V2X, Inc 8-K/A, filed Sep 1, 2022
V2X, Inc. (VVX)
About this 8-K/A
V2X, Inc filed this 8-K/A on September 1, 2022, reporting on events of July 5, 2022.
Items reported
- Item 9.01: Financial statements and exhibits
UNITED
STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
Amendment No. 1
CURRENT REPORT
Pursuant to Section 13 or 15(d)
of The Securities Exchange Act of 1934
Date of report (Date of earliest event reported):
(Exact Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of Incorporation)
| (Commission | (IRS Employer |
| File Number) | Identification No.) |
(Address of Principal Executive Offices) (Zip Code)
(
(Registrant's Telephone Number, Including Area Code)
Securities Registered Under Section 12(b) of the Act:
| Title of each class | Trading symbol(s) |
Name of each exchange on which registered |
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions ( see General Instruction A.2. below):
| Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425) |
| Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12) |
| Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b)) |
| Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c)) |
Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (§230.405 of this chapter) or Rule 12b-2 of the Securities Exchange Act of 1934 (§240.12b-2 of this chapter).
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
EXPLANATORY NOTE
This Current Report on Form 8-K/A (“Amendment”) amends and supplements the Current Report on Form 8-K filed by V2X, Inc., an Indiana corporation formerly known as Vectrus, Inc. (the “Company”), with the Securities and Exchange Commission on July 5, 2022 (the “Original Filing”) in connection with the closing of the transactions contemplated by the Agreement and Plan of Merger, dated as of March 7, 2022, by and among Vertex Aerospace Services Holding Corp., a Delaware corporation, the Company, Andor Merger Sub Inc., a Delaware corporation, and Andor Merger Sub LLC, a Delaware limited liability company.
Pursuant to the instructions on Item 9.01 of Form 8-K, the Original Filing is amended and supplemented by this Amendment to provide the financial statements and pro forma financial information required by Items 9.01(a) and (b) of Form 8-K. No other amendments to the Original Filing are being made by this Amendment.
Item 9.01. Financial Statements and Exhibits.
| (a) | Financial Statements of Business Acquired |
The audited consolidated financial statements of Vertex Aerospace Services Holding Corporation as of and for the years ended December 31, 2021 and 2020 and the related notes thereto are attached hereto as Exhibit 99.1 and incorporated herein by reference.
The audited consolidated financial statements of Vertex Aerospace Services Holding Corporation as of and for the years ended December 31, 2020 and 2019 and the related notes thereto are attached hereto as Exhibit 99.1 and incorporated herein by reference.
The unaudited consolidated financial statements of Vertex Aerospace Services Holding Corporation as of and for the six months ended July 3, 2022 and June 25, 2021 and the related notes thereto attached hereto as Exhibit 99.2 and incorporated herein by reference.
The audited combined financial statements of the Mission Critical Solutions and Training Services Business (a business of Raytheon Technologies Corporation) as of and for the years ended December 31, 2020 and 2019 and the related notes thereto are attached hereto as Exhibit 99.3 and incorporated herein by reference.
The unaudited condensed combined financial statements of the Mission Critical Solutions and Training Services Business (a business of Raytheon Technologies Corporation) as of and for the nine months ended September 30, 2021 and the related notes thereto attached hereto as Exhibit 99.4 and incorporated herein by reference.
| (b) | Pro Forma Financial Information |
The unaudited pro forma combined financial information of the Company giving effect to the merger, including the pro forma combined balance sheet as of July 1, 2022, the related pro forma combined statement of income for the six months ended July 1, 2022 and the year ended December 31, 2021, and the related notes thereto, are attached hereto as Exhibit 99.5 and incorporated herein by reference.
(d) Exhibits.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
| V2X, INC. | ||
| Dated: September 1, 2022 | ||
| By: | /s/ Kevin T. Boyle | |
| Kevin T. Boyle | ||
| Chief Legal Officer, General Counsel and Corporate Secretary | ||
Exhibit 23.1
Consent of Independent Auditor
We consent to the incorporation by reference in Registration Statement (No. 333-235774) on Form S-3 and Registration Statements (Nos. 333-266022 and 333-198895) on Form S-8 of V2X, Inc. of our reports dated April 13, 2022 and March 31, 2021, relating to the consolidated financial statements of Vertex Aerospace Services Holding Corp. and Subsidiaries, appearing in this Current Report on Form 8-K/A.
/s/ RSM US LLP
McLean, Virginia
September 1, 2022
Exhibit 23.2
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (No. 333-235774) and Form S-8 (Nos. 333-266022 and 333-198895) of V2X, Inc. of our report dated October 11, 2021, except for the effects of the revisions discussed in Note 2 to the combined financial statements, as to which the date is September 1, 2022, relating to the financial statements of the Mission Critical Solutions and Training Services Business (a business of Raytheon Technologies Corporation), which appears in this Current Report on Form 8-K/A.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
September 1, 2022
Exhibit 99.1
Vertex Aerospace Services Holding Corp.
Consolidated Financial Statements
For the Years Ended December 31, 2021 and December 31, 2020
1
Table of Contents
| Page | ||
| Independent auditor’s report | 3 | |
| Financial statements | ||
| Consolidated balance sheets | 5 | |
| Consolidated statements of operations | 6 | |
| Consolidated statements of comprehensive income | 7 | |
| Consolidated statements of changes in stockholders’ equity | 8 | |
| Consolidated statements of cash flows | 9 | |
| Notes to the consolidated financial statements | 10 |
2
Independent Auditor’s Report
Opinion
We have audited the consolidated financial statements of Vertex Aerospace Services Holding Corp. and Subsidiaries (the Company), which comprise the consolidated balance sheets as of December 31, 2021 and 2020, the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements).
In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.
Basis for Opinion
We conducted our audits in accordance with auditing standards generally accepted in the United States of America (GAAS). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are required to be independent of the Company and to meet our other ethical responsibilities, in accordance with the relevant ethical requirements relating to our audits. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Responsibilities of Management for the Financial Statements
Management is responsible for the preparation and fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America, and for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.
In preparing the financial statements, management is required to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable).
Auditor’s Responsibilities for the Audit of the Financial Statements
Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance but is not absolute assurance and therefore is not a guarantee that an audit conducted in accordance with GAAS will always detect a material misstatement when it exists. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Misstatements are considered material if there is a substantial likelihood that, individually or in the aggregate, they would influence the judgment made by a reasonable user based on the financial statements.
3
In performing an audit in accordance with GAAS, we:
| • | Exercise professional judgment and maintain professional skepticism throughout the audit. |
| • | Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, and design and perform audit procedures responsive to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. |
| • | Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control. Accordingly, no such opinion is expressed. |
| • | Evaluate the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluate the overall presentation of the financial statements. |
| • | Conclude whether, in our judgment, there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern for a reasonable period of time. |
We are required to communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit, significant audit findings, and certain internal control-related matters that we identified during the audit.
Birmingham, Alabama
April 13, 2022
4
Vertex Aerospace Services Holding Corp.
Consolidated Balance Sheets
(in thousands)
| As of December 31, | As of December 31, | |||||||
| 2021 | 2020 | |||||||
| ASSETS | ||||||||
| Cash | $ | 44,904 | $ | 115,528 | ||||
| Accounts receivable, net | 66,250 | 18,286 | ||||||
| Unbilled contract receivables, net | 251,179 | 75,189 | ||||||
| Inventories, net | 37,718 | 42,370 | ||||||
| Prepaids and other current assets | 1,254 | 5,185 | ||||||
| Available for sale assets | — | 968 | ||||||
| Total current assets | 401,305 | 257,526 | ||||||
| Property and equipment, net | 47,232 | 25,529 | ||||||
| Intangible assets, net | 233,169 | 83,014 | ||||||
| Goodwill | 891,729 | 240,504 | ||||||
| Deferred tax assets, net | 8,296 | 12,550 | ||||||
| Other long-term assets | 7,299 | 1,199 | ||||||
| Total assets | $ | 1,589,030 | $ | 620,322 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Accounts payable | $ | 120,714 | $ | 70,047 | ||||
| Accrued salaries and benefits | 33,230 | 19,734 | ||||||
| Advance payments and billings in excess | 81,340 | 14,104 | ||||||
| Other accrued expenses | 8,974 | 8,238 | ||||||
| Current portion of long-term debt | 6,938 | 3,300 | ||||||
| Current portion of loss contract reserve | 20,647 | 17,923 | ||||||
| Dividends payable | — | 100,000 | ||||||
| Other current liabilities | 6,257 | 1,599 | ||||||
| Total current liabilities | 278,100 | 234,945 | ||||||
| Long-term debt, net | 1,069,290 | 311,620 | ||||||
| Long-term portion of loss contract reserve | 14,188 | 16,345 | ||||||
| Other long-term liabilities | 13,823 | 5,467 | ||||||
| Total liabilities | 1,375,401 | 568,377 | ||||||
| Stockholders’ Equity | ||||||||
| Common Stock, $.01 par value, 400,000 and 251,332 shares authorized, respectively; 273,944 and 226,220 shares issued and outstanding, respectively | 3 | 2 | ||||||
| Preferred Stock, 8% Paid-in-Kind, $.001 par value, 75,000 and 0 shares authorized, respectively; 75,000 and 0 shares issued and outstanding, respectively | — | — | ||||||
| Additional paid in capital – common stock | 301,476 | 226,218 | ||||||
| Additional paid in capital – preferred stock | 75,000 | — | ||||||
| Other comprehensive loss | (204 | ) | — | |||||
| Retained earnings | (162,646 | ) | (174,275 | ) | ||||
| Total stockholders’ equity | 213,629 | 51,945 | ||||||
| Total liabilities and stockholders’ equity | $ | 1,589,030 | $ | 620,322 | ||||
See notes to consolidated financial statements
5
Vertex Aerospace Services Holding
Corp.
Consolidated Statements of Operations
(in thousands)
| Year Ended December 31, 2021 | Year Ended December 31, 2020 | |||||||
| Revenues: | ||||||||
| Sales | $ | 813,159 | $ | 819,940 | ||||
| Cost of sales | 719,169 | 726,776 | ||||||
| Gross profit | 93,990 | 93,164 | ||||||
| Operating costs and expenses: | ||||||||
| Selling, general and administrative expenses | 48,220 | 49,530 | ||||||
| Operating income | 45,770 | 43,634 | ||||||
| Other expenses: | ||||||||
| Loss on spin-off of net assets (Note 4 and 9) | — | (22,509 | ) | |||||
| Loss on disposal of assets | (1,303 | ) | — | |||||
| Loss on debt extinguishment | (7,295 | ) | — | |||||
| Interest expense, net | (19,546 | ) | (18,693 | ) | ||||
| Total other expenses | (28,144 | ) | (41,202 | ) | ||||
| Income before income taxes | 17,626 | 2,432 | ||||||
| Income tax (expense) benefit | (5,977 | ) | 13,528 | |||||
| Net income | $ | 11,649 | $ | 15,960 | ||||
See notes to consolidated financial statements
6
Vertex Aerospace Services Holding Corp.
Consolidated Statements of
Comprehensive Income
(in thousands)
| Year Ended December 31, 2021 | Year Ended December 31, 2020 | |||||||
| Net income | $ | 11,649 | $ | — | ||||
| Other comprehensive loss: | ||||||||
| Foreign currency translation adjustments | (204 | ) | — | |||||
| Total other comprehensive loss | (204 | ) | — | |||||
| Comprehensive income | $ | 11,445 | $ | — | ||||
See notes to consolidated financial statements
7
Vertex Aerospace Services Holding Corp.
Consolidated Statements of
Changes in Stockholders’ Equity
(in thousands)
| Common Stock | Preferred Stock | |||||||||||||||||||||||||||||||||||
| Shares | Value | Additional Paid in Capital | Shares | Value | Additional Paid in Capital | Accumulated Other Comprehensive Loss | Retained Earnings | Total Shareholders’ Equity | ||||||||||||||||||||||||||||
| Beginning balance, December 31, 2019 | 226,345 | $ | 2 | $ | 226,343 | — | $ | — | $ | — | $ | — | $ | (57,274 | ) | $ | 169,071 | |||||||||||||||||||
| Shares repurchased and retired | (125 | ) | — | (125 | ) | — | — | — | — | — | (125 | ) | ||||||||||||||||||||||||
| Dividend declared | — | — | — | — | — | — | — | (100,000 | ) | (100,000 | ) | |||||||||||||||||||||||||
| Crestview spin-off | — | — | — | — | — | — | — | (32,961 | ) | (32,961 | ) | |||||||||||||||||||||||||
| Net income | — | — | — | — | — | — | — | 15,960 | 15,960 | |||||||||||||||||||||||||||
| Ending balance, December 31, 2020 | 226,220 | $ | 2 | $ | 226,218 | — | $ | — | $ | — | $ | — | $ | (174,275 | ) | $ | 51,945 | |||||||||||||||||||
| Shares repurchased and retired | (100 | ) | — | (100 | ) | — | — | — | — | (20 | ) | (120 | ) | |||||||||||||||||||||||
| Contributions by shareholders | 47,824 | 1 | 75,358 | — | — | — | — | — | 75,359 | |||||||||||||||||||||||||||
| Preferred stock issued | — | — | — | 75,000 | — | 75,000 | — | — | 75,000 | |||||||||||||||||||||||||||
| Foreign currency translation adjustments | — | — | — | — | — | — | (204 | ) | — | (204 | ) | |||||||||||||||||||||||||
| Net income | — | — | — | — | — | — | 11,649 | 11,649 | ||||||||||||||||||||||||||||
| Ending balance, December 31, 2021 | 273,944 | $ | 3 | $ | 301,476 | 75,000 | $ | — | $ | 75,000 | $ | (204 | ) | $ | (162,646 | ) | $ | 213,629 | ||||||||||||||||||
See notes to consolidated financial statements
8
Vertex Aerospace Services Holding
Corp.
Consolidated Statements of Cash Flows
(in thousands)
| Cash flows from operating activities: | Year Ended December 31, 2021 | Year Ended December 31, 2020 | ||||||
| Net income | $ | 11,649 | $ | 15,960 | ||||
| Adjustments to reconcile net income to net cash flows provided by operating activities: | 5,388 | 10,487 | ||||||
| Depreciation of property and equipment Amortization of intangibles | 14,445 | 13,013 | ||||||
| Bad debt recovery | (6,447 | ) | (4,465 | ) | ||||
| Inventory obsolescence reserve | (469 | ) | (16,126 | ) | ||||
| Amortization of deferred financing costs | 919 | 1,179 | ||||||
| Loss on spin-off of net assets | — | 22,509 | ||||||
| Deferred tax assets, net | 4,254 | (12,550 | ) | |||||
| Loss contract provision | (10,034 | ) | (13,647 | ) | ||||
| Gain on disposition of property and equipment | (1,960 | ) | — | |||||
| Loss on disposition | 3,263 | — | ||||||
| Loss on debt extinguishment | 7,295 | — | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | 17,248 | 23,029 | ||||||
| Unbilled contract receivables | (52,491 | ) | 5,420 | |||||
| Inventories | 4,361 | 12,748 | ||||||
| Prepaids and other current assets | 4,345 | 3,609 | ||||||
| Available for sale assets | 968 | (968 | ) | |||||
| Other assets | 1,191 | 227 | ||||||
| Accounts payable | (2,596 | ) | (3,084 | ) | ||||
| Accrued salaries and benefits | 5,569 | 236 | ||||||
| Advance payments and billings in excess | (184 | ) | (17,190 | ) | ||||
| Other accrued expenses | 526 | (1,232 | ) | |||||
| Other liabilities | (1,099 | ) | (1,382 | ) | ||||
| Net cash provided by operating activities | 6,141 | 37,773 | ||||||
| Cash flows from investing activities: | ||||||||
| Acquisition of business, net of cash acquired | (810,683 | ) | — | |||||
| Net change in property and equipment | 5,585 | (2,550 | ) | |||||
| Net cash used in investing activities | (805,098 | ) | (2,550 | ) | ||||
| Cash flows from financing activities: | ||||||||
| Borrowings from ABL credit facility | 108,750 | — | ||||||
| Repayments on ABL credit facility | (108,750 | ) | — | |||||
| Repayments on long term debt | (321,750 | ) | (3,300 | ) | ||||
| Proceeds from long term debt | 1,110,000 | — | ||||||
| Dividends paid | (100,000 | ) | — | |||||
| Debt issuance costs | (35,156 | ) | — | |||||
| Contributions by stockholders | 75,359 | — | ||||||
| Stock repurchased from stockholders | (120 | ) | (125 | ) | ||||
| Net cash provided by (used in) financing activities | 728,333 | (3,425 | ) | |||||
| Net (decrease) increase in cash | (70,624 | ) | 31,798 | |||||
| Cash, beginning of period | 115,528 | 83,730 | ||||||
| Cash, end of period | $ | 44,904 | $ | 115,528 | ||||
| Supplemental disclosures of cash flow information Cash paid during the period for: | ||||||||
| Interest | $ | 17,509 | $ | 17,382 | ||||
| Income taxes | 1,518 | 746 | ||||||
| Supplemental schedule of non-cash investing and financing activities: | ||||||||
| Dividend declared and unpaid | $ | — | $ | 100,000 | ||||
| Spin-off of net assets | — | 32,961 | ||||||
| Issuance of preferred stock | 75,000 | — | ||||||
| Cash acquired in business acquisition | 16,985 | — | ||||||
See notes to consolidated financial statements
9
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
| 1. | Description of the Business and Transaction |
The Company: Vertex Aerospace Services Holding Corp. (“Holding”) was incorporated in 2018 under the laws of Delaware by an affiliate of American Industrial Partners Capital Fund VI, L.P. (“AIP”) to facilitate the acquisition of 100% of the voting interest of the business of Vertex Aerospace, Crestview Aerospace, TCS Aerospace and various other assets from L-3 Communications Integrated Systems L.P. and L-3 Technologies, Inc. (collectively referred to herein as “L3”). The acquisition was completed on June 29, 2018.
Holding and its consolidated subsidiaries (herein referred to as the “Company”, “we”, “us”, or “our”) provide aviation and aerospace technical services, managing and servicing fixed- and rotary-wing aircraft primarily for government customers by providing logistics support, maintenance, repair, overhaul services and supply chain management. The Company also provides aircraft modification and assembly to customers including the U.S. Government (primarily the Department of Defense, or “DoD”) and commercial and original equipment manufacturers by providing parts, facilities, technology and experience for the manufacture and modification of aircrafts. In addition, the Company designs, develops, integrates, tests, modifies and provides documentation for every aspect of aircraft and avionics hardware and software systems to address critical needs of the U.S. military’s conventional and Special Operations forces.
On December 31, 2020, the Company distributed substantially all of the assets and liabilities of its Crestview Aerospace business to the Company’s shareholders in a spin-off transaction. See Note 4 for additional information.
The Transaction: On December 6, 2021 (the “Transaction Date”), the Company completed the acquisition of the Technology and Training Solutions business lines (“the TTS Business”) from Raytheon Company (the “Transaction”). The acquired business is comprised of four product lines: Defense Training Solutions, Commercial Training Solutions, Mission Critical Solutions and Modernization and Sustainment.
The Transaction was comprised of the following steps:
| • | AIP contributed $75 million of cash to Holding. |
| • | Holding contributed $75 million of cash to Vertex Aerospace Services Corp (“Services”), a wholly- owned subsidiary of Holding. |
| • | Services borrowed $925 million pursuant to seven-year term first lien term loan agreement (“First Lien Term Loan”) and $185 million pursuant to eight-year term second lien term loan agreement (“Second Lien Term Loan”). |
| • | Services amended its Asset Backed Lending revolving line-of-credit agreement (the “ABL Credit Facility”) to increase the facility size from $75 million to $100 million and borrowed $25 million. |
| • | Services remitted $320 million to fully repay the outstanding principal balance and accrued interest on an existing term loan. |
| • | Services purchased the TTS Business from Raytheon Company for approximately $828 million in cash and $75 million of preferred equity. |
| • | Services paid transaction fees and expenses to lenders and various service providers of approximately $44 million, including approximately $35 million of debt issuance costs, which were capitalized, and approximately $8 million of transactions costs, which were expensed. |
| • | Services transferred $21 million of cash to Vertex Aerospace LLC, a wholly-owned subsidiary of Services. |
| 2. | Summary of Significant Accounting Policies |
Accounting Periods: The Company has adopted the calendar year as its accounting period.
10
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
Principles of Consolidation: The Company’s financial statements include the accounts of Holding and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates: The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of sales and cost of sales during the reporting period. The most significant of these estimates and assumptions relate to sales, profit and loss recognition for performance obligations satisfied over time, fair values of assets acquired and liabilities assumed in business combinations, market values for inventories reported at lower of cost or net realizable value, income taxes, including valuations of deferred tax assets, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill. Changes in estimates are reflected in the periods during which they become known. Actual amounts may differ from these estimates and could differ materially.
Foreign Operations: The Company’s operations are subject to various political, economic, and other risks and uncertainties inherent in the foreign countries in which the Company operates. Among other risks, the Company’s operations in China are subject to the risks of restrictions on transfer of Chinese Renminbi (“RMB”) funds, which is not a freely transferable currency; export duties, quotas, and embargoes; domestic and international customs and tariffs; changing taxation policies; foreign exchange restrictions; and political conditions and governmental regulations. The Company had the U.S. Dollar equivalent of $8.1 million and $0.0 million of cash and cash equivalents of RMB held in Chinese bank accounts at December 31, 2021and 2020, respectively.
Foreign Currency Translation: The functional currency for the majority of the Company’s foreign subsidiaries is the local foreign currency. For those subsidiaries, the assets and liabilities are translated into U.S. dollars at the exchange rates in effect at the balance sheet date. Income and expense items are translated at an average exchange rate for the period. Certain foreign subsidiaries, which is primarily the U.K and Canada as of December 31, 2021, designate the U.S dollar as the functional currency. For these subsidiaries, assets and liabilities denominated in foreign currency are re-measured into U.S dollars at the current exchange rates for monetary assets and liabilities and historical exchange rates for nonmonetary assets and liabilities. Foreign exchange differences resulting from translation are included in accumulated other comprehensive loss as a component of stockholder’s equity. Foreign exchange differences from re- measurement and settlement of monetary assets and liabilities are included in other income, net on the consolidated statements of operations. At December 31, 2021 and December 31, 2020, the Company recorded other comprehensive loss of $0.2 million and $0.0 million respectively.
Cash and Cash Equivalents: The Company considers all highly liquid investments with an original maturity date of less than three months when purchased to be cash equivalents. The Company maintains cash and cash equivalents in bank deposit accounts which, at times, may exceed federally insured limits. As of December 31, 2021 and 2020, approximately $16.1 million and $0 million of cash was held in bank accounts outside of the U.S., respectively, inclusive of the $8.1 million in RMB disclosed in the “Foreign Operations” footnote. The Company has not experienced any significant losses in such accounts and believes it is not exposed to any significant risks on cash. At December 31, 2021 and December 31, 2020, the Company had no cash equivalents.
Revenue Recognition: The Company adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, as amended (commonly referred to as Accounting Standards Codification (“ASC”) 606), for revenue recognition purposes.
11
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
The majority of the Company’s consolidated net sales are generated from long-term contracts with customers that require it to maintain, repair or overhaul aircraft. These contracts are primarily with agencies of, and prime system contractors to, the U.S. Government and foreign governments and are generally priced on a fixed-price, cost-plus or time-and-material type basis. Substantially all of the Company’s cost- plus and time-and-material type contracts are with the Department of Defense (“DoD”). Certain of the Company’s contracts with the U.S. Government are multi-year contracts incrementally funded by the customer. The transaction price for these incrementally funded contracts includes contract value amounts not yet funded by the U.S. Government when the Company has a firm order for the goods or services and it is probable that the customer will fund such amounts. In assessing probability, the Company considers, among other factors, the period of time before contract funding is expected, communication from the customer that indicates funding will be obtained and the Company’s history of receiving funding under the current contract or previous similar contracts. The Company also generates sales, to a lesser extent, from contracts with commercial and government customers for standard product and service offerings, which are priced on a firm fixed basis. See Note 16 for additional information regarding the composition of the Company’s net sales.
The Company records sales for a contract when it has the approval and commitment of all parties, the contract identifies the rights of the parties and payment terms, the contract has commercial substance and collectability of the consideration is probable.
To determine the proper revenue recognition method, the Company first evaluates each of its contractual arrangements to identify its performance obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. Some of the Company’s contracts have a single performance obligation because the promise to transfer the individual good or service is not separately identifiable from other promises within the contract and is, therefore, not distinct. The majority of the Company’s contracts have multiple performance obligations, primarily (i) related to the provision of multiple goods or services that have alternative use to the Company or that are not substantially the same or (ii) due to the contract covering multiple phases of the product lifecycle (development and engineering, production, maintenance and support). For contracts with more than one performance obligation, the Company allocates the total transaction price in an amount based on the estimated relative standalone selling prices underlying each performance obligation. In cases where a contract requires a customized good or service, the primary method used to estimate standalone selling price is the expected cost plus a margin approach. In cases where the Company sells a standard product or service offering, the stand-alone selling price is based on an observable standalone selling price
The majority of the Company’s sales are from performance obligations satisfied over time. Sales are recognized over time when control is continuously transferred to the customer during the contract. For U.S. Government contracts, the continuous transfer of control to the customer is supported by contract clauses that provide for (i) progress or performance-based payments or (ii) the unilateral right of the customer to terminate the contract for its convenience, in which case the Company has the right to receive payment for costs incurred plus a reasonable profit for products and services that do not have alternative use to the Company. Foreign government and certain commercial contracts contain similar termination for convenience clauses, or the Company has a legally enforceable right to receive payment for costs incurred and a reasonable profit for products or services that do not have alternative use to the Company. Sales on fixed price and cost-plus type contracts that include performance obligations satisfied over time are generally recorded at amounts equal to the ratio of actual cumulative costs incurred divided by total estimated costs at completion, multiplied by (i) the transaction price, less (ii) the cumulative sales recognized in prior periods (cost-to-cost input method).
12
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
Accounting for the sales and profits on performance obligations for which progress is measured using the cost-to-cost input method involves the preparation of estimates of: (1) transaction price and (2) 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. Incurred costs include labor, material, overhead and, for the Company’s U.S. Government contractor businesses, allowable general and administrative (G&A) expenses. Incurred costs represent work performed, which corresponds with and thereby represents the transfer of control to the customer. The estimated profit or loss at completion on a contract is equal to the difference between the transaction price and the total estimated cost at completion. In the case of a contract for which the total estimated costs exceed the total transaction price, a loss arises, and a provision for the entire loss is recorded in the period that the loss becomes evident. The unrecoverable costs on a loss contract that are expected to be incurred in future periods are presented on the consolidated balance sheet as a component of liabilities entitled either “Short-term Portion of Loss Contract Reserve” or “Long-term Portion of Loss Contract Reserve”.
The Company’s contracts give rise to variable consideration, including award and incentive fees, as well as amounts incrementally funded by the U.S. Government, or other provisions that can either increase or decrease the transaction price. 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 costs and target costs. Variable consideration may require the Company to exercise significant judgment to determine the total transaction price of the contract. The Company includes variable consideration in the transaction price when there is a basis to reasonably estimate the variable amount it will be entitled to receive and it is probable that a significant reversal in revenue recognized will not be required when the uncertainty is resolved. These estimates are based on historical experience, current and forecasted performance and the Company’s judgment at the time of the evaluation.
Contract modifications routinely occur to account for changes in contract specifications or requirements. In most cases, contract modifications are for goods or services that are not distinct and, therefore, are accounted for as part of the existing contract. Transaction price estimates include additional consideration for submitted contract modifications or claims when the Company believes it has an enforceable right to the modification or claim, the amount can be reliably estimated and its realization is reasonably assured. Amounts representing modifications accounted for as part of the existing contract are included in the transaction price and recognized as an adjustment to sales on a cumulative catch-up basis.
The Company’s fixed-price type contracts with the U.S. Government are typically billed based on monthly firm fixed prices. Since cost is often incurred beyond the period of performance of the contract, billings often exceed costs, which are presented as current liabilities on the consolidated balance sheet. For certain fixed-price contracts with foreign governments and commercial customers, the Company receives advance payments. Advanced payments are not considered a significant financing component because they are a negotiated contract term to ensure the customer meets its financial obligation, particularly when there are significant upfront working capital requirements. These two liabilities are combined on the consolidated balance sheet in the line item entitled “advance payments and billings in excess.” Contract assets often arise from cost-plus type contracts, time-and-material type contracts and fixed-price services type contracts for revenue amounts that have not been billed by the end of the accounting period due to the timing of preparation of invoices to customers. The Company records an asset for these revenues as current assets on the consolidated balance sheet in the line item entitled “unbilled contract receivables, net.”
Revisions or adjustments to estimates of the transaction price, estimated costs at completion and estimated profit or loss of a performance obligation may be required as work progresses under a contract, as experience is gained, as facts and circumstances change and as new information is obtained, even though the scope of work required under the contract may not change. Revisions or adjustments may also be required if contract modifications occur. The impact of revisions in profit or loss estimates are recognized on a cumulative catch-up basis in the period in which the revisions are made. The revisions in contract estimates, if significant, can materially affect the Company’s results of operations and cash flows, as well as reduce the valuations of contract assets, and in some cases result in liabilities to complete contracts in a loss position.
Sales from performance obligations satisfied at a point in time are typically for standard goods and are recognized when the customer obtains control, which is generally upon delivery and acceptance. The Company also records sales for performance obligations relating to standard services (i.e., maintenance and extended warranties covering standard goods sold by the Company) over time by using output measures of time elapsed to measure progress toward satisfying the performance obligation.
13
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
For cost plus type contracts, revenue is recognized as performance obligations are satisfied over time on a percentage of completion basis using the costs incurred to ate relative to total estimated costs at completion to measure progress. Incurred costs represent work performed, which correspond with the best depict transfer of control to the customer.
Sales on time-and-material type contracts are generally recognized each period based on the amount billable to the customer, which is based on direct labor hours expended multiplied by the contractual fixed rate per hour, plus the actual costs of materials and other direct non-labor costs.
Contract Assets and Contract Liabilities: Contract assets include unbilled contract receivables related to long-term contracts for which sales and profits are recognized primarily using cost-to-cost input method of accounting and are classified as current. Unbilled contract receivables are reduced by amounts of unliquidated progress or performance-based payments. Under the terms of certain revenue arrangements (contracts) with the U.S. Government, the Company is entitled to receive progress payments as costs are incurred or performance-based payments upon the achievement of predetermined performance milestones. Unliquidated progress or performance-based payments arise from fixed-price type contracts with the U.S. Government that contain progress or performance-based payment clauses, and represent payments on invoices that have been collected in cash, but have not yet been liquidated. Progress payment invoices are billed to the customer as contract costs are incurred at an amount generally equal to 80% of incurred costs. Performance based payments are billed to the customer upon the achievement of predetermined performance milestones at amounts not to exceed 90% of contract price. Unliquidated progress or performance-based payments are liquidated as deliveries or other contract performance milestones are completed, at an amount equal to a percentage of the contract sales price for the items delivered or work performed, based on a contractual liquidation rate. Contract liabilities include advance payments, billings in excess of the revenue recognized and amounts received in excess of sales recognized on contracts (deferred revenue). Contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period. Advance payments and billings in excess of revenue recognized are both classified as current, and deferred revenue as current or noncurrent based on the timing of expected revenue recognition. As of December 31, 2021, and December 31, 2020, all contract liabilities are classified as current. Contract loss reserves are contract liabilities and reported as current and long-term.
Property and Equipment: Property and equipment are stated at cost minus accumulated depreciation. Depreciation is computed by applying the straight-line method to the estimated useful lives of the related assets. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the improvements. Expenditures for maintenance, repairs and minor improvements are charged to expense as incurred. When property or equipment is retired or otherwise disposed of, the net book value of the asset is removed from the Company’s consolidated balance sheet and the net gain or loss is included in the determination of net income.
Goodwill: The Company records goodwill in connection with the acquisition of businesses when the purchase price exceeds the fair values of the assets acquired and liabilities assumed. The carrying value of goodwill is not amortized, but is tested for impairment annually and is reviewed for impairment on an interim basis whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The Company has adopted Financial Accounting Standards Board (FASB) ASU 2017-04, Simplifying the Test for Goodwill Impairment. Under ASU 2017-04, the Company will determine the amount of goodwill impairment by comparing the Step 1 fair value of a reporting unit with its carrying amount. To the extent the carrying value of a reporting unit exceeds its Step 1 fair value, a goodwill impairment charge is recorded. Based on the results of these tests, the Company did not record a goodwill impairment charge for the period ended December 31, 2021 and December 31, 2020. See Note 3 and 8 for additional information on Goodwill due to the recent asset purchase from Raytheon.
14
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
On December 31, 2020, substantially all of the assets and liabilities of the Crestview business were spun-off to the Company’s shareholders. Per ASC 350, Intangibles — Goodwill and Other, when an entity spins-off a reporting unit or component of a reporting unit that constitutes a business, goodwill of the reporting unit should be assigned to the business being spun-off. Accordingly, the Company allocated $12.1 million of goodwill to the portion of the Crestview business to be spun-off. In accordance with ASC 845, Nonmonetary Transactions, a pro-rata nonreciprocal transfer of nonmonetary assets to owners in a spin-off is recognized at the carrying amount, after reduction for any indicated impairment, of the nonmonetary assets transferred if the nonmonetary assets being distributed meet the definition of a business. After testing for impairment, the allocated goodwill was determined to be impaired. Accordingly, the Company recorded a Loss on Disposal which included the entire $12.1 million for the period ended December 31, 2020. See Note 4 and Note 8 for additional information on the December 31, 2020 allocation of goodwill.
