A Promising Future, Solid End to 2022

A Strong Start to the Merged Company

A Final Quarter for Vectrus

Vertex Combination Approved by Shareholders

Joe Gomes

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Industrials

Aerospace & Defense

V2X Inc.

Second Quarter Operating Results
V2X, Inc, as Vectrus is now called, reported strong second quarter results, the last results as an independent entity. Following the end of the quarter, the previously announced merger with Vertex was completed. The second quarter record revenue was driven by the continued phasing of LOGCAP V, continued high OPTEMPO in the regions V2X operates in support of ongoing world affairs, as well as organic core program growth.
Second quarter 2022 revenue was $498.1 million, up $27.2 million or 5.8% year-on-year. The top line growth was boosted by the transition to full operational capability on LOGCAP V programs in Iraq and Kuwait late last year and Kwajalein this year. In addition, revenue benefited from transitioning the Fort Benning program and volume associated with rapid response and contingency efforts. Significantly, the top line growth came in spite of the headwinds associated with the withdrawal of the U.S. military from Afghanistan and the absence of the 2021 Pacific Defender exercise.
By geography, Middle East revenue declined 3.2% year-over-year to $250.2 million in the second quarter, compared to $258.5 million in the same period last year. U.S.-based revenue of $158.7 million increased 8.3% from $146.5 million last year. European revenue rose 18.4% to $42.7 million in the second quarter of 2022 from $36.1 million. Finally, Asia revenue rose 56.1% to $46.4 million from $29.7 million in last year&#8217;s second quarter. By client, Army revenue increased 5.2% to $326.8 million from $310.6 million. Air Force revenue rose 8.3% to $68.4 million from $63.2 million. Revenue from the Navy increased 15% to $64.9 million from $56.4 million while Other revenue fell 6.5% to $38 million from $40.6 million.
During the second quarter of 2022, the LOGCAP V&nbsp;â€”&nbsp;Kuwait Task Order accounted for $113.8 million of revenue, up from $98.4 million sequentially and $19.7 million of revenue in the second quarter of 2021, or 22.2% of the overall revenue during the quarter, this is up from 3.1% in the second quarter last year. The LOGCAP Vâ€”&nbsp;Iraq Task Order accounted for $73.4 million, compared to $71.5 million sequentially, and $51.9 million in the second quarter of 2021, or 15.2% of overall second quarter revenue, up from 2.3% last year. Finally, the K-BOSSS contract accounted for 1.7% of second quarter revenue, or $5.6 million, compared to $10.2 million in the first quarter of the year, and down from 25.7%, or $115.9 million, in the same period last year, as the majority of the K-BOSSS operations were assumed under the LOGCAP V&nbsp;â€”&nbsp;Kuwait Task Order.
Cost of revenue as a percentage of revenue in the second quarter of 2022 was 91% compared to 89.8% for the three months ended July 2, 2021. The increase in cost of revenue of $30.6 million, or 7.3%, was primarily due to the volume fluctuations described for revenue. In addition, second quarter COGS reflects an increase in material and pass through content which carry a lower gross margin to certain clients and the lower margins associated with early phases of new contracts. SG&amp;A costs in the second quarter were $29.7 million, increasing by $4.1 million, or 16.1%, as compared to the same period last year. The increase in SG&amp;A expenses was due to $5.9 million of M&amp;A and integration costs.
Operating income decreased by $7.6 million, or 33.5% year-over-year to $15 million, or 3.0% of revenue, from $22.6 million, or 4.8% of revenue. Operating income was impacted by the M&amp;A and integration-related costs and the lower margin early stage awards.
Adjusted EBITDA was $24.7 million or a 5% margin as compared to $26.6 million or a 5.6% margin in the prior year. The reduction in adjusted EBITDA margin is related to the large amount of business in the early, low margin stages of award. For example, LOGCAP V is generating higher revenue volumes, but with a greater amount of material and pass-through content that have a different margin complexion. Notably, about two-thirds of Vectrus&#8217; revenue is coming from contracts in the first 18 months of their life cycle, a testament to the Company&#8217;s recent prowess in award wins. This provides substantial future revenue visibility and, as is standard in the business, operating margins tend to be lower at the beginning of the contract and generally improve over time. Margin also was affected by increased support of clients&#8217; supply chain needs which is driving an increase in material and pass-through content.
Net income for the second quarter of 2022 was $10.5 million, or $0.88 per diluted share, compared to $15.9 million, or $1.35 per diluted share in the second quarter of 2021. Adjusted net income was $16.7 million compared to $17.9 million in the prior year. Adjusted EPS, which adds back merger, integration and amortization of acquired intangible assets, was $1.41 compared to $1.52 in the prior year.
How Margins Will Improve on the Business 
