NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1

DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Separation from Exelis Inc.

On September 27, 2014, Exelis Inc. ("Exelis") completed the previously announced Spin-off (the "Spin-off") of Vectrus, Inc. ("Vectrus" or the "Company"), formerly Exelis' Mission Systems business, which was part of Exelis' Information and Technical Services segment. Effective as of 12:01 a.m., Eastern Time on September 27, 2014 (the "Distribution Date"), the common stock of Vectrus was distributed, on a pro rata basis, to Exelis shareholders of record as of the close of business on September 18, 2014 (the "Record Date"). On the Distribution Date, each of the shareholders of Exelis received one share of Vectrus common stock for every 18 shares of common stock of Exelis held on the Record Date. The Spin-off was completed pursuant to the Distribution Agreement, dated September 25, 2014, between Exelis and Vectrus (the "Distribution Agreement"). After the Distribution Date, Exelis does not beneficially own any shares of Vectrus common stock.

Vectrus' Registration Statement on Form 10 (the “Registration Statement”) was declared effective by the U.S. Securities and Exchange Commission (the “SEC”) on September 8, 2014. Vectrus' common stock began trading “regular way” under the symbol "VEC" on the New York Stock Exchange (“NYSE”) on September 29, 2014.

In connection with the Spin-off, Vectrus entered in to a term loan agreement to fund a $136 million distribution to a subsidiary of Exelis that occurred on September 26, 2014. Specifically, on September 17, 2014, Vectrus entered into a $140 million term loan (See Note 7, "Debt"). As of September 30, 2014 , Vectrus had cash of $42 million .

Unless the context otherwise requires, references in these notes to "Vectrus", "we," "us," "our," "the Company" and "our Company" refer to Vectrus, Inc. References in these notes to Exelis or "Parent" refer to Exelis Inc., an Indiana corporation, and its consolidated subsidiaries (other than Vectrus).

Our Business

The Company is a leading provider of infrastructure asset management, logistics and supply chain management and information technology and network communication services to the United States ("U.S.") government worldwide. The Company operates in 18 countries across four continents and its services include operations, maintenance, management, engineering and sustainment for physical assets including a wide variety of facilities, information technology, network and communication systems, vehicles and equipment. We operate in a single reportable segment. Our primary customer is the U.S. Department of Defense ("DoD") with a high concentration in the U.S. Army, followed by the U.S. Air Force and U.S. Navy.

For the nine months ended September 30, 2014 , we generated approximately 87% of our total revenue from the U.S. Army of which our four largest contracts amounted to approximately $619 million or 67% of our revenue.

Principles of Combination and Basis of Presentation

Our quarterly financial periods end on the Friday closest to the last day of the calendar quarter (September 26, 2014 for the third quarter of 2014 and September 27, 2013 for the third quarter of 2013), except for the last quarter of the fiscal year, which ends on December 31. For ease of presentation and to conform with Exelis' presentation, the quarterly financial statements included herein are described as ending on the last day of the calendar quarter. The results reported in these financial statements are not necessarily indicative of results that may be expected for the entire year.

Our unaudited Condensed Combined Financial Statements reflect the Company's wholly-owned domestic and international subsidiaries and allocated costs from Exelis. The unaudited Condensed Combined Financial Statements have been prepared on a stand-alone basis and are derived from the consolidated financial statements and accounting records of Exelis and may not be indicative of Vectrus' future performance. Periods prior to the Spin-off do not necessarily reflect what the results of operations, financial position and cash flows would have been had Vectrus operated as a stand-alone company. The unaudited Condensed Combined Financial Statements reflect our financial position, results of operations and cash flows as we were historically managed, in conformity with generally accepted accounting principles in the United States of America ("GAAP").

The unaudited Condensed Combined Financial Statements have been prepared pursuant to the rules and regulations of the SEC and, in the opinion of management, reflect all adjustments necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules. We believe that the disclosures made are adequate to make the information presented not misleading. We consistently applied the

accounting policies described in the information statement filed as an exhibit to the Registration Statement, in preparing these financial statements. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Registration Statement.

