS-5 Kuwait/Qatar contract award. The APS-5 Kuwait contract's final extension runs through the first quarter of 2017.    
Competition within our markets may reduce our revenue and market share.
Our business is highly competitive, and we compete with larger companies that have greater name recognition, greater financial resources and larger technical staffs. Within our industry, companies have engaged in merger and acquisition activity, with a goal to increase their competitive position. Our competitors may be able to provide our customers with different or greater capabilities or better contract terms than we can provide, including past contract experience, geographic presence, price and the availability of qualified professional personnel. Moreover, even if we are qualified to work on a government contract, we may not be awarded the contract because of existing government policies designed to assist small businesses and other designated classifications of business, such as under-represented minority contractors. In addition, our competitors may consolidate or establish teaming or other relationships among themselves or with third parties to increase their ability to address customers’ needs. Accordingly, larger or new competitors or alliances among competitors may emerge that may adversely affect our ability to compete. If we are unable to compete successfully against our current or future competitors, we may experience declines in revenue and market share, which could negatively impact our financial position, results of operations, or cash flows.
We may not be successful in winning new contracts, which could have an adverse impact on our business and prospects.
Our contracts with the federal government are typically awarded through a competitive bidding process. This competitive bidding process presents a number of risks, including the following:
We may bid on programs for which the work activities, deliverables, and timelines are vague or for which the solicitation incompletely describes the actual work, which may result in inaccurate pricing assumptions;
We may incur substantial costs and spend a significant amount of managerial time and effort preparing bids and proposals; and
We may incur the opportunity cost of not bidding on and winning other contracts that we may have pursued otherwise.

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Because our contracts are typically for a fixed duration, if we are unable to win a particular new contract, we may be prevented from providing the customer the services that are purchased under that contract for a number of years. If we are unable to consistently win new contract awards, our business and prospects will be adversely affected and our actual results may differ materially and adversely from those anticipated.
The expiration, non-renewal or termination of our existing U.S. government contracts may adversely affect our business.
The U.S. government services marketplace is characterized by contracts of shorter duration as compared to large production and systems integration programs. Services contracts generally are of a finite duration of five years and usually range between three and ten years. Prior to the expiration of a contract, if the customer requires further services of the type provided by the contract, it typically begins a competitive rebidding process. There can be no assurance that we will be able to renew or replace our current contracts upon expiration or completion. In addition, the U.S. government may terminate any of our government contracts, in whole or in part, at any time at its convenience with little or no notice. Additionally, the U.S. government may terminate our contracts for default if we fail to meet our obligations under a contract. If any of our contracts were to be terminated for convenience, we generally would be entitled to receive payment for work completed and allowable termination or cancellation costs. If any of our government contracts were to be terminated for default, generally the customer would pay us only for the work that has been accepted; moreover, the customer can require us to pay the difference between the original contract price and the cost to re-procure the contract deliverables, net of the work accepted from the original contract. In addition, the U.S. government can also hold us liable for damages resulting from the default.
The expiration, non-renewal or termination of any of our government contracts, whether for convenience or default, would adversely affect our current programs and reduce our revenue, earnings and cash flows. A termination for default may also negatively affect our reputation, performance ratings and our ability to win new contracts, particularly for contracts covering the same or similar types of services.
Our business could be adversely affected by bid protests.
We may experience additional costs and delays if our competitors protest or challenge awards of contracts to us in competitive bidding. Any such protest or challenge could result in the resubmission of bids on modified specifications, or in the termination, reduction or modification of the awarded contract. It can take a significant amount of time to resolve contract protests and, in the interim, the contracting U.S. federal agency may suspend our performance under the contract pending the outcome of the protest. For example, in October 2014, a Danish subsidiary of Vectrus received notice of an award of an approximately $411 million Hybrid Firm-Fixed Price Contract for Thule Base Maintenance (the Thule Contract), which was protested by three competitors. Following a lengthy litigation process, the cases related to the Thule Contract award protests were dismissed in October 2016. On December 14, 2016, the Air Force directed our Danish subsidiary to begin the transition of the Thule Contract. On January 31, 2017, the Court of Federal Claims granted one protestor’s motion for reconsideration to address two claims that were not expressly ruled upon in the court’s dismissal of the case in October 2016.
Our Danish subsidiary has begun the phase-in period, with full contract operations scheduled to begin on October 1, 2017.
In addition, we may protest the contract awards of our competitors when it is prudent to do so to protect our rights and interest in the competition, such as our protests of the K-BOSSS award in October 2016 and the APS-5 Kuwait/Qatar award in September 2016 with the GAO. This process requires the time, effort and attention of our management and employees and incurs additional costs.
We are dependent on the U.S. government and, if our reputation or relationship with the U.S. government was harmed, our revenue and growth prospects could be adversely affected.
All of our 2016, 2015, and 2014 revenue was derived from services ultimately sold to the U.S. government, primarily the DoD, either as a prime contractor or as a subcontractor to other contractors engaged in work for the U.S. government. For the year ended December 31, 2016, we generated approximately 84% of our total revenue from the U.S. Army. We expect to continue to derive all or most of our revenue from work performed under U.S. government contracts. Our reputation and relationship with the U.S. government, and in particular with the branches and agencies of the DoD, are key factors in maintaining and growing this revenue. Negative press reports or publicity, which could pertain to employee or subcontractor misconduct, conflicts of interest, termination of a contract or task order, poor contract performance, deficiencies in services, reports or other deliverables, information security breaches, business system disapprovals, or other aspects of our business, regardless of accuracy, could harm our reputation, particularly with these branches and agencies. If our reputation is negatively affected, we lose our ability to conduct business in a foreign country (e.g., loss of business license), we lose a required security clearance, or we are suspended or debarred from contracting with government agencies or any branch of the DoD for any reason, the amount of our business with the U.S. government and other customers could decrease and our future revenue and growth prospects could be adversely affected.

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As a U.S. government contractor, we are subject to a number of procurement laws and regulations and could be adversely affected by changes in regulations or our failure to comply with these regulations.
We operate in a highly regulated environment and must comply with many significant procurement regulations and other requirements. These regulations and requirements, although customary in government contracts, increase our performance and compliance costs. If any such regulations or procurement requirements change, our costs of complying with them could increase and therefore reduce our margins. Some significant statutes and regulations that affect us include:
The FAR and department or agency-specific regulations that implement or supplement the FAR, such as the DoD’s DFARS, which regulate the formation, administration and performance of U.S. government contracts;
The Truth in Negotiations Act, which requires certification and disclosure of cost and pricing data in connection with certain contract negotiations;
The Procurement Integrity Act, which regulates access to competitor bid and proposal information and government source selection information, and our ability to provide compensation to certain former government officials;
The Civil False Claims Act, which provides for substantial civil penalties for violations, including for submission of a false or fraudulent claim to the U.S. government for payment or approval; and
The U.S. Government Cost Accounting Standards (CAS), which impose accounting requirements that govern our right to reimbursement under certain cost-based U.S. government contracts.
If we are found to have violated these or other laws or regulations, or are found not to have acted responsibly as defined by them, we may be subject to reductions of the value of contracts; contract modifications or terminations; the assessment of penalties and fines, compensatory damages or treble damages; or suspension or debarment from government contracting or subcontracting, any of which could have a material adverse effect on our financial position, results of operations, or cash flows.
Our business is subject to audits, reviews, cost adjustments, and investigations by the U.S. government, which, if resolved unfavorably to us, could adversely affect our profitability, cash position or growth prospects.
U.S. government agencies, including the DCAA, the DCMA and others, routinely audit and review our performance on government contracts, indirect rates and pricing practices, and compliance with applicable contracting and procurement laws, regulations and standards. They also review the adequacy of our compliance with government standards for our business systems, including our accounting, earned value management, estimating, materials management, purchasing, and property management systems.
Both contractors and the U.S. government agencies conducting these audits and reviews have come under increased scrutiny. As a result, audits and reviews have become more rigorous and the standards to which we are held are being more strictly interpreted and applied, increasing the likelihood of an audit or review resulting in an adverse outcome. In addition, these audits and reviews, although customary in government contracts, increase our performance and compliance costs.
Government audits or other reviews could result in adjustments to contract costs, mandatory customer refunds, or decreased billings to our U.S. government customers until the control deficiencies identified in the audits or reviews are corrected and our corrections are accepted by DCMA. Such adjustments could be applied retroactively, which could result in significant customer refunds. A determination of non-compliance with applicable contracting and procurement laws, regulations and standards could result in the U.S. government imposing penalties and sanctions against us, including withholding of payments, suspension of payments and increased government scrutiny that could delay or adversely affect our ability to invoice and receive timely payment on contracts, perform contracts or compete for contracts. Non-compliance by us could result in our being placed on the “Excluded Parties List” maintained by the General Services Administration, and we could become ineligible to receive certain contracts, subcontracts and other benefits from the U.S. government or to perform work under a government contract or subcontract until the basis for the listing has been appropriately addressed. In addition, the U.S. government, from time to time, may require its contractors to reduce certain contract prices, or may disallow costs allocated to certain contracts. These adjustments can involve substantial amounts. In the past, as a result of such audits and other investigations and inquiries, we have on occasion made adjustments to our contract prices and the costs allocated to our government contracts.
We are routinely subjected to governmental investigations relating to our contracts and operations. If a review or investigation identifies improper or illegal activities, we may be subject to civil or criminal penalties or administrative sanctions, including the termination of contracts, forfeiture of profits, the triggering of price reduction clauses, suspension of payments, fines and suspension or debarment from doing business with governmental agencies. Civil penalties and sanctions are not uncommon in our industry. If we incur a material penalty or administrative sanction, our reputation, business and future prospects could be adversely affected.

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We rely on our information and communications systems in our operations. Security breaches and other disruptions could adversely affect our business and results of operations.
As a U.S. defense contractor, we face certain security threats, including cybersecurity threats to our information technology infrastructure, attempts to gain access to proprietary or classified information, and threats to physical security. In connection with the information technology and network communications services that we provide to our customers, we also may encounter cybersecurity threats at customer sites that we operate. Cybersecurity threats are significant and evolving and include, among others, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in mission critical systems, unauthorized release of confidential or otherwise protected information and corruption of data. In addition to security threats, we are also subject to other systems failures, including network, software or hardware failures, whether caused by us, third-party service providers, natural disasters, power shortages, terrorist attacks or other events. The unavailability of our information or communications systems, the failure of these systems to perform as anticipated or any significant breach of data security could cause loss of data, disrupt our operations, lead to financial losses from remedial actions, require significant management attention and resources, subject us to claims for breach of contract, damages, penalties or contract termination, and negatively impact our reputation among our customers and the public, which could have a negative impact on our financial condition, results of operations and liquidity. Our property and business interruption insurance may be inadequate to compensate us for all losses that may occur as a result of any system or operational failure or disruption.
Our systems are decentralized, which presents various risks, including the risk that we may be slower or less able to identify or react to problems affecting a business function than we would be in a more centralized environment. In addition, “company-wide” business initiatives, such as the integration of information technology systems or the formation of a technology system impacting different parts of our business, are often more challenging and costly to implement, and carry a higher risk of failure, than they would be in a more centralized environment. Depending on the nature of the initiative in question, such failure could materially adversely affect our business, financial condition or results of operations. Although preventative measures may help mitigate the damage from such occurrences, the damage and disruption to our business resulting from any of these events may be significant. If our insurance and other risk mitigation mechanisms are not sufficient to recover the costs, we could experience an adverse effect on our financial position and results of operations.
As a U.S. government contractor, we are also subject to regulatory compliance requirements under the DFARS and other federal regulations that require our IT systems to comply with the security and privacy controls in National Institute of Standards and Technology Special Publication 800-171 (NIST 800-171). We are required to implement the NIST 800-171 requirements by no later than December 31, 2017. We may also be responsible if our subcontractors do not comply with these requirements. A failure to comply with the requirements could negatively impact our business and financial condition.
Misconduct of our employees, subcontractors, agents, prime contractors or business partners could cause us to lose customers and could have a significant adverse impact on our business and reputation, adversely affecting our ability to obtain new contracts.
Misconduct, fraud or other improper activities by our employees, subcontractors, agents, prime contractors or business partners could have a material adverse impact on our business and reputation. Such misconduct could include the failure to comply with federal, state, local or foreign government procurement regulations, regulations regarding the protection of classified or personal information, legislation regarding the pricing of labor and other costs in government contracts, laws and regulations relating to environmental matters, bribery of foreign government officials, lobbying or similar activities, boycotts, antitrust and any other applicable laws or regulations. Misconduct involving data security lapses resulting in the compromise of personal information or the improper use of our customer’s sensitive or classified information could result in remediation costs, regulatory sanctions against us and serious harm to our reputation. Although we have implemented policies, procedures and controls that are designed to prevent and detect these activities, these precautions may not prevent all misconduct and as a result, we could face unknown risks or losses. Misconduct by any of our employees, subcontractors, agents, prime contractors or business partners or our failure to comply with applicable laws or regulations could subject us to fines and penalties, loss of security clearance, loss of current and future customer contracts and suspension or debarment from contracting with federal, state or local government agencies, any of which would adversely affect our business, our reputation and our future financial results.
Our level of indebtedness and our ability to make payments on or service our indebtedness may have a material adverse effect on our business, financial condition or results of operations.
As of December 31, 2016, we had approximately $85.0 million of aggregate debt outstanding, which consists of a term loan (See Note 6, "Debt," in the Notes to the Consolidated and Combined Financial Statements included in this Annual Report on Form 10-K). We also have the ability to incur up to $75.0 million of additional debt under our revolving facility. Our ability to make payments on and to refinance our indebtedness as well as any future debt that we may incur, will depend on our ability to generate cash in the future from operations, financings or asset sales. Our ability to generate cash is subject to