We touched on it briefly above, but the way things typically work is the base year is the lowest margin. Then what will happen from there is some margin improvement going into the first option year or the second year of the contract. From there, the second and third option year is where the full operational realization of the margins occurs. Historically, this is the typical ramp for V2X across its contracts. And, again, with about two-thirds of the combined entity&#8217;s revenue coming from contracts in the first 18 months of their life cycle, there should be notably margin upside as these contracts age.
In addition to the normal contract aging process, the amount of urgent rapid response and contingency task orders that Vectrus has been awarded over the past 12 to 18 months is higher than the levels witnessed over the past several years. This is being driven in part by LOGCAP V. We believe this pattern will continue for the next several years and are expecting a greater volume of task orders that could quickly materialize as revenue in the same period the order is booked. Typically, rapid response and contingency task orders carry higher margins.&nbsp; &nbsp; &nbsp; 
Ve2X continued to expand its geographic footprint through additional growth in INDOPACOM which now makes up 9% of revenue. We expect continued growth in the region and note that the DoD&#8217;s recently released fiscal year 2023 budget calls for another major exercise in the region, which we believe could be similar in size to the tasks V2X performed in 2021, or some $50 million of revenue.
Vertex Merger Update
With the merger now complete, management provided a brief update. We won&#8217;t go into all the details as we have previously published an in-depth report about the merger. Nonetheless, we thought it instructive to once again list the benefits of the merged company:
<ul>
<li>With $3.6 billion of 2022 pro forma revenue, Vectrus is a leader in the operational segment of the federal services market providing converged solutions throughout the mission lifecycle of clients most critical and enduring global missions.</li>
</ul>
<ul>
<li>Geographic, client, and contract diversity. No task order exceeds 11% of revenue and cost plus contracts are less than 50% of overall contracts. V2X operates through over 330 locations globally.</li>
</ul>
<ul>
<li>The combined entity has access to a larger client base and funding streams, including national security, defense, civilian, and international clients.</li>
</ul>
<ul>
<li>V2X&#8217;s $12 billion of backlog provides significant revenue visibility, with more than 40% of revenue on contract through at least 2025. There is limited near-term re-compete risk as no contract representing more than 2% of revenue comes up for re-compete over the next 2 1/2 years.</li>
</ul>
<ul>
<li>V2X has a large pipeline of opportunities, exceeding $14 billion over the next 12-months. As a combined entity with additional qualifications and scale, we believe there is substantial opportunity for revenue synergies and increased addressable market opportunities.</li>
</ul>
<ul>
<li>V2X&#8217;s combination of robust cash flow and low capex should enable the Company to rapidly pay down merger debt.</li>
</ul>
<ul>
<li> With rising budgets and increased conflict around the globe, market drivers remain strong for V2X.</li>
</ul>
<ul>
<li> V2X&#8217;s solutions and capability are aligned with key spending priorities for the DoD and international clients such as mission essential operations, platform modernization and sustainment, technology upgrades and lifecycle support, security, readiness and training.</li>
</ul>
Updated Guidance 
Management provided an estimate of second half 2022 performance for the combined entity. Revenues are projected to be between $1.90-$1.94 billion, with adjusted EBITDA in the range of $140-$150 million, and operating cash flow in the $130-$150 million range. The revenue and adjusted EBITDA ranges for the second half, if annualized, are above the $3.6 billion and $290 million 2022 estimated pro forma numbers provided in the first quarter slide deck. While management noted some seasonality between the third and fourth quarters, it remains to be seen if there is any additional seasonality.
Using management&#8217;s projections as a base, for the third quarter we are estimating the combined entity will generate revenue of $855 million, with adjusted EBITDA of $63.5 million, and adjusted EPS of $0.81. For the fourth quarter, our estimates call for revenue of $1,045 million, adjusted EBITDA of $81.5 million, and adjusted EPS of $1.25. We would note that in the accompanying model for 2022, the full year is a combination of half a year of Vectrus results and half a year of V2X&#8217;s results.
Looking out to 2023, we are assuming continued growth of existing and new programs, with the sequential growth throughout the year. As a first cut, we are estimating revenue comes in at $3.85 billion, adjusted EBITDA at $294 million, and adjusted EPS at $3.89. While we believe these estimates to be reasonable, we would like to see a quarter or two of actual operating results to fine tune our projections.

V2X Inc. (VVX)

A Final Quarter for Vectrus

Fundamental Analysis:

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A Promising Future, Solid End to 2022 (VVX)

A Strong Start to the Merged Company (VVX)

A Final Quarter for Vectrus (VVX)

Vertex Combination Approved by Shareholders (VVX)

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