Long-Lived Assets Other Than Goodwill: The Company reviews its long-lived assets, including software development costs, amortizable customer contract relationships and indefinite-lived tradenames for impairment annually, or whenever events or circumstances indicate that the carrying amount(s) of an asset may not be recoverable. When such events or changes in circumstances occur, a recoverability test is performed comparing projected undiscounted cash flows from the use and eventual disposition of an asset or asset group to its carrying amount. If the projected undiscounted cash flows are less than the carrying amount, an impairment is recorded to the extent the carrying amount exceeds fair value. The Company reviews indefinite-lived trade names at least annually by comparing fair value to carrying value of the intangible asset. Fair value is determined through various valuation techniques, including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. Estimates critical to the Company’s evaluation of indefinite-lived trade names for impairment include the discount rate, royalty rates used in its evaluation of trade names, projected average revenue growth and projected long-term growth rates in the determination of terminal values. Based on the results of these tests, the Company did not record an impairment charge to other long-lived intangible assets for the period ended December 31, 2021 and December 31, 2020. See Note 8 for additional information.
Deferred Debt Issuance Costs: Costs to issue debt are capitalized and deferred when incurred, and subsequently amortized to interest expense over the term of the related debt using the effective interest rate method. Deferred debt issuance costs, other than for revolving line-of-credit arrangements, are presented in the Company’s consolidated balance sheet as a direct deduction from the carrying amount of the associated debt liability. Deferred debt issuance costs for revolving line-of-credit arrangements are included in the Company’s consolidated balance sheet in other assets. The deferred debt issuance costs for the revolving line of credit were $1.6 million for the period ended December 31, 2021, and $1.2 million for the period ended December 31, 2020.
Contingencies and Commitments: In accordance with ASC 450, Contingencies (Topic 450): Disclosure of Certain Loss Contingencies, the Company records a loss contingency when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company reviews its loss contingencies on an ongoing basis to ensure that it has appropriate reserves recorded in its consolidated balance sheets. These reserves are based on historical experience with claims incurred but not received, estimates and judgments made by management and applicable insurance coverage for litigation matters, and, as such, adjusted as circumstances warrant. Legal costs incurred in connection with loss contingencies are expensed as incurred. See Note 15 for additional information.
Accounts Receivable and Unbilled Contract Receivables: Accounts receivable, net and unbilled contract receivables, net are generated from prime and subcontracting arrangements primarily with U.S. governmental agencies. Billed amounts represent invoices that have been prepared and sent to the customer. Unbilled amounts primarily represent costs and fees incurred in excess of billings and rate variances on cost- plus contracts as well as retainage amounts. In accordance with industry practice, contract receivables relating to long-term contracts are classified as current, even though portions of these amounts may not be realized within one year. Billed accounts receivable are considered past due if the invoice has been outstanding more than 30 days. The Company does not charge interest on accounts receivable; however, U.S. governmental agencies pay interest on invoices outstanding more than 30 days. The Company records interest income from U.S. governmental agencies when received. The provision for doubtful accounts is based on management’s evaluation of the status of existing accounts receivable. Receivables are written off when deemed uncollectible. Recoveries of accounts receivable previously written off are recorded when received. The reserve for doubtful accounts was $3.6 million and $8.1 million as of December 31, 2021 and December 31, 2020, respectively.
15
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
Income Taxes: The Company is a taxable entity for federal income tax purposes and files a consolidated U.S. federal income tax return. The Company uses the liability method of accounting for income taxes. Deferred income tax assets and liabilities reflect tax carryforwards and the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes, as determined under enacted tax laws and rates expected to be in effect when such differences reverse. The effect of changes in tax laws or rates is accounted for in the period of enactment. Valuation allowances for deferred tax assets are provided when it is more likely than not that some portion or all of the assets will not be realized considering, when appropriate, tax planning strategies.
Income tax accounting standards prescribe (1) a minimum recognition threshold that an income tax benefit arising from an uncertain income tax position taken, or expected to be taken, on an income tax return is required to meet before being recognized in the financial statements and (2) the measurement of the income tax benefits recognized from such positions. The Company’s account policy is to classify uncertain income tax positions that are not expected to be resolved within one year as non-current income tax liabilities and to classify potential interest and penalties on uncertain tax positions as elements of the provision for income taxes on its financial statements.
New Accounting Standards Issued and Not Yet Implemented: In January 2020, the FASB issued ASU 2020-01, Investments — Equity Securities (Topic 321), Investments — Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815), which clarifies that the observable price changes in orderly transactions that should be considered when applying the measurement alternative in accordance with ASC 321 include transactions that require it to either apply or discontinue the equity method of accounting under ASC 323. ASU 2020-01 also addresses questions about how to apply the guidance in Topic 815, Derivatives and Hedging, for certain forward contracts and purchased options to purchase securities that, upon settlement or exercise, would be accounted for under the equity method of accounting. This ASU is effective for the Company beginning on January 1, 2022. The adoption of ASU 2020-01 is not expected to have a significant impact on our consolidated financial statements. We are currently evaluating the impact of this new guidance on its consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in ASC 740 and also clarifies and amends existing guidance to improve consistent application. This ASU is effective for the Entity beginning on January 1, 2022. The adoption of ASU 2019-12 is not expected to have a significant impact on the Entity’s consolidated financial statements. The Company is currently evaluating the impact of this new guidance on its consolidated financial statements.
In March 2019, the FASB issued ASU 2019-01, Leases (Topic 842): Codification Improvements, which addressed issues lessors sometimes encounter. Specifically the ASU addresses issues related to (1) determining the fair value of the underlying asset by the lessor that are not manufacturers or dealers (generally financial institutions and captive finance companies), and (2) lessors that are depository and lending institutions, which should classify principal and payments received under sales-type and direct financing leases within investing activities in the cash flow statement. The ASU also exempts both lessees and lessors from having to provide the interim disclosures required by ASC 250-10-50-3 in the fiscal year in which an entity adopts the new leases standard. In June 2020, the FASB issued ASU 2020-05, Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842) Effective Dates for Certain Entities, which delays the effective date of ASU 2019-01 for certain entities. This ASU is effective for the Company beginning on January 1, 2022. The adoption of ASU 2019-02 is not expected to have a significant impact on the Company’s consolidated financial statements. The Company is currently evaluating the impact of this new guidance on its consolidated financial statements.
16
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
| 3. | Purchase Accounting |
The Company’s acquisition of the TTS Business was accounted for in accordance with the provisions of ASC 805 Business Combination, whereby the fair value of the consideration transferred to Raytheon has been allocated to the assets acquired and the liabilities assumed at estimated fair values. The TTS Business acquisition significantly expands the Company’s value-added technology solutions and services, including defense and commercial training, mission critical support solutions, and engineering and modernization capabilities. Further, the TTS Business acquisition expands the Company’s strategy to deliver integrated and comprehensive solutions to its customers globally. The TTS Business acquisition was funded through the First Lien Term Loan and Second Lien Term Loan (Note 10), borrowings under the Company’s ABL Credit Facility (Note 10), a $75 million equity contribution by AIP, and issuance of $75 million of preferred equity (Note 3). The allocation of the fair value of the consideration transferred was recorded for accounting purposes as of the Transaction Date using inputs that are classified as Level 1, Level 2 or Level 3. Acquisition- related expenses were recognized separately from the business combination and expensed as incurred unless otherwise prescribed under U.S. GAAP.
The Company has accounted for the Transaction based on the provisions of ASC 805, in which estimated fair values of assets acquired and liabilities assumed have been provisionally assigned. The estimate of the fair value of the consideration transferred and the allocation of the consideration transferred to the assets acquired and liabilities assumed is preliminary as the Company is still gathering the necessary information required to finalize its estimates. The Company expects to finalize its estimates of fair value within one year of Transaction Date, which could result in material adjustments to the provisional amounts recorded.
These assets and liabilities include the following:
| • | Unbilled contract receivables and Advance payments and billings in excess — These amounts are recorded as provisional due to the Company seeking additional information related to contractual right-of-offset provisions. The Company expects that finalizing the provisional accounting for these amounts may result in adjustments of offsetting amounts to the current asset and the current liability. |
| • | Deferred tax amounts — These amounts are recorded as provisional due to the Company seeking additional information related to certain non-U.S. entity information, and the allocation of acquired intangible assets and goodwill to non-U.S. entities. No deferred tax amounts have been recorded related to these items. Any adjustments to the deferred tax amounts in the available measurement period would result in an increase or decrease in goodwill. |
| • | Working capital adjustment — The Transaction agreement provides for a working capital adjustment, as defined, between the Seller and the Company. Management anticipates the working capital adjustment will be settled during 2022 as scheduled in the Transaction agreement. Consideration transferred does not include any amounts related to the working capital adjustment due to uncertainty of the negotiations between the Seller and the Company. Any adjustments resulting from the working capital adjustment provisions with the Seller would result in an increase or decrease in goodwill. |
17
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
The provisional allocation of the consideration transferred to assets acquired and liabilities assumed, based on their estimated fair values on the Transaction Date were as follows ($ in thousands):
| Cash | $ | 16,985 | ||
| Accounts receivable | 58,765 | |||
| Unbilled contract receivables | 123,499 | |||
| Inventories | 2,503 | |||
| Prepaids and other current assets | 414 | |||
| Property and equipment | 30,919 | |||
| Other assets | 7,291 | |||
| Customer related intangible assets | 164,600 | |||
| Total assets | 404,976 | |||
| Accounts payable | 53,263 | |||
| Accrued salaries and benefits | 7,927 | |||
| Advance payments and billings in excess | 67,420 | |||
| Accrued other expenses | 210 | |||
| Loss contract reserves | 10,600 | |||
| Other current liabilities | 1,868 | |||
| Other long-term liabilities | 12,245 | |||
| Total liabilities | 153,533 | |||
| Goodwill | 651,225 | |||
| Total consideration transferred | $ | 902,668 |
Total consideration transferred represents the estimated fair value of $827.7 million in cash and $75.0 million of preferred stock. Buyer Transaction costs of $8.0 million were recorded as selling, general and administrative expenses in the consolidated statements of income for the period ended December 31, 2021. The Company has assessed collectability of the acquired accounts receivable and unbilled contract receivable amounts and determined that the amounts are billable and collectible as of December 31, 2021.
The preliminary fair value of the assets acquired and liabilities assumed was determined and assigned based on the following:
Property and Equipment: The depreciation replacement cost new was used to determine the fair market value of personal and real property. As a result, the carrying value of the Company’s personal and real property was established at approximately $31 million.
Intangible Assets: The multi-period excess earnings method, a form of the income approach, was used to determine fair value of the Company’s Customer Contract Relationships. Such estimations require the use of inputs that were unobservable in the market place (Level 3), including a discount rate that would be used by a market participant, projections of revenues and cash flow, among others. As a result, the Company recorded a $165 million customer contract relationship to the Company’s identifiable intangible assets. The acquired intangible assets will be amortized over the estimated weighted average period of 10 years.
Other Assets and Liabilities: The net contractual value of all other assets and liabilities approximates their fair values.
Goodwill: The residual amount of consideration transferred after allocation to the above mentioned assets acquired and liabilities assumed is allocated to goodwill. Goodwill primarily represents the assembled workforce and synergies expected to result from the acquisition.
Transition Services Agreement: In connection with the acquisition, the Company and Raytheon entered into a Transition Services Agreement, primarily involving Raytheon providing certain services to the Company related to information technology, human resources benefits and accounting services. See Note 17.
18
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
Preferred Equity: The company issued $75 million of Series A Preferred Shares to the Raytheon Company in connection with the Transaction. The preferred yield is 8% per annum, accrued daily and compounded quarterly. As of December 31, 2021, the cumulative amount of undeclared dividend payable is $0.5 million. The Series A Preferred Shares, as well as the accrued and unpaid preferred yield, become redeemable upon a Change in Control, as defined in the related agreement.
Net Working Capital: Once the net working capital negotiations are finalized, the Company will record a receivable from or a payable to the seller with an offsetting adjustment to goodwill.
| 4. | Divestiture |
Crestview Aerospace Spin-Off: On December 31, 2020, the Company completed the spin-off of substantially all of the assets and liabilities of the Crestview business to the Company’s shareholders. The spin- off was distributed on a pro-rata basis as a dividend to the Company’s shareholders of record as of December 30, 2020.
The Company spun-off net assets with a carrying amount of $55.4 million with a fair value of $32.9 million, which resulted in recording a loss on disposal of $22.5 million. The spin-off was distributed at the net asset carrying amount of $32.9 million for the period ended December 31, 2020, the effective date of the spin-off. The spun-off net assets were removed through Retained Earnings from the Company’s Consolidated Balance Sheet. The results of operations and cash flows are included in the Consolidated Statement of Operations and Consolidated Statement of Cash Flows through the effective date of the spin- off. The income before taxes associated with the spin-off entity was a $0.3 million loss for the period ended December 31, 2020. See Note 2 and Note 8 for additional information on the allocation of goodwill and subsequent impairment as a loss on disposal.
The following Net Assets were distributed in the spin-off transaction:
| Total assets | 63,861 | |||
| Total liabilities | 8,412 | |||
| Total equity | 55,449 |
Transition Services Agreement: In connection with the spin-off, the Company and Crestview Aerospace LLC entered into a Transition Services Agreement, primarily involving the Company providing certain services to Crestview Aerospace LLC related to information technology, human resources benefits and accounting services. The agreement is for a period of one year beginning January 2021 and renewable annually thereafter. See Note 17 for additional information.
| 5. | Accounting for Contracts |
The components of contracts in process are presented in the table below. The unbilled contract receivables, inventoried contract costs and unliquidated progress payments principally relate to contracts with the U.S. Government and prime contractors or subcontractors of the U.S. Government.
| Period Ended December 31, | ||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Unbilled contract receivables, gross | $ | 251,179 | $ | 75,189 | ||||
| Unbilled contract receivables, net | 251,179 | 75,189 | ||||||
| Inventoried contract costs | 498 | 692 | ||||||
| Total contracts in progress | $ | 251,677 | $ | 75,881 | ||||
19
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
Unbilled Contract Receivables. Unbilled contract receivables represent accumulated incurred costs and earned profits on contracts (revenue arrangements), which have been recorded as sales, but have not yet been billed to customers. Unbilled contract receivables arise from the cost-to-cost input method of revenue recognition that is used to record sales on certain fixed-price contracts. Unbilled contract receivables from fixed-price type contracts are converted to billed receivables when amounts are invoiced to customers according to contractual billing terms, which generally occur when deliveries or other performance milestones are completed. Unbilled contract receivables also arise from cost-plus type contracts, time-and-material type contracts and fixed-price service type contracts for revenue amounts that have not been billed by the end of the accounting period due to the timing of preparation of invoices to customers.
Inventoried Contract Costs: In accordance with contract accounting standards, the Company’s U.S. Government contractor businesses account for the portion of their general and administrative (“G&A”), independent research and development (“IRAD”) and bids and proposals (“B&P”) costs that are allowable and reimbursable indirect contract costs under U.S. Government procurement regulations on their U.S. Government contracts (revenue arrangements) as inventoried contract costs. G&A, IRAD and B&P costs are allocated to contracts for which the U.S. Government is the end customer and are charged to costs of sales when sales on the related contracts are recognized. The Company’s U.S. Government contractor businesses record the unallowable portion of their G&A, IRAD and B&P costs to expense as incurred and do not include them in inventoried contract costs.
| 6. | Inventories |
Inventories at Lower of Cost or Net Realizable Value: The table below presents the components of inventories at the lower of cost (first-in, first-out or average cost) or net realizable value. In accordance with ASC 606, all work in process relating to goods that customers do not currently control are classified within inventories on the Company’s consolidated balance sheets at December 31, 2021 and December 31, 2020. The Company establishes provisions for excess and obsolete inventories after evaluation of historical sales, current economic trends, forecasted sales, product lifecycles, and current inventory levels.
| Period ended December 31, | ||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Raw materials, components and sub-assemblies | $ | 41,830 | $ | 46,951 | ||||
| Excess and obsolete reserve | (4,112 | ) | (4,581 | ) | ||||
| Total inventories, net | $ | 37,718 | $ | 42,370 | ||||
Inventory Sale: In 2020 the Company completed the bulk sale of consignment inventory to third-party, held off-site at the buyer’s location. The sale resulted in proceeds of $0.8 million. The bulk sold was fully reserved, resulting in a significant reduction to the Excess and Obsolete reserve balance for the period ended December 31, 2020.
Government-owned Inventories: The Company has four programs where inventory purchases are billed directly to the customer and where the Company is obligated under the contract to maintain and track quantities of the government-owned inventory. These inventories are issued to the contract as required and billed to the Customer when the inventory is replenished. The Customers provide the Company with an initial inventory balance when the contract was awarded. The Company is obligated by contractual inventory schedules to return that inventory back to the Customer at the conclusion of the contract. The contractual inventory liability changes over the life of the contract based on inventory levels, contract schedule modifications caused by aircraft retirements, parts obsolescence, part substitution and changes to the aircraft life cycle repairs.
The Company actively tracks the Government’s inventory on hand versus the contractual inventory schedules for each program. Contract liabilities are not recorded due to the occurrence of significant changes to the contract schedules over the life of the program. A contract liability is not recognized until there is a final negotiated inventory listing with the customer or at the time the inventory requirement is fixed and determinable. This typically occurs at or very near to the end of a contract. A liability, if any, would be recognized at that time if the on-hand inventory value was below the required contractual inventory schedule.
20
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
| 7. | Property and Equipment |
The table below presents the components of property, plant and equipment:
| Useful Lives | Period ended December 31, | |||||||||
| ($ in thousands) | (Years) | 2021 | 2020 | |||||||
| Land | Indefinite | $ | 378 | $ | 384 | |||||
| Buildings and improvements | 4 – 13 | 8,612 | 7,956 | |||||||
| Machinery, equipment, furniture and fixtures | 2 – 9 | 47,259 | 28,996 | |||||||
| Leasehold improvements | 2 – 6 | 9,327 | — | |||||||
| Gross property and equipment | $ | 65,576 | $ | 37,336 | ||||||
| Accumulated depreciation and amortization | (18,344 | ) | (11,807 | ) | ||||||
| Property and equipment, net | $ | 47,232 | $ | 25,529 | ||||||
Available for Sale Assets: In accordance with ASC 205, Presentation of Financial Statements, long- lived assets to be sold are classified as Available for Sale when management approves their sale, a program is initiated to actively sell the asset in its present condition, at a reasonable price in relation to its fair value, and the sale of the asset is probable. In November 2020, the Company classified as Available for Sale the land and buildings associated with a specific facility in Warner Robbins, GA. These assets were sold in 2021. Assets available for sale are classified as current assets on the Company’s Balance Sheet and recorded at the lower of carrying amount or fair value less costs to sell, and are no longer depreciated.
| Period ended December 31, | ||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Available for Sale | $ | — | $ | 968 | ||||
| 8. | Goodwill and Identified Intangible Assets |
The table below summarizes the Company’s goodwill carrying value for the years ended December 31, 2021 and December 31, 2020.
| Period ended December 31, | ||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Beginning of period | $ | 240,504 | $ | 252,575 | ||||
| Recorded in connection with the Transaction | 651,225 | — | ||||||
| Goodwill allocated to spin-off | — | (12,071 | ) | |||||
| End of period | $ | 891,729 | $ | 240,504 | ||||
21
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
Identifiable intangible assets consist of the following:
| 2021 | 2020 | |||||||||||||||||||||||
| ($ in thousands) | Gross Carrying Amount | Accum. Amort. | Total | Gross Carrying Amount | Accum. Amort. | Total | ||||||||||||||||||
| Finite Lived: | ||||||||||||||||||||||||
| Customer Contract Relationships | $ | 233,100 | $ | (69,931 | ) | $ | 163,169 | $ | 68,500 | $ | (55,486 | ) | $ | 13,014 | ||||||||||
| Infinite Lived: | ||||||||||||||||||||||||
| Trademark | 70,000 | — | 70,000 | 70,000 | — | 70,000 | ||||||||||||||||||
| Ending Balance | $ | 303,100 | $ | (69,931 | ) | $ | 233,169 | $ | 138,500 | $ | (55,486 | ) | $ | 83,014 | ||||||||||
Amortization expense for acquired finite lived intangible assets of $14.5 million and $13.0 million is included in selling, general and administrative expense for the periods ended December 31, 2021 and December 31, 2020, respectively. The weighted average useful life of customer contract relationship intangible assets is 10 years.
| 9. | Loss on Spin-off of Net Assets |
On December 31, 2020, the Company recognized a loss on disposal of $22.5 million associated with the spin-off of substantially all of the assets and liabilities of the Crestview business. A review of the disposal group’s carrying value, per ASC 845, determined the disposal group’s carrying value exceeded its fair value. Accordingly, goodwill of $12.1 million and net assets of $10.4 million were written down to fair value.
| 10. | Debt |
The components of debt and a reconciliation to the carrying amount of long-term debt are presented below:
| Period ended December 31, | ||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Outstanding borrowings under ABL Credit Facility | $ | — | $ | — | ||||
| Term Loan agreement due 2027 | — | 321,750 | ||||||
| First Lien Term Loan agreement due 2028 | 925,000 | — | ||||||
| Second Lien Term Loan agreement due 2029 | 185,000 | — | ||||||
| Principal amount of long-term debt | 1,110,000 | 321,750 | ||||||
| Deferred debt issuance costs | (33,772 | ) | (6,830 | ) | ||||
| Carrying amount of long-term debt | 1,076,228 | 314,920 | ||||||
| Less current maturities | (6,938 | ) | (3,300 | ) | ||||
| Total long-term debt, less current maturities | $ | 1,069,290 | $ | 311,620 | ||||
ABL Credit Facility: On June 29, 2018, the Company entered into a $75 million, five-year secured ABL revolving credit agreement (“the ABL Credit Facility”). During 2021, the ABL Credit Facility was amended to increase the facility size to $100 million and extend the maturity date on which any outstanding obligations under the ABL Credit Facility will be due and payable to June 29, 2026.
22
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
Borrowings under the ABL Credit Facility may consist of (1) base rate loans, which shall bear interest at a rate equal to the sum of the applicable rate (as defined in the ABL Credit Facility) and the “base rate” (as defined in the ABL Credit Facility) and/or (2) Eurodollar loans, which shall bear interest at a rate equal to the sum of the applicable rate plus the “Eurodollar rate” (as defined in the ABL Credit Facility). The applicable rate for base rate loans under the ABL Credit Facility ranges from 0.75% to 1.25% per annum, and the applicable rate for Eurodollar loans ranges 1.75% to 2.25% per annum, in each case based on the average daily excess availability (as defined in the ABL Credit Facility). On both December 31, 2021 and December 31, 2020, the interest rate on the ABL facility was 4.00%.
The ABL Credit Facility includes a letter of credit sub-facility of $15 million and a swingline sub- facility of $10 million. The letter of credit and swingline sub-facilities are part of, and not in addition to the ABL Credit Facility. Swingline loans bear interest at a rate equal to base rate loans.
The Company had outstanding letters of credit to various entities, primarily for insurance matters, of $6.4 million and $6.4 million as of December 31, 2021 and December 31, 2020, respectively. The ABL Credit Facility provides for payment of a letter of credit fee equal to the applicable rate for Eurodollar loans, as well as a fronting fee of 0.125% per annum.
Availability under the ABL Credit Facility is calculated monthly based on the balances of billed accounts receivable, unbilled accounts receivable and inventory of the Company with each amount reduced by defined ineligible balances and subject to varying advance rates. The calculated amount is reduced by the outstanding amount of letters of credit and certain other availability reserves as defined in the ABL Credit Facility.
The Company had borrowing availability of $69.6 million under the ABL Credit Facility as of December 31, 2021. The ABL Credit Facility provides for the payment of a commitment fee ranging from 0.25% to 0.375% per annum on the daily unused portion of the ABL Credit Facility.
Term Loan Agreement: On June 29, 2018, the Company entered into a $330 million, seven-year secured Term Loan agreement (the “Term Loan”).
Borrowings under the Term Loan may consist of (1) base rate loans, which shall bear interest at a rate equal to the sum of the applicable rate (as defined in the Term Loan) and the “base rate” (as defined in the Term Loan) and/or (2) Eurodollar loans, which shall bear interest at a rate equal to the sum of the applicable rate plus the “Eurodollar rate” (as defined in the Term Loan). The applicable rate for base rate loans under the Term Loan ranges from 3.5% to 3.75% per annum, and the applicable rate for Eurodollar loans ranges 4.5% to 4.75% per annum, in each case based on the consolidated secured net leverage ratio (as defined in the Term Loan).
In March 2021, the Company amended the Term Loan Agreement to extend the maturity date to June 2027, modify the repayment schedule, and to lower the interest rates. The applicable rates were decreased to 3.00% and 4.00% for base rate and Eurodollar loans, respectively.
For the periods ended December 31, 2021 and December 31, 2020, the Company made scheduled principal payments of $1.6 million and $3.3 million, respectively. The outstanding Term Loan balance of $320.1 million was repaid in connection with the Transaction.
First Lien Term Loan Agreement: On the Transaction Date, the Company entered into a $925 million, seven-year secured Term Loan agreement (the “First Lien Term Loan”).
Borrowings under the First Lien Term Loan may consist of (1) base rate loans, which shall bear interest at a rate equal to the sum of the applicable rate (as defined in the First Lien Term Loan) and the “base rate” (as defined in the First Lien Term Loan) and/or (2) Eurodollar loans, which shall bear interest at a rate equal to the sum of the applicable rate plus the “Eurodollar rate” (as defined in the First Lien Term Loan). The applicable rate for base rate loans under the First Lien Term Loan ranges from 2.75% to 3.00% per annum, and the applicable rate for Eurodollar loans ranges 3.75% to 4.00% per annum, in each case based on the consolidated first lien net leverage ratio (as defined in the First Lien Term Loan). On December 31, 2021, the interest rate on the First Lien Term Loan was 4.75%.
23
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
The First Lien Term Loan provides for scheduled principal payments of $2.3 million as of the end of each calendar quarter commencing on June 30, 2022. The Company is permitted to make voluntary prepayments without premium or penalty. In addition, the Company is required to make mandatory prepayments (subject to certain carve-outs and baskets) using net proceeds upon sale of certain assets, net proceeds of certain issuances of debt, and an agreed-upon percentage of the Company’s excess cash flow as determined annually at the end of each fiscal year (beginning with the year ending December 31, 2022).
Second Lien Term Loan Agreement: On the Transaction Date, the Company entered into a $185 million, eight-year secured Second Lien Term Loan Agreement (the “Second Lien Term Loan”).
Borrowings under the Second Lien Term Loan may consist of (1) base rate loans, which shall bear interest at a rate equal to the sum of the applicable rate (as defined in the Second Lien Term Loan) and the “base rate” (as defined in the Second Lien Term Loan) and/or (2) Eurodollar loans, which shall bear interest at a rate equal to the sum of the applicable rate plus the “Eurodollar rate” (as defined in the Second Lien Term Loan). The applicable rate for base rate loans under the Second Lien Term Loan is 6.50% per annum, and the applicable rate for Eurodollar loans is 7.50% per annum. On December 31, 2021, the interest rate on the Second Lien Term Loan was 8.25%.
The Second Lien Term Loan does not require any scheduled principal payments. The Company is permitted to make voluntary prepayments. However, the Company will be required to pay a premium of 2% or 1% of the prepayment amount if such prepayment occurs prior to the first or second anniversaries of the Transaction Date, respectively. In addition, the Company is required to make mandatory prepayments (subject to certain carve-outs and baskets) using net proceeds upon sale of certain assets, net proceeds of certain issuances of debt, and an agreed-upon percentage of the Company’s excess cash flow as determined annually at the end of each fiscal year (beginning with the year ending December 31, 2022).
Future scheduled principal payments on the First Lien and Second Lien Term Loans as of December 31, 2021 are as follows:
| ($ in thousands) | ||||
| 2022 | $ | 6,938 | ||
| 2023 | 9,250 | |||
| 2024 | 9,250 | |||
| 2025 | 9,250 | |||
| 2026 | 9,250 | |||
| Thereafter | 1,066,062 | |||
| Total | $ | 1,110,000 | ||
Security: The ABL Credit Facility, First Lien Term Loan and Second Lien Term Loan are secured by substantially all the assets of the Company including (a) a pledge of (i) all of the capital stock of the Company and (ii) all the equity interests held by the Company of each subsidiary (subject to certain exceptions) and (b) security interests in, and mortgages on, substantially all tangible and intangible assets of the Company. The administrative agents under the ABL Credit Facility, First Lien Term Loan and Second Lien Term Loan have entered into an intercreditor agreement which outlines the relative priority of the liens established under each agreement, as well as certain other rights, priorities and interests.
Covenants: The ABL Credit Facility, First Lien Term Loan and Second Lien Term Loan contain restrictive covenants which limit, subject to certain exceptions, among other things, the ability of the Company and its subsidiaries to incur additional indebtedness; create liens; make investments or loans; consolidate, merge or consolidate or dispose of assets; enter into certain transactions with affiliates; pay dividends and repurchase stock. At December 31, 2021, the Company was in compliance with its restrictive covenants.
24
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
During periods when excess availability under the ABL Credit Facility is less than the greater of 10% of the amount available under the borrowing base or $10.0 million, a financial covenant is triggered which requires the Company to maintain a minimum Fixed Charge Coverage Ratio. The financial covenant was not applicable at any time during the period ended December 31, 2021 and December 31, 2020.
| 11. | Income Taxes |
The provision for income taxes is summarized in the table below:
| Period ended December 31, | ||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Domestic | $ | 5,860 | $ | (13,457 | ) | |||
| Foreign | 117 | (71 | ) | |||||
| Total provision for income taxes | $ | 5,977 | $ | (13,528 | ) | |||
The components of the Company’s current and deferred portions of the provision for income taxes are presented in the table below:
| Period ended December 31, | ||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Current income tax provision: | ||||||||
| Federal | $ | — | $ | (216 | ) | |||
| State and local | 1,606 | 384 | ||||||
| Foreign | 117 | (71 | ) | |||||
| Sub-total | 1,723 | 97 | ||||||
| Deferred income tax provision: | ||||||||
| Federal | 3,289 | (11,723 | ) | |||||
| State and local | 965 | (1,902 | ) | |||||
| Foreign | — | — | ||||||
| Sub-total | 4,254 | (13,625 | ) | |||||
| Total provision for income taxes | $ | 5,977 | $ | (13,528 | ) | |||
The tax effect of temporary differences that gave rise to deferred tax assets and liabilities are summarized in the table below:
| Period ended December 31, | ||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Deferred tax assets: | ||||||||
| Inventory reserve | $ | 451 | $ | 503 | ||||
| Compensation and benefits | 1,939 | 3,439 | ||||||
| Interest expense carryforwards | 2,205 | — | ||||||
| Loss carryforwards | 4,356 | 3,168 | ||||||
| Intangible assets other than goodwill | 11,549 | 8,911 | ||||||
| Other accrued expenses and reserves | 7,816 | 10,608 | ||||||
| Deferred tax assets | 28,316 | 26,629 | ||||||
| Less valuation allowance | — | — | ||||||
| Deferred tax assets, net of valuation allowance | 28,316 | 26,629 | ||||||
| Deferred tax liabilities: | ||||||||
| Goodwill | (13,464 | ) | (9,113 | ) | ||||
| Property and equipment | (6,556 | ) | (4,966 | ) | ||||
| Deferred tax liabilities | (20,020 | ) | (14,079 | ) | ||||
| Total net deferred tax asset | $ | 8,296 | $ | 12,550 | ||||
25
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in those jurisdictions during the periods in which those temporary differences become deductible. The Company considers the scheduled reversal of deferred tax liabilities (including the impact of available carryforward periods), projected future taxable income, and tax-planning strategies in making this assessment. Current projections of income before income taxes are sufficient for the Company to believe that it is more likely than not that it will realize the benefits of those certain deductible differences, and therefore, did not record a valuation allowance as of December 31, 2021 or December 31, 2020.
Net operating loss (“NOL”) carryforwards for federal and state income tax purposes as of December 31, 2021 and 2020 are summarized in the table below:
| Period ended December 31, | ||||||||||||||||
| 2021 | 2020 | |||||||||||||||
| ($ in thousands) | Federal | State | Federal | State | ||||||||||||
| NOL carryforwards, beginning of period | $ | 14,143 | $ | 1,507 | $ | 26,281 | $ | 2,698 | ||||||||
| NOLs generated | 6,100 | 474 | ||||||||||||||
| NOLs absorbed | — | — | (12,138 | ) | (1,191 | ) | ||||||||||
| NOLs, end of period | $ | 20,243 | $ | 1,981 | $ | 14,143 | $ | 1,507 | ||||||||
Federal NOLs can be carried forward indefinitely. State NOLs will expire, if unused, beginning in 2028 and ending in 2040.