All intercompany transactions between Vectrus and Exelis have been included in these unaudited Condensed Combined Financial Statements and are considered to be effectively settled for cash in the unaudited Condensed Combined Financial Statements at the time the transaction is recorded. The total net effect of the settlement of these intercompany transactions is reflected in the unaudited Condensed Combined Statements of Cash Flows as a financing activity and in the unaudited Condensed Combined Balance Sheets as “Parent company equity.” All intracompany and intercompany transactions among our businesses have been eliminated.

Our unaudited Condensed Combined Financial Statements include expenses of Exelis allocated to us for certain functions provided by Exelis, including, but not limited to, general corporate expenses related to finance, legal, information technology, human resources, communications, ethics and compliance, shared services, employee benefits and incentives, insurance and stock-based compensation. These expenses have been allocated to us on the basis of direct usage when identifiable, with the remainder allocated on the basis of revenue, headcount or other measures. We consider the basis on which the expenses have been allocated to be a reasonable reflection of the utilization of services provided to, or the benefit received by, us during the periods presented. The allocations may not, however, reflect the expense we would have incurred as an independent, publicly-traded company for the periods presented. Actual costs that may have been incurred if we had been a stand-alone company would depend on a number of factors, including the chosen organizational structure, what functions were outsourced or performed by employees and strategic decisions made in areas such as information technology and infrastructure. Following our Spin-off from Exelis, we will perform these functions using our own resources or purchased services. For an interim period, however, some of these functions will continue to be provided by Exelis under a transition services agreement, which generally has a term of one year or less for most services to be provided (See Note 10, "Related Party Transactions and Parent Company Equity"). In addition, in support of ongoing business, we have entered into subcontracts with Exelis whereby either we or Exelis serve as a subcontractor to the other on certain government contracts.

Exelis uses a centralized approach to cash management and financing of its operations. Prior to the Spin-off, the majority of our cash was transferred to Exelis daily and Exelis funded our operating and investing activities as needed. Cash transfers to and from the cash management accounts of Exelis are reflected in the unaudited Condensed Combined Statements of Cash Flows as “Transfer to Parent, net.”

The unaudited Condensed Combined Financial Statements also include the push down of certain assets and liabilities that have historically been held at the Exelis corporate level but are specifically identifiable or otherwise allocable to us. The cash and cash equivalents held by Exelis at the corporate level, prior to the Spin-off, are not specifically identifiable to the Company and therefore were not allocated to us for any of the periods presented. Cash in our unaudited Condensed Combined Balance Sheets represents cash held locally by entities included in our unaudited Condensed Combined Financial Statements. Third-party debt and the related interest expense of Exelis were not allocated to us for any of the periods presented as we are not the legal obligor of the debt and the Exelis borrowings were not directly attributable to our business.

Use of Estimates

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. Estimates and assumptions are used for, but not limited to, revenue recognition, income tax contingency accruals, fair value and impairment of goodwill and valuation of assets and certain contingent liabilities. Actual results could differ from these estimates.

During the performance of long-term sales contracts, estimated final contract prices and costs are reviewed periodically and revisions are made as required and recorded in income 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, claims, requests for equitable adjustment, or limitations in funding on contracts are recorded only if it is probable the claim will result in additional contract revenue and the amounts can be reliably estimated. 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. Contract revenue and cost estimates are reviewed and reassessed periodically. Changes in these estimates could result in recognition of 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, based on a contract’s percentage of completion. Changes in

revenue and cost estimates could also result in a forward loss or an adjustment to a forward loss. Net cumulative catch-up adjustments related to prior periods for the three months and nine months ended September 30, 2014 , were de minimis, and for the three months and nine months ended September 30, 2013 , increased operating income by approximately $5 million and $39 million , respectively.

Other new pronouncements issued but not effective until after September 30, 2014 are not expected to have a material impact on our financial position, results of operations or cash flows.