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our performance and to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
If we are not able to repay or refinance our debt as it becomes due, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional debt or equity on terms that may be onerous or highly dilutive, if we can obtain it at all. If we raise equity through the issuance of preferred stock, the terms of the preferred stock may give the holders rights, preferences and privileges senior to those of holders of our common stock, particularly in the event of liquidation. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.
Our credit agreement contains covenants with which we must comply or risk default.
Our credit agreement contains a number of significant covenants that, among other things, restrict our ability to create liens and encumbrances; incur additional indebtedness; merge, dissolve, liquidate or consolidate; make acquisitions, investments, advances or loans; dispose of or transfer assets; pay dividends or make other payments in respect of our capital stock; redeem or repurchase capital stock or prepay, redeem or repurchase certain debt; engage in certain transactions with affiliates; enter into speculative hedging arrangements; and enter into certain restrictive agreements.
These restrictions could impair our ability to finance our future operations or capital needs or engage in other business activities that may be in our interests. In addition, the credit agreement also requires us to maintain compliance with certain financial ratios, including those relating to earnings before interest, taxes, depreciation and amortization and consolidated indebtedness. Our ability to comply with these ratios and covenants may be affected by events beyond our control. A breach of the credit agreement or our inability to comply with or renegotiate the required financial ratios or covenants included therein could result in a default under the credit agreement and cause acceleration of the outstanding debt.
Our variable rate indebtedness may expose us to interest rate risk, which could cause our debt costs to increase significantly.
Our term loan and any revolving facility borrowings we may incur have variable rates of interest, which expose us to interest rate risks and to the risk of rising interest rates. As of December 31, 2016, we had approximately $85.0 million outstanding under our floating-rate term loan and the ability to incur up to $75.0 million of additional floating-rate debt under our revolving facility. Although we have hedged a portion of our exposure to interest rate risk under the term loan through interest rate swaps with a notional amount of $51.5 million at December 31, 2016, if interest rates increase in the future, then the interest expense on the variable rate debt could increase materially.
Unanticipated changes in our tax provisions or exposure to additional U.S. and foreign tax liabilities could affect our profitability.
We are subject to various taxes, including but not limited to income, gross receipts and payroll withholding taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Furthermore, changes in domestic or foreign tax laws and regulations, or their interpretation and enforcement, could result in higher or lower taxes assessed or changes in the taxability of certain revenue or the deductibility of certain expenses, thereby affecting our tax expense and profitability. In addition, we regularly are under audit by tax authorities. The final determination of tax audits and any related litigation could be materially different from our historical tax provisions and accruals. Additionally, changes in the geographic mix of our revenue could also impact our tax liabilities and affect our overall tax expense and profitability.
We are subject to risks associated with operating internationally.
Our U.S. government contracts operating internationally represented approximately 87% of total revenue for the year ended December 31, 2016. We are subject to a variety of U.S. and foreign laws and regulations, including, without limitation, business compliance, tax and anti-corruption laws, including the U.S. Foreign Corrupt Practices Act. We also employ international personnel and engage with foreign subcontractors and labor brokers, which requires compliance with numerous foreign laws and regulations related to labor, benefits, taxes, insurance and reporting requirements, among others. Failure by us or our subcontractors or vendors to comply with these laws and regulations could result in administrative, civil, or criminal liabilities, suspension or debarment from government contracts, which could have a material adverse effect on us.
Our business operations are also subject to a variety of risks associated with conducting business internationally, including, without limitation:
Political instability in foreign countries;
Terrorist activity by various groups in the areas in which we operate;

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Imposition of inconsistent foreign laws, regulations or policies or changes in or interpretations of such laws, regulations or policies;
Conducting business in places where laws, business practices and customs are unfamiliar or unknown; and
Imposition of limitations on or increases in withholding and other taxes on payments by foreign operations.
The services we provide internationally, including through the use of subcontractors, are sometimes in countries with unstable governments, in areas of military conflict, in hostile and unstable environments, including war zones, or at military installations. This increases the risk of an incident resulting in damage or destruction to our work or living sites or resulting in injury or loss of life to our employees, subcontractors or other third parties. We maintain insurance to mitigate risk and potential liabilities related to our international operations, but our insurance coverage may not be adequate to cover these claims and liabilities and we may be forced to bear substantial costs arising from those claims. The impact of these factors is difficult to predict, but any one or more of them could adversely affect our financial position, results of operations or cash flows.
Our contract sites are inherently dangerous workplaces. Failure to maintain safe work sites and equipment could result in environmental disasters, employee deaths or injuries, reduced profitability, the loss of projects or customers and possible exposure to litigation.
Our project sites often put our employees and others in close proximity with mechanized equipment, moving vehicles, and highly regulated materials. Although we have safety procedures in place, if we fail to implement them or if the procedures we implement are ineffective, we may suffer the loss of or injury to our employees, as well as expose ourselves to possible litigation. As a result, our failure to maintain adequate safety standards and equipment, as well as the nature of the environment in which we conduct business, could result in the loss of projects or customers, and could have a material adverse impact on our business, financial condition, and results of operations.
A decline in the U.S. government defense budget, changes in spending or budgetary priorities or delays in contract awards may significantly and adversely affect our future revenue and limit our growth prospects.
Our contracts and revenue depend upon the U.S. DoD budget, which is subject to the congressional budget authorization and appropriations process. Congress usually appropriates funds for a given program on a September 30 fiscal year basis, even though contract periods of performance may extend over many years. Consequently, at the beginning of a major program, the contract is usually partially funded, and additional monies are normally committed to the contract by the procuring agency only as appropriations are made by Congress in future fiscal years. DoD budgets are a function of a number of factors beyond our control, including, but not limited to, changes in U.S. procurement policies, budget considerations, current and future economic conditions, presidential administration priorities, changing national security and defense requirements, geo-political developments and actual fiscal year congressional appropriations for defense budgets. Any of these factors could result in a significant redirection of current and future DoD budgets and impact our future operations and cash flows. Such factors may have direct bearing on our new business opportunities as well as on whether the U.S. government will exercise its options for services under existing contracts, thus affecting the timing and volume of our business.
The U.S. government also conducts periodic reviews of U.S. defense strategies and priorities, which may shift DoD budgetary priorities, reduce overall U.S. government spending or delay contract or task order awards for defense related programs. A reduction in U.S. government defense spending could potentially reduce our future revenue and earnings and have a material impact on our business. Further, delays in the completion of the U.S. government’s budget process could delay procurement of the services we provide and have an adverse effect on our business.
We use estimates in accounting for many of our programs, and changes in our estimates could adversely affect our future financial results.
Revenue from our contracts is recognized primarily using the percentage-of-completion method or on the basis of partial performance towards completion. These methodologies require estimates of total costs at completion, fees earned on the contract, or both. Contract estimates are based on various assumptions to project the outcome of future events that often span several years. These assumptions include labor productivity and availability; the complexity of the work to be performed; the cost and availability of materials; and the performance of subcontractors. This estimation process, particularly due to the nature of the services being performed and the long-term nature of certain contracts, is complex and involves significant judgment. Adjustments to original estimates are often required as work progresses, experience is gained and additional information becomes known, even though the scope of the work required under the contract may not change. Any adjustment as a result of a change in estimates is recognized as additional information becomes known. Changes in the underlying assumptions, circumstances or estimates could result in adjustments that may adversely affect our future financial results.

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We may not realize as revenue the full amounts reflected in our backlog, which could adversely affect our future revenue and growth.
As of December 31, 2016, our total backlog was $2.4 billion, which included $664.6 million in funded backlog. Due to the U.S. government’s ability to not exercise or award contracts or to terminate, modify or curtail our programs or contracts, we may realize less than expected revenue or in some cases never realize revenue from some of the contracts that are included in our backlog. Our unfunded backlog, in particular, contains management’s estimate of amounts expected to be realized on unfunded contracts that may never be realized as revenue. If we fail to realize as revenue amounts included in our backlog, our future revenue, growth prospects and profitability could be adversely affected.
Our earnings and margins depend, in part, on subcontractor performance.
We rely on other companies to perform some of the services that we provide to our customers. Disruptions or performance problems caused by our subcontractors could have an adverse effect on our ability as a prime contractor or higher tier subcontractor to meet our commitments to customers.
We may have disputes with our subcontractors arising from, among other things, the quality and timeliness of work performed by the subcontractor, customer concerns about the subcontractor, our failure to extend existing task orders or issue new task orders under a subcontract, proper invoicing, cost reasonableness, allocability, allowability, the hiring of each other’s personnel, adjustments to the scope of the subcontractor’s work, or the subcontractor’s failure to comply with applicable law or regulations. Uncertain economic conditions heighten the risk of financial stress of our subcontractors, which could adversely impact their ability to meet their contractual requirements to us. If any of our subcontractors fail to timely meet their contractual obligations or have regulatory compliance or other problems, our ability to fulfill our obligations may be jeopardized. Significant losses could arise in future periods and subcontractor performance deficiencies could result in our termination for default.
Our earnings and margins may vary based on the mix of our contracts, our performance, and our ability to control costs.
We generate revenue under various types of contracts, which include cost-plus, cost-reimbursable (including non-fee-bearing costs) and firm-fixed-price. Our earnings and profitability may vary materially depending on changes in the proportionate amount of revenue derived from each type of contract, the nature of services provided, as well as the achievement of performance objectives and the stage of performance at which the right to receive fees, particularly under incentive and award fee contracts, is finally determined. Cost-reimbursable contracts generally have lower profitability than firm-fixed-price contracts.
Our profitability is adversely affected when we incur contract costs that we cannot bill to our customers. To varying degrees, each of our contract types involves some risk that we could underestimate the costs and resources necessary to fulfill the contract. While firm-fixed-price contracts allow us to benefit from cost savings, these contracts also increase our exposure to the risk of cost overruns. Revenue derived from firm-fixed-price contracts represented approximately 25% of our total revenue for the year ended December 31, 2016. When making proposals on firm-fixed-price contracts, we rely heavily on our estimates of costs and timing for completing the associated projects, as well as assumptions regarding technical issues. In each case, our failure to accurately estimate costs or the resources needed to perform our contracts or to effectively manage and control our costs during the performance of our work could result in reduced profits or in losses. If we incur costs in excess of initial estimates or funding on a contract, we generally seek reimbursement for those costs, but we may not be able to negotiate full recovery for these costs. More generally, any increased or unexpected costs or unanticipated delays in connection with the performance of our contracts, including costs and delays caused by contractual disputes or other factors outside of our control, such as performance failures of our subcontractors, natural disasters or other force majeure events, could make our contracts less profitable than expected or unprofitable.
The failure to perform to customer expectations or contract requirements may result in reduced fees or claims made against us by our customers and may affect our financial performance in that period. Under each type of contract, if we are unable to control costs, our operating results could be adversely affected, particularly if we are unable to justify an increase in contract value to our customers. Cost overruns or the failure to perform on existing programs also may adversely affect our ability to retain existing programs and win future contract awards.
The DoD continues to modify its business practices, which could have a material effect on its overall procurement processes and adversely impact our current programs and potential new awards.
The DoD continues to pursue various initiatives designed to gain efficiencies and to focus and enhance business practices. These initiatives and resulting changes, such as increased usage of firm-fixed-price contracts, where we bear the risk that increased or unexpected costs may reduce our profit or cause us to sustain losses, multiple award IDIQ contracts and small and disadvantaged business set-aside contracts, are having an impact on the contracting environment in which we do business. Any of these changes could impact our ability to obtain new contracts or renew our existing contracts when those