At December 31, 2021 and December 31, 2020, the Company’s balance sheet reflected liabilities for income tax uncertainties of $0.0 million. In accordance with ASC 740-10, Accounting for Uncertainty in Income Taxes, the Company’s policy is to recognize interest and penalties related to unrecognized tax benefits through interest expense and other expense (income), respectively, in the consolidated statements of operations.
The Company is subject to taxation in the United States and various states and foreign jurisdictions. The Company’s income tax returns for the period ended December 31, 2020 are generally subject to examination through October 2024. The Company’s income tax returns for the period ended December 31, 2021 have not yet been filed. Once filed, such income tax returns will be subject to examination by tax authorities for a minimum of three years.
26
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
| 12. | Stock Option Plan |
Under the Company’s Equity Incentive Plan (the Plan), non-qualified options to purchase common shares of Vertex Aerospace Services Holding Corp. are granted by the Board of Directors to the Company’s directors, officers and employees. Stock options are granted at exercise prices equal to the estimated fair market value at the issue date and expire at the earlier of the tenth anniversary of the Date of Grant, or termination of employment date. Under the terms of the Plan, the option holder can elect to receive either a cash payout equivalent to the excess of the then fair market value of the common shares over the exercise price of the option, or common shares upon exercise of the vested options. Twenty five percent (25%) of the optioned shares will be eligible to vest on each anniversary of the date of grant over a period of four years following the date hereof, provided that, upon the occurrence of a change of control, as defined in the Plan, all such units shall immediately become eligible to vest at the time of such change of control.
The following assumptions were used to estimate the fair value of the stock option awards granted and outstanding:
| Dividend yield | Nil | |||
| Expected volatility | 41.34 | % | ||
| Risk free interest rate | .68 | % | ||
| Expected life of options (in years) | 5.25 | |||
| Weighted-average fair value | $ | 401.74 |
During 2018, 17,201 options were granted with an exercise price of $1,000 per option. No options were granted during 2019. During 2020, 7,785 options were granted with an exercise price of $1,105 per option. During 2021, 1,256 options were granted with an exercise price of $1,061 per option. None of the outstanding 17,201 options issued in 2018, the outstanding 7,785 options issued in 2020, or the outstanding 1,256 options issued in 2021 were vested or exercisable in 2021 or 2020. As a result, no liability exists as of December 31, 2021, or as of December 31, 2020, and no related compensation expense was recorded during 2021 or 2020.
| 13. | Declaration of Dividends |
On November 6, 2020, the Board approved that the Company make (1) a dividend on December 31, 2020 of the net assets described as the Crestview spin-off entity (“Crestview Dividend”), (2) a cash dividend on January 4, 2021 in the aggregate amount of $91.2 million (“Cash Dividend 1”), (3) a cash dividend on January 4, 2021 in the aggregate amount of $8.8 million (“Cash Dividend 2”), and, together with Cash Dividend 1, the (“Cash Dividends”). The Crestview dividend was payable to the stockholders of the Company as of December 30, 2020, whereas the Cash Dividends were payable to the stockholders of the Company as of January 3, 2021.
The Cash Dividends were reported as a $100 million Dividends Payable on December 31, 2020 for the cash dividends declared and unpaid. The Cash Dividends declared in 2020 were paid in January 2021.
| 14. | Employee Benefit Plans |
Defined Contribution Plan: The Company maintains a defined contribution 401(k) employee benefit plan (the “Benefit Plan”) under which substantially all U.S. employees are eligible to participate. Under the terms of the Benefit Plan, eligible employees may contribute tax-deferred compensation deduction amounts up to the maximum amount that Internal Revenue Service regulations permit. The Benefit Plan provides for a discretionary Company match program based on a certain percentage of the eligible employee’s compensation which may be suspended or discontinued at any time. During the periods ended December 31, 2021 and December 31, 2020, the Company funded matching contributions of $5.3 million and $5.2 million, respectively.
Multi-employer Plan: The Company, in certain of its U.S. operating locations, participates in a multi- employer pension plan under an industry-wide agreement with a trade organization. The plan provides defined benefits to substantially all employees covered by collective bargaining agreements that have been negotiated with the related trade organization. Approximately 69% and 53% of the Company’s total labor hours for customers were completed by workers subject to this collective bargaining agreement during the periods ended December 31, 2021 and December 31, 2020, respectively.
27
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
In connection with this collective bargaining agreement with the trade organization, the Company participates with other companies in the union’s multi-employer pension plan. The plan covers substantially all of the Company’s employees who are members of such union. Under the agreement, the Company pays specified wages to covered employees, observes designated workplace rules and makes payments to the multi-employer pension plan rather than administering the funds on behalf of these employees. The Company recognizes expense in connection with this plan as contributions are funded. The Company made contributions to the multi-employer pension plan and recognized expense during the periods ended December 31, 2021 and December 31, 2020 of $10.4 million and $9.3 million, respectively. The financial risks of participating in multi-employer defined benefit pension plans are different from single-employer defined benefit pension plans in the following respects: (1) assets contributed to the multiemployer plan by one employer may be used to provide benefits to employees of other participating employers, (2) if a participating employer discontinues contributions to a plan, the unfunded obligations of the plan may be borne by the remaining participating employers and (3) if a participating employer chooses to stop participating in a plan, a withdrawal liability may be created based on the unfunded vested benefits for all employees in the plan.
The Company may receive future funding deficiency demands from the multi-employer pension plan to which the Company currently contributes in the form of a withdrawal claim from such plans. The Company is unable to estimate the amount of any potential future funding deficiency demands, because: (i) the actions of each of the other contributing employers in the plan have an effect on each of the other contributing employers, (ii) the development or implementation of a rehabilitation plan by the trustees and approval by the applicable U.S. regulatory agency is not predictable and (iii) the allocation of fund assets and return assumptions by trustees are variable, as are actual investment returns relative to the plan assumptions. Accordingly, since a reasonable estimate or probable outcome cannot be determined and, pursuant to certain accounting principles, the Company has no reserves recorded in its consolidated balance sheets for any potential funding obligations related to the plan. Balance sheet as of December 31, 2021 includes $5.4 million of pension benefit obligation associated with a pension plan in Germany and is included in Other long-term liabilities.
| 15. | Commitments and Contingencies |
Non-Cancellable Operating Leases: The Company rents certain equipment and facilities under operating leases. Certain major plant facilities and equipment are furnished by the U.S. Government under short-term or cancelable arrangements. The total rental expense under non-cancellable operating leases was $3.0 million and $1.3 million for the periods ended December 31, 2021 and December 31, 2020, respectively. Future minimum lease commitments at December 31, 2021 for long-term non-cancelable operating leases are $1.5 million in 2022.
Procurement Regulations: A substantial majority of the Company’s revenues are generated from providing products and services under legally binding agreements or contracts with the U.S. Government, foreign government customers and state and local governments. U.S. Government contracts are subject to extensive legal and regulatory requirements, and, from time to time, agencies of the U.S. Government perform audits to determine whether such contracts were and are being conducted in accordance with these requirements. The Company is currently cooperating with the U.S. Government on several audits from which civil, criminal or administrative proceedings have or could result and give rise to fines, penalties, compensatory and treble damages, restitution and/or forfeitures. The Company does not currently anticipate that any of these audits will have a material adverse effect, individually or in the aggregate, on its consolidated financial position, results of operations or cash flows. Under U.S. Government regulations, an indictment of the Company by a federal grand jury, or an administrative finding against the Company as to its present responsibility to be a U.S. Government contractor or subcontractor, could result in the Company being suspended for a period of time from eligibility for awards of new government contracts or task orders or in a loss of export privileges. A conviction, or an administrative finding against the Company that satisfies the requisite level of seriousness, could result in debarment from contracting with the federal government for a specified term. In addition, all of the Company’s U.S. Government contracts: (1) are subject to audit and various pricing and cost controls, (2) include standard provisions for termination for the convenience of the U.S. Government or for default and (3) are subject to cancellation if funds for contracts become unavailable. Foreign government contracts generally include comparable provisions relating to terminations for convenience or default, as well as other procurement clauses relevant to the foreign government.
28
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
Litigation Matters: The Company is also subject to litigation, proceedings, claims or assessments and various contingent liabilities incidental to its businesses, including the matter specified below. Furthermore, in connection with certain business acquisitions, the Company has assumed some or all claims against, and liabilities of, such acquired businesses, including both asserted and unasserted claims and liabilities.
In accordance with the accounting standard for contingencies, the Company records a liability when management believes that it is both probable that a liability has been incurred and the Company can reasonably estimate the amount of the loss. Generally, the loss is recorded at the amount the Company expects to resolve the liability. Amounts recoverable from insurance contracts or third parties are recorded as assets when deemed probable. At December 31, 2021, the Company did not record any amounts for recoveries from insurance contracts or third parties in connection with the amount of liabilities recorded for pending and threatened litigation. Legal defense costs are expensed as incurred. The Company believes it has recorded adequate provisions for its litigation matters. The Company reviews these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. While it is reasonably possible that an unfavorable outcome may occur, unless otherwise stated, the Company believes that it is not probable that a loss has been incurred. Although the Company believes that it has valid defenses with respect to legal matters and investigations pending against it, the results of litigation can be difficult to predict, particularly those involving jury trials. Therefore, it is possible that one or more of these contingencies could have a material impact on the financial position, results of operations or cash flows of the Company in future periods.
| 16. | Disaggregation of Net Sales |
The Company disaggregates its sales from contracts with customers by: (1) end customer and (2) contract type. The Company believes these factors affect the nature, amount, timing and uncertainty of the Company’s revenue and cash flows.
Sales by End Customer: Direct sales to the end customer represented approximately 95% of the Company’s consolidated sales in the year ended December 31, 2021, and 89% in the year ended December 31, 2020. Indirect sales as a subcontractor or supplier represented the remaining 5% in the year ended December 31, 2021 and 11% in the year ended December 31, 2020. The table below presents total net sales disaggregated by end customer.
| Period ended December 31, | ||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Total DoD | $ | 731,790 | $ | 703,428 | ||||
| Other U.S. Government | 56,308 | 51,217 | ||||||
| Total U.S. Government | 788,098 | 754,645 | ||||||
| Foreign governments | 6,046 | 2,523 | ||||||
| Commercial | 19,015 | 62,772 | ||||||
| Total | $ | 813,159 | $ | 819,940 | ||||
29
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
Sales by Contract Type: Generally, the sales price arrangements for the Company’s contracts are either fixed price, cost-plus or time-and-material type. Fixed-price type contracts generally offer higher profit margin potential than cost-plus type or time-and-material type contracts due to the greater levels of risk assumed on a fixed price type contract. The table below presents total net sales disaggregated by contract type.
| Period ended December 31, | ||||||||
| ($ in thousands) | 2021 | 2020 | ||||||
| Fixed-price | $ | 693,501 | $ | 760,513 | ||||
| Cost-plus | 98,466 | 51,217 | ||||||
| Time-and-material | 21,192 | 8,210 | ||||||
| Total | $ | 813,159 | $ | 819,940 | ||||
On a fixed-price type contract, the Company agrees to perform the contractual statement of work for a predetermined sales price. On a cost-plus type contract, the Company is paid its allowable incurred costs plus a profit which can be fixed or variable depending on the contract’s fee arrangement up to predetermined funding levels determined by the customer. Cost-plus type contracts with award and incentive fee provisions are the Company’s primary variable contract fee arrangement. On a time-and-material type contract, the Company is paid on the basis of direct labor hours expended at specified fixed-price hourly rates (that include wages, overhead, allowable general and administrative expenses and profit) and materials at cost.
Substantially all of the Company’s cost-plus type contracts and time-and-material type contracts are with U.S. Government customers, while sales to foreign government and commercial customers are generally transacted under fixed-price sales arrangements and are included in the Company’s fixed-price contract type sales.
| 17. | Related Party Transactions |
Advisory Services Agreement with AIP: The Company has entered into an advisory services agreement with AIP. Pursuant to the agreement, certain financial advisory, monitoring and oversight activities are performed for the Company. The Company does not pay a fee for these services, but does reimburse AIP for reasonable travel and other out-of-pocket expenses incurred in connection with the provision of the services. The Company also provides customary indemnification to AIP. Fees paid under this agreement totaled $0.8 million and $1.3 million for the periods ended December 31, 2021 and December 31, 2020, respectively, and were included in selling, general and administrative expenses.
Transition Services Agreement: On December 31, 2020, in conjunction with the spin-off of the Crestview Aerospace LLC (Crestview) transaction described in Note 4, the Company executed a Transition Services Agreement (TSA) with Crestview, primarily involving the Company providing certain services to Crestview Aerospace related to information technology, human resources benefits and accounting services. This TSA has an effective date of January 1, 2021. For the year ended December 31, 2021, the Company recorded $5.5 million of income related to the TSA with Crestview; and is recorded as a reduction in cost of sales.
On December 6, 2021, in conjunction with the Transaction described in Note 1 and Note 3, the Company executed a Transition Services Agreement (Raytheon Company TSA) with Raytheon Company, primarily involving Raytheon Company providing certain services to the Company related to information technology, human resources benefits and accounting services. This Raytheon Company TSA has an effective date of December 6, 2021. For the year ended December 31, 2021, the Company recorded $2.0 million of expense related to the Raytheon Company TSA; and is recorded as a component of cost of sales.
30
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
| 18. | Fair Value |
Accounting principles generally accepted in the U.S. define fair value as the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The authoritative guidance discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). These valuation techniques are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. As a basis for evaluating such inputs, a three-tier value hierarchy prioritizes the inputs used in measuring fair value as follows:
Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets.
Level 2: Observable inputs other than quoted prices that are directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets; quoted prices for similar or identical assets or liabilities in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.
Nonrecurring Fair Value Measurements. The Company’s nonfinancial assets which are measured at fair value on a nonrecurring basis include property, plant and equipment, goodwill, intangible assets and certain other assets.
The Company’s goodwill and indefinite-lived intangibles are fair valued using discounted cash flows and market multiple methods. Goodwill impairment testing requires significant use of judgment and assumptions including the identification of reporting units; the assignment of assets and liabilities to reporting units; and the estimation of future cash flows, business growth rates, terminal values and discount rates. The testing of indefinite-lived intangibles under established guidelines for impairment also requires significant use of judgment and assumptions, such as the estimation of cash flow projections, terminal values royalty rates, contributory cross charges, where applicable, and discount rates.
The following table summarizes the assets that are measured at fair value on a non-recurring basis at December 31, 2021 and December 31, 2020 (in thousands). This includes the fair value measurement performed after the Transaction was completed.
| December 31, | December 31, | |||||||||||
| 2021 | 2020 | Level 3 | ||||||||||
| Goodwill | $ | 891,729 | $ | 240,504 | $ | 891,729 | ||||||
The Company reviews property, plant and equipment for impairment whenever events or circumstances indicate that carrying amounts may not be recoverable through future undiscounted cash flows. If the Company concludes that impairment exists, the carrying amount is reduced to fair value.
31
VERTEX AEROSPACE SERVICES HOLDING
CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021
| 19. | Covid-19 |
On January 30, 2020, the World Health Organization declared the coronavirus outbreak (COVID-19) a “Public Health Emergency of International Concern” and on March 11, 2020, declared COVID-19 a pandemic. The impact of COVID-19 could negatively impact the Company’s operations, suppliers or other vendors, and customer base. The operations for the Company’s services could be negatively impacted by the on-going regional and global impact of COVID-19, including stop-work orders on existing contract work for an unknown period of time. Any quarantines, labor shortages or other disruptions to the Company’s operations, or those of their customers, may adversely impact the Company’s revenues, ability to provide its services and operating results. In addition, a significant outbreak of epidemic, pandemic or contagious diseases in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, including the geographical area in which the Company operates, resulting in an economic downturn that could affect demand for its services. The Company’s workforce has been designated as Critical Infrastructure in the Defense Industrial Base Sector by the Department of Homeland Security. As such, the Department of Defense has informed the Company that it is expected to maintain normal work schedules and continue providing products and services as required under its contracts while following guidance to limit disease spread from the Centers for Disease Control and Prevention, as well as State and local government officials. Through December 31, 2021, no material changes have occurred in the Company’s operations. The extent to which the coronavirus impacts the Company’s results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus and actions taken to contain the coronavirus or its impact, among others.
| 20. | Subsequent Events |
On March 7, 2022, the Company entered into an agreement and plan of merger with Vectrus, Inc. (“Vectrus”), a facility and logistics services company providing base operations support, supply chain and logistics, IT mission support, engineering and digital integration, security, and maintenance services in 205 locations in 28 countries. Vectrus generated sales of approximately $1.8 billion in 2021. Under the terms of the merger agreement, the Company’s shareholders will own approximately 62% of the combined company and Vectrus shareholders will own approximately 38% of the combined company. The transaction is expected to close in the third quarter of 2022, subject to the satisfaction of customary closing conditions, including receipt of regulatory and Vectrus shareholder approvals.
The Company has evaluated subsequent events through April 13, 2022, the date that the consolidated financial statements were available to be issued, and concluded no events, other than those disclosed in these consolidated financial statements, had occurred that would require recognition or disclosure in these consolidated financial statements and notes.
32
Vertex Aerospace Services Holding Corp.
Consolidated Financial Statements
For the Years Ended December 31, 2020
and December 31, 2019
33
Table of Contents
| Page | ||
| Independent auditor’s report | 35 | |
| Financial statements | ||
| Consolidated balance sheets | 36 | |
| Consolidated statements of operations | 37 | |
| Consolidated statements of changes in stockholders’ equity | 38 | |
| Consolidated statements of cash flows | 39 | |
| Notes to the consolidated financial statements | 40 |
34
Independent Auditor’s Report
Board of Directors
Vertex Aerospace Services Holding Corp.
Report on the Financial Statements
We have audited the accompanying consolidated financial statements of Vertex Aerospace Services Holding Corporation and its subsidiaries (the Company), which comprise the consolidated balance sheets as of December 31, 2020 and 2019, the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the years ended December 31, 2020 and 2019, and the related notes to the consolidated financial statements (collectively, the financial statements).
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Vertex Aerospace Services Holding Corporation and its subsidiaries as of December 31, 2020 and 2019, and the results of their operations and their cash flows for the years ended December 31, 2020 and 2019 in accordance with accounting principles generally accepted in the United States of America.
Birmingham, Alabama
March 31, 2021
35
Vertex Aerospace Services Holding Corp.
Consolidated Balance Sheets
(in thousands)
| As of December 31, 2020 | As of December 31, 2019 | |||||||
| ASSETS | ||||||||
| Cash | $ | 115,528 | $ | 83,730 | ||||
| Accounts receivable, net | 18,286 | 41,662 | ||||||
| Unbilled contract receivables, net | 75,189 | 104,591 | ||||||
| Inventories, net | 42,370 | 40,015 | ||||||
| Prepaids and other current assets | 5,185 | 8,844 | ||||||
| Available for sale assets | 968 | — | ||||||
| Total current assets | 257,526 | 278,842 | ||||||
| Property and equipment, net | 25,529 | 55,411 | ||||||
| Intangible assets, net | 83,014 | 96,027 | ||||||
| Goodwill | 240,504 | 252,575 | ||||||
| Deferred tax assets, net | 12,550 | — | ||||||
| Other long-term assets | 1,199 | 1,426 | ||||||
| Total assets | $ | 620,322 | $ | 684,281 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Accounts payable | $ | 70,047 | $ | 77,735 | ||||
| Accrued salaries and benefits | 19,734 | 21,217 | ||||||
| Advance payments and billings in excess | 14,104 | 32,454 | ||||||
| Other accrued expenses | 8,238 | 10,020 | ||||||
| Current portion of long-term debt | 3,300 | 3,300 | ||||||
| Current portion of loss contract reserve | 17,923 | 17,766 | ||||||
| Dividends payable | 100,000 | — | ||||||
| Other current liabilities | 1,599 | 6,395 | ||||||
| Total current liabilities | 234,945 | 168,887 | ||||||
| Long-term debt | 311,620 | 313,741 | ||||||
| Long-term portion of loss contract reserve | 16,345 | 30,149 | ||||||
| Other long-term liabilities | 5,467 | 2,433 | ||||||
| Total liabilities | 568,377 | 515,210 | ||||||
| Stockholders’ Equity | ||||||||
| Stockholders’ equity (common stock, $.01 par value, 251,332 and 251,457 shares authorized, respectively; 226,220 and 226,345 shares issued and outstanding, respectively; 125 shares repurchased and retired) | 2 | 2 | ||||||
| Additional paid in capital | 226,218 | 226,343 | ||||||
| Retained earnings | (174,275 | ) | (57,274 | ) | ||||
| Total stockholders’ equity | 51,945 | 169,071 | ||||||
| Total liabilities and stockholders’ equity | 620,322 | 684,281 | ||||||
See notes to consolidated financial statements
36
Vertex Aerospace Services Holding Corp.
Consolidated Statement of Operations
(in thousands)
| Year
Ended December 31, 2020 | Year
Ended December 31, 2019 | |||||||
| Revenues: | ||||||||
| Sales | $ | 819,940 | $ | 933,622 | ||||
| Cost of sales | 726,776 | 858,323 | ||||||
| Gross profit | 93,164 | 75,299 | ||||||
| Operating costs and expenses: | ||||||||
| Selling, general and administrative expenses | 49,530 | 103,911 | ||||||
| Operating income (loss) | 43,634 | (28,612 | ) | |||||
| Other expenses: | ||||||||
| Loss on spin-off of net assets (Note 4 and 9) | (22,509 | ) | (2,623 | ) | ||||
| Interest expense, net | (18,693 | ) | (23,028 | ) | ||||
| Total other expenses | (41,202 | ) | (25,651 | ) | ||||
| Income (loss) before income taxes | 2,432 | (54,263 | ) | |||||
| Income tax benefit (expense) | 13,528 | 609 | ||||||
| Net income (loss) | $ | 15,960 | $ | (53,654 | ) | |||
See notes to consolidated financial statements
37
Vertex
Aerospace Services Holding Corp.
Consolidated Statements of Changes in Stockholders’ Equity
(in thousands)
| Common Stock | Additional Paid in | Retained | Total Shareholders’ | |||||||||||||||||
| Shares | Value | Capital | Earnings | Equity | ||||||||||||||||
| Beginning balance, December 31, 2018 | 226,000 | $ | 2 | $ | 225,998 | $ | (3,620 | ) | $ | 222,380 | ||||||||||
| Contributions by stockholders | 345 | — | 345 | — | 345 | |||||||||||||||
| Net loss | — | — | — | (53,654 | ) | (53,654 | ) | |||||||||||||
| Ending balance, December 31, 2019 | 226,345 | $ | 2 | $ | 226,343 | $ | (57,274 | ) | $ | 169,071 | ||||||||||
| Shares repurchased and retired | (125 | ) | — | (125 | ) | — | (125 | ) | ||||||||||||
| Dividend declared | — | — | — | (100,000 | ) | (100,000 | ) | |||||||||||||
| Crestview spin-off | — | — | — | (32,961 | ) | (32,961 | ) | |||||||||||||
| Net income | — | — | — | 15,960 | 15,960 | |||||||||||||||
| Ending balance, December 31, 2020 | 226,220 | $ | 2 | $ | 226,218 | $ | (174,275 | ) | $ | 51,945 | ||||||||||
See notes to consolidated financial statements
38
Vertex Aerospace Services
Holding Corp.
Consolidated Statements of Cash Flows
(in thousands)
| Year
Ended December 31, 2020 | Year
Ended December 31, 2019 | |||||||
| Cash flows from operating activities: | ||||||||
| Net income (loss) | $ | 15,960 | $ | (53,654 | ) | |||
| Adjustments to reconcile net income (loss) to net cash flows provided by operating activities: | ||||||||
| Depreciation of property and equipment | 10,487 | 5,427 | ||||||
| Amortization of intangibles | 13,013 | 31,826 | ||||||
| Goodwill impairment charge | — | 60,782 | ||||||
| Bad debt expense (recovery) | (4,465 | ) | 12,495 | |||||
| Inventory obsolescence reserve | (16,126 | ) | (1,250 | ) | ||||
| Amortization of software licensing fees | 3,843 | — | ||||||
| Amortization of deferred financing costs | 1,179 | 1,181 | ||||||
| Loss on spin-off of net assets (Note 9) | 22,509 | 2,623 | ||||||
| Deferred tax assets, net | (12,550 | ) | — | |||||
| Loss contract provision | (13,647 | ) | (36,299 | ) | ||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | 23,029 | (574 | ) | |||||
| Unbilled contract receivables, net | 5,420 | 40,904 | ||||||
| Inventories | 12,748 | 4,231 | ||||||
| Prepaids and other current assets | (234 | ) | (3,221 | ) | ||||
| Available for sale assets | (968 | ) | — | |||||
| Other assets | 227 | — | ||||||
| Accounts payable | (3,084 | ) | 3,351 | |||||
| Accrued salaries and benefits | 236 | (10,121 | ) | |||||
| Advance payments and billings in excess | (17,190 | ) | 12,678 | |||||
| Accrued transition services costs | — | (18,882 | ) | |||||
| Other accrued expenses | (1,232 | ) | (3,140 | ) | ||||
| Contract rate reserve | — | (722 | ) | |||||
| Other liabilities | (1,382 | ) | (653 | ) | ||||
| Net cash provided by operating activities | 37,773 | 46,982 | ||||||
| Cash flows from investing activities: | ||||||||
| Purchase of property and equipment | (2,550 | ) | (16,885 | ) | ||||
| Proceeds on disposition of property and equipment | — | 848 | ||||||
| Receivable from seller | — | 19,847 | ||||||
| Net cash (used in) provided by investing activities | (2,550 | ) | 3,810 | |||||
| Cash flows from financing activities: | ||||||||
| Principal payments on long term debt | (3,300 | ) | (5,961 | ) | ||||
| Stock (repurchased from) purchased by stockholders | (125 | ) | 345 | |||||
| Net cash used in financing activities | (3,425 | ) | (5,616 | ) | ||||
| Net increase in cash | 31,798 | 45,176 | ||||||
| Cash, beginning of period | 83,730 | 38,554 | ||||||
| Cash, end of period | $ | 115,528 | $ | 83,730 | ||||
| Supplemental disclosures of cash flow information | ||||||||
| Cash paid during the period for: | ||||||||
| Interest | $ | 17,382 | $ | 23,224 | ||||
| Income taxes | 746 | 1,725 | ||||||
| Supplemental schedule of noncash activity related to purchase of business: | ||||||||
| Goodwill measurement period adjustment for loss contract reserve | $ | — | $ | 80,276 | ||||
| Supplemental schedule of non-cash investing and financing activities: | ||||||||
| Dividend declared and unpaid | $ | 100,000 | — | |||||
| Spin-off of net assets | 32,961 | — | ||||||
See notes to consolidated financial statements
39
VERTEX AEROSPACE SERVICES HOLDING CORP.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2020
| 1. | Description of the Business |
Vertex Aerospace Services Holding Corp. (“Holding”) was incorporated in 2018 under the laws of Delaware by an affiliate of American Industrial Partners Capital Fund VI, L.P. (“AIP”) to facilitate the acquisition of 100% of the voting interest of the business of Vertex Aerospace, Crestview Aerospace, TCS Aerospace and various other assets from L-3 Communications Integrated Systems L.P. and L-3 Technologies, Inc. (collectively referred to herein as “L3”). The acquisition was completed on June 29, 2018.
Holding and its consolidated subsidiaries (collectively referred to herein as the “Company”) provide aviation and aerospace technical services, managing and servicing fixed- and rotary-wing aircraft primarily for government customers by providing logistics support, maintenance, repair, overhaul services and supply chain management. The Company also provides aircraft modification, aero structures fabrication and assembly to customers including the U.S. Government (primarily the Department of Defense, or “DoD”) and commercial and original equipment manufacturers by providing parts, facilities, technology and experience for the manufacture and modification of aircrafts. In addition, the Company designs, develops, integrates, tests, modifies and provides documentation for every aspect of aircraft and avionics hardware and software systems to address critical needs of the U.S. military’s conventional and Special Operations forces.
On December 31, 2020, the Company distributed substantially all of the assets and liabilities of its Crestview Aerospace business to the Company’s shareholders in a spin-off transaction. See Note 4 for additional information.
| 2. | Summary of Significant Accounting Policies |
Accounting Periods: The Company has adopted the calendar year as its accounting period.
Principles of Consolidation: The Company’s financial statements include the accounts of Holding and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
The Company’s wholly owned subsidiaries are listed below. Unless otherwise noted, all are 100% owned and incorporated in Delaware.
Vertex Aerospace Services Corp
Vertex Aerospace LLC
Crestview Aerospace LLC (see Note 4 for additional information)
Vertex Aircraft Integration and Sustainment LLC (formerly TCS Aerospace LLC)
Army Sustainment LLC
Flight International Aviation LLC
Vector International Aviation LLC
Vertex Global Aerospace Service LLC (100% control; incorporated in United Arab Emirates)
Use of Estimates: The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of sales and cost of sales during the reporting period. The most significant of these estimates and assumptions relate to sales, profit and loss recognition for performance obligations satisfied over time, fair values of assets acquired and liabilities assumed in business combinations, market values for inventories reported at lower of cost or net realizable value, income taxes, including the valuations of deferred tax assets, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill. Changes in estimates are reflected in the periods during which they become known. Actual amounts may differ from these estimates and could differ materially.
40
Cash and Cash Equivalents: The Company considers all highly liquid investments with an original maturity date of less than three months when purchased to be cash equivalents. The Company maintains cash and cash equivalents in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any significant losses in such accounts and believes it is not exposed to any significant risks on cash. At December 31, 2020 and December 31, 2019, the Company had no cash equivalents.
Revenue Recognition: The Company adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, as amended (commonly referred to as Accounting Standards Codification (“ASC”) 606), for revenue recognition purposes.
The majority of the Company’s consolidated net sales are generated from long-term contracts with customers that require it to maintain, repair or overhaul aircraft. These contracts are primarily with agencies of, and prime system contractors to, the U.S. Government and foreign governments and are generally priced on a fixed-price, cost-plus or time-and-material type basis. Substantially all of the Company’s cost- plus and time-and-material type contracts are with the Department of Defense (“DoD”). Certain of the Company’s contracts with the U.S. Government are multi-year contracts incrementally funded by the customer. The transaction price for these incrementally funded contracts includes contract value amounts not yet funded by the U.S. Government when the Company has a firm order for the goods or services and it is probable that the customer will fund such amounts. In assessing probability, the Company considers, among other factors, the period of time before contract funding is expected, communication from the customer that indicates funding will be obtained and the Company’s history of receiving funding under the current contract or previous similar contracts. The Company also generates sales, to a lesser extent, from contracts with commercial and government customers for standard product and service offerings, which are priced on a firm fixed basis. See Note 16 for additional information regarding the composition of the Company’s net sales.
The Company records sales for a contract when it has the approval and commitment of all parties, the contract identifies the rights of the parties and payment terms, the contract has commercial substance and collectability of the consideration is probable.
To determine the proper revenue recognition method, the Company first evaluates each of its contractual arrangements to identify its performance obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. Some of the Company’s contracts have a single performance obligation because the promise to transfer the individual good or service is not separately identifiable from other promises within the contract and is, therefore, not distinct. The majority of the Company’s contracts have multiple performance obligations, primarily (i) related to the provision of multiple goods or services that have alternative use to the Company or that are not substantially the same or (ii) due to the contract covering multiple phases of the product lifecycle (development and engineering, production, maintenance and support). For contracts with more than one performance obligation, the Company allocates the total transaction price in an amount based on the estimated relative standalone selling prices underlying each performance obligation. In cases where a contract requires a customized good or service, the primary method used to estimate standalone selling price is the expected cost plus a margin approach. In cases where the Company sells a standard product or service offering, the stand-alone selling price is based on an observable standalone selling price
The majority of the Company’s sales are from performance obligations satisfied over time. Sales are recognized over time when control is continuously transferred to the customer during the contract. For U.S. Government contracts, the continuous transfer of control to the customer is supported by contract clauses that provide for (i) progress or performance-based payments or (ii) the unilateral right of the customer to terminate the contract for its convenience, in which case the Company has the right to receive payment for costs incurred plus a reasonable profit for products and services that do not have alternative use to the Company. Foreign government and certain commercial contracts contain similar termination for convenience clauses, or the Company has a legally enforceable right to receive payment for costs incurred and a reasonable profit for products or services that do not have alternative use to the Company. Sales on fixed price and cost-plus type contracts that include performance obligations satisfied over time are generally recorded at amounts equal to the ratio of actual cumulative costs incurred divided by total estimated costs at completion, multiplied by (i) the transaction price, less (ii) the cumulative sales recognized in prior periods (cost-to-cost input method).
41
Accounting for the sales and profits on performance obligations for which progress is measured using the cost-to-cost input method involves the preparation of estimates of: (1) transaction price and (2) 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. Incurred costs include labor, material, overhead and, for the Company’s U.S. Government contractor businesses, allowable general and administrative (G&A) expenses. Incurred costs represent work performed, which corresponds with and thereby represents the transfer of control to the customer. The estimated profit or loss at completion on a contract is equal to the difference between the transaction price and the total estimated cost at completion. In the case of a contract for which the total estimated costs exceed the total transaction price, a loss arises, and a provision for the entire loss is recorded in the period that the loss becomes evident. The unrecoverable costs on a loss contract that are expected to be incurred in future periods are presented on the consolidated balance sheet as a component of liabilities entitled either “Short-term Portion of Loss Contract Reserve” or “Long-term Portion of Loss Contract Reserve” See Note 3 for additional information.