NOTE 3

INCOME TAXES

Effective Tax Rate

Our quarterly income tax expense is measured using an estimated annual effective income tax rate, adjusted for discrete items within the period. The comparison of effective income tax rates between periods may be significantly affected by discrete items recognized during the periods, the level and mix of earnings by tax jurisdiction and permanent differences.

For the three months ended September 30, 2014 , the Company recorded an income tax provision of $1 million or 35.4% of income from continuing operations before income tax expense compared to $10 million or 35.8% during the same prior year period. For the nine months ended September 30, 2014 , the Company recorded an income tax provision of $11 million or 35.7% of income from continuing operations before income tax expense compared to $38 million or 35.8% during the same prior year period. The effective income tax rate varies from the federal statutory rate of 35% primarily due to the impact of state taxes and non-deductible expenses.    

Uncertain Tax Position

As of September 30, 2014 and December 31, 2013 , unrecognized tax benefits were $11 million and $9 million , respectively and would not, if recognized, affect the Company's tax rate. We do not believe that uncertain tax positions will significantly change within the next twelve months.

All billed receivables are due from the U.S. government, either directly as prime contractor to the government or as subcontractor to another prime contractor to the U.S. government, as of September 30, 2014 and December 31, 2013 , respectively. Because the Company’s billed receivables are with the U.S. government, the Company does not have a material credit risk exposure.

Unbilled contract receivables represent revenue recognized on long-term contracts in excess of amounts billed as of the balance sheet date. We expect to bill and collect substantially all of the September 30, 2014 unbilled contract receivables during the next twelve months.

¹ Inventory represents costs incurred in excess of billings.

Compensation and other employee benefits

Compensation and other employee benefits were comprised of the following:

NOTE 6

GOODWILL

Goodwill at September 30, 2014 , of $222 million remained unchanged from December 31, 2013 . There was no impairment of goodwill during the nine months ended September 30, 2014 . We conduct our annual impairment testing as of the first day of the last fiscal quarter.

NOTE 7

DEBT

Credit Agreement

On September 17, 2014, Vectrus entered into a Credit Agreement (the "Credit Agreement") by and among Vectrus, our 100% owned subsidiary Vectrus Systems Corporation ("VSC"), formerly known as Exelis Systems Corporation, as the Borrower, the Lenders and Issuing Banks party thereto and JP Morgan Chase Bank, N.A., as Administrative Agent. The Credit Agreement provided for $215 million in senior secured financing, consisting of a $140 million term loan facility (the "Term Facility") and a $75 million revolving credit facility (the "Revolver" and, together with the Term Facility, the "Senior Secured Credit Facilities"). The net proceeds from the Term Facility were used to pay a $136 million distribution to a subsidiary of Exelis on September 26, 2014. The Revolver is available for working capital, capital expenditures and other general corporate purposes.

Term Facility

The Term Facility consists of a five -year term loan in an aggregate principal amount of $140 million . The full amount of the term loan was made in a single drawing on September 26, 2014. The Term Facility amortizes in quarterly installments at the following rates per annum: 7.5% in year one; 10% in each of years two and three, 15% in year four and 57.5% in year five. Amounts borrowed under the Term Facility that are repaid or prepaid may not be re-borrowed. Any unpaid amounts must be repaid by September 17, 2019.

The Company's aggregate scheduled maturities of the Term Facility as of September 30, 2014, are as follows:

Revolver

The Revolver consists of a five -year senior secured revolving credit facility with aggregate commitments in an amount equal to $75 million , of which up to $35 million is available for the issuance of letters of credit and including a swingline facility in an amount equal to $10 million . The Revolver will mature and the commitments thereunder will terminate on September 17, 2019. As of September 26, 2014, there was $75 million available under the Revolver and no letters of credit outstanding.