19



contracts are re-competed. These initiatives, such as IDIQ contracts, continue to evolve, and the full impact to our business remains uncertain and subject to the manner in which the DoD implements them. Any new contracting requirements or procurement methods could be costly or administratively difficult for us to implement and could adversely affect our future revenue, profitability and prospects.
Goodwill represents a significant portion of our assets and any impairment of these assets could negatively impact our results of operations.
At December 31, 2016, our goodwill was approximately $216.9 million, which represented approximately 47% of our total assets. We test goodwill for impairment on an annual basis, or whenever events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable. We estimate the fair value of the reporting unit used in the goodwill impairment test using an income approach and market approach, and as a result the fair value measurements depend on revenue growth rates, future operating margin assumptions, risk-adjusted discount rates, future economic and market conditions, and identification of appropriate market comparable data. Because of the significance of our goodwill, any future impairment of this asset could have a material adverse effect on our results of operations.
Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business and our stock price.
As a public company, we are required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act), which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent registered public accounting firm as to whether we maintained, in all material respects, effective internal controls over financial reporting as of the last day of the year. Under the Sarbanes-Oxley Act, we are also required to maintain effective disclosure controls and procedures. These reporting and other obligations place significant demands on our management, administrative and operational resources, including accounting systems and resources. Any failure to achieve and maintain effective internal or disclosure controls could have a material adverse effect on our financial condition, results of operations or cash flows.
Our profitability or performance could suffer if we are unable to recruit and retain qualified personnel or if we are unable to maintain adequate staffing levels for our contracts.
Due to the specialized nature of our business, our future performance is highly dependent upon the continued services of our personnel and executive officers, the development of additional management personnel and the hiring of new qualified technical, marketing, sales and management personnel for our operations. Competition for qualified personnel is intense, and we may not be successful in attracting or retaining qualified personnel. In addition, certain personnel may be required to receive security clearance and substantial training in order to work on certain contracts or perform certain tasks. The loss of key employees, our inability to attract new qualified employees or adequately train employees or the delay in hiring key personnel could have an adverse effect on our business, results of operations and financial condition.
In addition, our profitability is affected by how efficiently we utilize our workforce, including our ability to transition employees from completed contracts to new assignments, to hire and assimilate new employees; to hire personnel in or timely deploy expatriates to foreign countries; to manage attrition and a subcontractor workforce; and to devote time and resources to training, business development, professional development and other non-chargeable activities.
Our business depends upon obtaining and maintaining required facility security clearance and individual security clearances.
Many of our federal government contracts require our employees to maintain various levels of security clearances complying with U.S. government requirements. Obtaining and maintaining security clearances for employees involves a lengthy process and it can be difficult to identify, recruit and retain employees who already hold security clearances. If our employees are unable to obtain or retain security clearances or if our employees who hold security clearances terminate employment with us, our ability to perform the work under the contract may be negatively affected, and the customer whose work requires cleared employees could terminate the contract or decide not to renew it upon its expiration. In addition, many of the contracts on which we bid require us to maintain a facility security clearance. To the extent we are not able to maintain a facility security clearance, we may not be able to bid on or win new contracts, or effectively re-bid on expiring contracts.

20



Some of our workforce is represented by labor unions so our business could be harmed in the event of a prolonged work stoppage.
Approximately 1,800 of our employees, or approximately 32% of our employee base at December 31, 2016, are unionized. We have five collective bargaining agreements with labor unions. Three of the five collective bargaining agreements are due to be negotiated in 2017. We cannot predict how stable our union relationships will be or whether we will be able to successfully negotiate successor agreements without impacting our financial condition. In addition, the presence of unions may limit our flexibility in dealing with our workforce. Work stoppages by our union employees could negatively impact our ability to provide services to our customers on a timely basis, which could negatively impact our results of operations and financial condition.
Legal disputes could require us to pay potentially large damage awards and could be costly to defend, which would adversely affect our cash balances and profitability, and could damage our reputation.
We are subject to a number of lawsuits and claims as described under Part I, Item 3, "Legal Proceedings," in this report. We are also subject to, and may become a party to, a variety of other litigation or claims and suits that arise from time to time in the ordinary course of our business. Adverse judgments or settlements in some or all of these legal disputes may result in significant monetary damages or injunctive relief against us. Any claims or litigation could be costly to defend, and even if we are successful or if fully indemnified or insured, could damage our reputation and make it more difficult to compete effectively or obtain adequate insurance in the future. Litigation and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future.
Environmental, health and safety issues could have a material adverse effect on our business, financial position or results of operations
We are subject to federal, state, local, and foreign environmental health and safety laws and regulations, including those governing: air emissions; discharges to water; the management, storage, transportation and disposal of hazardous wastes, petroleum, and other regulated substances; the investigation and cleanup of contaminated property; and, and the maintenance of a safe and healthy workplace for our employees, contractors, and visitors. These laws and their implementing regulations can impose certain operational controls for minimization of pollution, permitting, training, recordkeeping, monitoring and reporting requirements or other operational or siting constraints on our business, result in costs to remediate releases of regulated substances into the environment, or require costs to remediate sites to which we sent regulated substances for disposal. We have incurred and will continue to incur operating, maintenance and other expenditures as a result of environmental, health and safety laws and regulations. Developments such as the adoption of new environmental, health and safety laws and regulations, stricter enforcement of existing laws and regulations, violations by us of such laws and regulations, litigation involving environmental impacts, our inability to recover costs associated with any such developments under previously priced contracts, or financial insolvency of other responsible parties could in the future have a material adverse effect on our business, financial position or results of operations.
Our insurance may be insufficient to protect us from claims or losses.
We maintain insurance coverage with third-party insurers as part of our overall risk management strategy and because some of our contracts require us to maintain specific insurance coverage limits. However, not every risk or liability is or can be protected by insurance, and, for those risks we insure, the limits of coverage we purchase or that are reasonably obtainable in the market may not be sufficient to cover all actual losses or liabilities incurred. If any of our third-party insurers fail, cancel our coverage or otherwise are unable to provide us with adequate insurance coverage, then our overall risk exposure and our operational expenses would increase and the management of our business operations would be disrupted. Our insurance may be insufficient to protect us from significant warranty and other liability claims or losses. Moreover, there is a risk that commercially available liability insurance will not continue to be available to us at a reasonable cost, if at all. If liability claims or losses exceed our current or available insurance coverage, our business and prospects may be harmed. We are also subject to the requirements of the Defense Base Act (DBA), which generally requires insurance coverage to be provided to persons employed at U.S. military bases outside of the U.S. Failure to obtain DBA insurance may result in fines or other sanctions, including the loss of a particular contract.
Business disruptions caused by natural disasters and other crises could adversely affect our profitability and our overall financial position.
We have operations located in regions of the U.S. and internationally that may be exposed to natural disasters, such as hurricanes, tornadoes, blizzards, flooding, wildfires or earthquakes. Our business could also be disrupted by pandemics and other national or international crises. Although preventative measures may help mitigate the damage from such occurrences, the damage and disruption to our business resulting from any of these events may be significant. If our insurance and other risk mitigation mechanisms are not sufficient to recover all costs, including loss of revenue from sales to customers, we could experience a material adverse effect on our financial position and results of operations.

21



We depend on our teaming arrangements and relationships with other contractors. If we are not able to maintain these relationships, or if these parties fail to satisfy their obligations to us or the customer, our revenue, profitability and growth prospects could be adversely affected.
We rely on our teaming relationships and other arrangements with other prime contractors in order to submit bids for large procurements or other opportunities where we believe the combination of services provided by us and the other companies will help us to win and perform the contract. Our future revenue and growth prospects could be adversely affected if other contractors eliminate or reduce their contract relationships with us, or if the U.S. government terminates or reduces these other contractors' programs, does not award them new contracts or refuses to pay under a contract.
Government withholding regulations could adversely affect our operating performance.
A DFARS rule allows withholding of a percentage of payments when a contractor’s business system has one or more significant deficiencies. The DFARS rule applies to CAS covered contracts that have the DFARS clause in the contract terms and conditions. Contracting officers may withhold 5% of contract payments for one or more significant deficiencies in any single contractor business system or up to 10% of contract payments for significant deficiencies in multiple contractor business systems. A significant deficiency as defined by the DoD is a “shortcoming in the system that materially affects the ability of officials of the DoD to rely upon information produced by the system that is needed for management purposes.” If we have significant deficiencies and contract payments are withheld, our revenue and financial position may be adversely affected.
The effects of changes in worldwide economic and capital markets conditions may significantly affect our ability to maintain liquidity or procure capital.
Our business may be adversely affected by factors in the U.S. and other countries that are beyond our control, such as disruptions in financial markets or downturns in economic activity in specific countries or regions, or in the various industries in which our company operates; social, political or labor conditions in specific countries or regions; or adverse changes in the availability and cost of capital, interest rates, foreign currency exchange rates, tax rates, or regulations in the jurisdictions in which our company operates. If we lose access to our currently available revolving facility, or if we are required to raise additional capital, we may be unable to do so in the current credit and stock market environment, or we may be able to do so only on unfavorable terms.
Adverse changes to financial conditions also could jeopardize certain counterparty obligations, including those of our insurers and financial institutions and other third parties.
We may make or enter into acquisitions, investments, joint ventures and divestitures that involve numerous risks and uncertainties.
We may selectively pursue strategic acquisitions, investments and joint ventures. These transactions require significant investment of time and resources and may disrupt our business and distract our management from other responsibilities. Even if successful, these transactions could reduce earnings for a number of reasons, including the amortization of intangible assets, impairment charges, acquired operations that are not yet profitable or the payment of additional consideration under earn-out arrangements if an acquisition performs better than expected. If we engage in such transactions, we may incur significant transaction and integration costs and have difficulty integrating personnel, operations, products or technologies or otherwise realizing synergies or other benefits from the transactions. The integration process could result in the loss of key employees, loss of key customers, loss of key vendors, decreases in revenue and increases in operating costs. Such transactions may dilute our earnings per share, disrupt our ongoing business, distract our management and employees, increase our expenses, perform poorly, and subject us to liabilities and increase our risk of litigation, all of which could harm our business.
Risks Relating to Our Spin-off from Exelis
We face the following risks in connection with our Spin-off from Exelis:
In connection with the Spin-off, we and Exelis have each agreed to a broad release of claims and indemnification of the other party; we may be required to expend cash and resources to satisfy our indemnification obligations to Exelis and there is no assurance that Exelis’ indemnities to us will be sufficient to insure us against the full amount of such liabilities, or that Exelis will have the ability to satisfy its indemnification obligations to us in the future.
In the Distribution Agreement that we and Exelis entered into in connection with the Spin-off, Exelis agreed to indemnify us from certain claims and liabilities, and we agreed to indemnify Exelis for certain claims and liabilities as discussed further in Note 15, “Agreements and Transactions with Former Parent” in the Notes to Consolidated and Combined Financial Statements included in this Annual Report on Form 10-K. Indemnities that we are required to provide Exelis may be

22



significant and could negatively impact our business, particularly those indemnities relating to our actions that could impact the tax-free nature of the Spin-off. Third-parties could also seek to hold us responsible for any of the liabilities that Exelis has agreed to retain. Further, there can be no assurance that the indemnity from Exelis will be sufficient to protect us against the full amount of such liabilities, or that Exelis will be able to fully satisfy its indemnification obligations. Moreover, even if we ultimately succeed in recovering from Exelis any amounts for which we are held liable, we may have to bear these losses ourselves until we receive these payments. Each of these risks could negatively affect our business, results of operations and financial condition.
Our historical financial information has been derived in part from the financial information of Exelis, and our historical financial information may not be a reliable indicator of our future results.
The historical financial information we have included in this Annual Report on Form 10-K for periods prior to the Spin-off has been derived in part from the consolidated financial statements of Exelis and does not necessarily reflect what our financial position, results of operations and cash flows would have been as a separate, stand-alone entity. Exelis did not account for us, and we were not operated, as a single stand-alone entity for certain of the periods presented even if we represented an important business in the historical consolidated financial statements of Exelis. In addition, the historical information is not necessarily indicative of our future results of operations, financial position and cash flows.
The Spin-off may expose us to potential liabilities arising out of state and Federal fraudulent conveyance laws and legal distribution requirements.
The Spin-off could be challenged under various state and Federal fraudulent conveyance laws. An unpaid creditor or an entity vested with the power of such creditor (such as a trustee or debtor-in-possession in a bankruptcy) could claim that Exelis did not receive fair consideration or reasonably equivalent value in the Spin-off, and that the Spin-off left Exelis insolvent or with unreasonably small capital or that Exelis intended or believed it would incur debts beyond its ability to pay such debts as they mature. If a court were to agree with such a plaintiff, then such court could void the Spin-off as a fraudulent transfer and could impose a number of different remedies, including without limitation, returning our assets or your shares in our company to Exelis or providing Exelis with a claim for money damages against us in an amount equal to the difference between the consideration received by Exelis and the fair market value of our company at the time of the Spin-off.
The distribution by Exelis of the Vectrus common stock in the Spin-off could also be challenged under state corporate distribution statutes. Under the Indiana Business Corporation Law, a corporation may not make distributions to its shareholders if, after giving effect to the distribution, (i) the corporation would not be able to pay its debts as they become due in the usual course of business; or (ii) the corporation’s total assets would be less than the sum of its total liabilities. No assurance can be given that a court will not later determine that the distribution by Exelis of Vectrus common stock in the Spin-off was unlawful.
Under the Distribution Agreement, we are responsible for the debts, liabilities and other obligations related to the business or businesses which we own and operate following the consummation of the Spin-off. Although we do not expect to be liable for any obligations not expressly assumed by us pursuant to the Distribution Agreement, it is possible that we could be required to assume responsibility for certain obligations retained by Exelis should Exelis fail to pay or perform its retained obligations.
Risks Relating to Our Common Stock
You face the following risks in connection with ownership of our common stock:
There is not a long market history for our common stock and the market price of our common stock may fluctuate significantly.
We have been a publicly traded company only since September 2014. As a result, our common stock does not have a long trading history. We cannot predict the prices at which our common stock may trade. The market price of our common stock may fluctuate widely, depending on many factors, including the risk factors described herein. Some of these factors depend on our operating and financial performance, and others may be beyond our control. Stock markets in general have experienced volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations could adversely affect the trading price of our common stock.
We do not currently plan to pay dividends on our common stock, and our indebtedness could limit our ability to pay dividends on our common stock in the future.
We do not currently plan to pay dividends on our common stock. The declaration of any future cash dividends and, if declared, the amount of any such dividends, will be subject to our financial condition, earnings, capital requirements, financial covenants and other contractual restrictions and to the discretion of our Board of Directors. Our Board of Directors may take