The Company’s contracts give rise to variable consideration, including award and incentive fees, as well as amounts incrementally funded by the U.S. Government, or other provisions that can either increase or decrease the transaction price. 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 costs and target costs. Variable consideration may require the Company to exercise significant judgment to determine the total transaction price of the contract. The Company includes variable consideration in the transaction price when there is a basis to reasonably estimate the variable amount it will be entitled to receive and it is probable that a significant reversal in revenue recognized will not be required when the uncertainty is resolved. These estimates are based on historical experience, current and forecasted performance and the Company’s judgment at the time of the evaluation.
Contract modifications routinely occur to account for changes in contract specifications or requirements. In most cases, contract modifications are for goods or services that are not distinct and, therefore, are accounted for as part of the existing contract. Transaction price estimates include additional consideration for submitted contract modifications or claims when the Company believes it has an enforceable right to the modification or claim, the amount can be reliably estimated and its realization is reasonably assured. Amounts representing modifications accounted for as part of the existing contract are included in the transaction price and recognized as an adjustment to sales on a cumulative catch-up basis.
The Company’s fixed-price type contracts with the U.S. Government are typically billed based on monthly firm fixed prices. Since cost is often incurred beyond the period of performance of the contract, billings often exceed costs, which are presented as current liabilities on the consolidated balance sheet. For certain fixed-price contracts with foreign governments and commercial customers, the Company receives advance payments. Advanced payments are not considered a significant financing component because they are a negotiated contract term to ensure the customer meets its financial obligation, particularly when there are significant upfront working capital requirements. These two liabilities are combined on the consolidated balance sheet in the line item entitled “advance payments and billings in excess.” Contract assets often arise from cost-plus type contracts, time-and-material type contracts and fixed-price services type contracts for revenue amounts that have not been billed by the end of the accounting period due to the timing of preparation of invoices to customers. The Company records an asset for these revenues as current assets on the consolidated balance sheet in the line item entitled “unbilled contract receivables, net.”
Revisions or adjustments to estimates of the transaction price, estimated costs at completion and estimated profit or loss of a performance obligation may be required as work progresses under a contract, as experience is gained, as facts and circumstances change and as new information is obtained, even though the scope of work required under the contract may not change. Revisions or adjustments may also be required if contract modifications occur. The impact of revisions in profit or loss estimates are recognized on a cumulative catch-up basis in the period in which the revisions are made. The revisions in contract estimates, if significant, can materially affect the Company’s results of operations and cash flows, as well as reduce the valuations of contract assets, and in some cases result in liabilities to complete contracts in a loss position.
42
Sales from performance obligations satisfied at a point in time are typically for standard goods and are recognized when the customer obtains control, which is generally upon delivery and acceptance. The Company also records sales for performance obligations relating to standard services (i.e., maintenance and extended warranties covering standard goods sold by the Company) over time by using output measures of time elapsed to measure progress toward satisfying the performance obligation.
Sales on time-and-material type contracts are generally recognized each period based on the amount billable to the customer, which is based on direct labor hours expended multiplied by the contractual fixed rate per hour, plus the actual costs of materials and other direct non-labor costs.
Contract Assets and Contract Liabilities: Contract assets include unbilled contract receivables related to long-term contracts for which sales and profits are recognized primarily using cost-to-cost input method of accounting and are classified as current. Unbilled contract receivables are reduced by amounts of unliquidated progress or performance-based payments. Under the terms of certain revenue arrangements (contracts) with the U.S. Government, the Company is entitled to receive progress payments as costs are incurred or performance-based payments upon the achievement of predetermined performance milestones. Unliquidated progress or performance-based payments arise from fixed-price type contracts with the U.S. Government that contain progress or performance-based payment clauses, and represent payments on invoices that have been collected in cash, but have not yet been liquidated. Progress payment invoices are billed to the customer as contract costs are incurred at an amount generally equal to 80% of incurred costs. Performance based payments are billed to the customer upon the achievement of predetermined performance milestones at amounts not to exceed 90% of contract price. Unliquidated progress or performance-based payments are liquidated as deliveries or other contract performance milestones are completed, at an amount equal to a percentage of the contract sales price for the items delivered or work performed, based on a contractual liquidation rate. Contract liabilities include advance payments, billings in excess of the revenue recognized and amounts received in excess of sales recognized on contracts (deferred revenue). Contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period. Advance payments and billings in excess of revenue recognized are both classified as current, and deferred revenue as current or noncurrent based on the timing of expected revenue recognition. As of December 31, 2020, and December 31, 2019, all deferred revenue is classified as current.
Property and Equipment: Property and equipment are stated at cost minus accumulated depreciation. Depreciation is computed by applying the straight-line method to the estimated useful lives of the related assets. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the improvements. Expenditures for maintenance, repairs and minor improvements are charged to expense as incurred. When property or equipment is retired or otherwise disposed of, the net book value of the asset is removed from the Company’s consolidated balance sheet and the net gain or loss is included in the determination of net income.
Goodwill: The Company records goodwill in connection with the acquisition of businesses when the purchase price exceeds the fair values of the assets acquired and liabilities assumed. The carrying value of goodwill is not amortized, but is tested for impairment annually and is reviewed for impairment on an interim basis whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The Company has adopted Financial Accounting Standards Board (FASB) ASU 2017-04, Simplifying the Test for Goodwill Impairment. Under ASU 2017-04, the Company will determine the amount of goodwill impairment by comparing the Step 1 fair value of a reporting unit with its carrying amount. To the extent the carrying value of a reporting unit exceeds its Step 1 fair value, a goodwill impairment charge is recorded. Based on the results of these tests, the Company recorded a goodwill impairment charge of $60.8 million in Cost of Sales for the period ended December 31, 2019.
On December 31, 2020, substantially all of the assets and liabilities of the Crestview business were spun- off to the Company’s shareholders. Per ASC 350, Intangibles — Goodwill and Other, when an entity spins- off a reporting unit or component of a reporting unit that constitutes a business, goodwill of the reporting unit should be assigned to the business being spun-off. Accordingly, the Company allocated $12.1 million of goodwill to the portion of the Crestview business to be spun-off. In accordance with ASC 845, Nonmonetary Transactions, a pro-rata nonreciprocal transfer of nonmonetary assets to owners in a spin-off is recognized at the carrying amount, after reduction for any indicated impairment, of the nonmonetary assets transferred if the nonmonetary assets being distributed meet the definition of a business. After testing for impairment, the allocated goodwill was determined to be impaired. Accordingly, the Company recorded a Loss on Disposal which included the entire $12.1 million for the period ended December 31, 2020. See Note 4 and Note 8 for additional information on the December 31, 2020 allocation of goodwill.
43
Long-Lived Assets Other Than Goodwill: The Company reviews its long-lived assets, including software development costs, amortizable customer contract relationships and indefinite-lived tradenames for impairment annually, or whenever events or circumstances indicate that the carrying amount(s) of an asset may not be recoverable. When such events or changes in circumstances occur, a recoverability test is performed comparing projected undiscounted cash flows from the use and eventual disposition of an asset or asset group to its carrying amount. If the projected undiscounted cash flows are less than the carrying amount, an impairment is recorded to the extent the carrying amount exceeds fair value. The Company reviews indefinite-lived trade names at least annually by comparing fair value to carrying value of the intangible asset. Fair value is determined through various valuation techniques, including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. Estimates critical to the Company’s evaluation of indefinite-lived trade names for impairment include the discount rate, royalty rates used in its evaluation of trade names, projected average revenue growth and projected long-term growth rates in the determination of terminal values. Based on the results of these tests, the Company did not record an impairment charge to other long-lived intangible assets for the period ended December 31, 2020 and December 31, 2019. See Note 8 for additional information.
Deferred Debt Issuance Costs: Costs to issue debt are capitalized and deferred when incurred, and subsequently amortized to interest expense over the term of the related debt using the effective interest rate method. Deferred debt issuance costs, other than for revolving line-of-credit arrangements, are presented in the Company’s consolidated balance sheet as a direct deduction from the carrying amount of the associated debt liability. Deferred debt issuance costs for revolving line-of-credit arrangements are included in the Company’s consolidated balance sheet in other assets. The deferred financing costs for the revolving line-of- credit were $1.2 million for the period ended December 31, 2020, and $1.4 million for the period ended December 31, 2019.
Contingencies and Commitments: In accordance with ASC 450, Contingencies (Topic 450): Disclosure of Certain Loss Contingencies, the Company records a loss contingency when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company reviews its loss contingencies on an ongoing basis to ensure that it has appropriate reserves recorded in its consolidated balance sheets. These reserves are based on historical experience with claims incurred but not received, estimates and judgments made by management and applicable insurance coverage for litigation matters, and, as such, adjusted as circumstances warrant. Legal costs incurred in connection with loss contingencies are expensed as incurred. See Note 15 for additional information.
Accounts Receivable and Unbilled Contract Receivables: Accounts receivable, net and unbilled contract receivables, net are generated from prime and subcontracting arrangements primarily with U.S. governmental agencies. Billed amounts represent invoices that have been prepared and sent to the customer. Unbilled amounts primarily represent costs and fees incurred in excess of billings and rate variances on cost- plus contracts as well as retainage amounts. In accordance with industry practice, contract receivables relating to long-term contracts are classified as current, even though portions of these amounts may not be realized within one year. Billed accounts receivable are considered past due if the invoice has been outstanding more than 30 days. The Company does not charge interest on accounts receivable; however, U.S. governmental agencies pay interest on invoices outstanding more than 30 days. The Company records interest income from U.S. governmental agencies when received. The provision for doubtful accounts is based on management’s evaluation of the status of existing accounts receivable. Receivables are written off when deemed uncollectible. Recoveries of accounts receivable previously written off are recorded when received. The reserve for doubtful accounts was $8.1 million and $12.6 million as of December 31, 2020 and December 31, 2019, respectively.
Income Taxes: The Company is a taxable entity for federal income tax purposes and files a consolidated U.S. federal income tax return. The Company uses the liability method of accounting for income taxes. Deferred income tax assets and liabilities reflect tax carryforwards and the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes, as determined under enacted tax laws and rates expected to be in effect when such differences reverse. The effect of changes in tax laws or rates is accounted for in the period of enactment. Valuation allowances for deferred tax assets are provided when it is more likely than not that some portion or all of the assets will not be realized considering, when appropriate, tax planning strategies.
44
Income tax accounting standards prescribe (1) a minimum recognition threshold that an income tax benefit arising from an uncertain income tax position taken, or expected to be taken, on an income tax return is required to meet before being recognized in the financial statements and (2) the measurement of the income tax benefits recognized from such positions. The Company’s account policy is to classify uncertain income tax positions that are not expected to be resolved within one year as non-current income tax liabilities and to classify potential interest and penalties on uncertain tax positions as elements of the provision for income taxes on its financial statements.
Classification of Costs: In 2020, the Company changed the classification of certain costs from Selling, General and Administrative expense to Cost of Sales. The classification change was reviewed and approved by cognizant government contract and audit agencies and deemed compliant with applicable government contracting Cost Accounting Standards. If this change had been made in the December 31, 2019 Consolidated Statement of Operations, Cost of Sales would have increased by $34.8 million and the Selling, General & Administrative expenses would have been reduced by that same amount.
Reclassifications: Certain reclassifications have been made to prior year balances in order for these balances to be comparable to the current year presentation. These reclassifications had no impact on previously reported financial position and results of operations.
New Accounting Standards Issued and Not Yet Implemented: In February 2016, the FASB issued ASU 2016-02, Leases, which updates the existing guidance on accounting for leases and requires new qualitative and quantitative disclosures about the Company’s leasing activities. The new standard requires the Company to recognize lease assets and lease liabilities on the consolidated balance sheet for all leases under which the Company is the lessee, including those classified as operating leases under previous accounting guidance. The Company will measure leases commencing after the adoption date based on the present value of the lease payments due over the lease term (as defined in ASU 2016-02). The Company will measure and recognize its existing leases on the date of adoption based on the present value of the remaining minimum lease payments, as defined in existing guidance on accounting for leases. The new standard, as amended, will be effective for the Company for interim and annual reporting periods beginning after December 15, 2021, with early adoption permitted. The Company will elect to use a modified retrospective approach for leases that exist or were entered into after the beginning of January 1, 2021, the earliest comparative period in the financial statements, with certain practical expedients available, and will recognize a cumulative-effect adjustment to the opening balance of retained earnings at January 1, 2021. The Company is still evaluating and has not yet determined the impact of adoption to the Company’s assets and liabilities for right-of-use assets and lease liabilities, but does not expect ASU 2016-02 to have an impact on its results of operations or cash flows. The Company does not expect the cumulative effect adjustment to the opening balance of retained earnings at January 1, 2021 to be material. See Note 15 for additional information about the Company’s leases, including the future minimum lease payments of the Company’s operating leases at December 31, 2020.
In December 2019, the FASB issued ASC 2019-12, Income Taxes (Topic 740), guidance to simplify accounting for income taxes by removing specific technical exceptions that often produce information investors have a hard time understanding. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The amendments are effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.
Other accounting standard updates, effective for periods beginning after December 31, 2020, are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
45
New Accounting Standards Implemented: In October 2018, the FASB issued Accounting Standards Update 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities (ASU 2018-17), which effectively expands the private company alternative for common control leasing arrangements to all private company common control arrangements as long as both the parent and legal entity being evaluated for consolidation are not public business entities. If elected, a company must apply the accounting alternative to all current and future legal entities under common control that meet the criteria for applying this alternative. Additionally, under the accounting alternative, a private company is required to provide detailed disclosures about its involvement with and exposure to the legal entity under common control. ASU 2018-17 also amends certain variable interest entity (VIE) guidance for related party arrangements. Specifically, indirect interests held through related parties in common control arrangements should be considered on a proportional basis (as opposed to direct interest in its entirety) for determining whether fees paid to decision makers and service providers are variable interests. ASU 201817 is effective for the Company beginning on January 1, 2021, with early adoption permitted. The Company has elected to early adopt this accounting pronouncement for legal entities under common control (see Note 4 and Note 17 for additional information).
| 3. | Purchase Accounting |
The Company’s acquisition was accounted for in accordance with the provisions of ASC 805, Business Combinations, whereby the implied fair value of the consideration paid and liabilities assumed from L-3 has been allocated to the Company’s assets and liabilities at fair value. The allocation of the implied fair value was recorded for accounting purposes as of June 29, 2018, using inputs that are classified as Level 1, Level 2 or Level 3. Acquisition-related expenses were recognized separately from the business combination and expensed as incurred unless otherwise prescribed under U.S. GAAP.
Measurement Period Adjustments and Final Purchase Price Allocation:
In June 2019, the Company updated provisional amounts recorded in the Initial Purchase Price Allocation to increase loss contract reserves under the guidance of ASC 606, Revenue Recognition. The Company determined that the resulting changes to the Initial Purchase Price Allocation are Measurement Period Adjustments (“MPAs)” in accordance with ASC 805-10-25-15. Under ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, MPAs are recorded in the period in which the underlying facts become known, but are measured as of the acquisition date. Accordingly, the Company recorded an increase in its Loss Contract Reserve liability of $80.3 million and an increase in Goodwill of the same amount. See Note 4 and Note 8 for additional information on Goodwill.
| 4. | Divestiture |
Crestview Aerospace Spin-Off: On December 31, 2020, the Company completed the spin-off of substantially all of the assets and liabilities of the Crestview business to the Company’s shareholders. The spin- off was distributed on a pro-rata basis as a dividend to the Company’s shareholders of record as of December 30, 2020.
The Company spun-off net assets with a carrying amount of $55.4 million with a fair value of $33.0 million, which resulted in recording a loss on disposal of $22.4 million. The spin-off was distributed at the net asset carrying amount of $33.0 million for the period ended December 31, 2020, the effective date of the spin-off. The spun-off net assets were removed through Retained Earnings from the Company’s Consolidated Balance Sheet. The results of operations and cash flows are included in the Consolidated Statement of Operations and Consolidated Statement of Cash Flows through the effective date of the spin- off. The income before taxes associated with the spin-off entity was a $0.3 million loss for the period ended December 31, 2020. See Note 2 and Note 8 for additional information on the allocation of goodwill and subsequent impairment as a loss on disposal.
The following Net Assets were distributed in the spin-off transaction:
| Total assets | $ | 63,861 | ||
| Total liabilities | 8,412 | |||
| Total equity | $ | 55,449 |
46
Transition Services Agreement: In connection with the spin-off, the Company and Crestview Aerospace LLC entered into a Transition Services Agreement, primarily involving the Company providing certain services to Crestview Aerospace LLC related to information technology, human resources benefits and accounting services. The agreement is for a period of one year beginning January 2021 and renewable annually thereafter. There were no services provided or amounts due as of December 31, 2020. See Note 17 for additional information.
| 5. | Accounting for Contracts |
The components of contracts in process are presented in the table below. The unbilled contract receivables, inventoried contract costs and unliquidated progress payments principally relate to contracts with the U.S. Government and prime contractors or subcontractors of the U.S. Government.
| Period Ended December 31, | ||||||||
| ($ in thousands) | 2020 | 2019 | ||||||
| Unbilled contract receivables, gross | $ | 75,189 | $ | 106,212 | ||||
| Unliquidated progress payments | 0 | (1,621 | ) | |||||
| Unbilled contract receivables, net | 75,189 | 104,591 | ||||||
| Inventoried contract costs | 692 | 1,304 | ||||||
| Total contracts in progress | $ | 75,881 | $ | 105,895 | ||||
Unbilled Contract Receivables. Unbilled contract receivables represent accumulated incurred costs and earned profits on contracts (revenue arrangements), which have been recorded as sales, but have not yet been billed to customers. Unbilled contract receivables arise from the cost-to-cost input method of revenue recognition that is used to record sales on certain fixed-price contracts. Unbilled contract receivables from fixed-price type contracts are converted to billed receivables when amounts are invoiced to customers according to contractual billing terms, which generally occur when deliveries or other performance milestones are completed. Unbilled contract receivables also arise from cost-plus type contracts, time-and-material type contracts and fixed-price service type contracts for revenue amounts that have not been billed by the end of the accounting period due to the timing of preparation of invoices to customers.
Unliquidated Progress Payments: Unliquidated progress payments are a contra asset account, and are classified against unbilled contract receivables if revenue for the underlying contract is recorded using the cost- to-cost input method, and against inventoried contract costs if revenue is recorded using the units-of- delivery method.
Inventoried Contract Costs: In accordance with contract accounting standards, the Company’s U.S. Government contractor businesses account for the portion of their general and administrative (“G&A”), independent research and development (“IRAD”) and bids and proposals (“B&P”) costs that are allowable and reimbursable indirect contract costs under U.S. Government procurement regulations on their U.S. Government contracts (revenue arrangements) as inventoried contract costs. G&A, IRAD and B&P costs are allocated to contracts for which the U.S. Government is the end customer and are charged to costs of sales when sales on the related contracts are recognized. The Company’s U.S. Government contractor businesses record the unallowable portion of their G&A, IRAD and B&P costs to expense as incurred and do not include them in inventoried contract costs.
| 6. | Inventories |
Inventories at Lower of Cost or Net Realizable Value: The table below presents the components of inventories at the lower of cost (first-in, first-out or average cost) or net realizable value. In accordance with ASC 606, all work in process relating to goods that customers do not currently control are classified within inventories on the Company’s consolidated balance sheets at December 31, 2020 and December 31, 2019. The Company establishes provisions for excess and obsolete inventories after evaluation of historical sales, current economic trends, forecasted sales, product lifecycles, and current inventory levels.
47
| Period ended December 31, | ||||||||
| ($ in thousands) | 2020 | 2019 | ||||||
| Raw materials, components and sub-assemblies | $ | 46,951 | $ | 60,924 | ||||
| Excess and obsolete reserve | (4,581 | ) | (20,909 | ) | ||||
| Total inventories, net | $ | 42,370 | $ | 40,015 | ||||
Inventory Sale: In 2020 the Company completed the bulk sale of consignment inventory to third-party, held off-site at the buyer’s location. The sale resulted in proceeds of $0.8 million. The bulk sold was fully reserved, resulting in a significant reduction to the Excess and Obsolete reserve balance for the period ended December 31, 2020.
Government-owned Inventories: The Company has four programs where inventory purchases are billed directly to the customer and where the Company is obligated under the contract to maintain and track quantities of the government-owned inventory. These inventories are issued to the contract as required and billed to the Customer when the inventory is replenished. The Customers provide the Company with an initial inventory balance when the contract was awarded. The Company is obligated by contractual inventory schedules to return that inventory back to the Customer at the conclusion of the contract. The contractual inventory liability changes over the life of the contract based on inventory levels, contract schedule modifications caused by aircraft retirements, parts obsolescence, part substitution and changes to the aircraft life cycle repairs.
The Company actively tracks the Government’s inventory on hand versus the contractual inventory schedules for each program. Contract liabilities are not recorded due to the occurrence of significant changes to the contract schedules over the life of the program. A contract liability is not recognized until there is a final negotiated inventory listing with the customer or at the time the inventory requirement is fixed and determinable. This typically occurs at or very near to the end of a contract. A liability, if any, would be recognized at that time if the on-hand inventory value was below the required contractual inventory schedule.
| 7. | Property and Equipment |
The table below presents the components of property, plant and equipment:
| Useful Lives | Period ended December 31, | |||||||||||
| ($ in thousands) | (Years) | 2020 | 2019 | |||||||||
| Land | Indefinite | $ | 384 | $ | 1,252 | |||||||
| Buildings and improvements | 4 – 13 | 7,956 | 22,800 | |||||||||
| Machinery, equipment, furniture and fixtures | 2 – 9 | 28,996 | 42,278 | |||||||||
| Leasehold improvements | 2 – 6 | — | — | |||||||||
| Gross property and equipment | $ | 37,336 | $ | 66,330 | ||||||||
| Accumulated depreciation and amortization | (11,807 | ) | (10,919 | ) | ||||||||
| Property and equipment, net | $ | 25,529 | $ | 55,411 | ||||||||
Available for Sale Assets: In accordance with ASC 205, Presentation of Financial Statements, long- lived assets to be sold are classified as Available for Sale when management approves their sale, a program is initiated to actively sell the asset in its present condition, at a reasonable price in relation to its fair value, and the sale of the asset is probable. In November 2020, the Company classified as Available for Sale the land and buildings associated with a specific facility in Warner Robbins, GA. Assets available for sale are classified as current assets on the Company’s Balance Sheet and recorded at the lower of carrying amount or fair value less costs to sell, and are no longer depreciated.
| Period ended December 31, | ||||||||
| ($ in thousands) | 2020 | 2019 | ||||||
| Available for Sale | $ | 968 | $ | — | ||||
48
| 8. | Goodwill and Identified Intangible Assets |
The table below summarizes the Company’s goodwill carrying value for the years ended December 31, 2020 and December 31, 2019.
| Period ended December 31, | ||||||||
| ($ in thousands) | 2020 | 2019 | ||||||
| Beginning of period | $ | 252,575 | $ | 233,081 | ||||
| Measurement Period Adjustment (see Note 3) | — | 80,276 | ||||||
| Impairment (see Note 2) | — | (60,782 | ) | |||||
| Goodwill Allocated to Spin-off | (12,071 | ) | — | |||||
| End of period | $ | 240,504 | $ | 252,575 | ||||
Identifiable intangible assets consist of the following:
| 2020 | 2019 | |||||||||||||||||||||||
| ($ in thousands) | Gross Carrying Amount | Accum. Amort. | Total | Gross Carrying Amount | Accum. Amort. | Total | ||||||||||||||||||
| Finite Lived: | ||||||||||||||||||||||||
| Customer Contract Relationships | $ | 68,500 | $ | (55,486 | ) | $ | 13,014 | $ | 68,500 | $ | (42,473 | ) | $ | 26,027 | ||||||||||
| Indefinite-Lived | ||||||||||||||||||||||||
| Trademark | 70,000 | — | 70,000 | 70,000 | — | 70,000 | ||||||||||||||||||
| Ending Balance | $ | 138,500 | $ | (55,486 | ) | $ | 83,014 | $ | 138,500 | $ | (42,473 | ) | $ | 96,027 | ||||||||||
Amortization expense for acquired finite lived intangible assets of $13.0 million and $31.8 million is included in selling, general and administrative expense for the periods ended December 31, 2020 and December 31, 2019, respectively.
The remaining Customer Contract Relationship asset is expected to be fully amortized in 2021. No residual value is assumed to exist for any of the Company’s amortizable intangible assets.
| 9. | Loss on Spin-off of Net Assets |
On December 31, 2020, the Company recognized a loss on disposal of $22.4 million associated with the spin-off of substantially all of the assets and liabilities of the Crestview business. A review of the disposal group’s carrying value, per ASC 845, determined the disposal group’s carrying value exceeded its fair value. Accordingly, goodwill of $12.1 million and net assets of $10.4 million were written down to fair value.
| 10. | Debt |
The components of debt and a reconciliation to the carrying amount of long-term debt are presented below:
| Period ended December 31, | ||||||||
| ($ in thousands) | 2020 | 2019 | ||||||
| Outstanding borrowings under ABL Credit Facility | $ | — | $ | — | ||||
| Term Loan agreement due 2025 | 321,750 | 325,050 | ||||||
| Principal amount of long-term debt | 321,750 | 325,050 | ||||||
| Deferred debt costs | (6,830 | ) | (8,009 | ) | ||||
| Carrying amount of long-term debt | 314,920 | 317,041 | ||||||
| Less current maturities | (3,300 | ) | (3,300 | ) | ||||
| Total long-term debt, less current maturities | $ | 311,620 | $ | 313,741 | ||||
49
ABL Credit Facility: On June 29, 2018, the Company entered into a $75 million, five-year secured ABL revolving credit agreement (“the ABL Credit Facility”). Any outstanding obligations under the ABL Credit Facility are due and payable on June 29, 2023.
Borrowings under the ABL Credit Facility may consist of (1) base rate loans, which shall bear interest at a rate equal to the sum of the applicable rate (as defined in the ABL Credit Facility) and the “base rate” (as defined in the ABL Credit Facility) and/or (2) Eurodollar loans, which shall bear interest at a rate equal to the sum of the applicable rate plus the “Eurodollar rate” (as defined in the ABL Credit Facility). The applicable rate for base rate loans under the ABL Credit Facility ranges from 0.75% to 1.25% per annum, and the applicable rate for Eurodollar loans ranges 1.75% to 2.25% per annum, in each case based on the average daily excess availability (as defined in the ABL Credit Facility).
The ABL Credit Facility includes a letter of credit sub-facility of $15 million and a swingline sub- facility of $10 million. The letter of credit and swingline sub-facilities are part of, and not in addition to the ABL Credit Facility. Swingline loans bear interest at a rate equal to base rate loans.
The Company had outstanding letters of credit to various entities, primarily for insurance matters, of $6.4 million and $7.4 million as of December 31, 2020 and December 31, 2019, respectively. The ABL Credit Facility provides for payment of a letter of credit fee equal to the applicable rate for Eurodollar loans, as well as a fronting fee of 0.125% per annum.
Availability under the ABL Credit Facility is calculated monthly based on the balances of billed accounts receivable, unbilled accounts receivable and inventory of the Company with each amount reduced by defined ineligible balances and subject to varying advance rates. The calculated amount is reduced by the outstanding amount of letters of credit and certain other availability reserves as defined in the ABL Credit Facility.
The Company had borrowing availability of $46.3 million under the ABL Credit Facility as of December 31, 2020. The ABL Credit Facility provides for the payment of a commitment fee ranging from 0.25% to 0.375% per annum on the daily unused portion of the ABL Credit Facility.
Term Loan Agreement: On June 29, 2018, the Company entered into a $330 million, seven-year secured Term Loan agreement (the “Term Loan”).
Borrowings under the Term Loan may consist of (1) base rate loans, which shall bear interest at a rate equal to the sum of the applicable rate (as defined in the Term Loan) and the “base rate” (as defined in the Term Loan) and/or (2) Eurodollar loans, which shall bear interest at a rate equal to the sum of the applicable rate plus the “Eurodollar rate” (as defined in the Term Loan). The applicable rate for base rate loans under the Term Loan ranges from 3.5% to 3.75% per annum, and the applicable rate for Eurodollar loans ranges 4.5% to 4.75% per annum, in each case based on the consolidated secured net leverage ratio (as defined in the Term Loan).
In March 2021, the Company amended the Term Loan Agreement to extend the maturity date to June 2027, modify the repayment schedule, and to lower the interest rates. The applicable rates were decreased to 3.00% and 4.00% for base rate and Eurodollar loans, respectively. See Note 20.
The Term Loan provides for scheduled principal payments of $0.8 million as of the end of each calendar quarter. For the period ended December 31, 2020 and December 31, 2019, the Company made scheduled principal payments of $3.3 million and $3.3 million, respectively. The Company is permitted to make voluntary prepayments without premium or penalty. In addition, the Company is required to make mandatory prepayments (subject to certain carve-outs and baskets) using net proceeds upon sale of certain assets, net proceeds of certain issuances of debt, and an agreed-upon percentage of the Company’s excess cash flow as determined annually at the end of each fiscal year (beginning with the year ending December 31, 2019). For the period ended December 31, 2020 and December 31, 2019, the Company did not make any voluntary or mandatory prepayments.
50
Future scheduled principal payments on the Term Loan as of December 31, 2020 are as follows:
| ($ in thousands) | Term Loan | |||
| 2021 | 3,300 | |||
| 2022 | 3,300 | |||
| 2023 | 3,300 | |||
| 2024 | 3,300 | |||
| 2025 | 3,300 | |||
| Thereafter | 305,250 | |||
| Total | $ | 321,750 | ||
Security: The ABL Credit Facility and Term Loan are secured by substantially all the assets of the Company including (a) a pledge of (i) all of the capital stock of the Company and (ii) all the equity interests held by the Company of each subsidiary (subject to certain exceptions) and (b) security interests in, and mortgages on, substantially all tangible and intangible assets of the Company. The administrative agents under the ABL Credit Facility and Term Loan have entered into an intercreditor agreement which outlines the relative priority of the liens established under each agreement, as well as certain other rights, priorities and interests.
Covenants: The ABL Credit Facility and Term Loan contain restrictive covenants which limit, subject to certain exceptions, among other things, the ability of the Company and its subsidiaries to incur additional indebtedness; create liens; make investments or loans; consolidate, merge or consolidate or dispose of assets; enter into certain transactions with affiliates; pay dividends and repurchase stock. At December 31, 2020, the Company was in compliance with its restrictive covenants.
During periods when excess availability under the ABL Credit Facility is less than the greater of 10% of the total facility amount or $7.5 million, a financial covenant is triggered which requires the Company to maintain a minimum Fixed Charge Coverage Ratio. The financial covenant was not applicable at any time during the period ended December 31, 2020 and December 31, 2019.
Promissory Note: The Company had an unsecured promissory note payable to the landlord of the Company’s headquarters location. The original principal amount of the note was $4.0 million with an interest rate of 8.5% and required monthly payments of $49 thousand (including interest) over a ten-year term ending in 2024. Proceeds from the note were used to purchase leasehold improvements at the Company’s headquarters location. On April 1, 2019, the Company repaid the entire outstanding principal amount of the promissory note of $2.7 million.
| 11. | Income Taxes |
The provision for income taxes is summarized in the table below:
| Period ended December 31, | ||||||||
| ($ in thousands) | 2020 | 2019 | ||||||
| Domestic | $ | (13,457 | ) | $ | (1,262 | ) | ||
| Foreign | (71 | ) | 653 | |||||
| Total provision for income taxes | $ | (13,528 | ) | $ | (609 | ) | ||
51
The components of the Company’s current and deferred portions of the provision for income taxes are presented in the table below:
| Period ended December 31, | ||||||||
| ($ in thousands) | 2020 | 2019 | ||||||
| Current income tax provision: | ||||||||
| Federal | $ | (216 | ) | $ | 216 | |||
| State and local | 384 | (175 | ) | |||||
| Foreign | (71 | ) | 653 | |||||
| Sub-total | 97 | 694 | ||||||
| Deferred income tax provision: | ||||||||
| Federal | (11,723 | ) | (1,061 | ) | ||||
| State and local | (1,902 | ) | (242 | ) | ||||
| Foreign | — | — | ||||||
| Sub-total | (13,625 | ) | (1,303 | ) | ||||
| Total provision for income taxes | $ | (13,528 | ) | $ | (609 | ) | ||
The tax effect of temporary differences that gave rise to deferred tax assets and liabilities are summarized in the table below:
| Period ended December 31, | ||||||||
| ($ in thousands) | 2020 | 2019 | ||||||
| Deferred tax assets: | ||||||||
| Inventory reserve | $ | 503 | $ | 1,579 | ||||
| Compensation and benefits | 3,439 | 1,416 | ||||||
| Interest expense carryforwards | 0 | 2,033 | ||||||
| Loss carryforwards | 3,168 | 3,826 | ||||||
| Intangible assets other than goodwill | 8,911 | 8,245 | ||||||
| Other accrued expenses and reserves | 10,608 | 14,269 | ||||||
| Deferred tax assets | 26,629 | 31,368 | ||||||
| Less valuation allowance | 0 | (18,425 | ) | |||||
| Deferred tax assets, net of valuation allowance | 26,629 | 12,943 | ||||||
| Deferred tax liabilities: | ||||||||
| Goodwill | (9,113 | ) | (5,536 | ) | ||||
| Property and equipment | (4,966 | ) | (8,482 | ) | ||||
| Deferred tax liabilities | (14,079 | ) | (14,018 | ) | ||||
| Total net deferred tax asset/(liability) | $ | 12,550 | $ | (1,075 | ) | |||
In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in those jurisdictions during the periods in which those temporary differences become deductible. The Company considers the scheduled reversal of deferred tax liabilities (including the impact of available carryforward periods), projected future taxable income, and tax-planning strategies in making this assessment. Based on evidence available at the time, the Company did not believe it more likely than not that it would realize the benefits of certain deductible differences for federal and state income tax purposes as of December 31, 2019 and therefore, as a result, recorded a valuation allowance of $18,425. However, current projections of income before income taxes are sufficient for the Company to believe that it is now more likely than not that it will realize the benefits of those certain deductible differences, and therefore, did not record a valuation allowance as of December 31, 2020.