Guarantees and Collateral

The indebtedness, obligations and liabilities under the Senior Secured Credit Facilities were unconditionally guaranteed jointly and severally on a senior secured basis by Vectrus and certain of its current and future restricted subsidiaries and is secured, subject to permitted liens and other exceptions and exclusions, by a first-priority lien on substantially all tangible and intangible assets of Vectrus, VSC and each domestic guarantor including (i) a perfected pledge of all of the capital stock of VSC and each direct, wholly-owned material restricted subsidiary held by VSC or any guarantor (subject to certain limitations with respect to foreign subsidiaries) and (ii) perfected security interests in and mortgages on, accounts, inventory, equipment, general intangibles, commercial tort claims, investment property, intellectual property, material fee-owned real property, letter of credit rights, deposit and securities accounts, intercompany notes and proceeds of the foregoing, except for certain excluded assets.

Mandatory Prepayments

The Term Facility requires the following amounts to be applied to prepay the Term Loan, subject to certain thresholds, exceptions and reinvestment rights:

inventory and other ordinary course dispositions, obsolete or worn-out property, property no longer useful in the business and other exceptions);

Voluntary Prepayments

VSC may voluntarily prepay the Term Facility in whole or in part at any time without premium or penalty, subject to the payment of customary breakage costs in the case of LIBOR rate loans as defined in the Credit Agreement. Optional prepayments of the Term Facility will be applied to the remaining installments thereof as directed by VSC.

Commitments under the Revolver may be reduced in whole or in part at any time without premium or penalty.

Covenants

The Senior Secured Credit Facilities contain certain covenants that, among other items, limit or restrict the ability of Vectrus and its restricted subsidiaries, including VSC, to (subject to certain qualifications and exceptions):

In addition, Vectrus is required to comply with (a) a maximum ratio of total consolidated indebtedness to consolidated Earnings Before Interest, Tax, Depreciation and Amortization ("EBITDA") of 3.50 to 1.00 , with step-downs to 3.00 to 1.00 beginning with the third fiscal quarter of 2015 and 2.75 to 1.00 beginning with the first fiscal quarter of 2016 and (b) a minimum ratio of consolidated EBITDA to consolidated interest expense (net of cash interest income) of 4.50 to 1.00 . The Company was in compliance with all financial covenants related to the Senior Secured Credit Facilities as of September 30, 2014 .

Interest Rates and Fees

Outstanding borrowings under the Senior Secured Credit Facilities accrue interest, at the option of VSC, at a per annum rate of (i) a LIBOR rate plus the applicable margin or (ii) a base rate plus the applicable margin. The applicable margin for borrowings under the Senior Secured Credit Facilities is subject to a leverage-based pricing grid with the LIBOR rate ranging from 2.50% to 3.00% . The interest rate under the Senior Secured Credit Facilities at September 30, 2014 , was 2.99% .

During an event of default, overdue principal under the Senior Secured Credit Facilities may bear interest at a rate of 2.00% in excess of the otherwise applicable rate of interest. On and after the funding date, VSC pays a commitment fee on the undrawn portion of the Revolver ranging from 0.40% to 0.50% depending on the leverage ratio.

The fair value of the Company's term loan approximates the carrying value as of September 30, 2014 , because of the short duration between the execution of the agreement and the balance sheet date and the term loan bears interest at the lender's floating interest rate. The fair value is based on observable inputs of interest rates that are currently available to the Company for debt with similar terms and maturities for non-public debt.

Carrying values and fair values of the Term Facility in the unaudited Condensed Combined Balance Sheets are as follows:

NOTE 8

STOCK-BASED COMPENSATION

On September 11, 2014, the Board of Directors of Vectrus (the "Board") adopted and approved the Vectrus, Inc. 2014 Omnibus Incentive Plan (the "2014 Omnibus Plan"). The purpose of the 2014 Omnibus Plan is to promote the long-term interests of the Company and its shareholders by strengthening the Company's ability to attract and retain employees and members of the Board upon whose judgment, initiative and efforts the financial success and growth of the business of the Company largely depend. The 2014 Omnibus Plan permits the Compensation and Personnel Committee of the Board (the "Committee") to grant to eligible employees and directors of the Company and its affiliates any of the following types of awards (or any combination thereof): nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units and other awards that may include, without limitation, unrestricted shares, the payment of shares in lieu of cash, the payment of cash based on attainment of performance goals, service conditions or other goals established by the Committee and the payment of shares in lieu of cash under other Company incentive or bonus programs. Subject to adjustment, the maximum number of shares of the Company's common stock authorized for issuance under the 2014 Omnibus Plan is 2,625,000 shares. The 2014 Omnibus Plan also generally governs equity awards that were issued under equity plans of Exelis and converted into awards denominated in the Company's common stock, provided that such converted awards will generally continue to be subject to the material terms and conditions of the original equity incentive plans under which they were granted. No awards were granted under the 2014 Omnibus Plan for the periods presented (See Note 12, "Subsequent Events").