23



into account 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.
Additionally, our indebtedness could have important consequences for holders of our common stock. If we cannot generate sufficient cash flow from operations to meet our debt payment obligations, then our ability to pay dividends, if so determined by the Board of Directors, will be impaired. In addition, the terms of the agreements governing our current debt limit the payment of dividends and debt that we may incur in the future may also limit the payment of dividends.
Anti-takeover provisions in our organizational documents and Indiana law could delay or prevent a change in control.
Certain provisions of our amended and restated articles of incorporation and our amended and restated by-laws may delay or prevent a merger or acquisition that a shareholder may consider favorable. For example, the amended and restated articles of incorporation and the amended and restated by-laws, among other things, provide for a classified board and do not permit shareholders to convene special meetings or to remove our directors other than for cause. In addition, the amended and restated articles of incorporation authorize our Board of Directors to issue one or more series of preferred stock. These provisions may also discourage acquisition proposals or delay or prevent a change in control, which could harm our stock price. Indiana law also imposes some restrictions on mergers and other business combinations between any holder of 10% or more of our outstanding common stock and us as well as certain restrictions on the voting rights of “control shares” of an “issuing public corporation.”
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We have 143 locations in 18 countries on three continents. Our contract performance typically occurs on the government customer’s facility. Our significant locations are our corporate headquarters office located at 655 Space Center Drive, Colorado Springs, Colorado and our strategic information technology and network communications services operations office located at 11730 Plaza America Drive, Reston, Virginia. Both our Colorado Springs and Reston offices are leased and have approximately 104,000 and 7,000 square feet, respectively. We consider the properties that we lease to be in good condition and generally suitable for the purposes for which they are used.
ITEM 3. LEGAL PROCEEDINGS
From time to time we are involved in legal proceedings that are incidental to the operation of our business. Some of these proceedings seek remedies relating to employment matters, matters in connection with our contracts and matters arising under laws relating to the protection of the environment.
Among these proceedings, we are defending a purported class action employment lawsuit that was initiated in the United States District Court for the Western District of Washington in April 2010 against our former parent by individuals who worked on a particular contract in Kuwait after April 12, 2009. The plaintiffs are alleging a breach of employment contract by our former parent due to an alleged violation of Kuwait labor law. On November 3, 2016, following an interlocutory appeal by Vectrus, the Ninth Circuit Court of Appeals affirmed the District Court’s decision certifying a class of plaintiffs. Vectrus continues to vigorously defend the case, and plans to file a petition for certiorari with the U.S. Supreme Court on the class certification decision in March 2017.
Although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including our assessment of the merits of the particular claim, we do not expect that any asserted or unasserted legal claims or proceedings, individually or in the aggregate, will have a material adverse effect on our cash flow, results of operations or financial condition.
See Note 16, "Commitments and Contingencies" in the Notes to Consolidated and Combined Financial Statements included in this Annual Report on Form 10-K for further information.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable.



24



PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
COMMON STOCK – MARKET PRICES AND DIVIDENDS
Our common stock is traded on the New York Stock Exchange (NYSE) under the symbol “VEC". Our common stock started trading on the NYSE in September 2014. As of February 22, 2017, there were approximately 6,053 stockholders of record and 10.9 million outstanding shares of common stock.
The trading price data, as reported on the NYSE for the indicated periods, are as follows:
 
 
Year Ended December 31, 2016
 
 
Sales Price
 
 
High
 
Low
1st Quarter
 
$23.04
 
$17.78
2nd Quarter
 
$29.20
 
$21.36
3rd Quarter
 
$34.56
 
$15.23
4th Quarter
 
$25.10
 
$15.91
 
 
Year Ended December 31, 2015
 
 
Sales Price
 
 
High
 
Low
1st Quarter

$33.75

$24.94
2nd Quarter

$28.53

$23.90
3rd Quarter

$26.91

$22.05
4th Quarter
 
$26.14
 
$20.89
To date, we have not declared or paid any dividends on our common stock. The declaration and payment of dividends by us are subject to the discretion of our Board of Directors and depend on many factors including our financial condition, earnings, capital requirements, covenants associated with our debt obligations, legal requirements, regulatory constraints and other factors deemed relevant by the Board of Directors. Therefore, there can be no assurance as to what level of dividends, if any, will be paid in the future. In deciding whether to pay future dividends on our common stock, our Board of Directors may take into account such matters as general business conditions, industry practice, our financial condition and performance, our future prospects, our cash needs and capital investment plans, debt levels and requirements, income tax consequences, applicable law and such other factors as our Board of Directors may deem relevant. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources". For a discussion of restrictions on the payment of dividends under our credit agreement, see Note 6. "Debt", in the Notes to Consolidated and Combined Financial Statements included in this Annual Report on Form 10-K.
EQUITY COMPENSATION PLAN INFORMATION
For a discussion of the securities authorized under our equity compensation plans, see Item 12 of this Annual Report on Form 10-K, which incorporates by reference the information to be disclosed in our definitive proxy statement for our 2017 Annual Meeting of Shareholders.
ISSUER PURCHASES OF EQUITY SECURITIES
We did not repurchase any of our equity securities for the year ended December 31, 2016.
STOCK PERFORMANCE GRAPH
The following graph provides a comparison of the cumulative total shareholder return on our common stock to the returns of the Russell 2000 Index and the S&P Aerospace & Defense Select Industry Index from September 16, 2014 (the first day our common stock began “when-issued” trading on the NYSE) through December 31, 2016. Our common stock began “regular-way” trading in connection with the Spin-off on September 29, 2014. "When-issued" trading refers to a sale or purchase made conditionally because the security has been authorized but not yet issued. "Regular-way" trading refers to

25



trading after a security has been issued. The graph is not, and is not intended to be, indicative of future performance of our common stock. This graph is not deemed to be “filed” with the SEC or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended (Exchange Act) and should not be deemed to be incorporated by reference into any of our prior or subsequent filings under the Securities Act of 1933 as amended (Securities Act), or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.
38311906_vec-1231201_chartx16991.jpg
The above graph assumes the following:
(1)
$100 invested at the close of business on September 16, 2014, in Vectrus common stock, Russell 2000 Index and S&P Aerospace & Defense Select Industry Index.
(2)
The cumulative total return assumes reinvestment of dividends.

ITEM 6. SELECTED FINANCIAL DATA
The financial statements presented in this Annual Report on Form 10-K represent:
(i) periods prior to September 27, 2014 when we were part of Exelis (referred to as "Combined Financial Statements") and
(ii) the period as of and subsequent to September 27, 2014 when we became a separate publicly traded company (referred to as "Consolidated Financial Statements").
The statement of income data for each of the three years ended December 31, 2016 and 2015 are derived from audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The statement of income data for the year ended December 31, 2014 is derived from audited combined financial statements included elsewhere in this Annual Report on Form 10-K. Balance sheet data as of December 31, 2016 and 2015 are derived from audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Balance sheet data as of December 31, 2014 is derived from audited consolidated financial statements not included in this Annual Report on Form 10-K. Balance sheet data as of December 31, 2013 is derived from audited combined financial statements not included in this Annual Report on Form 10-K. The statement of income data for the years ended December 31, 2013 and 2012 are derived from audited combined financial statements that are not included in this Annual Report on Form 10-K. The balance sheet data as of December 31, 2012 is derived from unaudited combined financial statements that are not included in this Annual Report on Form 10-K, which has been prepared on the same basis as the audited data and, in the opinion of management, includes all adjustments necessary for a fair presentation of the information set forth herein.

26



 

Year Ended December 31,
(In thousands, except per share data)

2016

2015

2014

2013

2012
Results of Operations










Total Revenue

$
1,190,519

 
$
1,180,684

 
$
1,203,269

 
$
1,511,638

 
$
1,828,364

Operating income

42,826

 
39,962

 
38,417

 
131,322

 
110,351

Operating margin

3.6
%
 
3.4
%
 
3.2
%
 
8.7
%
 
6.0
%
Net income

$
23,655

 
$
30,973

 
$
22,812

 
$
84,392

 
$
74,665

Basic earnings per common share ¹

$
2.21

 
$
2.94

 
$
2.18

 
$
8.06

 
$
7.13

Diluted earnings per common share ¹

$
2.16

 
$
2.86

 
$
2.13

 
$
8.06

 
$
7.13

Financial Position

 
 
 
 
 
 
 
 
 
Total assets

465,305

 
484,396

 
499,491

 
489,164

 
591,139

Total debt

$
85,000

 
$
111,615

 
$
137,375

 
$

 
$












¹ For the periods ended September 27, 2014 and prior, basic and diluted earnings per share are computed using the number of shares of Vectrus common stock outstanding on September 27, 2014, the date on which Vectrus common stock was distributed to the shareholders of Exelis in the Spin-off.
The selected historical consolidated and combined financial data presented above should be read in conjunction with our audited Consolidated and Combined Financial Statements and accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Annual Report on Form 10-K. Our historical financial information may not be indicative of our future performance. Our historical consolidated and combined financial information prior to September 27, 2014 reflects our performance as a business division of Exelis and may not provide a useful indicator of future performance. For further discussion of the factors that may affect comparability, see “Risk Factors” in Item 1A of this Annual Report on Form 10-K.

ITEM 7. 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 audited Consolidated and Combined Financial Statements and notes thereto as well as the discussion in Item 1 of this Annual Report on Form 10-K entitled "Business." This Annual Report provides additional information regarding the Company, our services, industry outlook and forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements. See "Forward-Looking Statement Information" for further information regarding forward-looking statements. Amounts presented in and throughout this Item 7 are rounded and, as such, any rounding differences could occur in period over period changes and percentages reported.
Forward-Looking Statement Information
This Annual Report on Form 10-K and certain information incorporated herein by reference contain forward-looking statements within the meaning of Section 21E of the Exchange Act, and Section 27A of the Securities Act, and the Private Securities Litigation Reform Act of 1995 and, as such, may involve risks and uncertainties. All statements included or incorporated by reference in this report, other than statements that are purely historical, are forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “could,” “potential,” “continue” or similar terminology. These statements are based on the beliefs and assumptions of the management of the Company based on information currently available to management. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements.
The forward-looking statements included or incorporated by reference in this report are subject to additional risks and uncertainties further discussed under Item 1A. “Risk Factors” and are based on information available to us on the filing date of this report. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this report. New risks and uncertainties arise from time to time, and we cannot predict those events or how they may affect us.
The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from the Company’s historical experience and