52
Net operating loss (“NOL”) carryforwards for federal and state income tax purposes as of December 31, 2020 and 2019 are summarized in the table below:
| Period ended December 31, | ||||||||||||||||
| 2020 | 2019 | |||||||||||||||
| ($ in thousands) | Federal | State | Federal | State | ||||||||||||
| NOL carryforwards, beginning of period | $ | 26,281 | $ | 2,698 | $ | 22,214 | $ | 2,305 | ||||||||
| NOLs generated | — | — | 4,067 | 393 | ||||||||||||
| NOLs absorbed | (11,567 | ) | (1,109 | ) | — | — | ||||||||||
| NOLs, end of period | $ | 14,714 | $ | 1,589 | $ | 26,281 | $ | 2,698 | ||||||||
Federal NOLs can be carried forward indefinitely. State NOLs will expire, if unused, beginning in 2028 and ending in 2039.
At December 31, 2020 and December 31, 2019, the Company’s balance sheet reflected liabilities for income tax uncertainties of nil. In accordance with ASC 740-10, Accounting for Uncertainty in Income Taxes, the Company’s policy is to recognize interest and penalties related to unrecognized tax benefits through interest expense and other expense (income), respectively, in the consolidated statements of operations.
The Company is subject to taxation in the United States and various states and foreign jurisdictions. The Company’s income tax returns for the period ended December 31, 2019 are generally subject to examination through October 2023. The Company’s income tax returns for the period ended December 31, 2020 have not yet been filed. Once filed, such income tax returns will be subject to examination by tax authorities for a minimum of three years.
| 12. | Stock Option Plan |
Under the Company’s Equity Incentive Plan (the Plan), non-qualified options to purchase common shares of Vertex Aerospace Services Holding Corp. are granted by the Board of Directors to the Company’s directors, officers and employees. Stock options are granted at exercise prices equal to the estimated fair market value at the issue date and expire at the earlier of the tenth anniversary of the Date of Grant, or termination of employment date. Under the terms of the Plan, the option holder can elect to receive either a cash payout equivalent to the excess of the then fair market value of the common shares over the exercise price of the option, or common shares upon exercise of the vested options. Twenty five percent (25%) of the optioned shares will be eligible to vest on each anniversary of the date of grant over a period of four years following the date hereof, provided that, upon the occurrence of a change of control, as defined in the Plan, all such units shall immediately become eligible to vest at the time of such change of control.
The following assumptions were used to estimate the fair value of the stock option awards granted and outstanding:
| Dividend yield | Nil | |||
| Expected volatility | 41.34 | % | ||
| Risk free interest rate | .93 | % | ||
| Expected life of options (in years) | 5.25 | |||
| Weighted-average fair value | $ | 401.91 | ||
During 2018, 17,201 options were granted with an exercise price of $1,000 per option. No options were granted during 2019. During 2020, 7,785 options were granted with an exercise price of $1,105 per option. Of the outstanding 17,201 options issued in 2018, none were vested or exercisable in either 2020 or 2019. Of the outstanding 7,785 options issued in 2020, none were vested or exercisable in 2020. As a result, no liability exists as of December 31, 2020, or as of December 31, 2019, and no related compensation expense was recorded during 2020 or 2019.
53
| 13. | Declaration of Dividends |
On November 6, 2020, the Board approved that the Company make (1) a dividend on December 31, 2020 of the net assets described as the Crestview spin-off entity (“Crestview Dividend”), (2) a cash dividend on January 4, 2021 in the aggregate amount of $91.2 million (“Cash Dividend 1”), (3) a cash dividend on January 4, 2021 in the aggregate amount of $8.8 million (“Cash Dividend 2”), and, together with Cash Dividend 1, the (“Cash Dividends”). The Crestview dividend was payable to the stockholders of the Company as of December 30, 2020, whereas the Cash Dividends were payable to the stockholders of the Company as of January 3, 2021.
The Crestview Dividend was distributed to stockholders on December 31, 2020. The Cash Dividends were reported as a $100 million Dividends Payable on December 31, 2020 for the cash dividends declared and unpaid. See Note 20 for additional information on the cash dividend payment.
| 14. | Employee Benefit Plans |
Defined Contribution Plan: The Company maintains a defined contribution 401(k) employee benefit plan (the “Benefit Plan”) under which substantially all U.S. employees are eligible to participate. Under the terms of the Benefit Plan, eligible employees may contribute tax-deferred compensation deduction amounts up to the maximum amount that Internal Revenue Service regulations permit. The Benefit Plan provides for a discretionary Company match program based on a certain percentage of the eligible employee’s compensation which may be suspended or discontinued at any time. During the periods ended December 31, 2020 and December 31, 2019, the Company funded matching contributions of $5.2 million and $7.1 million, respectively.
Multi-employer Plan: The Company, in certain of its U.S. operating locations, participates in a multi- employer pension plan under an industry-wide agreement with a trade organization. The plan provides defined benefits to substantially all employees covered by collective bargaining agreements that have been negotiated with the related trade organization. Approximately 53% and 33% of the Company’s total labor hours for customers were completed by workers subject to this collective bargaining agreement during the periods ended December 31, 2020 and December 31, 2019, respectively.
In connection with this collective bargaining agreement with the trade organization, the Company participates with other companies in the union’s multi-employer pension plan. The plan covers substantially all of the Company’s employees who are members of such union. Under the agreement, the Company pays specified wages to covered employees, observes designated workplace rules and makes payments to the multi-employer pension plan rather than administering the funds on behalf of these employees. The Company recognizes expense in connection with this plan as contributions are funded. The Company made contributions to the multi-employer pension plan and recognized expense during the periods ended December 31, 2020 and December 31, 2019 of $9.3 million and $7.8 million, respectively. The financial risks of participating in multi-employer defined benefit pension plans are different from single-employer defined benefit pension plans in the following respects: (1) assets contributed to the multiemployer plan by one employer may be used to provide benefits to employees of other participating employers, (2) if a participating employer discontinues contributions to a plan, the unfunded obligations of the plan may be borne by the remaining participating employers and (3) if a participating employer chooses to stop participating in a plan, a withdrawal liability may be created based on the unfunded vested benefits for all employees in the plan.
The Company may receive future funding deficiency demands from the multi-employer pension plan to which the Company currently contributes in the form of a withdrawal claim from such plans. The Company is unable to estimate the amount of any potential future funding deficiency demands, because: (i) the actions of each of the other contributing employers in the plan have an effect on each of the other contributing employers, (ii) the development or implementation of a rehabilitation plan by the trustees and approval by the applicable U.S. regulatory agency is not predictable and (iii) the allocation of fund assets and return assumptions by trustees are variable, as are actual investment returns relative to the plan assumptions. Accordingly, since a reasonable estimate or probable outcome cannot be determined and, pursuant to certain accounting principles, the Company has no reserves recorded in its consolidated balance sheets for any potential funding obligations related to the plan.
54
| 15. | Commitments and Contingencies |
Non-Cancellable Operating Leases: The Company rents certain equipment and facilities under operating leases. Certain major plant facilities and equipment are furnished by the U.S. Government under short-term or cancelable arrangements. The total rental expense under non-cancellable operating leases was $1.3 million and $1.7 million for the periods ended December 31, 2020 and December 31, 2019, respectively. Future minimum lease commitments at December 31, 2020 for long-term non-cancelable operating leases are $3.6 million in 2021.
Procurement Regulations: A substantial majority of the Company’s revenues are generated from providing products and services under legally binding agreements or contracts with the U.S. Government, foreign government customers and state and local governments. U.S. Government contracts are subject to extensive legal and regulatory requirements, and, from time to time, agencies of the U.S. Government perform audits to determine whether such contracts were and are being conducted in accordance with these requirements. The Company is currently cooperating with the U.S. Government on several audits from which civil, criminal or administrative proceedings have or could result and give rise to fines, penalties, compensatory and treble damages, restitution and/or forfeitures. The Company does not currently anticipate that any of these audits will have a material adverse effect, individually or in the aggregate, on its consolidated financial position, results of operations or cash flows. Under U.S. Government regulations, an indictment of the Company by a federal grand jury, or an administrative finding against the Company as to its present responsibility to be a U.S. Government contractor or subcontractor, could result in the Company being suspended for a period of time from eligibility for awards of new government contracts or task orders or in a loss of export privileges. A conviction, or an administrative finding against the Company that satisfies the requisite level of seriousness, could result in debarment from contracting with the federal government for a specified term. In addition, all of the Company’s U.S. Government contracts: (1) are subject to audit and various pricing and cost controls, (2) include standard provisions for termination for the convenience of the U.S. Government or for default and (3) are subject to cancellation if funds for contracts become unavailable. Foreign government contracts generally include comparable provisions relating to terminations for convenience or default, as well as other procurement clauses relevant to the foreign government.
Litigation Matters: The Company is also subject to litigation, proceedings, claims or assessments and various contingent liabilities incidental to its businesses, including the matter specified below. Furthermore, in connection with certain business acquisitions, the Company has assumed some or all claims against, and liabilities of, such acquired businesses, including both asserted and unasserted claims and liabilities.
In accordance with the accounting standard for contingencies, the Company records a liability when management believes that it is both probable that a liability has been incurred and the Company can reasonably estimate the amount of the loss. Generally, the loss is recorded at the amount the Company expects to resolve the liability. Amounts recoverable from insurance contracts or third parties are recorded as assets when deemed probable. At December 31, 2020, the Company did not record any amounts for recoveries from insurance contracts or third parties in connection with the amount of liabilities recorded for pending and threatened litigation. Legal defense costs are expensed as incurred. The Company believes it has recorded adequate provisions for its litigation matters. The Company reviews these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. While it is reasonably possible that an unfavorable outcome may occur, unless otherwise stated, the Company believes that it is not probable that a loss has been incurred. Although the Company believes that it has valid defenses with respect to legal matters and investigations pending against it, the results of litigation can be difficult to predict, particularly those involving jury trials. Therefore, it is possible that one or more of these contingencies could have a material impact on the financial position, results of operations or cash flows of the Company in future periods.
55
| 16. | Disaggregation of Net Sales |
The Company disaggregates its sales from contracts with customers by: (1) end customer and (2) contract type. The Company believes these factors affect the nature, amount, timing and uncertainty of the Company’s revenue and cash flows.
Sales by End Customer: Direct sales to the end customer represented approximately 89% of the Company’s consolidated sales in the year ended December 31, 2020, and 90% in the year ended December 31, 2019. Indirect sales as a subcontractor or supplier represented the remaining 11% in the year ended December 31, 2020 and 10% in the year ended December 31, 2019. The table below presents total net sales disaggregated by end customer.
| Period ended December 31, | ||||||||
| ($ in thousands) | 2020 | 2019 | ||||||
| Total DoD | $ | 703,428 | $ | 771,001 | ||||
| Other U.S. Government | 51,217 | 57,267 | ||||||
| Total U.S. Government | 754,645 | 828,268 | ||||||
| Foreign governments | 2,523 | 20,879 | ||||||
| Commercial | 62,772 | 84,475 | ||||||
| Total | $ | 819,940 | $ | 933,622 | ||||
Sales by Contract Type: Generally, the sales price arrangements for the Company’s contracts are either fixed price, cost-plus or time-and-material type. Fixed-price type contracts generally offer higher profit margin potential than cost-plus type or time-and-material type contracts due to the greater levels of risk assumed on a fixed price type contract. The table below presents total net sales disaggregated by contract type.
| Period ended December 31, | ||||||||
| ($ in thousands) | 2020 | 2019 | ||||||
| Fixed-price | $ | 760,513 | $ | 779,633 | ||||
| Cost-plus | 51,217 | 82,438 | ||||||
| Time-and-material | 8,210 | 71,551 | ||||||
| Total | $ | 819,940 | $ | 933,622 | ||||
On a fixed-price type contract, the Company agrees to perform the contractual statement of work for a predetermined sales price. On a cost-plus type contract, the Company is paid its allowable incurred costs plus a profit which can be fixed or variable depending on the contract’s fee arrangement up to predetermined funding levels determined by the customer. Cost-plus type contracts with award and incentive fee provisions are the Company’s primary variable contract fee arrangement. On a time-and-material type contract, the Company is paid on the basis of direct labor hours expended at specified fixed-price hourly rates (that include wages, overhead, allowable general and administrative expenses and profit) and materials at cost.
Substantially all of the Company’s cost-plus type contracts and time-and-material type contracts are with U.S. Government customers, while sales to foreign government and commercial customers are generally transacted under fixed-price sales arrangements and are included in the Company’s fixed-price contract type sales.
| 17. | Related Party Transactions |
Advisory Services Agreement with AIP: The Company has entered into an advisory services agreement with AIP. Pursuant to the agreement, certain financial advisory, monitoring and oversight activities are performed for the Company. The Company does not pay a fee for these services, but does reimburse AIP for reasonable travel and other out-of-pocket expenses incurred in connection with the provision of the services. The Company also provides customary indemnification to AIP. Fees paid under this agreement totaled $1.3 million and $0.8 million for the periods ended December 31, 2020 and December 31, 2019, respectively, and were included in selling, general and administrative expenses.
56
Transition Services Agreement: On December 31, 2020, in conjunction with the spin-off of the Crestview Aerospace LLC (Crestview) transaction described in Note 4, the Company executed a Transition Services Agreement (TSA) with Crestview, primarily involving the Company providing certain services to Crestview Aerospace related to information technology, human resources benefits and accounting services. This TSA has an effective date of January 1, 2021. Subsequent to the spin-off transaction, Vertex and Crestview are now under common control with both entities having the same majority stockholder. Crestview was previously consolidated by the Company as a wholly-owned subsidiary prior to the reorganization and spin-off transaction. Effective January 1, 2020, the Company early adopted and applied the provisions of ASU 2018-17, see Note 2 New Accounting Standards Implemented. Under the services agreement, the Company engages with Crestview through the TSA as a routine provider of services.
For the year ended December 31, 2020, the Company did not record any revenue or expense related to the TSA with Crestview. As the Company effectively spun-off the Crestview entity as of December 31, 2020, the results of the Company include the operations of the previously wholly-owned subsidiary Crestview for the period of January 1, 2020 through December 31, 2020, the date of the spin-off transaction (see Note 4). Going forward, an agreed-to fixed amount will be billed monthly, with receipts expected based on standard payment terms. The Company sees no risk of loss associated with the services provided under the services agreement.
| 18. | Fair Value |
Accounting principles generally accepted in the U.S. define fair value as the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The authoritative guidance discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). These valuation techniques are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. As a basis for evaluating such inputs, a three-tier value hierarchy prioritizes the inputs used in measuring fair value as follows:
Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets.
Level 2: Observable inputs other than quoted prices that are directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets; quoted prices for similar or identical assets or liabilities in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.
Nonrecurring Fair Value Measurements: The Company’s non-financial assets which are measured at fair value on a nonrecurring basis include property, plant and equipment, goodwill, intangible assets and certain other assets.
The Company’s goodwill and indefinite-lived intangibles are fair valued using discounted cash flows and market multiple methods. Goodwill impairment testing requires significant use of judgment and assumptions including the identification of reporting units; the assignment of assets and liabilities to reporting units; and the estimation of future cash flows, business growth rates, terminal values and discount rates. The testing of indefinite-lived intangibles under established guidelines for impairment also requires significant use of judgment and assumptions, such as the estimation of cash flow projections, terminal values royalty rates, contributory cross charges, where applicable, and discount rates.
57
The following table summarizes the assets that are measured at fair value on a non-recurring basis at December 31, 2020 and December 31, 2019 (in thousands):
| December 31, 2020 | December 31, 2019 | Level 3 | ||||||||||
| Goodwill | $ | 240,504 | $ | 252,575 | $ | 240,504 | ||||||
The Company reviews property, plant and equipment for impairment whenever events or circumstances indicate that carrying amounts may not be recoverable through future undiscounted cash flows. If the Company concludes that impairment exists, the carrying amount is reduced to fair value.
| 19. | Covid-19 |
On January 30, 2020, the World Health Organization declared the coronavirus outbreak (COVID-19) a “Public Health Emergency of International Concern” and on March 11, 2020, declared COVID-19 a pandemic. The impact of COVID-19 could negatively impact the Company’s operations, suppliers or other vendors, and customer base. The operations for the Company’s services could be negatively impacted by the on-going regional and global impact of COVID-19, including stop-work orders on existing contract work for an unknown period of time. Any quarantines, labor shortages or other disruptions to the Company’s operations, or those of their customers, may adversely impact the Company’s revenues, ability to provide its services and operating results. In addition, a significant outbreak of epidemic, pandemic or contagious diseases in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, including the geographical area in which the Company operates, resulting in an economic downturn that could affect demand for its services. The Company’s workforce has been designated as Critical Infrastructure in the Defense Industrial Base Sector by the Department of Homeland Security. As such, the Department of Defense has informed the Company that it is expected to maintain normal work schedules and continue providing products and services as required under its contracts while following guidance to limit disease spread from the Centers for Disease Control and Prevention, as well as State and local government officials. Through December 31, 2020, no material changes have occurred in the Company’s operations. The extent to which the coronavirus impacts the Company’s results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus and actions taken to contain the coronavirus or its impact, among others.
| 20. | Subsequent Events |
Cash Dividends: Cash Dividends declared on November 6, 2020 of $100 million were paid to shareholders on January 4, 2021.
Term Loan: In March 2021, the Company amended the Term Loan Agreement to extend the maturity date, modify the repayment schedule, and lower the interest rates. The maturity date was extended to June 2027. The applicable rates were decreased to 3.00% and 4.00% for base rate and Eurodollar loans, respectively.
The Company has evaluated subsequent events through March 31, 2021, the date that the consolidated financial statements were available to be issued, and concluded no events, other than those disclosed in these consolidated financial statements, had occurred that would require recognition or disclosure in these consolidated financial statements and notes.
58
Exhibit 99.2
VERTEX AEROSPACE SERVICES HOLDING CORP.
Consolidated Financial Statements
For the Periods Ended July 3, 2022 and
June 25, 2021
Table of Contents
| Page | |
| Financial statements | |
| Consolidated balance sheets | 3 |
| Consolidated statements of operations | 4 |
| Consolidated statements of comprehensive income | 5 |
| Consolidated statements of changes in stockholders’ equity | 6 |
| Consolidated statements of cash flows | 7 |
| Notes to the consolidated financial statements | 8 |
2
Vertex Aerospace Services Holding Corp.
Consolidated Balance Sheets
(unaudited)
(in thousands)
| As of | As of | |||||||
| July 3, 2022 | June 25, 2021 | |||||||
| ASSETS | ||||||||
| Cash | $ | 21,199 | $ | 21,339 | ||||
| Accounts receivable, net | 156,294 | 18,377 | ||||||
| Unbilled contract receivables, net | 238,160 | 79,744 | ||||||
| Inventories, net | 41,742 | 39,402 | ||||||
| Prepaids and other current assets | 16,328 | 4,577 | ||||||
| Available for sale assets | - | 981 | ||||||
| Total current assets | 473,723 | 164,420 | ||||||
| Property and equipment, net | 43,107 | 22,159 | ||||||
| Operating lease right-of-use assets | 16,141 | - | ||||||
| Intangible assets, net | 220,900 | 76,507 | ||||||
| Goodwill | 883,675 | 240,504 | ||||||
| Deferred tax assets, net | 8,296 | 12,550 | ||||||
| Other long-term assets | 5,108 | 1,457 | ||||||
| Total assets | $ | 1,650,950 | $ | 517,597 | ||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
| Accounts payable | $ | 124,158 | $ | 57,663 | ||||
| Accrued salaries and benefits | 30,710 | 29,898 | ||||||
| Advance payments and billings in excess | 68,477 | 18,368 | ||||||
| Other accrued expenses | 15,051 | 4,782 | ||||||
| Current portion of long-term debt | 62,250 | 3,218 | ||||||
| Current portion of loss contract reserve | 17,151 | 13,117 | ||||||
| Operating lease liabilities, current | 5,146 | - | ||||||
| Other current liabilities | 15,416 | 4,313 | ||||||
| Total current liabilities | 338,359 | 131,359 | ||||||
| Long-term debt, net | 1,067,031 | 310,693 | ||||||
| Operating lease liabilities, non-current | 10,996 | - | ||||||
| Long-term portion of loss contract reserve | 14,082 | 14,457 | ||||||
| Other long-term liabilities | 16,219 | 934 | ||||||
| Total liabilities | 1,446,687 | 457,443 | ||||||
| Stockholders' Equity | ||||||||
| Common Stock, $.01 par value, 400,000 and 251,332 shares authorized, respectively; 273,950 and 226,220 shares issued and outstanding, respectively | 3 | 2 | ||||||
| Preferred Stock, 8% Paid-in-Kind, $.01 par value, 75,000 and 0 shares authorized, respectively; 64,407 and 0 shares issued and outstanding, respectively | - | - | ||||||
| Additional paid in capital - common stock | 301,486 | 226,118 | ||||||
| Additional paid in capital - preferred stock | 64,000 | - | ||||||
| Other comprehensive loss | (3,925 | ) | - | |||||
| Retained earnings | (157,301 | ) | (165,966 | ) | ||||
| Total stockholders' equity | 204,263 | 60,154 | ||||||
| Total liabilities and stockholders' equity | $ | 1,650,950 | $ | 517,597 | ||||
See notes to consolidated financial statements
3
Vertex Aerospace Services Holding Corp.
Consolidated Statements of Operations
(unaudited)
(in thousands)
| Six months ended | Six months ended | |||||||
| July 3, 2022 | June 25, 2021 | |||||||
| Revenues: | ||||||||
| Sales | $ | 775,581 | $ | 343,294 | ||||
| Cost of sales | 671,102 | 304,209 | ||||||
| Gross profit | 104,479 | 39,085 | ||||||
| Operating costs and expenses: | ||||||||
| Selling, general and administrative expenses | 63,320 | 19,962 | ||||||
| Operating income | 41,159 | 19,123 | ||||||
| Other expenses: | ||||||||
| Loss on disposal of assets | 44 | - | ||||||
| Interest expense, net | (33,852 | ) | (7,791 | ) | ||||
| Total other expenses | (33,808 | ) | (7,791 | ) | ||||
| Income before income taxes | 7,351 | 11,332 | ||||||
| Income tax expense | (2,006 | ) | (3,003 | ) | ||||
| Net income | $ | 5,345 | $ | 8,329 | ||||
See notes to consolidated financial statements
4
Vertex Aerospace Services Holding Corp.
Consolidated Statements of Comprehensive Income
(unaudited)
(in thousands)
| Six months ended | Six months ended | |||||||
| July 3, 2022 | June 25, 2021 | |||||||
| Net income | $ | 5,345 | $ | 8,329 | ||||
| Other comprehensive loss: | ||||||||
| Foreign currency translation adjustments | (3,721 | ) | - | |||||
| Total other comprehensive loss | (3,721 | ) | - | |||||
| Comprehensive income | $ | 1,624 | $ | 8,329 | ||||
See notes to consolidated financial statements
5
Vertex Aerospace Services Holding Corp.
Consolidated Statements of Changes in Stockholders' Equity
(unaudited)
(in thousands)
| Common Stock | Preferred Stock | |||||||||||||||||||||||||||||||||||
| Shares | Value | Additional Paid in Capital |
Shares | Value | Additional Paid in Capital |
Accumulated Other Comprehensive Loss |
Retained Earnings |
Total Shareholders' Equity |
||||||||||||||||||||||||||||
| Beginning balance, December 31, 2020 | 226,220 | $ | 2 | $ | 226,218 | - | $ | - | $ | - | $ | - | $ | (174,275 | ) | $ | 51,945 | |||||||||||||||||||
| Shares repurchased and retired | (100 | ) | - | (100 | ) | - | - | - | - | (20 | ) | (120 | ) | |||||||||||||||||||||||
| Net income | - | - | - | - | - | - | - | 8,329 | 8,329 | |||||||||||||||||||||||||||
| Ending balance, June 25, 2021 | 226,120 | $ | 2 | $ | 226,118 | - | $ | - | $ | - | $ | - | $ | (165,966 | ) | $ | 60,154 | |||||||||||||||||||
| Beginning balance, December 31, 2021 | 273,944 | $ | 3 | $ | 301,476 | 75,000 | $ | - | $ | 75,000 | $ | (204 | ) | $ | (162,646 | ) | $ | 213,629 | ||||||||||||||||||
| Contributions by shareholders | 6 | - | 10 | - | - | - | - | - | 10 | |||||||||||||||||||||||||||
| Preferred stock redeemed | - | - | - | (10,593 | ) | - | (11,000 | ) | - | - | (11,000 | ) | ||||||||||||||||||||||||
| Foreign currency translation adjustments | - | - | - | - | - | - | (3,721 | ) | - | (3,721 | ) | |||||||||||||||||||||||||
| Net income | - | - | - | - | - | - | 5,345 | 5,345 | ||||||||||||||||||||||||||||
| Ending balance, July 3, 2022 | 273,950 | $ | 3 | $ | 301,486 | 64,407 | $ | - | $ | 64,000 | $ | (3,925 | ) | $ | (157,301 | ) | $ | 204,263 | ||||||||||||||||||
See notes to consolidated financial statements
6
Vertex Aerospace Services Holding Corp.
Consolidated Statements of Cash Flows
(unaudited)
(in thousands)
| Six months ended | Six months ended | |||||||
| July 3, 2022 | June 25, 2021 | |||||||
| Cash flows from operating activities: | ||||||||
| Net income | $ | 5,345 | $ | 8,329 | ||||
| Adjustments to reconcile net income to net cash flows provided by operating activities: | ||||||||
| Depreciation of property and equipment | 5,175 | 2,702 | ||||||
| Amortization of intangibles | 12,269 | 6,507 | ||||||
| Amortization of deferred financing costs | 2,547 | 741 | ||||||
| Loss contract provision | (3,602 | ) | (6,694 | ) | ||||
| Gain on disposition of property and equipment | (44 | ) | - | |||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | (90,044 | ) | (91 | ) | ||||
| Unbilled contract receivables | 13,019 | (4,555 | ) | |||||
| Inventories | (4,024 | ) | 2,968 | |||||
| Prepaids and other current assets | (15,074 | ) | 582 | |||||
| Other assets | (935 | ) | - | |||||
| Accounts payable | 3,444 | (12,384 | ) | |||||
| Accrued salaries and benefits | (2,520 | ) | 10,164 | |||||
| Advance payments and billings in excess | (12,863 | ) | 4,264 | |||||
| Other accrued expenses | 6,077 | (3,456 | ) | |||||
| Other liabilities | 7,834 | (305 | ) | |||||
| Net cash (used in) provided by operating activities | (73,396 | ) | 8,772 | |||||
| Cash flows from investing activities: | ||||||||
| Purchase of property and equipment | (1,006 | ) | (846 | ) | ||||
| Net cash used in investing activities | (1,006 | ) | (846 | ) | ||||
| Cash flows from financing activities: | ||||||||
| Borrowings from ABL credit facility, net | 53,000 | - | ||||||
| Principal payments on long term debt | (2,313 | ) | ||||||
| Dividends paid | - | (100,000 | ) | |||||
| Debt issuance costs | - | (1,995 | ) | |||||
| Contributions by stockholders | 10 | - | ||||||
| Stock repurchased from stockholders | - | (120 | ) | |||||
| Net cash provided by (used in) financing activities | 50,697 | (102,115 | ) | |||||
| Net decrease in cash | (23,705 | ) | (94,189 | ) | ||||
| Cash, beginning of period | 44,904 | 115,528 | ||||||
| Cash, end of period | $ | 21,199 | $ | 21,339 | ||||
| Supplemental disclosures of cash flow information | ||||||||
| Cash paid during the period for: | ||||||||
| Interest | $ | 30,723 | $ | 5,916 | ||||
| Income taxes | 491 | 234 | ||||||
See notes to consolidated financial statements
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1
DESCRIPTION OF BUSINESS
Vertex Aerospace Services Holding Corp. (“Holding”) was incorporated in 2018 under the laws of Delaware by an affiliate of American Industrial Partners Capital Fund VI, L.P. (“AIP”) to facilitate the acquisition of 100% of the voting interest of the business of Vertex Aerospace, Crestview Aerospace, TCS Aerospace and various other assets from L-3 Communications Integrated Systems L.P. and L-3 Technologies, Inc. (collectively referred to herein as “L3”). The acquisition was completed on June 29, 2018.
Holding and its consolidated subsidiaries (herein referred to as the “Company”, “we”, “us”, or “our”) provides aviation and aerospace technical services, managing and servicing fixed- and rotary-wing aircraft primarily for government customers by providing logistics support, maintenance, repair, overhaul services and supply chain management. The Company also provides aircraft modification and assembly to customers including the U.S. Government (primarily the Department of Defense, or “DoD”) and commercial and original equipment manufacturers by providing parts, facilities, technology and experience for the manufacture and modification of aircrafts. In addition, the Company designs, develops, integrates, tests, modifies and provides documentation for every aspect of aircraft and avionics hardware and software systems to address critical needs of the U.S. military’s conventional and Special Operations forces.
The Transaction: On December 6, 2021 (the “Transaction Date”), the Company completed the acquisition of the Technology and Training Solutions business lines (“the TTS Business”) from Raytheon Company (the “Transaction”) (Note 3). The acquired business is comprised of four product lines: Defense Training Solutions, Commercial Training Solutions, Mission Critical Solutions and Modernization and Sustainment.
NOTE 2
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: Our accounting periods ended on July 3, 2022 for the six months of 2022 and June 25, 2021 for the six months of 2021. Our accounting monthly calendar is based on 4-4-5 periods. Year end is based on calendar year. The Company’s consolidated financial statements include the accounts of Holding and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in the consolidation. It is management’s opinion that these consolidated financial statements include all normal and recurring adjustments necessary for a fair presentation of the Company’s financial position and operating results.
Use of Estimates: The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of sales and cost of sales during the reporting period. The most significant of these estimates and assumptions relate to sales, profit and loss recognition for performance obligations satisfied over time, fair values of assets acquired and liabilities assumed in business combinations, market values for inventories reported at lower of cost or net realizable value, income taxes, including valuations of deferred tax assets, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill. Changes in estimates are reflected in the periods during which they become known. Actual amounts may differ from these estimates and could differ materially.
Foreign Operations: The Company’s operations are subject to various political, economic, and other risks and uncertainties inherent in the foreign countries in which the Company operates. Among other risks, the Company’s operations in China are subject to the risks of restrictions on transfer of Chinese Renminbi (“RMB”) funds, which is not a freely transferable currency; export duties, quotas, and embargoes; domestic and international customs and tariffs;
8
changing taxation policies; foreign exchange restrictions; and political conditions and governmental regulations. The Company had the U.S. Dollar equivalent of $5.4 million and $0.0 million of cash and cash equivalents of RMB held in Chinese bank accounts at July 3, 2022 and June 25, 2021 respectively.
Foreign Currency Translation: The functional currency for the majority of the Company’s foreign subsidiaries is the local foreign currency. For those subsidiaries, the assets and liabilities are translated into U.S. dollars at the exchange rates in effect at the balance sheet date. Income and expense items are translated at an average exchange rate for the period. Certain foreign subsidiaries, which is primarily the U.K and Canada as of December 31, 2021, designate the U.S dollar as the functional currency. For these subsidiaries, assets and liabilities denominated in foreign currency are re-measured into U.S dollars at the current exchange rates for monetary assets and liabilities and historical exchange rates for nonmonetary assets and liabilities. Foreign exchange differences resulting from translation are included in accumulated other comprehensive loss as a component of stockholder’s equity. Foreign exchange differences from re-measurement and settlement of monetary assets and liabilities are included in other income, net on the consolidated statements of operations. At July 3, 2022 and June 25, 2021, the Company recorded other comprehensive loss of $3.7 million and $0.0 million respectively.
Cash and Cash Equivalents: The Company considers all highly liquid investments with an original maturity date of less than three months when purchased to be cash equivalents. The Company maintains cash and cash equivalents in bank deposit accounts which, at times, may exceed federally insured limits. As of July 3, 2022, and June 25, 2021, approximately $15.2 million and $0 million of cash was held in bank accounts outside of the U.S., respectively, inclusive of the $5.4 million in RMB disclosed in the “Foreign Operations” footnote. The Company has not experienced any significant losses in such accounts and believes it is not exposed to any significant risks on cash. At July3, 2022 and June 25, 2021, the Company had no cash equivalents.