NOTE 9

POST EMPLOYMENT BENEFIT PLANS

Vectrus sponsors one defined contribution savings plan, which allows employees to contribute a portion of their pre-tax and/or after-tax income in accordance with specified guidelines. The plan requires us to match a percentage of the employee contributions up to certain limits, generally 2% - 6% of employee base pay. Our portion of the matching contributions charged to income amounted to $1 million for both the three months ended September 30, 2014 and 2013 . Our portion of the matching contributions charged to income amounted to $2 million and $3 million for the nine months ended September 30, 2014 and 2013 , respectively.

On September 11, 2014, the Board adopted and approved the Vectrus Systems Corporation Excess Savings Plan (the "Excess Savings Plan"). Since federal law limits the amount of compensation that can be used to determine employee and employer contribution amounts to the Company's tax-qualified plans, the Company established a non-qualified Excess Savings Plan to allow for Company contributions based on an eligible employee's base salary in excess of these limits. No employee contributions are permitted. All balances under the Excess Savings Plan are maintained on the books of the Company and credits and deductions are made to the accumulated savings under the plan based on the earnings or losses attributable to a stable value fund as defined in the Excess Savings Plan. Benefits will be paid in a lump sum generally in the seventh month following the date on which the employee's separation from service occurs. Employees are 100% vested at all times in any amounts credited to their accounts. No contributions were accrued by the Company as of September 30, 2014 .

NOTE 10

RELATED PARTY TRANSACTIONS AND PARENT COMPANY EQUITY

The unaudited Condensed Combined Financial Statements have been prepared on a stand-alone basis and are derived from the consolidated and combined financial statements and accounting records of Exelis.

Allocation of General Corporate Expenses

The unaudited Condensed Combined Financial Statements include expense allocations for certain functions provided by Exelis as well as other Exelis employees not solely dedicated to the Company, including, but not limited to, general corporate expenses related to finance, legal, information technology, human resources, communications, ethics and compliance, shared services, employee benefits and incentives and stock-based compensation. These expenses have been allocated to us on the basis of direct usage when identifiable, with the remainder allocated on the basis of revenue, headcount or other measures. We were allocated $10 million and $8 million for the three months ended September 30, 2014 and 2013 , respectively, and $23 million and $27 million for the nine months ended September 30, 2014 , and 2013 , respectively, of general corporate expenses incurred by Exelis which are primarily included within selling, general and administrative expenses in the unaudited Condensed Combined Statements of Income.

The expense allocations from Exelis discussed above include costs associated with defined benefit pension and other post retirement benefit plans (the “Shared Plans”) sponsored by Exelis in which some of our employees participate. We account for such Shared Plans as multiemployer benefit plans. Accordingly, we do not record an asset or liability to recognize the funded status of

the Shared Plans. Subsequent to September 27, 2014, the date the employees' benefits were frozen in the plans, we do not expect to incur further costs.

The expense allocations have been determined on a basis that we consider to be a reasonable reflection of the utilization of services provided or the benefit received by us during the periods presented. The allocations may not, however, reflect the expense we would have incurred as an independent, publicly-traded company for the periods presented. Actual costs that may have been incurred if we had been a stand-alone company would depend on a number of factors, including the chosen organizational structure, functions outsourced or performed by employees and strategic decisions made in areas such as information technology and infrastructure.