27



our present expectations or projections. These risks and uncertainties include, but are not limited to: Our ability to submit proposals for and/or win all potential opportunities in our pipeline; our ability to retain and renew our existing contracts; protests of new awards; economic, political and social conditions in the countries in which we conduct our businesses; changes in U.S. or international government defense budgets; government regulations and compliance therewith, including changes to the DoD procurement process; changes in technology; intellectual property matters; governmental investigations, reviews, audits and cost adjustments; contingencies related to actual or alleged environmental contamination, claims and concerns; delays in completion of the U.S. government's budget; our success in extending, deepening, and enhancing our technical capabilities; our success in expanding our geographic footprint or broadening or customer base; our ability to realize the full amounts reflected in our backlog; impairment of goodwill; misconduct of our employees, subcontractors, agents, prime contractors and business partners; our ability to control costs; our level of indebtedness; subcontractor performance; economic and capital markets conditions; our ability to retain and recruit qualified personnel; security breaches and other disruptions to our information technology and operation; changes in our tax provisions or exposure to additional income tax liabilities and other risks and uncertainties relating to the Spin-off; changes in U.S. generally accepted accounting principles (GAAP); and other factors described in Item 1A, “Risk Factors,” and elsewhere in this report and described from time to time in our future reports filed with the SEC.
Use of Non-GAAP Financial Information
Certain matters discussed in this report, including the information presented in Part II under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” include measures not derived in accordance with GAAP. These measures should not be considered in isolation or as a substitute for any measure derived in accordance with GAAP, and also may be inconsistent with similar measures presented by other companies. In Part II under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the reasons for the Company’s use of these measures are presented under the heading, “Key Performance and Non-GAAP Measures,” and reconciliations of these measures to the most closely comparable GAAP measures are presented under the heading “Discussion of Financial Results.”
Overview
Vectrus is a leading provider of services to the U.S. government worldwide. We operate in one segment and offer the following services: facility and logistics services and information technology and network communications services.
On September 27, 2014, Exelis completed the Spin-off of Vectrus, formerly Exelis' Mission Systems business, which was part of Exelis' Information and Technical Services segment and Vectrus became an independent, publicly traded company.
Our primary customer is the U.S. DoD, with a high concentration in the U.S. Army. For each of the years ended December 31, 2016, 2015 and 2014, we had total revenue of $1.2 billion, all of which was derived from U.S. government customers. For the years ended December 31, 2016, 2015 and 2014, we generated approximately 84%, 85% and 88%, respectively, of our total revenue from the U.S. Army.
Executive Summary
Our revenue increased by $9.8 million, or 0.8%, for the year ended December 31, 2016 compared to the year ended December 31, 2015. The increase in revenue was attributable mainly to higher activity in our Middle East programs of $130.9 million, offset by decreases of $80.1 million from our Afghanistan programs, $35.7 million from our U.S. programs and $5.3 million from our European programs.
Operating income for the year ended December 31, 2016, was $42.8 million, an increase of $2.9 million, or 7.2%, compared to the year ended December 31, 2015. This increase was primarily due to higher operating income of $13.7 million from our Middle East programs and $0.4 million from our European programs, offset by decreases of $7.4 million in lower operating income from our Afghanistan programs and $3.8 million from our U.S. programs.
During the performance of our long-term 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 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 a cumulative catch-up adjustment, which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a contract's percentage of completion. Aggregate changes in contract estimates recognized using the cumulative catch-up method of accounting increased operating income by $7.5 million and decreased operating income by

28



$1.9 million for the year ended December 31, 2016 and December 31, 2015, respectively. Cumulative catch-up adjustments are driven by changes in contract terms, program performance, customer scope changes and changes to estimates in the reported period. These changes can increase or decrease operating income depending on the dynamics of each contract.
Further details related to the year ended December 31, 2016, compared to the year ended December 31, 2015 and the year ended December 31, 2015, compared to the year ended December 31, 2014, are contained in the Discussion of Financial Results section.
Recent Developments
In October 2014, a Danish company owned by Vectrus received notice of award of an approximately $411 million Hybrid Firm-Fixed Price Contract for Thule Base Maintenance (the Thule Contract). In February 2015, the GAO denied protests of the Thule Contract filed by three unsuccessful bidders, and all three of them filed subsequent protests with the U.S. Court of Federal Claims. Following a lengthy litigation process, the cases related to the Thule Contract award protests were dismissed in October 2016. On December 14, 2016, the Air Force directed our Danish subsidiary to begin the transition process for the Thule Contract. On January 31, 2017, the Court of Federal Claims granted one protestor’s motion for reconsideration to address two claims that were not expressly ruled upon in the court’s dismissal of the case in October 2016. Our Danish subsidiary has begun the phase-in period, with full contract operations scheduled to begin on October 1, 2017. 
On November 30, 2016, Kenneth Hunzeker, our former CEO, notified the Company of his intention to retire. Mr. Hunzeker's last day of active full-time employment with Vectrus was December 5, 2016. On November 30, 2016, our Board of Directors appointed Charles L. Prow, as President and Chief Executive Officer and a member of the Board of Directors, effective December 6, 2016.
On December 21, 2016, the GAO issued its decision denying Vectrus’ protest in connection with its not being selected for the renewal of the Kuwait based Army Pre-Positioned Stocks-5 (APS-5 Kuwait) contract, which was combined with the APS-5 Qatar contract for the solicitation and award. As previously disclosed, Vectrus filed the post-award protest with the GAO on the APS-5 Kuwait/Qatar award on September 13, 2016. The contract's final extension runs through the first quarter of 2017.
Recent developments regarding certain significant contracts are discussed in "Significant Contracts" below.     
Significant Contracts
The table below reflects contracts that accounted for more than 10% of our total revenue for the years ended December 31, 2016, 2015 and 2014:
 
 
% of Total Revenue
 
 
Years Ended December 31,
Contract Name
 
2016
 
2015
 
2014
Kuwait Base Operations and Security Support Services (K-BOSSS)
 
36.8%
 
32.6%
 
31.4%
Kuwait-based Army Pre-Positioned Stocks-5 (APS-5 Kuwait)
 
15.1%
 
14.0%
 
13.2%
Operations, Maintenance and Defense of Army Communications in Southwest Asia and Central Asia (OMDAC-SWACA)
 
12.8%
 
11.6%
 
11.5%
Logistics Civilian Augmentation Program (LOGCAP)
 
3.3%
 
7.4%
 
12.2%
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.
U.S. government contracts are multi-year contracts and typically include an initial period of one year or less with annual one year (or less) option periods for the remaining contract period. The number of option periods vary by contract, and there is no guarantee that an option period will be exercised by the U.S. government. The right to exercise an option period is at the sole discretion of the U.S. government. The U.S. government may also extend the term of a program by issuing extensions or bridge contracts, typically for periods of one year or less.
The K-BOSSS contract commenced in November 2010 and currently is exercised through March 28, 2017. The right to exercise an option period is at the sole discretion of the U.S. government. On September 29, 2016, we announced that we were not awarded the renewal of the K-BOSSS contract. We filed a post-award protest with the GAO on the K-BOSSS award on October 11, 2016. On November 7, 2016, we were notified by the Army that it was taking corrective action to resolve the protest of the K-BOSSS contract award. As such, the solicitation for the K-BOSSS contract was amended and re-issued to the

29



original bidders. We are awaiting a decision on the amended solicitation as our revised proposal is currently under evaluation by the Army. Based on the current status of the solicitation for the K-BOSSS contract, our knowledge of the history and timing of prior solicitations on the K-BOSSS contract and the expected phase-in period for a successful bidder, management believes the K-BOSSS contract could extend into the third quarter of 2017.
The APS-5 Kuwait contract commenced in April 2010 and ran through February 28, 2017. On September 1, 2016, we announced that we were not awarded the renewal of the APS-5 Kuwait contract. For the re-competition award, the APS-5 Kuwait contract was combined with the APS-5 Qatar contract as the APS-5 Kuwait/Qatar contract. We have operated the APS-5 Qatar contract since May 2011. In each of the periods presented, the APS-5 Qatar contract did not exceed 10% of our revenue. We have accounted for the APS-5 Kuwait and APS-5 Qatar contracts separately through the end date of the contracts. We filed a post-award protest on the APS-5 Kuwait/Qatar contract award with the GAO on September 13, 2016. On December 21, 2016, the GAO issued its decision denying our protest of the APS-5 Kuwait/Qatar contract award. The APS-5 Kuwait contract's final extension runs through the first quarter of 2017.
Performance on the OMDAC-SWACA contract commenced in July 2013 with a base period of 11 months and four option years. The U.S. government has exercised three option years through May 2017. The contract has one additional option period, which runs through May 2018, which has not been exercised by the U.S. government at this time.
Performance on the LOGCAP contract commenced in July 2011 as a subcontract basic ordering agreement in Afghanistan with task orders awarded at the discretion of the prime contractor. The contract ended in June 2016.
We anticipate the loss of the APS-5 Kuwait contract with associated revenue and costs will not have a material impact on our liquidity.
Backlog
Total backlog includes both 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 represents firm orders and potential options on multi-year contracts. Total backlog excludes potential orders under indefinite delivery and indefinite quantity (IDIQ) contracts. The value of the backlog is based on anticipated revenue levels over the anticipated life of the contract. Actual volumes 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.
We expect to recognize a substantial portion of our funded backlog as revenue within the next 12 months. However, the U.S. government 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.
Total backlog decreased by $56.3 million in the year ended December 31, 2016. As of December 31, 2016, total backlog (funded and unfunded) was $2.4 billion.

As of December 31,
(In millions)
2016

2015
Funded backlog
$
665

 
$
685

Unfunded backlog
1,691

 
1,727

Total backlog
$
2,356

 
$
2,412

Funded orders, which are different from funded backlog, represent orders for which funding was received during the period. We received funded orders of $1.2 billion during the year ended December 31, 2016, which was an increase of $118.9 million compared to the year ended December 31, 2015 due to the timing of funded orders for some of our contracts.
Economic Opportunities, Challenges and Risks
The U.S. government’s investment in services and capabilities in response to changing security challenges creates a complex and fluid business environment for Vectrus and other firms in this market segment. The pace and depth of U.S. government acquisition reform and cost savings initiatives, combined with increased industry competitiveness to win long-term positions on key programs, could add pressure to revenue levels and profit margins going forward. However, we expect the U.S. government will continue to place a high priority on national security and will continue to invest in affordable solutions for its facilities, logistics, equipment and communication needs, which aligns with our services and strengths. Further, the DoD budget remains the largest in the world and management believes our addressable portion of the DoD budget offers substantial opportunity for growth.

30



We anticipate and will be experiencing reductions in revenue and profitability related to certain programs in which we participate, including from the contracts that are terminating due to our not being selected for re-compete awards. However, other programs are expanding. We believe spending on operation and maintenance of defense assets, as well as civilian agency infrastructure and equipment, will continue to be a U.S. government priority. Our focus is on sustaining facilities, equipment and IT networks, which we believe aligns with our customers' intent to utilize existing equipment and infrastructure rather than executing new purchases. Many of the core functions we perform are mission-essential. The following are examples of a few of these core functions: (i) keeping communications networks operational; (ii) operating and repairing utilities such as electricity and gas; and (iii) providing firefighting services. While customers may reduce the level of services required from us, we do not currently anticipate the complete elimination of these services.
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 this Annual Report on Form 10-K and the matters identified under the caption “Forward-Looking Information" herein.
Key Performance and Non-GAAP Measures
The primary financial performance measures we use to manage our businesses and monitor results of operations are revenue trends and operating income trends. Management believes that these financial performance measures are the primary drivers for our earnings and net cash from operating activities. Operating income represents revenue less both cost of revenue and selling, general and administrative (SG&A) expenses.
We define operating margin as operating income divided by revenue. Cost of revenue consists of labor, subcontracting costs, materials, and an allocation of indirect costs, which includes service center transaction costs. SG&A expenses consist of indirect labor costs (including wages and salaries for executives and administrative personnel), bid and proposal expenses and other general and administrative expenses not allocated to cost of revenue.
We manage the nature and amount of costs at the program level, which forms the basis for estimating our total costs and profitability. Management evaluates its contracts and business performance by focusing on revenue, operating income and operating margin. This is consistent with our approach for managing our business, which begins with management's assessing the bidding opportunity for each contract and then managing contract profitability throughout the performance period.
In addition to the key performance measures discussed above, we consider adjusted revenue and adjusted operating income to be useful to management and investors in evaluating our operating performance for the periods presented and to provide a tool for evaluating our ongoing operations. Adjusted revenue, a non-GAAP measure, is defined as revenue adjusted to exclude the Tethered Aerostat Radar System (TARS) program revenue, which was retained by Exelis. Adjusted operating income, a non-GAAP measure, is defined as operating income, adjusted to exclude items that may include, but are not limited to, other income; significant charges or credits that impact current results but are not related to our ongoing operations; unusual and infrequent non-operating items and non-operating tax settlements or adjustments, such as separation costs incurred to become a stand-alone public company and tax indemnifications in connection with the Spin-off. We believe that this information can assist investors in assessing our financial performance and measures our ability to generate capital for use among competing strategic alternatives and initiatives. Adjusted revenue and adjusted operating income, however, are not measures of financial performance under GAAP and should not be considered a substitute for revenue or operating income, as determined in accordance with GAAP. Adjusted operating margin, a non-GAAP measure, is defined as adjusted operating income divided by revenue.
Reconciliations of adjusted revenue to revenue and adjusted operating income to operating income are provided below.