Revenue Recognition: The Company adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, as amended (commonly referred to as Accounting Standards Codification (“ASC”) 606), for revenue recognition purposes.
The majority of the Company’s consolidated net sales are generated from long-term contracts with customers that require it to maintain, repair or overhaul aircraft. These contracts are primarily with agencies of, and prime system contractors to, the U.S. Government and foreign governments and are generally priced on a fixed-price, cost-plus or time-and-material type basis. Substantially all of the Company's cost-plus and time-and-material type contracts are with the Department of Defense (“DoD”). Certain of the Company’s contracts with the U.S. Government are multi-year contracts incrementally funded by the customer. The transaction price for these incrementally funded contracts includes contract value amounts not yet funded by the U.S. Government when the Company has a firm order for the goods or services and it is probable that the customer will fund such amounts. In assessing probability, the Company considers, among other factors, the period of time before contract funding is expected, communication from the customer that indicates funding will be obtained and the Company's history of receiving funding under the current contract or previous similar contracts. The Company also generates sales, to a lesser extent, from contracts with commercial and government customers for standard product and service offerings, which are priced on a firm fixed basis. See Note 5 for additional information regarding the composition of the Company’s net sales.
The Company records sales for a contract when it has the approval and commitment of all parties, the contract identifies the rights of the parties and payment terms, the contract has commercial substance and collectability of the consideration is probable.
To determine the proper revenue recognition method, the Company first evaluates each of its contractual arrangements to identify its performance obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. Some of the Company’s contracts have a single performance obligation because the promise to transfer the individual good or service is not separately identifiable from other promises within the contract and is, therefore, not distinct. The majority of the Company's contracts have multiple performance obligations, primarily (i) related to the provision of multiple goods or services that have alternative use to the Company
9
or that are not substantially the same or (ii) due to the contract covering multiple phases of the product lifecycle (development and engineering, production, maintenance and support). For contracts with more than one performance obligation, the Company allocates the total transaction price in an amount based on the estimated relative standalone selling prices underlying each performance obligation. In cases where a contract requires a customized good or service, the primary method used to estimate standalone selling price is the expected cost plus a margin approach. In cases where the Company sells a standard product or service offering, the stand-alone selling price is based on an observable standalone selling price.
The majority of the Company's sales are from performance obligations satisfied over time. Sales are recognized over time when control is continuously transferred to the customer during the contract. For U.S. Government contracts, the continuous transfer of control to the customer is supported by contract clauses that provide for (i) progress or performance-based payments or (ii) the unilateral right of the customer to terminate the contract for its convenience, in which case the Company has the right to receive payment for costs incurred plus a reasonable profit for products and services that do not have alternative use to the Company. Foreign government and certain commercial contracts contain similar termination for convenience clauses, or the Company has a legally enforceable right to receive payment for costs incurred and a reasonable profit for products or services that do not have alternative use to the Company. Sales on fixed price and cost-plus type contracts that include performance obligations satisfied over time are generally recorded at amounts equal to the ratio of actual cumulative costs incurred divided by total estimated costs at completion, multiplied by (i) the transaction price, less (ii) the cumulative sales recognized in prior periods (cost-to-cost input method).
Accounting for the sales and profits on performance obligations for which progress is measured using the cost-to-cost input method involves the preparation of estimates of: (1) transaction price and (2) costs at completion, which is equal to the sum of the actual incurred variable costs to date on the contract and the estimated variable costs to complete the contract's statement of work. Incurred variable costs include labor, material, other direct costs, fringe, and benefits. Incurred variable costs represent work performed, which corresponds with and thereby represents the transfer of control to the customer. The estimated profit or loss at completion on a contract is equal to the difference between the transaction price and the estimated variable cost at completion. In the case of a contract for which the estimated variable costs exceed the total transaction price, a loss arises, and a provision for the entire loss is recorded in the period that the loss becomes evident. The unrecoverable costs on a loss contract that are expected to be incurred in future periods are presented on the consolidated balance sheet as a component of liabilities entitled either "Short-term Portion of Loss Contract Reserve" or "Long-term Portion of Loss Contract Reserve".
The Company’s contracts give rise to variable consideration, including award and incentive fees, as well as amounts incrementally funded by the U.S. Government, or other provisions that can either increase or decrease the transaction price. 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 costs and target costs. Variable consideration may require the Company to exercise significant judgment to determine the total transaction price of the contract. The Company includes variable consideration in the transaction price when there is a basis to reasonably estimate the variable amount it will be entitled to receive and it is probable that a significant reversal in revenue recognized will not be required when the uncertainty is resolved. These estimates are based on historical experience, current and forecasted performance and the Company’s judgment at the time of the evaluation.
Contract modifications routinely occur to account for changes in contract specifications or requirements. In most cases, contract modifications are for goods or services that are not distinct and, therefore, are accounted for as part of the existing contract. Transaction price estimates include additional consideration for submitted contract modifications or claims when the Company believes it has an enforceable right to the modification or claim, the amount can be reliably estimated and its realization is reasonably assured. Amounts representing modifications accounted for as part of the existing contract are included in the transaction price and recognized as an adjustment to
10
sales on a cumulative catch-up basis.
The Company’s fixed-price type contracts with the U.S. Government are typically billed based on monthly firm fixed prices. Since cost is often incurred beyond the period of performance of the contract, billings often exceed costs, which are presented as current liabilities on the consolidated balance sheet. For certain fixed-price contracts with foreign governments and commercial customers, the Company receives advance payments. Advanced payments are not considered a significant financing component because they are a negotiated contract term to ensure the customer meets its financial obligation, particularly when there are significant upfront working capital requirements. These two liabilities are combined on the consolidated balance sheet in the line item entitled “advance payments and billings in excess.” Contract assets often arise from cost-plus type contracts, time-and-material type contracts and fixed-price services type contracts for revenue amounts that have not been billed by the end of the accounting period due to the timing of preparation of invoices to customers. The Company records an asset for these revenues as current assets on the consolidated balance sheet in the line item entitled “unbilled contract receivables, net.”
Revisions or adjustments to estimates of the transaction price, estimated costs at completion and estimated profit or loss of a performance obligation may be required as work progresses under a contract, as experience is gained, as facts and circumstances change and as new information is obtained, even though the scope of work required under the contract may not change. Revisions or adjustments may also be required if contract modifications occur. The impact of revisions in profit or loss estimates are recognized on a cumulative catch-up basis in the period in which the revisions are made. The revisions in contract estimates, if significant, can materially affect the Company’s results of operations and cash flows, as well as reduce the valuations of contract assets, and in some cases result in liabilities to complete contracts in a loss position.
Sales from performance obligations satisfied at a point in time are typically for standard goods and are recognized when the customer obtains control, which is generally upon delivery and acceptance. The Company also records sales for performance obligations relating to standard services (i.e., maintenance and extended warranties covering standard goods sold by the Company) over time by using output measures of time elapsed to measure progress toward satisfying the performance obligation.
For cost plus type contracts, revenue is recognized as performance obligations are satisfied over time on a percentage of completion basis using the costs incurred to ate relative to total estimated costs at completion to measure progress. Incurred costs represent work performed, which correspond with the best depict transfer of control to the customer. Sales on time-and-material type contracts are generally recognized each period based on the amount billable to the customer, which is based on direct labor hours expended multiplied by the contractual fixed rate per hour, plus the actual costs of materials and other direct non-labor costs.
Contract Assets and Contract Liabilities: Contract assets include unbilled contract receivables related to long-term contracts for which sales and profits are recognized primarily using cost-to-cost input method of accounting and are classified as current. Unbilled contract receivables are reduced by amounts of unliquidated progress or performance-based payments. Under the terms of certain revenue arrangements (contracts) with the U.S. Government, the Company is entitled to receive progress payments as costs are incurred or performance-based payments upon the achievement of predetermined performance milestones. Unliquidated progress or performance-based payments arise from fixed-price type contracts with the U.S. Government that contain progress or performance-based payment clauses and represent payments on invoices that have been collected in cash but have not yet been liquidated. Progress payment invoices are billed to the customer as contract costs are incurred at an amount generally equal to 80% of incurred costs. Performance based payments are billed to the customer upon the achievement of predetermined performance milestones at amounts not to exceed 90% of contract price. Unliquidated progress or performance-based payments are liquidated as deliveries or other contract performance milestones are completed, at an amount equal to a percentage of the contract sales price for the items delivered or work performed, based on a contractual liquidation rate. Contract liabilities include advance payments, billings in excess of the revenue recognized and amounts received in excess of sales recognized on contracts (deferred revenue). Contract assets and liabilities are reported in a net
11
position on a contract-by-contract basis at the end of each reporting period. Advance payments and billings in excess of revenue recognized are both classified as current, and deferred revenue as current or noncurrent based on the timing of expected revenue recognition. As of July 3, 2022, and June 25, 2021, all contract liabilities are classified as current. Contract loss reserves are contract liabilities and reported as current and long-term.
Property and Equipment: Property and equipment are stated at cost minus accumulated depreciation. Depreciation is computed by applying the straight-line method to the estimated useful lives of the related assets. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the improvements. Expenditures for maintenance, repairs and minor improvements are charged to expense as incurred. When property or equipment is retired or otherwise disposed of, the net book value of the asset is removed from the Company’s consolidated balance sheet and the net gain or loss is included in the determination of net income. See Note 8 for additional information.
Goodwill: The Company records goodwill in connection with the acquisition of businesses when the purchase price exceeds the fair values of the assets acquired and liabilities assumed. The carrying value of goodwill is not amortized, but is tested for impairment annually and is reviewed for impairment on an interim basis whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The Company has adopted Financial Accounting Standards Board (FASB) ASU 2017-04, Simplifying the Test for Goodwill Impairment. Under ASU 2017-04, the Company will determine the amount of goodwill impairment by comparing the Step 1 fair value of a reporting unit with its carrying amount. To the extent the carrying value of a reporting unit exceeds its Step 1 fair value, a goodwill impairment charge is recorded. See Note 9 for additional information.
Long-Lived Assets Other Than Goodwill: The Company reviews its long-lived assets, including software development costs, amortizable customer contract relationships and indefinite-lived tradenames for impairment annually, or whenever events or circumstances indicate that the carrying amount(s) of an asset may not be recoverable. When such events or changes in circumstances occur, a recoverability test is performed comparing projected undiscounted cash flows from the use and eventual disposition of an asset or asset group to its carrying amount. If the projected undiscounted cash flows are less than the carrying amount, an impairment is recorded to the extent the carrying amount exceeds fair value. The Company reviews indefinite-lived trade names at least annually by comparing fair value to carrying value of the intangible asset. Fair value is determined through various valuation techniques, including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. Estimates critical to the Company’s evaluation of indefinite-lived trade names for impairment include the discount rate, royalty rates used in its evaluation of trade names, projected average revenue growth and projected long-term growth rates in the determination of terminal values. See Note 9 for additional information.
Deferred Debt Issuance Costs: Costs to issue debt are capitalized and deferred when incurred, and subsequently amortized to interest expense over the term of the related debt using the effective interest rate method. Deferred debt issuance costs, other than for revolving line-of-credit arrangements, are presented in the Company’s consolidated balance sheet as a direct deduction from the carrying amount of the associated debt liability. Deferred debt issuance costs for revolving line-of-credit arrangements are included in the Company’s consolidated balance sheet in other assets. The deferred debt issuance costs for the revolving line of credit were $1.5 million for the period ended July 3, 2022, and $1.4 million for the period ended June 25, 2021.
Contingencies and Commitments: In accordance with ASC 450, Contingencies (Topic 450): Disclosure of Certain Loss Contingencies, the Company records a loss contingency when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company reviews its loss contingencies on an ongoing basis to ensure that it has appropriate reserves recorded in its consolidated balance sheets. These reserves are based on historical experience with claims incurred but not received, estimates and judgments made by management and applicable insurance coverage for litigation matters, and, as such, adjusted as circumstances warrant.
12
Legal costs incurred in connection with loss contingencies are expensed as incurred. See Note 14 for additional information.
Accounts Receivable and Unbilled Contract Receivables: Accounts receivable, net and unbilled contract receivables, net are generated from prime and subcontracting arrangements primarily with U.S. governmental agencies. Billed amounts represent invoices that have been prepared and sent to the customer. Unbilled amounts primarily represent costs and fees incurred in excess of billings and rate variances on cost -plus contracts as well as retainage amounts. In accordance with industry practice, contract receivables relating to long-term contracts are classified as current, even though portions of these amounts may not be realized within one year. Billed accounts receivable are considered past due if the invoice has been outstanding more than 30 days. The Company does not charge interest on accounts receivable; however, U.S. governmental agencies pay interest on invoices outstanding more than 30 days. The Company records interest income from U.S. governmental agencies when received. The provision for doubtful accounts is based on management’s evaluation of the status of existing accounts receivable. Receivables are written off when deemed uncollectible. Recoveries of accounts receivable previously written off are recorded when received.
Income Taxes: The Company is a taxable entity for federal income tax purposes and files a consolidated U.S. federal income tax return. The Company uses the liability method of accounting for income taxes. Deferred income tax assets and liabilities reflect tax carryforwards and the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes, as determined under enacted tax laws and rates expected to be in effect when such differences reverse. The effect of changes in tax laws or rates is accounted for in the period of enactment. Valuation allowances for deferred tax assets are provided when it is more likely than not that some portion or all of the assets will not be realized considering, when appropriate, tax planning strategies.
Income tax accounting standards prescribe (1) a minimum recognition threshold that an income tax benefit arising from an uncertain income tax position taken, or expected to be taken, on an income tax return is required to meet before being recognized in the financial statements and (2) the measurement of the income tax benefits recognized from such positions. The Company’s account policy is to classify uncertain income tax positions that are not expected to be resolved within one year as non-current income tax liabilities and to classify potential interest and penalties on uncertain tax positions as elements of the provision for income taxes on its financial statements.
New Accounting Standards Issued and Not Yet Implemented: In January 2020, the FASB issued ASU 2020-01, Investments—Equity Securities (Topic 321), Investments—Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815), which clarifies that the observable price changes in orderly transactions that should be considered when applying the measurement alternative in accordance with ASC 321 include transactions that require it to either apply or discontinue the equity method of accounting under ASC 323. ASU 2020-01 also addresses questions about how to apply the guidance in Topic 815, Derivatives and Hedging, for certain forward contracts and purchased options to purchase securities that, upon settlement or exercise, would be accounted for under the equity method of accounting. This ASU is effective for the Company beginning on January 1, 2022. The adoption of ASU 2020-01 is not expected to have a significant impact on our consolidated financial statements. We are currently evaluating the impact of this new guidance on its consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in ASC 740 and also clarifies and amends existing guidance to improve consistent application. This ASU is effective for the Company beginning on January 1, 2022. The adoption of ASU 2019-12 is not expected to have a significant impact on the Entity’s consolidated financial statements. The Company is currently evaluating the impact of this new guidance on its consolidated financial statements.
13
New Accounting Standards Recently Implemented In March 2019, the FASB issued ASU 2019-01, Leases (Topic 842): Codification Improvements, which addressed issues lessors sometimes encounter. Specifically the ASU addresses issues related to (1) determining the fair value of the underlying asset by the lessor that are not manufacturers or dealers (generally financial institutions and captive finance companies), and (2) lessors that are depository and lending institutions, which should classify principal and payments received under sales-type and direct financing leases within investing activities in the cash flow statement. The ASU also exempts both lessees and lessors from having to provide the interim disclosures required by ASC 250-10-50-3 in the fiscal year in which an entity adopts the new leases standard. In June 2020, the FASB issued ASU 2020-05, Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842) Effective Dates for Certain Entities, which delays the effective date of ASU 2019-01 for certain entities. This ASU is effective for the Company beginning on January 1, 2022. The right-of-use assets and operating lease liabilities were both $16.1 million as of July 3, 2022.
NOTE 3
RECENT ACQUISITION OF RAYTHEON ASSETS AND PURCHASE ACCOUNTING
On December 6, 2021, the Company completed the acquisition of the Technology and Training Solutions business lines (“the TTS Business”) from Raytheon Company. The Company’s acquisition of the TTS Business was accounted for in accordance with the provisions of ASC 805 Business Combination, whereby the fair value of the consideration transferred to Raytheon has been allocated to the assets acquired and the liabilities assumed at estimated fair values. The TTS Business acquisition significantly expands the Company’s value-added technology solutions and services, including defense and commercial training, mission critical support solutions, and engineering and modernization capabilities. Further, the TTS Business acquisition expands the Company’s strategy to deliver integrated and comprehensive solutions to its customers globally. The TTS Business acquisition was funded through the First Lien Term Loan and Second Lien Term Loan, borrowings under the Company’s ABL Credit Facility, a $75.0 million equity contribution by AIP, and issuance of $75.0 million of preferred equity. Acquisition-related expenses of $8.0 million were recognized separately from the business combination and expensed in December 2021 as incurred unless otherwise prescribed under U.S. GAAP.
Deferred tax amounts are recorded as provisional due to the Company seeking additional information related to certain non-U.S. entity information, and the allocation of acquired intangible assets and goodwill to non-U.S. entities. No deferred tax amounts have been recorded related to these items. Any adjustments to the deferred tax amounts in the available measurement period would result in an increase or decrease in goodwill.
Total consideration transferred represents the estimated fair value of $827.7 million in cash and $75.0 million of preferred stock. The $11 million resulting from the net working capital settlement with the Seller, along with the recording of an assumed liability of $2.9 million, represent measurement period adjustments recorded in the six-month period ended July 3, 2022. These amounts were not finalized as of December 31, 2021 and resulted in a measurement period adjustment to goodwill of $8.1 million (Note 9). The seller and buyer agreed that the payment of the adjustment amount of $11.0 million be fulfilled via the redemption of Series A Preferred Stock. 10,593 shares of Series A Preferred Stock were reduced at $1,038.43 per share redemption price. The Preferred Stock was reduced in the balance sheet from $75.0 million to $64.0 million at July 3, 2022. The preferred yield is 8% per annum, accrued daily and compounded quarterly. As of July 3, 2022, the cumulative amount of undeclared dividend payable is $3.4 million.
14
The allocation of the consideration transferred to assets acquired and liabilities assumed, based on their estimated fair values on the Transaction Date were as follows ($ in thousands):
| Cash | $16,985 |
| Accounts receivable | 58,765 |
| Unbilled contract receivables | 123,499 |
| Inventories | 2,503 |
| Prepaids and other current assets | 414 |
| Property and equipment | 30,919 |
| Other assets | 7,291 |
| Customer related intangible assets | 164,600 |
| Total assets | 404,976 |
| Accounts payable | 53,263 |
| Accrued salaries and benefits | 7,927 |
| Advance payments and billings in excess | 67,420 |
| Accrued other expenses | 210 |
| Loss contract reserves | 10,601 |
| Other current liabilities | 1,868 |
| Other long-term liabilities | 12,245 |
| Total liabilities | 153,533 |
| Goodwill | 651,225 |
| Total consideration transferred | $902,668 |
NOTE 4
MERGER WITH VECTRUS, INC.
On March 7, 2022, the Company entered into an agreement and plan of merger with Vectrus, Inc. (“Vectrus”), a facility and logistics services company providing base operations support, supply chain and logistics, IT mission support, engineering and digital integration, security, and maintenance services in 205 locations in 28 countries. Vectrus generated sales of approximately $1.8 billion in 2021. Under the terms of the merger agreement, the Company’s shareholders will own approximately 62% of the combined company and Vectrus shareholders will own approximately 38% of the combined company. The Transaction was completed and closed on July 5, 2022 (the “Closing Date”).
As a result of the closing of the Mergers, on the Closing Date, the Company’s Equity Incentive Plan is cancelled and Restricted Stock Units (RSUs) were issued. Vertex is not expected to be the accounting acquirer under ASC 805.
15
NOTE 5
REVENUE
Disaggregation of Net Sales
The Company disaggregates its sales from contracts with customers by: (1) end customer and (2) contract type. The Company believes these factors affect the nature, amount, timing and uncertainty of the Company’s revenue and cash flows.
Sales by End Customer: Direct sales to the end customer represented approximately 93% of the Company’s consolidated sales in the period ended July 3, 2022, and 98% in the period ended June 25, 2021. Indirect sales as a subcontractor or supplier represented the remaining 7% in the period ended July 3, 2022 and 2% in the period ended June 25, 2021. The table below presents total net sales disaggregated by end customer.
| Periods Ended, | |||||||
| ($ in thousands) | |||||||
| July 3, 2022 | June 25, 2021 | ||||||
| Total DoD | $ | 645,203 | $ | 290,421 | |||
| Other U.S. Government | 91,972 | 43,332 | |||||
| Total U.S. Government | 737,175 | 333,753 | |||||
| Foreign governments | - | 4,659 | |||||
| Commercial | 38,406 | 4,882 | |||||
| Total | $ | 775,581 | $ | 343,294 | |||
Sales by Contract Type: Generally, the sales price arrangements for the Company’s contracts are either fixed price, cost-plus or time-and-material type. Fixed-price type contracts generally offer higher profit margin potential than cost-plus type or time-and-material type contracts due to the greater levels of risk assumed on a fixed price type contract. The table below presents total net sales disaggregated by contract type.
| Periods Ended, | |||||||
| ($ in thousands) | July 3, 2022 | June 25, 2021 | |||||
| Fixed-price | $ | 577,142 | $ | 297,974 | |||
| Cost-plus | 189,082 | 33,848 | |||||
| Time-and-material | 9,357 | 11,472 | |||||
| Total | $ | 775,581 | $ | 343,294 | |||
On a fixed-price type contract, the Company agrees to perform the contractual statement of work for a predetermined sales price. On a cost-plus type contract, the Company is paid its allowable incurred costs plus a profit which can be fixed or variable depending on the contract’s fee arrangement up to predetermined funding levels determined by the customer. Cost-plus type contracts with award and incentive fee provisions are the Company’s primary variable contract fee arrangement. On a time-and-material type contract, the Company is paid on the basis of direct labor hours expended at specified fixed-price hourly rates (that include wages, overhead, allowable general and administrative expenses and profit) and materials at cost.
Substantially all of the Company’s cost-plus type contracts and time-and-material type contracts are with U.S. Government customers, while sales to foreign government and commercial customers are generally transacted under fixed-price sales arrangements and are included in the Company’s fixed-price contract type sales.
16
NOTE 6
ACCOUNTING FOR CONTRACTS
The components of contracts in process are presented in the table below. The unbilled contract receivables, inventoried contract costs and unliquidated progress payments principally relate to contracts with the U.S. Government and prime contractors or subcontractors of the U.S. Government. The Company’s unbilled contract costs were as follows:
| Periods Ended, | ||||||||
| ($ in thousands) | July 3, 2022 | June 25, 2021 | ||||||
| Unbilled contract receivables, gross | $ | 238,160 | $ | 79,744 | ||||
| Unbilled contract receivables, net | 238,160 | 79,744 | ||||||
| Inventoried contract costs | 450 | 423 | ||||||
| Total contracts in progress | $ | 238,610 | $ | 80,167 | ||||
Unbilled Contract Receivables. Unbilled contract receivables represent accumulated incurred costs and earned profits on contracts (revenue arrangements), which have been recorded as sales, but have not yet been billed to customers. Unbilled contract receivables arise from the cost-to-cost input method of revenue recognition that is used to record sales on certain fixed-price contracts. Unbilled contract receivables from fixed-price type contracts are converted to billed receivables when amounts are invoiced to customers according to contractual billing terms, which generally occur when deliveries or other performance milestones are completed. Unbilled contract receivables also arise from cost-plus type contracts, time-and-material type contracts and fixed-price service type contracts for revenue amounts that have not been billed by the end of the accounting period due to the timing of preparation of invoices to customers.
Inventoried Contract Costs: In accordance with contract accounting standards, the Company’s U.S. Government contractor businesses account for the portion of their general and administrative (“G&A”), independent research and development (“IRAD”) and bids and proposals (“B&P”) costs that are allowable and reimbursable indirect contract costs under U.S. Government procurement regulations on their U.S. Government contracts (revenue arrangements) as inventoried contract costs. G&A, IRAD and B&P costs are allocated to contracts for which the U.S. Government is the end customer and are charged to costs of sales when sales on the related contracts are recognized. The Company’s U.S. Government contractor businesses record the unallowable portion of their G&A, IRAD and B&P costs to expense as incurred and do not include them in inventoried contract costs.
NOTE 7
INVENTORIES
The table below presents the components of inventories at the lower of cost (first-in, first-out or average cost) or net realizable value. In accordance with ASC 606, all work in process relating to goods that customers do not currently control are classified within inventories on the Company's consolidated balance sheets at July 3, 2022 and June 25, 2021. The Company establishes provisions for excess and obsolete inventories after evaluation of historical sales, current economic trends, forecasted sales, product lifecycles, and current inventory levels.
| Periods Ended | ||||||||
| ($ in thousands) | July 3, 2022 | June 25, 2021 | ||||||
| Raw materials, components and sub-assemblies | $ | 43,682 | $ | 43,985 | ||||
| Excess and obsolete reserve | (1,940) | (4,583) | ||||||
| Total inventories, net | $ | 41,742 | $ | 39,402 | ||||
17
Government-owned Inventories: The Company has four programs where inventory purchases are billed directly to the customer and where the Company is obligated under the contract to maintain and track quantities of the government-owned inventory. These inventories are issued to the contract as required and billed to the Customer when the inventory is replenished. The Customers provide the Company with an initial inventory balance when the contract was awarded. The Company is obligated by contractual inventory schedules to return that inventory back to the Customer at the conclusion of the contract. The contractual inventory liability changes over the life of the contract based on inventory levels, contract schedule modifications caused by aircraft retirements, parts obsolescence, part substitution and changes to the aircraft life cycle repairs.
The Company actively tracks the Government’s inventory on hand versus the contractual inventory schedules for each program. Contract liabilities are not recorded due to the occurrence of significant changes to the contract schedules over the life of the program. A contract liability is not recognized until there is a final negotiated inventory listing with the customer or at the time the inventory requirement is fixed and determinable. This typically occurs at or very near to the end of a contract. A liability, if any, would be recognized at that time if the on-hand inventory value was below the required contractual inventory schedule.
NOTE 8
PROPERTY AND EQUIPMENT
The table below presents the components of property and equipment:
| Useful | Period Ended | |||||||||
| ($ in thousands) | Lives (Years) | July 3, 2022 | June 25, 2021 | |||||||
| Land | Indefinite | $ | 378 | $ | 384 | |||||
| Buildings and improvements | 4-13 | 7,935 | 8,154 | |||||||
| Machinery, equipment, furniture and | 2-9 | 48,867 | 27,939 | |||||||
| fixtures | ||||||||||
| Leasehold improvements | 2-6 | 9,155 | - | |||||||
| Gross property and equipment | $ | 66,335 | $ | 36,477 | ||||||
| Accumulated depreciation and amortization | (23,228) | (14,318) | ||||||||
| Property and equipment, net | $ | 43,107 | $ | 22,159 | ||||||
NOTE 9
GOODWILL AND INTANGIBLE ASSETS
The table below summarizes the Company’s goodwill carrying value.
| Period Ended | ||||||||
| ($ in thousands) | July 3, 2022 | June 25, 2021 | ||||||
| Beginning of period | $ | 891,729 | $ | 240,504 | ||||
| Measurement period adjustment (Note 3) | (8,054) | - | ||||||
| End of period | $ | 883,675 | $ | 240,504 | ||||
18
Identifiable intangible assets consist of the following:
| July 3, 2022 | June 25, 2021 | |||||||||||||||||||||||
| Gross | Gross | |||||||||||||||||||||||
| Carrying | Accum. | Carrying | Accum. | |||||||||||||||||||||
| ($ in thousands) | Amount | Amort. | Total | Amount | Amort. | Total | ||||||||||||||||||
| Finite Lived: | ||||||||||||||||||||||||
| Customer Contract Relationships | $233,100 | $(82,200) | $150,900 | $68,500 | $(61,993) | $6,507 | ||||||||||||||||||
| Infinite Lived: | ||||||||||||||||||||||||
| Trademark | 70,000 | - | 70,000 | 70,000 | - | 70,000 | ||||||||||||||||||
| Ending Balance | $303,100 | $(82,200) | $220,900 | $138,500 | $(61,993) | $76,507 | ||||||||||||||||||
Amortization expense for acquired finite lived intangible assets of $12.3 million and $6.5 million is included in selling, general and administrative expense for the periods ended July 3, 2022 and June 25, 2021, respectively. The weighted average useful life of customer contract relationship intangible assets is 7 years.
NOTE 10
DEBT
The components of debt and a reconciliation to the carrying amount of long-term debt are presented below:
| ($ in thousands) | Period Ended | |||||
| July 3, 2022 | June 25, 2021 | |||||
| Outstanding borrowings under ABL Credit Facility | $ | 53,000 | $ | - | ||
| Term Loan agreement due 2025 | - | 320,946 | ||||
| First Lien Term Loan agreement due 2028 | 922,688 | - | ||||
| Second Lien Term Loan agreement due 2029 | 185,000 | - | ||||
| Principal amount of long-term debt | 1,160,688 | 320,946 | ||||
| Deferred financing costs | (31,407) | (7,035) | ||||
| Carrying amount of long-term debt | 1,129,281 | 31,911 | ||||
| Less current maturities | (62,250) | (3,218) | ||||
| Total long-term debt, less current maturities | $ | 1,067,031 | $ | 310,693 | ||
ABL Credit Facility: On June 29, 2018, the Company entered into a $75 million, five-year secured ABL revolving credit agreement (“the ABL Credit Facility”). During 2021, the ABL Credit Facility was amended to increase the facility size to $100 million and extend the maturity date on which any outstanding obligations under the ABL Credit Facility will be due and payable to June 29, 2026.
Borrowings under the ABL Credit Facility may consist of (1) base rate loans, which shall bear interest at a rate equal to the sum of the applicable rate (as defined in the ABL Credit Facility) and the “base rate” (as defined in the ABL Credit Facility) and/or (2) Eurodollar loans, which shall bear interest at a rate equal to the sum of the applicable rate plus the “Eurodollar rate” (as defined in the ABL Credit Facility). The applicable rate for base rate loans under the ABL Credit Facility ranges from 0.75% to 1.25% per annum, and the applicable rate for Eurodollar loans ranges 1.75% to 2.25% per annum, in each case based on the average daily excess availability (as defined in the ABL Credit Facility).
19
The ABL Credit Facility includes a letter of credit sub-facility of $15 million and a swingline sub-facility of $10 million. The letter of credit and swingline sub-facilities are part of, and not in addition to the ABL Credit Facility. Swingline loans bear interest at a rate equal to base rate loans.
The Company had outstanding letters of credit to various entities, primarily for insurance matters, of $6.4 million and $6.4 million as of July 5, 2022 and June 25, 2021, respectively. The ABL Credit Facility provides for payment of a letter of credit fee equal to the applicable rate for Eurodollar loans, as well as a fronting fee of 0.125% per annum.
Availability under the ABL Credit Facility is calculated monthly based on the balances of billed accounts receivable, unbilled accounts receivable and inventory of the Company with each amount reduced by defined ineligible balances and subject to varying advance rates. The calculated amount is reduced by the outstanding amount of letters of credit and certain other availability reserves as defined in the ABL Credit Facility.
The Company had borrowing availability of $17.9 million under the ABL Credit Facility as of July 3, 2022. The ABL Credit Facility provides for the payment of a commitment fee ranging from 0.25% to 0.375% per annum on the daily unused portion of the ABL Credit Facility.
Term Loan Agreement: On June 29, 2018, the Company entered into a $330 million, seven-year secured Term Loan agreement (the “Term Loan”).
Borrowings under the Term Loan may consist of (1) base rate loans, which shall bear interest at a rate equal to the sum of the applicable rate (as defined in the Term Loan) and the “base rate” (as defined in the Term Loan) and/or (2) Eurodollar loans, which shall bear interest at a rate equal to the sum of the applicable rate plus the “Eurodollar rate” (as defined in the Term Loan). The applicable rate for base rate loans under the Term Loan ranges from 3.5% to 3.75% per annum, and the applicable rate for Eurodollar loans ranges 4.5% to 4.75% per annum, in each case based on the consolidated secured net leverage ratio (as defined in the Term Loan).
In March 2021, the Company amended the Term Loan Agreement to extend the maturity date to June 2027, modify the repayment schedule, and to lower the interest rates. The applicable rates were decreased to 3.00% and 4.00% for base rate and Eurodollar loans respectively.
For the periods ended July 3, 2022 and June 25, 2021, the Company made scheduled principal payments of $1.6 million and $3.3 million, respectively. The outstanding Term Loan balance of $320,141 was repaid in connection with the Transaction.
First Lien Term Loan Agreement: On the Transaction Date, the Company entered into a $925 million, seven-year secured Term Loan agreement (the “First Lien Term Loan”).