Parent Company Equity

Parent company equity in the unaudited Condensed Combined Balance Sheets represents Exelis' historical investment in our accumulated net earnings after taxes and the net effect of the transactions with and allocations of general corporate expenses from Exelis described above.

NOTE 11

COMMITMENTS AND CONTINGENCIES

General

From time to time, we are involved in legal proceedings that are incidental to the operation of our businesses. Some of these proceedings seek remedies relating to environmental matters, employment matters and commercial or contractual disputes.

Although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including our assessment of the merits of each 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.

Environmental

In the ordinary course of business, we are subject to Federal, state, local and foreign environmental laws and regulations. Accruals for environmental matters are recorded on a site by site basis when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies available to us. Our accrued liabilities for these environmental matters represent the best estimates related to the investigation and remediation of environmental media such as water, soil, soil vapor, air and structures, as well as related legal fees. These estimates, and related accruals, are reviewed quarterly and updated for progress of investigation and remediation efforts and changes in facts and legal circumstances. Liabilities for these environmental expenditures are recorded on an undiscounted basis.

It is difficult to estimate the final costs of investigation and remediation due to various factors, including incomplete information regarding particular sites and other potentially responsible parties, uncertainty regarding the extent of investigation or remediation and our share, if any, of liability for such conditions, the selection of alternative remedial approaches and changes in environmental standards and regulatory requirements. We have estimated and accrued approximately $4 million as of each of September 30, 2014 and December 31, 2013 , for environmental matters. These amounts were included in Other non-current liabilities in our unaudited Condensed Combined Balance Sheets. In our opinion, the total amount accrued is appropriate based on existing facts and circumstances known to us. Any environmental liabilities as of the date of the Spin-off were retained by Exelis as set forth in the Distribution Agreement and accordingly, after the Spin-off the Company will eliminate the liability and record a contribution to capital.

The following table illustrates the range of our currently estimated loss and number of active sites for these environmental matters:

U.S. Government Contracts, Investigations and Claims

The Company has U.S. government contracts that are funded incrementally on a year-to-year basis. Changes in government policies, priorities or funding levels through agency or program budget reductions by the U.S. Congress or executive agencies could materially adversely affect the Company’s financial condition or results of operations. Furthermore, contracts with the U.S. government may be terminated or suspended by the U.S. government at any time, with or without cause. Such contract suspensions or terminations could result in unreimbursable expenses or charges or otherwise adversely affect the Company’s financial condition and results of operations.

Departments and agencies of the U.S. government have the authority to investigate various transactions and operations of the Company, and the results of such investigations may lead to administrative, civil or criminal proceedings, the ultimate outcome of which could be fines, penalties, repayments or compensatory or treble damages. U.S. government regulations provide that certain findings against a contractor may lead to suspension or debarment from future U.S. government contracts or the loss of export privileges for a company or an operating division or subdivision. Suspension or debarment could have a material adverse effect on the Company because of its reliance on U.S. government contracts.

U.S. government agencies, including the Defense Contract Audit Agency (DCAA) and others, routinely audit and review a contractor’s performance on government contracts, indirect rates and pricing practices, and compliance with applicable contracting and procurement laws, regulations and standards. Accordingly, costs billed or billable to the U.S. government customers are subject to potential adjustment upon audit by such agencies. The agencies also review the adequacy of the contractor’s compliance with government standards for its accounting and management internal control systems, including: control environment and accounting systems, general information technology systems, budget and planning systems, purchasing systems, material management systems, compensation systems, labor systems, indirect and other direct costs systems, property systems, billing systems and estimating systems. Audits currently underway include the Company’s control environment and accounting, billing, and indirect and other direct cost systems, as well as reviews of the Company’s compliance with certain U.S. government Cost Accounting Standards.

From time to time, U.S. government customers advise the Company of claims and penalties concerning certain potential disallowed costs. When such findings are presented, Vectrus and the U.S. government representatives engage in discussions to enable Vectrus to evaluate the merits of these claims as well as to assess the amounts being claimed. Where appropriate, provisions are made to reflect the expected exposure to the matters raised by the U.S. government representatives and such provisions are reviewed on a quarterly basis for sufficiency based on the most recent information available to us.