31



 
 
Year Ended December 31,
(In thousands)
 
2016
 
2015
 
2014
Revenue
 
$
1,190,519

 
$
1,180,684

 
$
1,203,269

TARS revenue
 

 

 
31,315

Adjusted revenue
 
$
1,190,519

 
$
1,180,684

 
$
1,171,954

 
 
 
 
 
 
 
Net income
 
$
23,655

 
$
30,973

 
$
22,812

Income tax expense
 
13,532

 
2,458

 
14,079

Interest (expense) income, net
 
(5,639
)
 
(6,531
)
 
(1,526
)
Operating income
 
42,826

 
39,962

 
38,417

Operating margin
 
3.6
%
 
3.4
%
 
3.2
%
TARS operating income (pretax)
 

 

 
(1,623
)
Separation costs to become a stand-alone public company (pretax)
 

 
177

 
13,237

Tax indemnification
 

 
3,300

 

Adjusted operating income
 
$
42,826

 
$
43,439

 
$
50,031

Adjusted operating margin
 
3.6
%
 
3.7
%
 
4.3
%

DISCUSSION OF FINANCIAL RESULTS
Year ended December 31, 2016, compared to Year ended December 31, 2015
Selected financial highlights are presented in the table below:


Year Ended December 31,

Change
(In thousands)

2016

2015

$
 
%
Revenue

$
1,190,519

 
$
1,180,684

 
$
9,835

 
0.8
 %
Cost of revenue

1,083,607

 
1,075,035

 
8,572

 
0.8
 %
% of revenue

91.0
%
 
91.1
%
 
 
 
 
Selling, general and administrative

64,086

 
65,687

 
(1,601
)
 
(2.4
)%
% of revenue

5.4
%
 
5.6
%
 
 
 
 
Operating income

42,826

 
39,962

 
2,864

 
7.2
 %
Operating margin

3.6
%
 
3.4
%
 
 
 
 
Interest (expense) income, net

(5,639
)
 
(6,531
)
 
892

 
(13.7
)%
Income before taxes

37,187

 
33,431

 
3,756

 
11.2
 %
% of revenue

3.1
%
 
2.8
%
 
 
 
 
Income tax expense

13,532

 
2,458

 
11,074

 
450.5
 %
Effective income tax rate

36.4
%
 
7.4
%
 
 
 
 
Net Income

$
23,655

 
$
30,973

 
$
(7,318
)
 
(23.6
)%
Revenue
Revenue for the year ended December 31, 2016, was $1.2 billion, reflecting an increase of $9.8 million, or 0.8%, as compared to the year ended December 31, 2015. The increase in revenue was attributable mainly to higher activity in our Middle East contracts of $130.9 million. The increase in revenue was partially offset by decreases in revenue in our Afghanistan programs of $80.1 million, our U.S. programs of $35.7 million and our European programs of $5.3 million.
Cost of Revenue
The increase in cost of revenue of $8.6 million, or 0.8%, for the year ended December 31, 2016, as compared to the year ended December 31, 2015, was primarily due to higher revenue as described above.

32



Selling, General & Administrative (SG&A) Expenses
For the year ended December 31, 2016, SG&A expenses of $64.1 million decreased by $1.6 million, or 2.4%, as compared to $65.7 million for the year ended December 31, 2015.
For the year ended December 31, 2016, SG&A expenses increased by $2.7 million due to costs associated with a work force reduction and CEO transition expenses and higher legal expenses of $1.1 million. These increases were offset by lower stock-based compensation expense of $2.0 million and the impact of items in the following paragraph that affected 2015 SG&A. We anticipate an annual savings of approximately $7.6 million related to the work force reduction in 2016.
For the year ended December 31, 2015, we recognized additional SG&A costs due to the one-time settlement of a tax indemnification of $3.3 million as described in Note 3, “Income Taxes” in the Notes to our Consolidated and Combined Financial Statements included in this Annual Report on Form 10-K and a one-time settlement of a receivable indemnified by Exelis of $0.2 million as described in Note 5, "Receivables" in the Notes to our Consolidated and Combined Financial Statements included in this Annual Report on Form 10-K.
Operating Income
Operating income for the year ended December 31, 2016, increased by $2.9 million, or 7.2%, as compared to the year ended December 31, 2015.
Operating income as a percentage of revenue was 3.6% for the year ended December 31, 2016, compared to 3.4% for the year ended December 31, 2015.
Aggregate cumulative catch-up adjustments for the years ended December 31, 2016 and 2015 increased operating income by $7.5 million and decreased operating revenue by $1.9 million, respectively. The aggregate cumulative catch-up adjustments for the year ended December 31, 2016 related to approved contract modifications and extensions with higher margins associated with labor-related items and additional negotiated fees, offset by lower earned incentive fees and higher subcontractor costs. The aggregate cumulative catch-up adjustments for the year ended December 31, 2015 related to the early closure of sites in Afghanistan and contract line item realignments with our customers offset by operational efficiencies related primarily to cost savings from decreased staffing levels due to productivity improvements on maturing contracts. The gross aggregate effects of these favorable and unfavorable changes in estimates in 2016 and 2015 were $15.3 million and $9.7 million favorable to operating income, respectively, and $7.8 million and $11.6 million unfavorable to operating income, respectively.
Interest (Expense) Income, Net
Interest (expense) income, net for the years ended December 31, 2016 and 2015 was as follows:
 
 
Year Ended December 31,
 
Change
(In thousands)
 
2016
 
2015
 
$
 
%
Interest income
 
$
41

 
$
80

 
$
(39
)
 
(48.6
)%
Interest (expense)
 
(5,680
)
 
(6,611
)
 
(931
)
 
(14.1
)%
Interest (expense) income, net
 
$
(5,639
)
 
$
(6,531
)
 
$
(892
)
 
(13.7
)%
Interest income is directly related to interest earned on our cash. Interest expense is directly related to borrowings under our senior secured credit facilities, the amortization of debt issuance costs and a derivative instrument used to hedge a portion of our exposure to interest rate risk. The decrease in interest expense of $0.9 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 was due to a lower average debt balance in 2016.
Income Tax Expense
We recorded income tax expense of $13.5 million and $2.5 million for the years ended December 31, 2016 and 2015, respectively, which represented effective income tax rates of 36.4% and 7.4%, respectively. The lower effective income tax rate for the year ended December 31, 2015 compared to the year ended December 31, 2016 was due to the one-time settlement of tax positions in 2015 as described in Note 3, “Income Taxes” in the Notes to Consolidated and Combined Financial Statements included in this Annual Report on Form 10-K.

33



Year ended December 31, 2015, compared to year ended December 31, 2014
Selected financial highlights are presented in the table below:
 
 
Year Ended December 31,
 
Change
(In thousands)
 
2015
 
2014
 
$
 
%
Revenue
 
$
1,180,684

 
$
1,203,269

 
$
(22,585
)
 
(1.9
)%
Cost of revenue
 
1,075,035

 
1,084,512

 
(9,477
)
 
(0.9
)%
% of revenue
 
91.1
%
 
90.1
%
 
 
 
 
Selling, general and administrative
 
65,687

 
80,340

 
(14,653
)
 
(18.2
)%
% of revenue
 
5.6
%
 
6.7
%
 
 
 
 
Operating income
 
39,962

 
38,417

 
1,545

 
4.0
 %
Operating margin
 
3.4
%
 
3.2
%
 
 
 
 
Interest (expense) income, net
 
(6,531
)
 
(1,526
)
 
(5,005
)
 
(100)% +

Income before taxes
 
33,431

 
36,891

 
(3,460
)
 
(9.4
)%
% of revenue
 
2.8
%
 
3.1
%
 
 
 
 
Income tax expense
 
2,458

 
14,079

 
(11,621
)
 
(82.5
)%
Effective income tax rate
 
7.4
%
 
38.2
%
 
 
 
 
Net Income
 
$
30,973

 
$
22,812

 
$
8,161

 
35.8
 %
Revenue
Revenue for the year ended December 31, 2015, was $1.2 billion, reflecting a decrease of $22.6 million, or 1.9%, as compared to the year ended December 31, 2014. The decline in revenue was attributable mainly to lower activity in our Afghanistan-based contracts. Programs with contract activity in Afghanistan experienced declines in revenue of approximately $102.4 million for the year ended December 31, 2015 compared to the year ended December 31, 2014, as maintenance responsibility was transferred to local Afghans on certain contracts and facility service levels were reduced to align with changing U.S. government priorities in Afghanistan. The decrease was also due to the absence of $31.3 million in revenue from the TARS program, which was retained by Exelis following the Spin-off in September 2014. The decrease in revenue was partially offset by a $111.1 million increase in revenue from our non-Afghanistan contracts, including our ACE-IT and TSBMC contracts, for the year ended December 31, 2015 as compared to the year ended December 31, 2014.
Cost of Revenue
The decrease in the cost of revenue of $9.5 million, or 0.9%, for the year ended December 31, 2015, as compared to the year ended December 31, 2014, was primarily due to lower revenue as described above. The cost of revenue as a percentage of revenue increased for the year ended December 31, 2015, as compared to the year ended December 31, 2014, due to the declining leverage of certain contract costs as a result of lower revenue in our Afghanistan-based programs.
SG&A Expenses
For the year ended December 31, 2015, SG&A expenses of $65.7 million decreased by 18.2% as compared to $80.3 million for the year ended December 31, 2014. The decreases were driven by lower general corporate expenses incurred for separation costs associated with becoming a stand-alone public company of $13.2 million and other cost controls implemented by management of approximately $5.0 million, including a reduction in marketing and selling expenses offset by the one-time settlement of a tax indemnification of $3.3 million, which is described in Note 3, “Income Taxes” in the Notes to our Consolidated and Combined Financial Statements.
Operating Income
Operating income for the year ended December 31, 2015, increased by $1.5 million, or 4.0%, as compared to the year ended December 31, 2014.
Operating income as a percentage of revenue was 3.4% for the year ended December 31, 2015, compared to 3.2% for the year ended December 31, 2014.
Aggregate cumulative catch-up adjustments for the years ended December 31, 2015 and 2014, decreased operating income by $1.9 million and $2.6 million, respectively. The aggregate cumulative catch-up adjustments for the years ended December 31, 2015 and 2014 relate to the early closure of sites in Afghanistan and contract line item realignments with our

34



customers offset by operational efficiencies related primarily to cost savings from decreased staffing levels due to productivity improvements on maturing contracts. The gross aggregate effects of these favorable and unfavorable changes in estimates in 2015 and 2014 were $9.7 million and $4.0 million favorable to operating income, respectively, and $11.6 million and $6.6 million unfavorable to operating income, respectively.
Interest (Expense) Income, Net
Interest (expense) income, net for the years ended December 31, 2015 and 2014 was as follows:
 
 
Year Ended December 31,
 
Change
(In thousands)
 
2015
 
2014
 
$
 
%
Interest income
 
$
80

 
$
52

 
$
28

 
53.8
%
Interest (expense)
 
(6,611
)
 
(1,578
)
 
5,033

 
100%+

Interest (expense) income, net
 
$
(6,531
)
 
$
(1,526
)
 
$
5,005

 
100%+

Interest income is directly related to interest earned on our cash. Interest expense is directly related to borrowings under our senior secured credit facilities, the amortization of debt issuance costs and a derivative instrument used to hedge a portion of our exposure to interest rate risk. The increase in interest expense of $5.0 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 was due to a higher average debt balance reflecting a full year of debt in 2015 compared to three months in 2014 as we entered into the senior secured credit facilities in September 2014.
Income Tax Expense
We recorded income tax expense of $2.5 million and $14.1 million for the years ended December 31, 2015 and 2014, respectively, which represented effective income tax rates of 7.4% and 38.2%, respectively. The decrease in the effective income tax rates for the year ended December 31, 2015 compared to the year ended December 31, 2014 is due to the one-time settlement of tax positions in 2015 as described in Note 3, “Income Taxes” in the Notes to Consolidated and Combined Financial Statements. Management does not believe the lower effective income tax rate in 2015 represents a trend in our future income tax rates.

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 expenditure and financing requirements through cash flows from operations, cash on hand and access to capital markets.
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. We anticipate the loss of the APS-5 Kuwait contract with associated revenue and costs will not have a material impact on our liquidity.
The cash presented on our balance sheet consists of U.S. and international cash from wholly owned subsidiaries. Approximately $14.6 million of our total $47.7 million in cash at December 31, 2016 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 connection with the Spin-off, we entered into a senior secured credit facility consisting of five-year term loan facility (the Term Loan) in the aggregate principal amount of $140.0 million and a five-year senior secured revolving credit facility (the Revolver) that permits borrowings up to $75.0 million, of which $35.0 million will be available for the issuance of letters of credit (see Note 6, "Debt" in the Notes to the Consolidated and Combined Financial Statements). Net proceeds from the Term Loan were used to fund a $136.3 million distribution to a subsidiary of Exelis on September 26, 2014. During 2016, 2015 and 2014, we made principal payments on the Term Loan of $29.0 million, $23.4 million and $2.6 million, respectively, reducing the principal balance on the Term Loan to $85.0 million as of December 31, 2016. In addition to the quarterly installments on the Term Loan, we voluntarily prepaid $15.0 million and $12.0 million of the principal of the Term Loan during the years ended December 31, 2016 and 2015, respectively. There were no outstanding borrowings under the Revolver at December 31, 2016.

35



At December 31, 2016, there were eight letters of credit outstanding in the aggregate amount of $12.3 million, which reduced our borrowing availability to $62.7 million under the Revolver.
Dividends
We do not currently plan to pay a regular dividend on our common stock. The declaration of any future cash dividends and if declared, the amount of any such dividends, will depend upon our financial condition, earnings, capital requirements, financial covenants and other contractual restrictions and the discretion of our Board of Directors. In deciding whether to pay future dividends on our common stock, our Board of Directors may take into account 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 and unbilled receivables 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 57 and 68 days as of December 31, 2016 and 2015, respectively. Continuous improvement in our collections process contributed to a lower DSO as of December 31, 2016.
The following table sets forth net cash provided by operating activities, investing and financing activities.