Borrowings under the First Lien Term Loan may consist of (1) base rate loans, which shall bear interest at a rate equal to the sum of the applicable rate (as defined in the First Lien Term Loan) and the “base rate” (as defined in the First Lien Term Loan) and/or (2) Eurodollar loans, which shall bear interest at a rate equal to the sum of the applicable rate plus the “Eurodollar rate” (as defined in the First Lien Term Loan). The applicable rate for base rate loans under the First Lien Term Loan ranges from 2.75% to 3.00% per annum, and the applicable rate for Eurodollar loans ranges 3.75% to 4.00% per annum, in each case based on the consolidated first lien net leverage ratio (as defined in the First Lien Term Loan).
The First Lien Term Loan provides for scheduled principal payments of $2.3 million as of the end of each calendar quarter commencing on June 30, 2022. The Company is permitted to make voluntary prepayments without premium or penalty. In addition, the Company is required to make mandatory prepayments (subject to certain carve-outs and baskets) using net proceeds upon sale of certain assets, net proceeds of certain issuances of debt, and an agreed-upon percentage of the Company’s excess cash flow as determined annually at the end of each fiscal year (beginning with the year ending December 31, 2022).
20
Second Lien Term Loan Agreement: On the Transaction Date, the Company entered into a $185 million, eight-year secured Second Lien Term Loan Agreement (the “Second Lien Term Loan”).
Borrowings under the Second Lien Term Loan may consist of (1) base rate loans, which shall bear interest at a rate equal to the sum of the applicable rate (as defined in the Second Lien Term Loan) and the “base rate” (as defined in the Second Lien Term Loan) and/or (2) Eurodollar loans, which shall bear interest at a rate equal to the sum of the applicable rate plus the “Eurodollar rate” (as defined in the Second Lien Term Loan). The applicable rate for base rate loans under the Second Lien Term Loan is 6.50% per annum, and the applicable rate for Eurodollar loans is 7.50% per annum.
The Second Lien Term Loan does not require any scheduled principal payments. The Company is permitted to make voluntary prepayments. However, the Company will be required to pay a premium of 2% or 1% of the prepayment amount if such prepayment occurs prior to the first or second anniversaries of the Transaction Date, respectively. In addition, the Company is required to make mandatory prepayments (subject to certain carve -outs and baskets) using net proceeds upon sale of certain assets, net proceeds of certain issuances of debt, and an agreed-upon percentage of the Company’s excess cash flow as determined annually at the end of each fiscal year (beginning with the year ending December 31, 2022).
Future scheduled principal payments on the First Lien and Second Lien Term Loans as of July, 3, 2022 are as follows:
| ($ in thousands) | |
| 2022 | $ 4,626 |
| 2023 | 9,250 |
| 2024 | 9,250 |
| 2025 | 9,250 |
| 2026 | 9,250 |
| Thereafter | 1,066,062 |
| Total | $ 1,107,688 |
Security: The ABL Credit Facility, First Lien Term Loan and Second Lien Term Loan are secured by substantially all the assets of the Company including (a) a pledge of (i) all of the capital stock of the Company and (ii) all the equity interests held by the Company of each subsidiary (subject to certain exceptions) and (b) security interests in, and mortgages on, substantially all tangible and intangible assets of the Company. The administrative agents under the ABL Credit Facility, First Lien Term Loan and Second Lien Term Loan have entered into an intercreditor agreement which outlines the relative priority of the liens established under each agreement, as well as certain other rights, priorities and interests.
Covenants: The ABL Credit Facility, First Lien Term Loan and Second Lien Term Loan contain restrictive covenants which limit, subject to certain exceptions, among other things, the ability of the Company and its subsidiaries to incur additional indebtedness; create liens; make investments or loans; consolidate, merge or consolidate or dispose of assets; enter into certain transactions with affiliates; pay dividends and repurchase stock. At July 3, 2022, the Company was in compliance with its restrictive covenants.
During periods when excess availability under the ABL Credit Facility is less than the greater of 10% of the amount available under the borrowing base or $10.0 million, a financial covenant is triggered which requires the Company to maintain a minimum Fixed Charge Coverage Ratio. The financial covenant was not applicable at any time during the periods ended July 3, 2022 and June 25, 2021.
21
NOTE 11
INCOME TAXES
Effective Tax Rate
Income tax expense during interim periods is based on an estimated annual effective income tax rate, plus discrete items that may occur in any given interim periods. The computation of the estimated effective income tax rate at each interim period requires certain estimates and judgment including, but not limited to, forecasted operating income for the year, projections of the income earned and taxed in various jurisdictions, newly enacted tax rate and legislative changes, permanent and temporary differences, and the likelihood of recovering deferred tax assets generated in the current year.
For the six months ended July 3, 2022 and June 25, 2021, we recorded an income tax provision of $2.0 million and $3.0 million, representing effective income tax rates of 28.1% and 28.0%, respectively. The effective income tax rates vary from the federal statutory rate of 21.0% due to state and foreign taxes, required tax income exclusions, nondeductible expenses, available deductions not reflected in book income, and income tax credits.
NOTE 12
LEASES
The Company has adopted new lease standard ASC Topic 842 on January 1, 2022. The Company has operating leases for office space, vehicles, and machinery and equipment. The Company recognizes a right of use (ROU) assets and lease liabilities upon the commencement of its operating leases. The initial lease liability is equal to the future fixed minimum lease payments discounted using the Company’s incremental borrowing rate on a secured basis. The lease term includes option renewal periods and early termination payments when it is reasonably certain that the Company will exercise those rights.
The balance sheet information related to our operating leases is as follows:
| Period Ended | ||||||||
| ($ in thousands) | July 3, 2022 | June 25, 2021 | ||||||
| Right-of-use assets | $ | 16,141 | $ | - | ||||
| Current lease liabilities | 5,145 | - | ||||||
| Long-term lease liabilities | 10,996 | - | ||||||
| Total operating lease liabilities | $ | 16,141 | $ | - | ||||
NOTE 13
EMPLOYEE BENEFIT PLANS
Defined Contribution Plan: The Company maintains a defined contribution 401(k) employee benefit plan (the “Benefit Plan”) under which substantially all U.S. employees are eligible to participate. Under the terms of the Benefit Plan, eligible employees may contribute tax-deferred compensation deduction amounts up to the maximum amount that Internal Revenue Service regulations permit. The Benefit Plan provides for a discretionary Company match program based on a certain percentage of the eligible employee’s compensation which may be suspended or discontinued at any time. During the periods ended July 3, 2022 and June 25, 2021, the Company funded matching contributions of $4.5 million and $2.6 million, respectively.
22
Multi-employer Plan: The Company, in certain of its U.S. operating locations, participates in a multi-employer pension plan under an industry-wide agreement with a trade organization. The plan provides defined benefits to substantially all employees covered by collective bargaining agreements that have been negotiated with the related trade organization. In connection with this collective bargaining agreement with the trade organization, the Company participates with other companies in the union’s multi-employer pension plan. The plan covers substantially all of the Company’s employees who are members of such union. The Company recognizes expense in connection with this plan as contributions are funded. The Company made contributions to the multi-employer pension plan and recognized expense during the periods ended July 3, 2022 and June 25, 2021 of $4.4 million and $4.3 million, respectively.
The balance sheet as of July 3, 2022 includes $5.1 million of pension benefit obligation associated with a pension plan in Germany and is included in Other long-term liabilities.
NOTE 14
COMMITMENTS AND CONTINGENCIES
Procurement Regulations: A substantial majority of the Company’s revenues are generated from providing products and services under legally binding agreements or contracts with the U.S. Government, foreign government customers and state and local governments. U.S. Government contracts are subject to extensive legal and regulatory requirements, and, from time to time, agencies of the U.S. Government perform audits to determine whether such contracts were and are being conducted in accordance with these requirements. The Company is currently cooperating with the U.S. Government on several audits from which civil, criminal or administrative proceedings have or could result and give rise to fines, penalties, compensatory and treble damages, restitution and/or forfeitures. The Company does not currently anticipate that any of these audits will have a material adverse effect, individually or in the aggregate, on its consolidated financial position, results of operations or cash flows. Under U.S. Government regulations, an indictment of the Company by a federal grand jury, or an administrative finding against the Company as to its present responsibility to be a U.S. Government contractor or subcontractor, could result in the Company being suspended for a period of time from eligibility for awards of new government contracts or task orders or in a loss of export privileges. A conviction, or an administrative finding against the Company that satisfies the requisite level of seriousness, could result in debarment from contracting with the federal government for a specified term. In addition, all of the Company’s U.S. Government contracts: (1) are subject to audit and various pricing and cost controls, (2) include standard provisions for termination for the convenience of the U.S. Government or for default and (3) are subject to cancellation if funds for contracts become unavailable. Foreign government contracts generally include comparable provisions relating to terminations for convenience or default, as well as other procurement clauses relevant to the foreign government.
Litigation Matters: The Company is also subject to litigation, proceedings, claims or assessments and various contingent liabilities incidental to its businesses, including the matter specified be low. Furthermore, in connection with certain business acquisitions, the Company has assumed some or all claims against, and liabilities of, such acquired businesses, including both asserted and unasserted claims and liabilities.
In accordance with the accounting standard for contingencies, the Company records a liability when management believes that it is both probable that a liability has been incurred and the Company can reasonably estimate the amount of the loss. Generally, the loss is recorded at the amount the Company expects to resolve the liability. Amounts recoverable from insurance contracts or third parties are recorded as assets when deemed probable. As of July 3, 2022, the Company did not record any amounts for recoveries from insurance contracts or third parties in connection with the amount of liabilities recorded for pending and threatened litigation. Legal defense costs are expensed as incurred. The Company believes it has recorded adequate provisions for its litigation matters. The Company reviews these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. While it is reasonably possible that an unfavorable outcome may occur, unless otherwise stated, the Company believes that it is not probable that a loss has been incurred. Although the Company believes that it has valid defenses with respect to legal matters and investigations pending against it, the results of litigation can be difficult to predict, particularly those involving jury
23
trials. Therefore, it is possible that one or more of these contingencies could have a material impact on the financial position, results of operations or cash flows of the Company in future periods.
NOTE 15
RELATED PARTY TRANSACTIONS
Advisory Services Agreement with AIP: The Company has entered into an advisory services agreement with AIP. Pursuant to the agreement, certain financial advisory, monitoring and oversight activities are performed for the Company. The Company does not pay a fee for these services, but does reimburse AIP for reasonable travel and other out-of-pocket expenses incurred in connection with the provision of the services. The Company also provides customary indemnification to AIP. Fees paid under this agreement totaled $0.7 million and $1 million for the periods ended July 3, 2022 and June 25, 2021, respectively, and were included in selling, general and administrative expenses.
Transition Services Agreement: On December 31, 2020, in conjunction with the spin-off of the Crestview Aerospace LLC (Crestview) transaction described in Note 4, the Company executed a Transition Services Agreement (TSA) with Crestview, primarily involving the Company providing certain services to Crestview Aerospace related to information technology, human resources benefits and accounting services. This TSA has an effective date of January 1, 2021. For the period ended July 3, 2022, the Company recorded $3.2 million of income related to the TSA with Crestview; and is recorded as a reduction in cost of sales.
On December 6, 2021, in conjunction with the Transaction completed with Raytheon, the Company executed a Transition Services Agreement (Raytheon Company TSA) with Raytheon Company, primarily involving Raytheon Company providing certain services to the Company related to information technology, human resources benefits and accounting services. This Raytheon Company TSA has an effective date of December 6, 2021. For the period ended July 3, 2022, the Company recorded $12.8 million of expense related to the Raytheon Company TSA; and is recorded as a component of cost of sales.
NOTE 16
COVID-19
On January 30, 2020, the World Health Organization declared the coronavirus outbreak (COVID-19) a “Public Health Emergency of International Concern” and on March 11, 2020, declared COVID -19 a pandemic. The impact of COVID-19 could negatively impact the Company’s operations, suppliers or other vendors, and customer base. The operations for the Company’s services could be negatively impacted by the on-going regional and global impact of COVID-19, including stop-work orders on existing contract work for an unknown period of time. Any quarantines, labor shortages or other disruptions to the Company’s operations, or those of their customers, may adversely impact the Company’s revenues, ability to provide its services and operating results. In addition, a significant outbreak of epidemic, pandemic or contagious diseases in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, including the geographical area in which the Company operates, resulting in an economic downturn that could affect demand for its services. The Company’s workforce has been designated as Critical Infrastructure in the Defense Industrial Base Sector by the Department of Homeland Security. As such, the Department of Defense has informed the Company that it is expected to maintain normal work schedules and continue providing products and services as required under its contracts while following guidance to limit disease spread from the Centers for Disease Control and Prevention, as well as State and local government officials. Through July 3, 2022, no material changes have occurred in the Company’s operations. The extent to which the coronavirus impacts the Company’s results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus and actions taken to contain the coronavirus or its impact, among others.
24
Exhibit 99.3
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
Combined Financial Statements
As of and for the years ended December 31, 2020 and 2019
(With Report of Independent Auditors Thereon)
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
TABLE OF CONTENTS
| Page No. | |
| Report of Independent Auditors | 2 |
| Combined Balance Sheets as of December 31, 2020 and 2019 | 3 |
| Combined Statements of Operations for the years ended December 31, 2020 and 2019 | 4 |
| Combined Statements of Comprehensive Income for the years ended December 31, 2020 and 2019 | 5 |
| Combined Statements of Cash Flows for the years ended December 31, 2020 and 2019 | 6 |
| Combined Statement of Changes in Net Parent Investment for the years ended December 31, 2020 and 2019 | 7 |
| Notes to Combined Financial Statements | 8 |
1
Report of Independent Auditors
To the Board of Directors and Management of Raytheon Technologies Corporation
We have audited the accompanying combined financial statements of the Mission Critical Solutions and Training Services Business (a business of Raytheon Technologies Corporation), which comprise the combined balance sheets as of December 31, 2020 and 2019, and the related combined statements of operations, comprehensive income, changes in net parent investment and cash flows for the years then ended.
Management's Responsibility for the Combined Financial Statements
Management is responsible for the preparation and fair presentation of the combined financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of combined financial statements that are free from material misstatement, whether due to fraud or error.
Auditors’ Responsibility
Our responsibility is to express an opinion on the combined financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the combined financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the combined financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the combined financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Company's preparation and fair presentation of the combined financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the combined financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of the Mission Critical Solutions and Training Services Business as of December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.
/s / PricewaterhouseCoopers LLP
Boston, Massachusetts
October 11, 2021, except for the effects of the revisions discussed in Note 2 to the combined financial statements, as to which the date is September 1, 2022
2
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
COMBINED BALANCE SHEETS
| As of December 31, | |||||||
| 2020 | 2019 | ||||||
| (In Thousands) | |||||||
| Assets | |||||||
| Current assets | |||||||
| Cash and cash equivalents | $ | 35,037 | $ | 39,595 | |||
| Accounts receivable, less allowance for credit losses of $0 and $253, respectively | 49,769 | 54,518 | |||||
| Contract assets | 154,084 | 157,332 | |||||
| Inventory, net | 1,056 | 731 | |||||
| Prepaid expenses and other current assets | 4,598 | 6,986 | |||||
| Total current assets | 244,544 | 259,162 | |||||
| Fixed assets, net | 16,020 | 12,460 | |||||
| Operating lease right-of-use assets | 3,897 | 3,791 | |||||
| Other assets | 5,693 | 6,804 | |||||
| Total assets | $ | 270,154 | $ | 282,217 | |||
| Liabilities and Net Parent Investment | |||||||
| Current liabilities | |||||||
| Accounts payable | $ | 68,895 | $ | 69,548 | |||
| Accrued employee compensation | 13,039 | 16,032 | |||||
| Other accrued liabilities | 10,652 | 10,670 | |||||
| Contract liabilities | 95,519 | 134,643 | |||||
| Total current liabilities | 188,105 | 230,893 | |||||
| Operating lease liabilities, non-current | 3,613 | 3,618 | |||||
| Other long-term liabilities | 10,776 | 4,966 | |||||
| Total liabilities | 202,494 | 239,477 | |||||
| Commitments and Contingencies (Note 11) | |||||||
| Net Parent Investment: | |||||||
| Net parent investment | 61,622 | 34,370 | |||||
| Accumulated other comprehensive income | 6,038 | 8,370 | |||||
| Total net parent investment | 67,660 | 42,740 | |||||
| Total liabilities and net parent investment | $ | 270,154 | $ | 282,217 | |||
The accompanying notes are an integral part of these Combined Financial Statements.
3
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
COMBINED STATEMENTS OF OPERATIONS
| Year Ended December 31, | |||||||
| 2020 | 2019 | ||||||
| (In Thousands) | |||||||
| Revenues | |||||||
| Revenues | $ | 976,060 | $ | 1,377,927 | |||
| Revenues – related party | 43,004 | 50,443 | |||||
| Total revenues | 1,019,064 | 1,428,370 | |||||
| Cost of revenues | |||||||
| Cost of services | 766,285 | 1,087,970 | |||||
| Cost of services – related party | 38,428 | 45,131 | |||||
| Total cost of revenues | 804,713 | 1,133,101 | |||||
| Gross profit | 214,351 | 295,269 | |||||
| Operating expenses | |||||||
| Selling, general and administrative | 54,805 | 69,989 | |||||
| Total operating expenses | 54,805 | 69,989 | |||||
| Operating profit | 159,546 | 225,280 | |||||
| Other expenses, net | 5,084 | 4,602 | |||||
| Income before income tax expense | 154,462 | 220,678 | |||||
| Income tax expense | 33,501 | 46,491 | |||||
| Net income | $ | 120,961 | $ | 174,187 | |||
The accompanying notes are an integral part of these Combined Financial Statements.
4
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
COMBINED STATEMENTS OF COMPREHENSIVE INCOME
| Year Ended December 31, | ||||||||
| 2020 | 2019 | |||||||
| (In Thousands) | ||||||||
| Net income | $ | 120,961 | $ | 174,187 | ||||
| Other comprehensive loss: | ||||||||
| Foreign currency translation adjustments | (2,332 | ) | (12 | ) | ||||
| Total other comprehensive loss | (2,332 | ) | (12 | ) | ||||
| Comprehensive income | $ | 118,629 | $ | 174,175 | ||||
The accompanying notes are an integral part of these Combined Financial Statements.
5
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
COMBINED STATEMENTS OF CASH FLOWS
| Year Ended December 31, | |||||||
| 2020 | 2019 | ||||||
| (In Thousands) | |||||||
| Cash flows from operating activities: | |||||||
| Net income | $ | 120,961 | $ | 174,187 | |||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
| Depreciation | 3,121 | 2,730 | |||||
| Provision for credit losses | - | 253 | |||||
| Stock-based compensation | 1,448 | 1,534 | |||||
| Deferred income taxes | 2,505 | (1,318) | |||||
| Changes in operating assets and liabilities: | |||||||
| Accounts receivable | 4,118 | 46,237 | |||||
| Contract assets | 1,296 | 65,430 | |||||
| Inventory, net | (383) | 3,817 | |||||
| Prepaid expenses and other assets | 380 | (159) | |||||
| Accounts payable | (1,526) | (42,397) | |||||
| Accrued employee compensation | (3,158) | 1,894 | |||||
| Accrued and other liabilities | 5,798 | (4,316) | |||||
| Contract liabilities | (40,334) | 13,483 | |||||
| Net cash provided by operating activities | 94,226 | 261,375 | |||||
| Cash flows from investing activities: | |||||||
| Purchases of fixed assets | (8,046) | (1,170) | |||||
| Proceeds from sale of fixed assets | 1,262 | - | |||||
| Net cash used in investing activities | (6,784) | (1,170) | |||||
| Cash flows from financing activities: | |||||||
| Net transfers to Parent | (95,157) | (250,615) | |||||
| Net cash used in financing activities | (95,157) | (250,615) | |||||
| Effects of foreign exchange rate changes on cash and cash equivalents | 3,157 | 11 | |||||
| Net increase (decrease) in cash and cash equivalents | (4,558) | 9,601 | |||||
| Cash and cash equivalents, beginning of period | 39,595 | 29,994 | |||||
| Cash and cash equivalents, end of period | $ | 35,037 | $ | 39,595 | |||
The accompanying notes are an integral part of these Combined Financial Statements.
6
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
COMBINED STATEMENTS OF CHANGES IN NET PARENT INVESTMENT
| Accumulated | |||||||||||
| Other | |||||||||||
| Net Parent | Comprehensive | Total Net Parent | |||||||||
| Investment | Income (Loss) | Investment | |||||||||
| (In Thousands) | |||||||||||
| Balance January 1, 2019 | $ | 109,264 | $ | 8,382 | $ | 117,646 | |||||
| Net income | 174,187 | - | 174,187 | ||||||||
| Other comprehensive income loss | - | (12) | (12) | ||||||||
| Net transfers to Parent | (249,081) | - | (249,081) | ||||||||
| Balance December 31, 2019 | 34,370 | 8,370 | 42,740 | ||||||||
| Net income | 120,961 | - | 120,961 | ||||||||
| Other comprehensive loss | - | (2,332) | (2,332) | ||||||||
| Net transfers to Parent | (93,709) | - | (93,709) | ||||||||
| Balance December 31, 2020 | $ | 61,622 | $ | 6,038 | $ | 67,660 | |||||
The accompanying notes are an integral part of these Combined Financial Statements.
7
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
NOTES TO COMBINED FINANCIAL STATEMENTS
(Dollars in Thousands, unless otherwise indicated)
| 1. | Nature of the Business |
The Mission Critical Solutions and Training Services Business (the “Company” or the “Business”) is comprised of Raytheon Professional Services (“RPS”) and certain contracts within the portfolio of Raytheon Intelligence & Space (“RIS”) which operates as a principal business segment of Raytheon Company, a subsidiary of Raytheon Technologies Corporation (“RTX”). The Company serves end users in the military, government and commercial segments, both domestically and internationally. The Company is comprised of four service lines, including:
| · | Engineering and Logistics and Senior and Platform Services, which provides equipment maintenance, repair and upgrades, testing and evaluations, logistics consulting, and operational support to government labs and facilities; |
| · | Modernization and Sustainment, which provides aircraft and ground related depot and engineering services in Indianapolis, Indiana; |
| · | Defense Training Solutions, which provides training of United States (“U.S.”) and international military personnel, as well as the management of complex global supply networks; and |
| · | Commercial Training Solutions, which provides training content development and delivery, on-site and digital training, learning management systems and leadership development consulting. |
On April 3, 2020, United Technologies Corporation and Raytheon Company completed their previously announced all-stock merger of equals transaction (the “Raytheon Merger”). Upon closing of the Raytheon Merger, Raytheon Company became a wholly owned subsidiary of United Technologies Corporation, which changed its name to “Raytheon Technologies Corporation.” Unless the context otherwise requires, the term “Parent” means Raytheon Company and its subsidiaries when referring to periods prior to the Raytheon Merger and to the combined company, Raytheon Technologies Corporation, when referring to periods after the Raytheon Merger.
Risks and Uncertainties
The Company is subject to risks common to companies in the markets it serves, including, but not limited to, global economic and financial market conditions, fluctuations in government and customer demand, acceptance of new services, development by its competitors of new technological innovations, risk of disruption in its supply chain, the implementation of tariffs and export controls, dependence on key personnel, protection of proprietary technology, and compliance with domestic and foreign regulatory authorities and agencies.
In March 2020, COVID-19 was declared a pandemic by the World Health Organization and a national emergency by the U.S. government. The pandemic has negatively affected the U.S. and global economy, disrupted global supply chains and financial markets, and resulted in significant travel restrictions, mandated facility closures and shelter-in-place and social distancing orders in numerous jurisdictions around the world. The Company is taking all prudent measures to protect the health and safety of our employees, such as practicing social distancing, performing deep cleaning in all of our facilities, temperature screening, health questionnaires and enabling our employees to work from home where possible. We have also taken appropriate actions to help support our communities in addressing the challenges posed by the pandemic, including the donation of personal protective equipment.
| 2. | Basis of Presentation |
The Company has historically operated as a part of Raytheon Company (prior to the Raytheon Merger) and Raytheon Technologies Corporation (subsequent to the Raytheon Merger); consequently, stand-alone financial statements have not historically been prepared for the Company. These Combined Financial Statements reflect the results of operations, balance sheets and cash flows of the Company as they were historically managed. These Combined Financial Statements have been derived from the consolidated financial statements and accounting records
8
of the Parent and have been prepared in accordance with accounting principles generally accepted (“GAAP”) in the United States of America, collectively (“U.S. GAAP”).
The Combined Statements of Operations include all revenues and costs directly attributable to the Company, including costs for facilities, functions and services utilized by the Company. The Parent provides certain services such as accounting, legal, information technology, human resources and other infrastructure support, on behalf of the Company. Due to Federal Acquisition Regulation (“FAR”) rules that govern our U.S. government business and related Cost Accounting Standards (“CAS”), most types of costs are allocable to U.S. government contracts. Costs allocated to the Business include both costs considered allowable or allocable to U.S. government contracts under applicable CAS or FAR as well as incremental costs necessary to present the Company’s Combined Financial Statements in accordance with U.S. GAAP. The costs of these services have been allocated to the Company on a direct usage basis when identifiable, with the remainder allocated based on the proportion of expenses, headcount or other relevant measures, depending on the nature of the cost. All allocations for facilities, functions and services performed by the Parent have been deemed settled in cash by the Company to the Parent in the period in which the cost was recorded in the Combined Statements of Operations. Current and deferred income taxes have been determined based on the stand-alone results of the Company. However, because the Company filed as part of various tax groups in certain jurisdictions, the Company’s actual tax balances may differ from those reported. The Company’s portion of its current income taxes are deemed to have been settled in the period the current tax expense was recorded. A portion of state income taxes are included in Selling, general and administrative expenses as these costs can generally be recovered through the pricing of services to the U.S. government.
All intracompany accounts and transactions within the Company have been eliminated in the preparation of the Combined Financial Statements. The Combined Financial Statements of the Company include assets and liabilities that have been determined to be specifically or otherwise attributable to the Business.
RTX uses a centralized approach to cash management and financing its operations. Accordingly, none of the cash, third-party debt, or related interest expense of RTX has been allocated to the Business in the Combined Financial Statements. However, cash balances primarily associated with certain foreign RPS entities that do not participate in the Parent’s cash management program have been included in the Combined Financial Statements. While the Company participates in the Parent’s centralized cash management function, which results in the majority of its cash being controlled by the Parent, it has and is expected to generate positive operating cash flows to fund its operating and investing activities. Transactions between the Parent and the Business are deemed to have been settled immediately through Net Parent Investment. The net effect of these transactions is reflected in the Combined Statements of Cash Flows as Net transfers to Parent within financing activities and in the Combined Balance Sheets as Net Parent Investment.
All of the allocations and estimates in the Combined Financial Statements are based on assumptions that management believes are reasonable. However, the Combined Financial Statements included herein may not be indicative of the financial position, results of operations and cash flows of the Company in the future, or if the Company had been a separate, stand-alone entity during the years presented.
Revisions to Previously Issued Combined Financial Statements
Required Incremental Disclosures
These Combined Financial Statements include incremental disclosures, in compliance with U.S. Securities and Exchange Commission ("SEC") Regulation S-X, to the Business’ previously issued Combined Financial Statements as of and for the years ended December 31, 2020 and 2019.
The incremental updates included in these notes to the Combined Financial Statements are summarized below:
| · | Note 3. Summary of Significant Accounting Policies – includes a table to present the impact of changes in estimates (net Estimate at Completion- adjustments) on the Company’s operating results in compliance with required disclosures; |
| · | Note 7. Supplemental Balance Sheet Information – includes incremental required disclosures related to inventory valuation reserve balances; |
9
| · | Note 10. Revenue from Contracts with Customers – includes additional required disclosures related to: |
| i. | The Company’s disaggregation of revenue by customer and contract type; | |
| ii. | The amount of revenue recognized related to the contract liability balance at the beginning of each period; and | |
| iii. | The amount of backlog at period end and expected timing of the future recognition of backlog as revenue. |
Revisions to Fixed Assets, net
On September 8, 2021, Vertex Aerospace LLC signed a definitive agreement to acquire Raytheon Technologies Corporation’s Mission Critical Solutions and Training Services Business (the “Transaction”). On December 6, 2021, Raytheon Technologies Corporation and Vertex Aerospace LLC completed the previously announced Transaction.
In connection with the final transaction close, management identified and corrected immaterial errors that affected certain fixed asset balances and related disclosures included in its Combined Financial Statements as of and for the years ended December 31, 2020 and 2019. Management evaluated these errors in relation to the years ended December 31, 2020 and 2019, and concluded these errors are not material to the Combined Financial Statements.
Management identified certain fixed assets at the Parent’s facilities that were within the perimeter of the Transaction but not captured in the Business’ previously issued Combined Financial Statements as of and for the years ended December 31, 2020 and 2019. These balances were identified as part of the Parent’s finalization of fixed asset registers in connection with the Business’ disposition.
The impacts of the revisions to the previously issued Combined Financial statements are summarized below as of and for the years ended December 31, 2020 and 2019:
Increase / (Decrease)
| Financial Statement and Line Item | 2020 | 2019 | |||||
| Balance Sheets – Fixed assets, net | $ | 7,875 | $ | 4,959 | |||
| Balance Sheets –Net Parent Investment | 7,875 | 4,959 | |||||
| Statements of Cash Flow – Depreciation | 1,681 | 652 | |||||
| Statements of Cash Flow – Purchases of Fixed Assets | 4,597 | 283 | |||||
| Statements of Cash Flow –Net Transfers to Parent | (2,916) | 369 | |||||
| Statements of Changes in Net Parent Investment – Net Parent Investment (opening balance) | - | 5,328 | |||||
| Statements of Changes in Net Parent Investment – Net Transfers to Parent | (2,916) | 369 | |||||
Note 5. Fixed Assets, net is revised to reflect the impact of the revisions. Summary reconciliations of these revisions are included below. Refer to Note 5 for additional information.
Below is a reconciliation between the amounts previously disclosed in Note 5 and the revised amounts included herein as of December 31, 2020:
| As Previously | |||||||||||
| Reported | Adjustments | Revised | |||||||||
| December 31, 2020 | |||||||||||
| Buildings and improvements | $ | 4,054 | $ | 14,079 | $ | 18,133 | |||||
| Machinery, tools and equipment | 53,217 | 3,476 | 56,693 | ||||||||
| Internal use software | 8,946 | - | 8,946 | ||||||||
| Other, including assets under construction | 3,190 | 4,316 | 7,506 | ||||||||
| 69,407 | 21,871 | 91,278 | |||||||||
| Less: Accumulated depreciation | (61,262) | (13,996) | (75,258) | ||||||||
| Fixed assets, net | $ | 8,145 | $ | 7,875 | $ | 16,020 | |||||
10
Below is a reconciliation between the amounts previously disclosed in Note 5 and the revised amounts included herein as of December 31, 2019:
| As Previously | |||||||||||
| Reported | Adjustments | Revised | |||||||||
| December 31, 2019 | |||||||||||
| Buildings and improvements | $ | 4,145 | $ | 12,661 | $ | 16,806 | |||||
| Machinery, tools and equipment | 51,992 | 3,408 | 55,400 | ||||||||
| Internal use software | 8,832 | - | 8,832 | ||||||||
| Other, including assets under construction | 2,045 | 1,201 | 3,246 | ||||||||
| 67,014 | 17,270 | 84,284 | |||||||||
| Less: Accumulated depreciation | (59,513) | (12,311) | (71,824) | ||||||||
| Fixed assets, net | $ | 7,501 | $ | 4,959 | $ | 12,460 | |||||
As part of the revision, the Company also increased the depreciation expense amounts previously disclosed in Note 5 by $1,681 and $652 for the years ended December 31, 2020 and 2019, respectively.
| 3. | Summary of Significant Accounting Policies |
Use of Estimates
The preparation of the Combined Financial Statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. In addition, estimates and assumptions may impact the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
The full extent to which the COVID-19 pandemic will directly or indirectly impact our business – including results of operations and financial condition, sales, expenses, reserves and allowances and asset recoverability – will depend on future developments that are highly uncertain. This includes results from new information that may emerge concerning COVID-19 and any actions taken to contain or treat COVID-19, as well as the economic impact on local, regional, national, and international customers and markets. We have made estimates of the impact of COVID-19 within our financial statements and there may be changes to those estimates in future periods. Other future events, including COVID-19, and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to our Combined Financial Statements.
Foreign Currency Translation
The determination of the functional currency of the Company’s foreign subsidiaries is based on their financial and operational environment and is the local currency of all of the Company’s foreign subsidiaries. The subsidiaries’ assets and liabilities are translated into the reporting currency at period-end exchange rates, while revenue, expenses, gains and losses are translated at the average exchange rates during the period. The Company uses the U.S. dollar as its functional currency. The aggregate effects of translating the balance sheets of these subsidiaries are deferred within Accumulated other comprehensive income as a separate component of Net Parent Investment.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash deposits, cash equivalents and accounts receivable. All of the Company’s cash and cash equivalents are maintained by major financial institutions. The Company regularly monitors the creditworthiness of its customers and believes that it has adequately provided for exposure to potential credit losses.
11
Fair Value of Financial Instruments
The Company’s financial instruments consist of cash and cash equivalents, accounts receivable and accounts payable. The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate their fair value due to their short-term nature.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and highly liquid investments with original maturities of three months or less that are readily convertible to known amounts of cash. Cash and cash equivalents reported in the Combined Balance Sheets represents the cash and cash equivalents that are directly attributable to the Company and to which the Company is entitled.