NOTE 12

SUBSEQUENT EVENTS

Working Capital Adjustment

In connection with the internal restructuring carried out by Exelis prior to the distribution to the separate Vectrus business, Exelis and its subsidiaries (including Vectrus) entered into a number of conveyance agreements, including a contribution agreement between Exelis Holdings, Inc., a subsidiary of Exelis, and VSC containing a two-way adjustment mechanism relating to the working capital and cash levels of VSC and its subsidiaries prior to the Spin-off. Pursuant to that agreement, payments were made by the applicable entity to the other, reflecting the difference between the actual level of working capital (including cash) of VSC and its subsidiaries prior to the Spin-off, adjusted for the indemnification of a receivable by Exelis, as compared to the target working capital (including cash) of $67 million . As a result, Vectrus received an initial payment of $17 million from Exelis on September 26, 2014. The final payment of $2.6 million will be made to Vectrus by Exelis during the quarter ended December 31, 2014. In addition, the contribution agreement states any cash collected on the indemnified receivable by the Company will be remitted to Exelis.

Stock-based Compensation Expense

Stock-based compensation expense associated with converted and recently approved post Spin-off awards are discussed below. Stock-based compensation expenses associated with these awards total approximately $6 million , of which approximately $2 million will be recognized during the three months ended December 31, 2014 .

Outstanding Exelis Awards

Exelis maintains an equity incentive plan to govern awards granted to Exelis employees and directors, including awards of non-qualified stock options (“NQOs”), restricted stock units (“RSUs”), total shareholder return (“TSR”) awards and other awards. On September 29, 2014, 324,669 outstanding NQOs granted to employees under the Exelis plan were converted to 274,745 NQOs granted to employees under the Vectrus 2014 Omnibus Plan. On September 29, 2014, 283,876 outstanding RSUs

granted to employees under the Exelis plan were converted to 240,196 RSUs granted to employees under the Vectrus 2014 Omnibus Plan. The estimated fair value of the converted Vectrus stock awards immediately following the Spin-off was higher than the fair value of such awards immediately prior to the Spin-off. As a result, Vectrus will incur incremental compensation expense which will be recognized following the Spin-off.

Employee Grants

On September 29, 2014, the Committee approved the grant of 6,727 RSUs, to be effective October 10, 2014, to executives who had outstanding Exelis TSR awards under the Exelis plan. The RSUs will vest on December 4, 2015, subject to the participants continued employment and the terms of the award agreement. The fair value of the RSUs is determined based on the closing price of Vectrus common stock on the date of grant, which was $20.62 . Stock compensation expense will be recognized ratably over the vesting period of the awards.

Founders' Grants

On September 29, 2014, the Committee approved the grant of 175,606 RSUs and 171,298 NQOs, effective October 10, 2014, to employees in positions deemed critical to the establishment and success of Vectrus. These Founders' Grants were a special one-time award intended to closely align the economic interest of the recipients with the Vectrus shareholders. The RSUs vest ratably over a three-year period from the date of the grant. The fair value of the RSUs is determined based on the closing price of Vectrus common stock on the date of grant, which was $20.62 . The NQOs expire 10 years from the date of the grant and vest ratably over a three -year period from the date of the grant. The fair value of each NQO grant was estimated on the date of grant using the Black-Scholes option pricing model as $8.24 . Stock compensation expense will be recognized ratably over the vesting period of the awards.

Non-employee Director Grants

On September 29, 2014, the Committee approved the grant of 21,024 RSUs, effective October 10, 2014, to directors representing the portion of their restricted stock compensation, prorated for their service from the Spin-off through the day before the May 2015 annual meeting. The RSUs vest one day prior to the Vectrus 2015 annual meeting. The fair value of the RSUs is determined based on the closing price of Vectrus common stock on the date of grant, which was $20.62 . Stock compensation expense will be recognized ratably over the vesting period of the awards.