Year Ended December 31,
(In thousands)

2016

2015

2014
Operating activities

$
36,618

 
$
18,880

 
$
42,979

Investing activities

(52
)
 
118

 
(3,350
)
Financing activities

(28,062
)
 
(21,710
)
 
(6,607
)
Foreign exchange

(848
)
 
(116
)
 
(645
)
Net change in cash

$
7,656

 
$
(2,828
)
 
$
32,377

Trends in our operating cash flows tend to follow trends in operating income, excluding non-cash charges. Net cash provided by operating activities increased for the year ended December 31, 2016, as compared to the year ended December 31, 2015. Net cash provided by operating activities for the year ended December 31, 2016 consisted of favorable net working capital changes of $4.7 million due to the timing of cash collections and payments, as reflected in receivables, non-cash items of $8.2 million and net income of $23.7 million.
Net cash provided by operating activities during the year ended December 31, 2015 consisted of net income of $31.0 million, increased by non-cash items of $11.6 million, offset by other unfavorable net working capital changes of $23.7 million due to the timing of cash collections and payments, as reflected in receivables and other liabilities.
Net cash provided by operating activities during the year ended December 31, 2014 consisted of net income of $22.8 million, increased by non-cash items of $4.7 million and favorable net working capital changes of $15.5 million due to the timing of cash collections and payments, as reflected in receivables, accounts payable and deferred taxes.
Net cash used in investing activities for the year ended December 31, 2016 consisted of capital expenditures for the purchase of capital assets offset by proceeds received from the disposition of capital assets and a distribution from an equity investment (see Note 1, "Description of Business and Summary of Significant Accounting Policies - Equity Investment," in the Notes to our Consolidated and Combined Financial Statements in this Annual Report on Form 10-K). Capital expenditures during the year ended December 31, 2016 were primarily for the purchase of hardware and software related to ongoing operations. Net cash provided by investing activities during the year ended December 31, 2015 primarily related to capital expenditures for the purchase of hardware and software related to ongoing operations and a distribution from an equity investment. Net cash used in investing activities during the year ended December 31, 2014 was primarily related to capital expenditures for the purchase of hardware and software driven by our separation from Exelis offset by proceeds received from the disposition of capital assets.
Net cash used in financing activities during the year ended December 31, 2016 consisted of repayments of long-term debt of $29.0 million, payments related to employee withholding taxes on share-based compensation in the amount of $1.0

36



million and a payment of $0.2 million related to an amendment of our credit agreement, offset by $2.1 million in cash received from the exercise of stock options. During the year ended December 31 2016, we borrowed and repaid a total of $74.0 million from the Revolver to meet short-term working capital requirements.
Net cash used in financing activities for the year ended December 31, 2015 was comprised of repayments of long-term debt of $23.4 million, repayment of financed insurance obligations of $12.1 million and payments related to employee withholding taxes on share-based compensation in the amount of $1.3 million, offset by cash provided by an arrangement the Company entered into to finance certain of its insurance obligations in the amount of $14.9 million and $0.2 million in cash received from the exercise of stock options. During the year ended December 31 2015, we borrowed and repaid a total of $324.0 million from the Revolver to meet short-term working capital requirements.
Net cash used in financing activities for the year ended December 31, 2014 was comprised of $140.0 million received under the Term Loan, net of $3.7 million of debt issuance costs (see Note 6, "Debt" in the Notes to the Consolidated and Combined Financial Statements included in this Annual Report on Form 10-K) and a final working capital adjustment payment from Exelis to the Company of $2.6 million, offset by a distribution to a subsidiary of Exelis of $136.3 million, transfers to and from Exelis in connection with the Spin-off (see Note 15, "Agreements and Transactions with Former Parent" in the Notes to Consolidated and Combined Financial Statements included in the Annual Report on Form 10-K) of $6.4 million, $2.6 million in repayments of long-term debt and $0.2 million was used in the payment of employee withholding taxes on share-based compensation. During the year ended December 31 2014, we borrowed and repaid a total of $23.0 million from the Revolver to meet short-term working capital requirements.
Capital Resources
At December 31, 2016, we held cash of $47.7 million, which included $14.6 million held by foreign subsidiaries, and had $62.7 million of available borrowing capacity under the Revolver which expires on September 17, 2019. We believe that our cash at December 31, 2016, as supplemented by cash flows from operations and the Revolver, will be sufficient to fund our anticipated operating costs, capital expenditures and current debt repayment obligations for at least the next 12 months.
Contractual Obligations
Our commitments to make future payments under long-term contractual obligations were as follows, as of December 31, 2016:
 
 
Payments Due by Period
 
 
 
 

 
Less than 1 Year
 

 

 
 
(In thousands)
 
Total
 
 
1 - 3 Years
 
3 - 5 Years
 
More than 5 Years
Operating leases
 
$
6,422

 
$
3,298

 
$
2,548

 
$
576

 
$

Principal payments on Term Loan
 
85,000

 
15,750

 
69,250

 

 

Interest on Term Loan and Revolver ¹
 
5,831

 
3,066

 
2,765

 

 

Severance costs
 
1,202

 
617

 
585

 

 

Total
 
$
98,455

 
$
22,731

 
$
75,148

 
$
576

 
$

 
 
 
 
 
 
 
 
 
 
 
¹ There were no outstanding borrowings on the Revolver at December 31, 2016.
 
 
Off-Balance Sheet Arrangements
We have obligations relating to operating leases, as discussed above, and letters of credit outstanding. Our Revolver permits borrowings up to $75.0 million, of which $35.0 million is available for the issuance of letters of credit. At December 31, 2016, there were eight letters of credit outstanding in the aggregate amount of $12.3 million, which reduced our borrowing availability to $62.7 million under the Revolver. These arrangements have not had, and management does not believe it is likely that they will in the future have, a material effect on our liquidity, capital resources, operations or financial condition. At December 31, 2016, we had no material off-balance sheet arrangements other than operating leases.

37



CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Estimates are revised as additional information becomes available. Management believes that the accounting estimates employed and the resulting balances are reasonable; however, actual results in these areas could differ from management's estimates under different assumptions or conditions.
Significant accounting policies used in the preparation of the Consolidated and Combined Financial Statements are discussed in Note 1, "Description of Business and Summary of Significant Accounting Policies," in the Notes to the Consolidated and Combined Financial Statements. We believe that the assumptions and estimates associated with revenue recognition, goodwill impairment assessments and income taxes have the greatest potential impact on our financial statements because they are inherently uncertain, involve significant judgments, include areas where different estimates reasonably could materially impact the financial statements. These significant critical accounting policies are discussed in this section. Management believes that the accounting estimates employed and the resulting balances are reasonable; however, actual results in these areas could differ from management's estimates under different assumptions or conditions.
Revenue Recognition
As a defense contractor engaging in long-term contracts, substantially all of our revenue is derived from long-term service contracts for which revenue is recognized under the percentage-of-completion method based on levels of effort or percentage of costs incurred to total costs. For levels of effort, revenue and profits are recognized based upon the ratio of actual services delivered to estimated total services to be delivered under the contract. Under the cost-to-total cost method, revenue is recognized based upon the ratio of costs incurred to estimated total costs at completion. Revenue under cost-reimbursable contracts is recorded as costs are incurred and includes estimated earned fees or profits calculated on the basis of the relationship between costs incurred and total estimated costs. Revenue and profits on time-and-material type contracts are recognized based on billable rates multiplied by direct labor hours incurred plus material and other reimbursable costs incurred. The completed contract method is utilized when reasonable and reliable cost estimates for a project cannot be made. Amounts invoiced to customers in excess of revenue recognized are recorded as deferred revenue, until the revenue recognition criteria are satisfied, and are recorded as billings in excess of costs in the accompanying Consolidated Balance Sheets. Revenue that is earned and recognized in excess of amounts invoiced is recorded as a component of receivables.
During the performance of our long-term contracts, estimated final contract prices and costs are reviewed periodically and changes are made as required and recorded as changes in revenue and cost of revenue in the period in which they are determined. Additionally, the fees under certain contracts may be increased or decreased in accordance with cost or performance incentive provisions which measure actual performance against established targets or other criteria. Such incentive fee awards or penalties are included in revenue when there is sufficient information to reasonably assess anticipated contract performance. Amounts representing contract change orders or limitations in funding on contracts are recorded only if it is probable the claim will result in additional contract revenue and the amounts can be reliably estimated. Changes in contract revenue and cost estimates and the related effect to operating income are recognized using a cumulative catch-up adjustment, which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a contract’s percentage of completion. Changes in estimated revenue and cost could result in a forward loss or an adjustment to a forward loss. Provisions for estimated losses on uncompleted long-term contracts are made in the period in which such losses are determined and are recorded as a component of cost of revenue.
In certain circumstances, pricing for contract elements, or contract line items, is finalized during or after work commences on the specified activity.
Aggregate revenue from our three largest contracts during 2016, which consisted of the K-BOSSS contract, the APS-5 Kuwait contract and the OMDAC-SWACA contract, which are described above under "Significant Contracts" was approximately $0.8 billion, or 65.0%, of our revenue for the year ended December 31, 2016.
Contract option exercises are at the sole discretion of the U.S. government. Changes in contract revenue and cost estimates on our largest contracts could result in significant cumulative catch-up adjustments to the contract’s inception to date revenue, cost of revenue and profit in the period in which such changes are made. Contract estimates are based on various assumptions to project the outcome of future events that often span several years. These assumptions include labor productivity and availability; the complexity of the work to be performed; the cost and availability of materials; and the performance of subcontractors. Due to the significance of judgment in the estimated final contract prices and costs, it is likely that materially different revenue, cost of revenue and profit amounts could be recorded if we used different assumptions, or if the underlying circumstances were to change. Changes in underlying assumptions/estimates, or other circumstances, will adversely or positively affect financial performance in future periods.

38



Goodwill
Goodwill represents purchase consideration paid in a business combination that exceeds the fair values assigned to the net assets of acquired businesses. Goodwill is not amortized, but instead is tested for impairment annually (or more frequently if impairment indicators arise, such as changes to the reporting unit structure or significant adverse changes in the business climate). We conduct our annual impairment testing during the fourth fiscal quarter. The impairment test is a two-step process measuring the magnitude of any impairment. In the first step, the estimated fair value of the reporting unit is developed and compared to the carrying value of the reporting unit. If the estimated fair value of the reporting unit exceeds its carrying value, goodwill is not impaired and the second step of the impairment test is not performed. If the carrying value of the reporting unit exceeds its estimated fair value, then the second step of the impairment test is performed in order to measure the impairment loss to be recorded. If the carrying value of the reporting unit's goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. We estimate the fair value of our reporting unit using an income approach and a market approach. Under the income approach, we estimate fair value based on the present value of estimated future cash flows. Under the market approach, we compare our company to select reasonably similar publicly traded companies. No impairment charges related to goodwill have been recorded during 2016, 2015 and 2014.
Income Taxes
Our income taxes as presented are calculated on a separate tax return basis, although our operations have historically been included in the U.S. Federal and state tax returns or non-U.S. jurisdictions tax returns of Exelis. The global tax model of Exelis has been developed based on its entire portfolio of businesses. Accordingly, our tax results as presented are not necessarily reflective of the tax results that we would have generated on a stand-alone basis.
We determine the provision for income taxes using the asset and liability approach. Under this approach, deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying enacted tax rates in effect for the year in which we expect the differences will reverse. Based on the evaluation of available evidence, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that we believe it is more likely than not we will realize these benefits. We periodically assess the likelihood that we will be able to recover our deferred tax assets and reflect any changes to our estimate of the amount we are more likely than not to realize in the valuation allowance, with a corresponding adjustment to earnings or other comprehensive income (loss), as appropriate. We believe all of our deferred tax assets are realizable with the exception of the net operating loss in Denmark. As such, we believe a valuation allowance is only required with regard to the net operating loss carryforward in that country.
Our effective tax rate reflects the impact of certain undistributed foreign earnings for which we have not provided U.S. taxes because we plan to reinvest such earnings indefinitely outside the U.S. We plan foreign earnings remittance amounts based on projected cash flow needs, as well as the working capital and long-term investment requirements of our foreign subsidiaries and our domestic operations. Based on these assumptions, we estimate the amount we will distribute to the U.S. and provide the U.S. Federal taxes due only on these amounts. Material changes in our estimates of cash, working capital and long-term investment requirements in the various jurisdictions in which we do business could impact our actual remittance amounts and, accordingly, our effective tax rate.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions across our global operations. We recognize potential liabilities and record tax liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. Furthermore, we recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.
We adjust our liability for unrecognized tax benefits in light of changing facts and circumstances; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. If our estimate of tax liabilities proves to be less than the ultimate assessment, an additional tax expense would result. If a payment of these amounts ultimately proves to be less than the recorded amounts, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary to be provided.
New Accounting Pronouncements
See Part IV, Item 15, Note 2, "Recent Accounting Pronouncements" in the Notes to Consolidated and Combined Financial Statements included in this Annual Report on Form 10-K for information regarding accounting pronouncements and accounting standards updates.


39



ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Vectrus has limited exposure to foreign currency exchange risk as the substantial majority of our business is conducted in U.S. dollars. As a business area within Exelis prior to the Spin-off, Vectrus did not directly experience exposure to the impacts of certain market risks, including those related to equity price risk and interest rate risk. Following the Spin-off, we are subject to interest rate risk with our Term Loan and Revolver, as both require us to pay interest on outstanding borrowings at variable rates. Each one percentage point change associated with the Term Loan would result in a $0.9 million change in our annual cash interest expenses. Assuming our Revolver was fully drawn to a principal amount equal to $75.0 million, each one percentage point change in interest rates would result in a $0.8 million change in our annual cash interest expense.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Consolidated and Combined Financial Statements herein.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.

ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company's management, with the participation of the Company's Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2016. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2016, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed in reports the Company files or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) accumulated and communicated to management to allow timely decisions regarding required disclosure.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 was audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report included herein.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2016. Management reviewed the results of its assessment with our Audit Committee.
Limitations on Effectiveness of Controls and Procedures
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there may be resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

40



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of
Vectrus, Inc.
Colorado Springs, Colorado

We have audited the internal control over financial reporting of Vectrus, Inc. (the "Company") as of December 31, 2016, based criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated and combined financial statements as of and for the year ended December 31, 2016 of the Company and our report dated March 1, 2017 expressed an unqualified opinion on those consolidated and combined financial statements.

/s/ DELOITTE & TOUCHE LLP

Denver, Colorado
March 1, 2017

ITEM 9B. OTHER INFORMATION
None.



41



PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information called for by Item 10 is incorporated herein by reference to the definitive proxy statement for the Company’s 2017 Annual Meeting of Shareholders to be filed within 120 days after the Company's fiscal year ended December 31, 2016 pursuant to Regulation 14A of the Exchange Act, except that the information called for by Item 10 with respect to executive officers is set forth in Part I, Item 1, "Description of Business".
The Company filed with the SEC, as exhibits to the Company’s Annual Report on Form 10-K, the certifications required under Section 302 of the Sarbanes-Oxley Act for its Chief Executive Officer and Chief Financial Officer.

ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 11 is incorporated herein by reference to the definitive proxy statement referred to in Item 10.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information called for by Item 12 is incorporated herein by reference to the definitive proxy statement referred to in Item 10.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information called for by Item 13 is incorporated herein by reference to the definitive proxy statement referred to in Item 10.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for by Item 14 is incorporated herein by reference to the definitive proxy statement referred to in Item 10.

PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
Documents filed as a part of this report:
1.
See Index to Consolidated and Combined Financial Statements appearing on page F-1 for a list of the financial statements filed as a part of this report.
2.
See Exhibit Index beginning on page 45 for a list of the exhibits filed or incorporated herein as a part of this report.
(b)
Financial Statement Schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the Consolidated and Combined Financial Statements filed as part of this report.


42



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

VECTRUS, INC.
Index to Consolidated and Combined Financial Statements
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

F-1




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of
Vectrus, Inc.
Colorado Springs, Colorado

We have audited the accompanying consolidated balance sheets of Vectrus, Inc. (the "Company") as of December 31, 2016 and 2015, respectively, and the related consolidated and combined statements of income, comprehensive income, cash flows, and shareholders’ and parent company equity for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated and combined financial statements present fairly, in all material respects, the financial position of Vectrus, Inc. as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2017 expressed an unqualified opinion on the Company's internal control over financial reporting.

As described in Note 1 to the consolidated and combined financial statements, on and prior to September 26, 2014, the combined financial statements were prepared from the separate records maintained by the Company and may not necessarily be indicative of the conditions that would have existed or the results of operations of the Company had it been operated as an independent entity.

/s/ DELOITTE & TOUCHE LLP

Denver, Colorado
March 1, 2017


F-2



VECTRUS, INC.
CONSOLIDATED AND COMBINED STATEMENTS OF INCOME
 
 
Year Ended December 31,
(In thousands, except per share data)
 
2016
 
2015
 
2014
Revenue
 
$
1,190,519

 
$
1,180,684

 
$
1,203,269

Cost of revenue
 
1,083,607

 
1,075,035

 
1,084,512

Selling, general and administrative expenses
 
64,086

 
65,687

 
80,340

Operating income
 
42,826

 
39,962

 
38,417

Interest (expense) income, net
 
(5,639
)
 
(6,531
)
 
(1,526
)
Income from operations before income taxes
 
37,187

 
33,431

 
36,891

Income tax expense
 
13,532

 
2,458

 
14,079

Net income
 
$
23,655

 
$
30,973

 
$
22,812

 
 
 
 
 
 
 
Earnings per share
 
 
 
 
 
 
Basic
 
$
2.21

 
$
2.94

 
$
2.18

Diluted
 
$
2.16

 
$
2.86

 
$
2.13

Weighted average common shares outstanding - basic
 
10,714

 
10,551

 
10,476

Weighted average common shares outstanding - diluted
 
10,974

 
10,825

 
10,692

 
 
 
 
 
 
 
 
The accompanying notes are an integral part of the Consolidated and Combined Financial Statements.

F-3



VECTRUS, INC.
CONSOLIDATED AND COMBINED STATEMENTS OF COMPREHENSIVE INCOME
 
 
Year Ended December 31,
(In thousands)
 
2016
 
2015
 
2014
Net income
 
$
23,655

 
$
30,973

 
$
22,812

Other comprehensive loss, net of tax
 
 
 
 
 
 
Changes in derivative instrument:
 
 
 
 
 
 
Net change in fair value of interest rate swap
 
216

 
(43
)
 

Net (loss) gain reclassified to interest expense
 
(2
)
 
3

 

Tax (expense) benefit
 
(76
)
 
14

 

Net change in derivative instrument
 
138

 
(26
)
 

Foreign currency translation adjustments
 
(975
)
 
(1,186
)
 
(1,642
)
Other comprehensive loss, net of tax
 
(837
)
 
(1,212
)
 
(1,642
)
Total comprehensive income
 
$
22,818

 
$
29,761

 
$
21,170

The accompanying notes are an integral part of the Consolidated and Combined Financial Statements.


F-4



VECTRUS, INC.
CONSOLIDATED BALANCE SHEETS
 
 
December 31,
(In thousands, except share information)
 
2016
 
2015
Assets
 
 
 
 
Current assets
 
 
 
 
Cash
 
$
47,651

 
$
39,995

Receivables
 
172,072

 
210,561

Costs incurred in excess of billings
 
11,002

 
1,243

Other current assets
 
13,412

 
9,708

Total current assets
 
244,137

 
261,507

Property, plant, and equipment, net
 
3,061

 
4,762

Goodwill
 
216,930

 
216,930

Other non-current assets
 
1,177

 
1,197

Total non-current assets
 
221,168

 
222,889

Total Assets
 
$
465,305

 
$
484,396

Liabilities and Shareholders' Equity
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
118,055

 
$
122,442

Billings in excess of costs
 
1,421

 
6,025

Compensation and other employee benefits
 
34,917

 
36,783

Short-term debt
 
15,750

 
22,000

Other accrued liabilities
 
17,693

 
25,268

Total current liabilities
 
187,836

 
212,518

Long-term debt, net
 
67,842

 
89,615

Deferred tax liability
 
89,667

 
91,343

Other non-current liabilities
 
2,559

 
1,610

Total non-current liabilities
 
160,068

 
182,568

Total liabilities
 
347,904

 
395,086

Commitments and contingencies (Note 16)
 

 

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; 10,894,924 and 10,612,246 shares issued and outstanding
 
109

 
106

Additional paid in capital
 
63,910

 
58,640

Retained earnings
 
57,959

 
34,304

Accumulated other comprehensive loss
 
(4,577
)
 
(3,740
)
Total shareholders' equity
 
117,401

 
89,310

Total Liabilities and Shareholders' Equity
 
$
465,305

 
$
484,396

The accompanying notes are an integral part of the Consolidated and Combined Financial Statements.

F-5



VECTRUS, INC.
CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
 
 
Year Ended December 31,
(In thousands)
 
2016
 
2015
 
2014
Operating activities
 
 
 
 
 
 
Net income
 
$
23,655

 
$
30,973

 
$
22,812

Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense
 
1,920

 
3,138

 
2,149

Loss on disposal of property, plant, and equipment
 
405

 
686

 
103

Stock-based compensation
 
4,649

 
6,658

 
2,324

Amortization of debt issuance costs
 
1,198

 
1,130

 
185

Changes in assets and liabilities:
 
 
 
 
 
 
Receivables
 
37,814

 
(9,886
)
 
21,608

Other assets
 
(13,903
)
 
12,005

 
(1,329
)
Accounts payable
 
(3,766
)
 
8,874

 
6,169

Billings in excess of costs
 
(4,605
)
 
219

 
(5,266
)
Deferred taxes
 
(2,163
)
 
(9,404
)
 
11,282

Compensation and other employee benefits
 
(1,808
)
 
275

 
(13,245
)
Other liabilities
 
(6,778
)
 
(25,788
)
 
(3,813
)
Net cash provided by operating activities
 
36,618

 
18,880

 
42,979

Investing activities
 
 
 
 
 
 
Purchases of capital assets
 
(741
)
 
(793
)
 
(3,847
)
Proceeds from the disposition of assets
 
116

 
387

 
497

Distributions from equity investment
 
573

 
524

 

Net cash (used in) provided by investing activities
 
(52
)
 
118

 
(3,350
)
Financing activities
 
 
 
 
 
 
Proceeds from issuance of long-term debt
 

 

 
140,000

Repayments of long-term debt
 
(29,000
)
 
(23,375
)
 
(2,625
)
Proceeds from revolver
 
74,000

 
324,000

 
23,000

Repayments of revolver
 
(74,000
)
 
(324,000
)
 
(23,000
)
Distribution to subsidiary of Exelis
 

 

 
(136,281
)
Proceeds from exercise of stock options
 
2,146

 
239

 

Payment of debt issuance costs
 
(221
)
 

 
(3,701
)
Proceeds from insurance financing
 

 
14,857

 

Repayments of insurance financing
 

 
(12,130
)
 

Payments of employee withholding taxes on share-based compensation
 
(987
)
 
(1,301
)
 
(229
)
Working capital adjustment payment from Exelis
 

 

 
2,600

Transfer to Former Parent, net
 

 

 
(6,371
)
Net cash (used in) financing activities
 
(28,062
)
 
(21,710
)
 
(6,607
)
Exchange rate effect on cash
 
(848
)
 
(116
)
 
(645
)
Net change in cash
 
7,656

 
(2,828
)
 
32,377

Cash-beginning of year
 
39,995

 
42,823

 
10,446

Cash-end of year
 
$
47,651

 
$
39,995

 
$
42,823

Supplemental Disclosure of Cash Flow Information:
 
 
 
 
 
 
Interest paid
 
$
5,278

 
$
6,047

 
$
1,201

Income taxes paid
 
$
26,068

 
$
16,096

 
$
2,667

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

 
$

 
$
92

The accompanying notes are an integral part of the Consolidated and Combined Financial Statements.

F-6



VECTRUS, INC.
CONSOLIDATED AND COMBINED STATEMENTS OF SHAREHOLDERS' AND PARENT COMPANY EQUITY
 
 
Common Stock Issued
 
Additional Paid-in Capital
 
 
 
Accumulated Other Comprehensive Income
 
Net Parent Company Equity
 
Total Shareholders' Equity
(In thousands)
 
Shares
 
Amount
 
 
Retained Earnings
 
 
 
Balance at December 31, 2013
 

 
$

 
$

 
$

 
$
(886
)
 
$
192,218

 
$
191,332

Net income
 

 

 

 
3,331

 

 
19,481

 
22,812

Foreign currency translation adjustments
 

 

 

 

 
(1,642
)
 

 
(1,642
)
Transfer to former parent, net
 

 

 

 

 

 
(6,371
)
 
(6,371
)
Distribution to subsidiary of Exelis
 

 

 

 

 

 
(136,281
)
 
(136,281
)
Spin-off related adjustments
 

 

 

 

 

 
(17,841
)
 
(17,841
)
Employee stock awards and stock options
 
11

 

 
(229
)
 

 

 

 
(229
)
Stock-based compensation
 

 

 
2,095

 

 

 

 
2,095

Reclassification of net parent equity to common stock and additional paid-in capital in conjunction with the Spin-off
 
10,474

 
105

 
51,101

 

 

 
(51,206
)
 

Balance at December 31, 2014
 
10,485

 
$
105

 
$
52,967

 
$
3,331

 
$
(2,528
)
 
$

 
$
53,875

Net income
 

 

 

 
30,973

 

 

 
30,973

Foreign currency translation adjustments
 

 

 

 

 
(1,186
)
 

 
(1,186
)
Unrealized (loss) gain on cash flow hedge
 

 

 
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