Accounts Receivable and Allowance for Credit Losses
Accounts receivable are stated at the net amount expected to be collected. The allowance for credit losses is established to provide for the expected lifetime credit losses by evaluating factors such as customer creditworthiness, historical payment and loss experiences, current economic conditions and the age, status of outstanding receivables, economic trends and historical experience. The Company reviews its allowance for credit losses on a quarterly basis and adjusts the balance based on the Company’s estimates of the receivables’ recoverability in the period the changes in estimates occur and become known. Accounts receivable balances are written off against the allowance for credit losses when the Company determines that the balances are not recoverable.
The following table details the Company’s accounts receivable, net balances arising from government contracts and non-government contracts as of December 31, 2020 and 2019:
| As of December 31, | |||||||
| 2020 | 2019 | ||||||
| Accounts receivable, net from government contracts | $ | 30,466 | $ | 28,946 | |||
| Accounts receivable, net from non-government contracts | 19,303 | 25,572 | |||||
| Total Accounts receivable, net | $ | 49,769 | $ | 54,518 | |||
Contract Assets and Liabilities
Contract assets and liabilities represent the difference in the timing of revenue recognition from receipt of cash from our customers. Contract assets reflect revenue recognized and performance obligations satisfied or partially satisfied in advance of customer billing.
Contract assets, which are unbilled receivables, represent revenues that are not currently billable to the customer under the terms of the contract and include unbilled amounts under commercial contracts where payment is solely subject to the passage of time. These items are expected to be billed and collected in the normal course of business. Other unbilled receivables not just subject to the passage of time are included in Contract assets in the Combined Balance Sheets and are generally classified as current. Progress Based Payments are interim payments equal to a negotiated percentage of the contract price based on quantifiable measures of performance or on the achievement of specified events or milestones.
Contract liabilities relate to payments received in advance of the satisfaction of performance under the contract. The Company receives payments from customers based on the terms established in our contracts.
Contract assets and contract liabilities are generally classified as current as our operating cycle is generally longer than one year.
Inventory, net
Inventory is stated at the lower of cost or net realizable value determined on a first-in, first-out basis and includes the cost of materials prior to the approval of the related contract awarded to the Company. Valuation reserves for excess, obsolete, and slow-moving inventory are estimated by comparing the inventory levels of individual parts to
12
both future sales forecasts and historical usage rates in order to identify inventory where the resale value or replacement value is less than inventoriable cost. Other factors that management considers in determining the adequacy of these reserves include whether individual inventory parts meet current specifications and can be substituted for a part currently being sold or used as a service part, overall market conditions, and other inventory management initiatives.
Fixed Assets, net
Fixed assets, net, are stated at cost less accumulated depreciation. Major improvements are capitalized, while expenditures for maintenance, repairs and minor improvements are expensed. Upon retirement or other disposal of fixed assets, the costs and related amounts of accumulated depreciation or amortization are eliminated from the asset and accumulated depreciation accounts, respectively. The difference, if any, between the net asset value and the proceeds are recorded in operating income.
For sales or asset retirements, the assets and related accumulated depreciation and amortization are eliminated from the accounts. Gains and losses on sales of our fixed assets are recorded in operating income.
| Estimated | ||
| Useful Lives | ||
| Buildings and improvements | 10 - 45 years | |
| Machinery, tools and equipment | 3 - 10 years | |
| Internal use software | 3 - 6 years | |
| Other, including assets under construction | 4 – 8 years |
Depreciation expense related to fixed assets is recorded utilizing the straight-line or 150% declining balance method.
Leases
The Company accounts for leases in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 842: Leases, which we adopted on January 1, 2019. As a lessee, the Company records a right-of-use asset and a lease liability on the Combined Balance Sheets for all leases with terms longer than 12 months. Leases are classified as either finance or operating, with classification affecting the pattern of expense recognition in the Combined Statements of Operations.
The Company enters into lease agreements for the use of real estate space, vehicles, information technology equipment, and certain other equipment under both operating and finance leases. The Company determines if an arrangement contains a lease at inception. Operating leases are included in Operating lease right-of-use assets, Other accrued liabilities for the current portion of the Company’s operating lease liabilities, and Operating lease liabilities, non-current in the Company’s Combined Balance Sheets. Finance leases are not considered significant to the Company’s Combined Balance Sheets or Combined Statements of Operations.
Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Lease right-of-use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of the Company’s leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments and use the implicit rate when readily determinable. We determine our incremental borrowing rate through market sources including relevant industry rates. Our lease right-of-use assets also include any initial direct costs and lease pre-payments made at or before the commencement date and are reduced for any lease incentives received at or before the commencement date. Certain of our leases include variable payments, which may vary based upon changes in facts or circumstances after the start of the lease. We exclude variable payments from lease right-of-use assets and lease liabilities, to the extent not considered fixed, and instead, expense variable payments as incurred. Variable lease expense and lease expense for short duration contracts are not a material component of lease expense. Some of our leases include the option to extend or terminate the lease. We include these options in the recognition of our right-of-use assets and lease liabilities when it is reasonably certain that we will exercise the option. Lease expense is generally recognized on a straight-line basis over the lease term.
13
Warranty Obligations
The Company offers warranties on the sales of certain of its services and records warranty obligations for estimated future claims at the time revenue is recognized within our Estimate at Completion (“EAC”). Warranty obligations are estimated based on historical experience and management’s estimate of the level of future claims.
Revenue Recognition
The Company generates revenue primarily from services, including the following:
| • | Engineering and Logistics and Sensor and Platform Services, including providing equipment maintenance, repair and upgrades, testing and evaluations, logistics consulting, and operational support to government labs and facilities; |
| • | Modernization and Sustainment, including providing aircraft and ground related depot and engineering services; |
| • | Defense Training Solutions, including training of United States and international military personnel as well as the management of complex global supply networks, and; |
| • | Commercial Training Solutions, including training content development and delivery, on-site and digital training, learning management systems, leadership development consulting, and tolling system maintenance. |
Under ASC 606, Revenue from Contracts with Customers (“ASC 606”), the Company recognizes revenue for the transfer of such promised services to customers in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those services. Revenue is recognized when or as the transfer of control of the underlying performance obligation occurs.
The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. For certain contracts that meet the foregoing requirements, primarily contracts that are directly with a foreign government, we are required to obtain certain regulatory approvals. In these cases, we recognize revenue based on the likelihood of obtaining regulatory approvals based upon all known facts and circumstances. A performance obligation is a promise in a contract with a customer to transfer a distinct good or service to the customer. Some of our contracts with customers contain a single performance obligation where contractual activities are highly interrelated with other activities such that no activity is distinct, while other contracts contain multiple performance obligations most commonly when a contract spans multiple phases of the project lifecycle such as maintenance and support or when there are distinct performance periods in a service arrangement such as an annual award fee score. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as the performance obligation is satisfied. When there are multiple performance obligations within a contract, we allocate the transaction price to each performance obligation based on its standalone selling price when available. If standalone selling price is not available, we estimate the standalone selling price of each performance obligation, which is generally based on an expected cost plus a margin approach.
We consider the contractual consideration payable by the customer and assess variable consideration that may affect the total transaction price, including contractual discounts, contract incentive payments, estimates of award fees or other customer usage activities on long term maintenance contracts, and other sources of variable consideration, when determining the transaction price of each contract. When reasonably able to estimate, we include variable consideration in the transaction price at the most likely amount to which we expect to be entitled. We include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. These estimates are based on historical experience, anticipated performance and our best judgment at the time. We also consider whether our contracts contain a significant financing component, which they generally do not.
Timing of the satisfaction of performance obligations varies across our businesses due to our diverse service mix, customer base, and contractual terms. However, as most of our revenues are generated from services performed, the majority of revenues are recognized over time.
14
Performance obligations are satisfied over-time if the customer receives the benefits as we perform work, if the customer controls the asset as it is being produced (continuous transfer of control), or if the service being produced for the customer has no alternative use and we have a contractual right to payment for performance to date. We recognize revenue on an over-time basis for substantially all service revenues where the U.S. government is the customer where arrangements are contracted under the FAR part 15 terms.
For performance obligations satisfied over time, revenue is recognized on a percentage of completion basis using costs incurred to date relative to total estimated costs at completion to measure progress. Incurred costs represent work performed, which correspond with and best depict transfer of control to the customer. Contract costs can include labor, materials, subcontractors’ costs, or other direct costs and indirect costs. The majority of costs incurred are related to labor as most of our contracts are service contracts. Our contracts with the U.S. government are typically subject to the FAR and are priced based on estimated or actual costs of producing goods or providing services. The FAR provides guidance on the types of costs that are allowable in establishing prices for goods and services provided under U.S. government contracts. The pricing for non-U.S. government contracts is based on the specific negotiations with each customer.
Under the typical payment terms of our U.S. government fixed-price contracts, the customer pays us either performance-based payments (“PBPs”) or progress payments. PBPs are interim payments equal to a negotiated percentage of the contract price based on quantifiable measures of performance or on the achievement of specified events or milestones. Progress payments are interim payments up to 80-90% of costs incurred as the work progresses. Because the customer retains a portion of the contract price until completion of the contract, our U.S. government fixed-price contracts generally result in revenue recognized in excess of billings which we present as Contract assets on the Combined Balance Sheets. For our U.S. government cost-type contracts, the customer generally pays us for our costs incurred within a short period of time. For non-U.S. government contracts, we typically receive interim payments as work progresses, although for some contracts, we may be entitled to receive an advance payment. Such advances are not considered a significant financing component because they are used to meet working capital demands that can be higher in the early stages of a contract and to protect us from the other party failing to adequately complete some or all of its obligations under the contract. We recognize a liability for advance payments in excess of revenue recognized and present it as Contract liabilities on the Combined Balance Sheets.
Contracts are often modified to account for changes in contract specifications or requirements. We consider contract modifications to exist when the modification either creates new or changes existing enforceable rights and obligations. Contract modifications for goods or services that are not distinct are accounted for as part of the existing contract either on a cumulative catch-up basis or prospective basis depending on the nature of the modification.
Loss provisions on contracts are recognized to the extent that estimated contract costs exceed the estimated consideration from the services contemplated under the contractual arrangement. For new commitments, we generally record loss provisions at contract signing. For existing commitments, anticipated losses on contractual arrangements are recognized in the period in which losses become evident. In estimating losses, services contemplated under contractual arrangements include firm quantities of services sold under contract as well as optional purchases to the extent the optional quantities would result in a loss.
We review our EACs on significant contracts on a periodic basis and for others, no less than annually or when a change in circumstances warrants a modification to a previous estimate. Due to the nature of the work required to be performed on many of the Company’s performance obligations, the estimation of total revenue and cost at completion is complex, subject to many variables and requires significant judgment by management on a contract-by-contract basis. As part of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities and the related changes in estimates of revenues and costs. The risks and opportunities relate to management’s judgment about the ability and cost to achieve the schedule, consideration of customer-directed delays or reductions in scheduled deliveries, practical requirements, customer activity levels and related variable consideration. Management’s judgment related to these considerations has become increasingly more significant given the current economic environment primarily caused by the COVID-19 pandemic. Management must make assumptions and estimates regarding contract revenue and costs, including estimates of labor productivity and availability, the complexity and scope of the work to be performed, the availability and cost of materials, the length of time to complete the performance obligation, execution by our subcontractors, the availability and timing of funding from our customer, overhead cost rates, and current and past maintenance cost. Efforts expended by our subcontractors are included in
15
our EACs and subcontractor costs incurred drive revenue recognition to the extent that they’re incurred in satisfying the performance obligation. Subcontract costs are accrued at the end of the reporting period.
For long-term contracts where revenue is recognized over time, changes in estimates of Revenues, Cost of revenues and the related impact to Operating profit are recognized on a cumulative catch-up basis, which recognizes the cumulative effect of changes in estimates on current and prior periods based on a performance obligation’s percentage of completion in the current period. A significant change in one or more of these estimates could affect the profitability of one or more of our performance obligations, including resulting in a significant recognition or derecognition event in the current period depending on the nature of the change in estimate. The Company’s EAC adjustments also include the establishment of loss provisions on our contracts accounted for on a percentage of completion basis.
The following table presents the impact of Net EAC adjustments on the Company’s operating results for the years ended December 31, 2020 and 2019:
| 2020 | 2019 | |||||||
| Revenues | $ | 53,151 | $ | 51,606 | ||||
| Operating profit | 53,720 | 50,453 | ||||||
| Net Income (1) | 42,439 | 39,858 | ||||||
| (1) | Amounts reflect a U.S. statutory tax rate of 21%, which approximates the Company’s tax rate on our EAC adjustments. |
In 2020 and 2019, revenue was increased by a net of $53,151 and $51,606, respectively, for performance obligations satisfied (or partially satisfied) in previous periods. These increases relate to EAC adjustments that impacted revenue.
Cost of services
Cost of services represents direct cost of sales on programs. During 2019, the Company sold certain assets related to the Warfighter FOCUS program ("WFF") for $12,957. The Company recognized a gain on the sale of these WFF assets of $12,913, which is included in Cost of services for the year ended December 31, 2019.
Research and Development Expense
Company-sponsored research and development costs, including those costs related to the Company’s portion in connection with cost-sharing arrangements, are charged to expense as incurred and recovery on these cost-sharing arrangements is recorded as a reduction to research and development expense as earned. Customer-sponsored research and development projects performed under contracts with customers are accounted for as contract costs and reported as cost of sales on the related revenue generating contracts.
Stock-Based Compensation Expense
Certain employees of the Business participate in long-term incentive plans of the Parent, which authorize various types of market and performance-based incentive awards including stock options, stock appreciation rights, performance share units and other such awards. Stock-based compensation expense reflected in the accompanying Combined Financial Statements relates to stock plan awards of the Parent that was allocated to the Business in conjunction with other functional service expenses and general corporate expenses and not stock awards of the Company as it does not grant stock awards.
The following table reflects stock-based compensation expense allocated to the Business for the years ended December 31, 2020 and 2019:
| Year Ended December 31, | |||||||
| 2020 | 2019 | ||||||
| Allocated stock-based compensation expense | $ | 1,448 | $ | 1,534 | |||
| Total stock-based compensation expense | $ | 1,448 | $ | 1,534 | |||
16
Income Taxes
Income taxes as presented in the Combined Financial Statements of the Company attribute current and deferred income taxes of the Parent to the Company’s financial statements in a manner that is systematic, rational and consistent with the asset and liability method prescribed by FASB ASC Topic 740: Income Taxes. Accordingly, the Company’s income tax provision was prepared following the separate return method. The separate return method applies ASC 740 to the financial statements of each member of the consolidated group as if the group members were separate taxpayers. The calculation of the Company’s income taxes on a separate return basis requires a considerable amount of judgment and use of both estimates and allocations. As a result, actual transactions included in the consolidated financial statements of Parent entities may not be included in the Company’s Combined Financial Statements. Similarly, the tax treatment of certain items reflected in the Company’s Combined Financial Statements may not be reflected in the consolidated financial statements and tax returns of Parent entities. Therefore, items such as net operating losses, tax credit carry-forwards and valuation allowances may exist in the Company’s Combined Financial Statements that may or may not exist in the Parent’s consolidated financial statements. As such, the income taxes of the Company, as presented in the Combined Financial Statements, may not be indicative of the income taxes that the Company will generate in the future.
The Company and its domestic subsidiaries provide for federal income taxes on pretax accounting income at rates in effect under existing tax law. Foreign subsidiaries record provisions for income taxes at applicable foreign tax rates in a similar manner. Such provisions differ from the amounts currently payable because certain items of income and expense are recognized in different time periods for financial reporting purposes than for income tax purposes. Consistent with the Parent’s assertion, the Company no longer intends to reinvest certain undistributed earnings of its foreign subsidiaries that have been previously taxed in the U.S. As such, the Company recorded the taxes associated with the future remittance of these foreign earnings. For the remainder of the Company’s undistributed foreign earnings, unless tax effective to repatriate, the Company will continue to indefinitely reinvest these earnings. The state income tax provision (benefit) is allocated to contracts when it is paid (recovered) or otherwise agreed as allocable with the U.S. government. A portion of state income taxes are included in Selling, general and administrative expenses, as these costs can generally be recovered through the pricing of services to the U.S. government.
Operations of the Company have historically been included in a consolidated return with other Parent entities. Income taxes payable were deemed settled with the Parent for purposes of the Combined Financial Statements.
Current and deferred income taxes have been determined based on the stand-alone results of the Company. However, because the Company filed as part of the Parent’s tax groups in certain jurisdictions, the Company’s actual tax balances may differ from those reported. The Company’s portion of its current income taxes are deemed to have been settled in the period the current tax expense was recorded.
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the Combined Financial Statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Changes in existing tax laws and rates, their related interpretations, and the uncertainty generated by the current economic environment may affect the amounts of deferred tax liabilities or the valuations of deferred tax assets over time. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. In the event that we determine that we would be able to realize our deferred income tax assets in the future in excess of the net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which impacts the provision for income taxes.
In the ordinary course of business, there is inherent uncertainty in quantifying income tax positions. The Company assesses its income tax positions and records tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available. For those tax positions where it is more-likely-than-not that a tax benefit will be sustained, the Company has recorded the amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge
17
of all relevant information. For those income tax positions where it is not more-likely-than-not that a tax benefit will be sustained, no tax benefit has been recognized. Where applicable, associated interest expense would be recorded in interest expense. Penalties, if incurred, would be recognized as a component of income tax expense. Refer to Note 8 for additional information.
The Tax Cuts and Jobs Act subjects the Company to a tax on global intangible low-taxed income ("GILTI"). GILTI is a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations, which the Company has elected to account for as a period cost.
Other Long-Lived Assets
We evaluate the potential impairment of other long-lived assets whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. If the carrying value of other long-lived assets held and used exceeds the sum of the undiscounted expected future cash flows, the carrying value is written down to fair value. In order for long-lived assets to be considered held for disposal, we must have committed to a plan to dispose of the assets. Once deemed held for disposal, the assets are stated at the lower of the carrying amount or fair value less costs to sell. The Company did not have any impairment of long-lived assets for the years ended December 31, 2020 and 2019.
Recent Accounting Pronouncements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU and its related amendments (collectively, the “Credit Loss Standard)” modifies the impairment model to utilize an expected loss methodology in place of the incurred loss methodology for financial instruments, including trade receivables, contract assets and off-balance sheet credit exposures. The Credit Loss Standard requires consideration of a broader range of information to estimate expected credit losses, including historical information, current economic conditions and a reasonable forecast period. This ASU requires that the statement of operations reflect estimates of expected credit losses for newly recognized financial assets as well as changes in the estimate of expected credit losses that have taken place during the period, which may result in earlier recognition of certain losses.
The Company adopted this standard effective January 1, 2020 utilizing a modified retrospective approach. The Company did not record a cumulative-effect non-cash adjustment to retained earnings as of January 1, 2020. The adoption of this standard did not have a material impact on the Company’s Combined Financial Statements.
The Company is exposed to credit losses primarily through our sales of services to commercial customers which are recorded as trade receivables, contract assets, long-term receivables, and notes and lease receivables on the Combined Balance Sheets. We do not have any significant exposure for credit losses related to sales of services to our government customers. Our method for developing our allowance for credit losses involves making informed judgments regarding whether an adjustment is necessary to our historical loss experiences to reflect our expectations around current economic conditions and reasonable and supportable forecast periods, where applicable. We utilize current economic market data as well as other internal and external information available to us to inform our decision making. In certain circumstances we may be able to develop reasonable and supportable forecasts over the contractual term of the financial asset or off-balance sheet exposure. For periods beyond which we are able to make or obtain reasonable and supportable forecasts, we revert to historical loss experience and information.
The Company determines credit ratings for each customer in our portfolio based upon public information and information obtained directly from our customers. We conduct a review of customer credit ratings, published historical credit default rates for different rating categories as a basis to validate the reasonableness of the allowance for credit losses on these balances quarterly or when events and circumstances warrant. In addition to credit quality indicators, factors considered in our evaluation of assessing collectability and risk include underlying value of any collateral or security interests, significant past due balances, historical losses, and existing economic conditions, including geographic and political risk. A credit limit is established for each customer based on the outcome of this review. Customer credit ratings range from customers with an extremely strong capacity to meet financial obligations, to customers whose uncollateralized receivable is in default. We may require collateral or prepayment to mitigate credit risk.
18
To estimate expected credit losses of financial assets with similar risk characteristics, we determine an asset is impaired when, based on historical experience, current information and a reasonable forecast period, there is risk that we will be unable to collect amounts due according to the contractual terms of the agreement. We monitor our ongoing credit exposure through reviews of customer balances against contract terms and due dates, current economic conditions, and dispute resolution. Estimated credit losses are written off in the period in which the financial asset is no longer collectible.
We can also be exposed to credit losses from off-balance sheet exposures, such as certain financial guarantees and financing commitments. The Company has assessed these potential exposures and concluded that there no material credit losses existed as of December 31, 2020.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The amendments in this update remove certain exceptions of Topic 740 including: exception to the incremental approach for intra-period tax allocation when there is a loss from continuing operations and income or gain from other items; exception to the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment; exception to the ability not to recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary; exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. There are also additional areas of guidance in regard to: franchise and other taxes partially based on income and the interim recognition of enactment of tax laws and rate changes. The ASU is effective for fiscal years ending after December 15, 2020 for public business entities and for all other entities for fiscal years ending after December 15, 2021. The adoption of this standard is not expected to have an impact on the Company’s Combined Financial Statements and related disclosures.
In August 2018, the FASB issued ASU 2018-14, Disclosure Framework – Changes to the Disclosure Requirements for Defined Benefit Plans, which amends ASC 715 to add, remove, and clarify disclosure requirements related to defined benefit pension and other postretirement plans. The amendments require additional disclosure for the weighted-average interest crediting rates, a narrative description of the reasons for significant gains and losses, and an explanation of any other significant changes in the benefit obligation or plan assets. The amendment removes disclosure requirement for accumulated other comprehensive income expected to be recognized over the next year, information about plan assets to be returned to the entity, and the effects of a one-percentage-point change on the assumed health care costs and the effect of this change in rates on service cost, interest cost, and the benefit obligation for postretirement health care benefits. The ASU is effective for fiscal years ending after December 15, 2020 for public business entities and for all other entities for fiscal years ending after December 15, 2021. Early adoption is permitted. The ASU does not amend the interim disclosure requirements of ASC 715-20. The Company is currently evaluating the impact that this guidance may have on the Combined Financial Statements and related disclosures.
Other new pronouncements issued but not effective until after December 31, 2020 did not and are not expected to have a material impact on our financial position, results of operations or liquidity.
4. Related Parties
The Combined Financial Statements have been prepared on a stand-alone basis and are derived from the consolidated financial statements and accounting records of the Parent.
The Parent incurs significant corporate costs for services provided to the Company as well as to other Parent-owned businesses. These services include accounting, legal, information technology, human resources and other infrastructure support. The costs associated with these services generally include all payroll and benefit costs, as well as overhead costs related to the support functions. The cost of these services has been allocated to the Business on a basis that the Company and the Parent consider a reasonable reflection of the benefits received by the Business. All such amounts have been deemed to have been incurred and settled by the Company in the period in which the costs were recorded.
The allocated functional service expenses and general corporate expenses for the years ended December 31, 2020 and 2019 were $93,654 and $122,226, respectively, and are included in Cost of services and Selling, general and administrative expenses within the Combined Statements of Operations. In the opinion of management of the Parent and the Company, the expense and cost allocations have been determined on a basis considered to be reasonable
19
reflection of the utilization of services provided to or the benefits received by the Company during the years ended December 31, 2020 and 2019. The amounts that would have been, or will be incurred, on a stand-alone basis could differ from the amounts allocated due to economies of scale, differences in management judgment, a requirement for more or fewer employees or other factors. In addition, the future results of operations, financial position and cash flows of the Company could differ materially from that of the historical results presented herein.
| 5. | Fixed Assets, Net |
Fixed assets, net was as follows as of December 31, 2020 and 2019:
| December 31, | |||||||
| 2020 | 2019 | ||||||
| Buildings and improvements | $ | 18,133 | $ | 16,806 | |||
| Machinery, tools and equipment | 56,693 | 55,400 | |||||
| Internal use software | 8,946 | 8,832 | |||||
| Other, including assets under construction | 7,506 | 3,246 | |||||
| 91,278 | 84,284 | ||||||
| Less: Accumulated depreciation | (75,258) | (71,824) | |||||
| Fixed assets, net | $ | 16,020 | $ | 12,460 | |||
Depreciation expense was $3,121 and $2,730 for the years ended December 31, 2020 and 2019, respectively.
Asset Retirement Obligations
The Company has an obligation at our Indianapolis facility that, under the terms of the lease, require restoration of certain fixtures upon termination. As a result, the Company maintains an asset retirement obligation of $2,947 and $2,770 as of December 31, 2020 and December 31, 2019, respectively.
The entirety of the Company’s asset retirement obligation liability is classified as long-term as of December 31, 2020. The Company does not have any assets that are legally restricted for purposes of selling assets that are subject to asset retirement obligations.
6. Leases
Operating lease expense was $479 and $461 for the years ended December 31, 2020 and 2019, respectively. Finance leases and lessor leases are not considered significant to the Company’s Combined Balance Sheets or Combined Statements of Operations.
Variable lease cost and sublease income were immaterial for the years ended December 31, 2020 and 2019.
Supplemental cash flow information related to operating leases were as follows:
| 2020 | 2019 | ||||||
| Operating cash flows used in the measurement of operating lease liabilities | $ | 477 | $ | 466 | |||
| Operating lease right-of-use assets obtained in exchange for operating lease obligations | 1,139 | - | |||||
Future lease payments related to operating lease liabilities as of December 31, 2020 are as follows:
| 2021 | $ | 427 | |
| 2022 | 232 | ||
| 2023 | 22 | ||
| 2024 | 9 | ||
| 2025 | 9 | ||
| Thereafter | - | ||
| Total undiscounted lease payments (1) | 699 | ||
| Less: imputed interest | (30) | ||
| Total discounted lease payments | $ | 669 |
(1) Total future lease payments do not include any future lease payments related to leases that were signed but had not yet commenced as of December 31, 2020.
20
The Company’s lease liabilities recognized in the Combined Balance Sheets were as follows as of December 31, 2020 and 2019:
| 2020 | 2019 | ||||||
| Operating lease liabilities, current (included in Other accrued liabilities) | $ | 337 | $ | 241 | |||
| Operating lease liabilities, noncurrent | 3,613 | 3,618 | |||||
| Total operating lease liabilities | $ | 3,950 | $ | 3,859 | |||
The weighted-average remaining lease term related to our operating leases was 3.18 years and 2.42 years as of December 31, 2020 and 2019, respectively. The weighted-average discount rate related to our operating leases was 3.46% and 6.65% as of December 31, 2020 and 2019, respectively.
| 7. | Supplemental Balance Sheet Information |
The following is a summary of accounts receivable, net as of December 31, 2020 and 2019:
| December 31, | |||||||
| 2020 | 2019 | ||||||
| Accounts receivable | $ | 49,769 | $ | 54,771 | |||
| Less: allowance for expected credit losses | - | (253) | |||||
| Accounts receivable, net | $ | 49,769 | $ | 54,518 | |||
The changes in the allowance for expected credit losses is as follows:
| Write-offs | |||||||||||||
| Charged Against | |||||||||||||
| Balance at | Provision for | Allowance for | |||||||||||
| Beginning | Expected Credit | Expected Credit | Balance at | ||||||||||
| of Period | Losses | Losses | End of Period | ||||||||||
| 2020 allowance for expected credit losses | $ | 253 | $ | - | $ | (253) | $ | - | |||||
| 2019 allowance for expected credit losses | - | 253 | - | 253 | |||||||||
The following is a summary of inventory as of December 31, 2020 and 2019:
| As of December 31, | |||||||
| 2020 | 2019 | ||||||
| Inventory | |||||||
| Raw materials | $ | - | $ | 1 | |||
| Work-in-process | 1,056 | 730 | |||||
| Finished goods | - | - | |||||
| Inventory, net | $ | 1,056 | $ | 731 | |||
Work-in-process is net of total valuation reserves of $383 and $411 as of December 31, 2020 and 2019, respectively.
The activity for valuation allowance for deferred tax assets is as follows for the years ended December 31, 2020 and 2019:
| Balance at | Charged | Charged to | Balance at | ||||||||||||
| Beginning | (Released) to | Other | End of | ||||||||||||
| of Period | Provisions | Accounts | Period | ||||||||||||
| 2020 valuation allowance for deferred tax assets | $ | - | $ | 8 | $ | - | $ | 8 | |||||||
| 2019 valuation allowance for deferred tax assets | - | - | - | - | |||||||||||
21
8. Income Taxes
Income Before Income Taxes
The sources of income from continuing operations before income taxes are as follows for the years ended December 31, 2020 and 2019:
| 2020 | 2019 | ||||||
| United States | $ | 149,380 | $ | 212,087 | |||
| Foreign | 5,082 | 8,591 | |||||
| $ | 154,462 | $ | 220,678 | ||||
Included in Selling, general and administrative expenses is the provision for recoverable state income taxes, which generally can be recovered through the pricing of services to the U.S. government.
Consistent with the Parent’s assertion, the Company no longer intends to reinvest certain undistributed earnings of its foreign subsidiaries that have been previously taxed in the U.S. As such, the Company recorded the taxes associated with the future remittance of these foreign earnings. For the remainder of the Company’s undistributed foreign earnings, unless tax effective to repatriate, the Company will continue to indefinitely reinvest these earnings. Unremitted foreign earnings, for which deferred taxes have not been provided, were $16,025 as of December 31, 2020. It is not practicable to estimate the amount of tax that might be payable on the remaining amounts.
Provision for Income Taxes
The income tax expense for the years ended December 31, 2020 and 2019 consisted of the following components:
| 2020 | 2019 | ||||||
| Current: | |||||||
| Federal | $ | 25,730 | $ | 39,067 | |||
| State | 3,855 | 6,315 | |||||
| Foreign | 1,411 | 2,427 | |||||
| 30,996 | 47,809 | ||||||
| Future: | |||||||
| Federal | 2,505 | (1,318) | |||||
| State | - | - | |||||
| Foreign | - | - | |||||
| 2,505 | (1,318) | ||||||
| Income tax expense | $ | 33,501 | $ | 46,491 | |||
Reconciliation of Effective Income Tax Rate
Differences between effective income tax rates and the statutory U.S. federal income tax rate are as follows for the years ended December 31, 2020 and 2019:
| 2020 | 2019 | |||||||||||
| Amount | Rate | Amount | Rate | |||||||||
| Statutory U.S. federal income tax rate | $ | 32,437 | 21.0% | $ | 46,342 | 21.0% | ||||||
| State income tax, net | 3,045 | 2.0 | 4,989 | 2.3 | ||||||||
| Foreign derived intangible income | (2,025) | (1.3) | (5,277) | (2.4) | ||||||||
| Other | 44 | - | 437 | 0.2 | ||||||||
| Income tax expense | $ | 33,501 | 21.7% | $ | 46,491 | 21.1% | ||||||
Deferred Tax Assets and Liabilities
The tax effects of temporary differences and tax carryforwards which gave rise to future income tax benefits and payables as of December 31, 2020 and 2019 are as follows:
22
| 2020 | 2019 | ||||||
| Future income tax benefits | |||||||
| Accrued compensation | $ 1,701 | $ - | |||||
| Advanced payments | 1,820 | 405 | |||||
| Lease liabilities | 944 | 923 | |||||
| Inventory and contract balances | 549 | 4,814 | |||||
| Reserves and other accruals | 181 | 396 | |||||
| Tax loss carryforwards | 8 | - | |||||
| Total deferred tax assets before valuation allowances | 5,203 | 6,538 | |||||
| Less: valuation allowances | (8 | ) | - | ||||
| Total deferred tax assets | $ 5,195 | $ 6,538 | |||||
| Future income taxes payable: | |||||||
| Fixed assets | (987 | ) | (906) | ||||
| Right-of-use assets | (932 | ) | (907) | ||||
| Prepaid expenses | (186 | ) | (435) | ||||
| Other | (647 | ) | (595) | ||||
| Total deferred tax liabilities | (2,752 | ) | (2,843) | ||||
| Net deferred tax asset | $ 2,443 | $ 3,695 | |||||
The Company evaluates the realizability of its deferred tax assets by tax-paying component and assesses the need for a valuation allowance on an annual basis. In the course of performing this analysis, the Company evaluates the profitability of each tax-paying component on a historic cumulative basis and a forward-looking basis. In 2020, the total valuation allowance for the Company increased by $8 due to net operating losses for which it is more likely than not that the benefit of these items will not be realized.
Unrecognized Tax Benefits
As of December 31, 2020, the Company had gross tax-effected unrecognized tax benefits of $547, of which $547, if recognized, would impact the effective tax rate. The interest expense related to unrecognized tax benefits for the years ended December 31, 2020 and 2019 are immaterial. A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2020 and 2019 is as follows:
| 2020 | 2019 | ||||||
| Balance at January 1 | $ | 469 | $ | 342 | |||
| Additions for tax positions related to the current year | 78 | 127 | |||||
| Balance at December 31 | $ | 547 | $ | 469 | |||
The Company conducts business primarily in the United States and, as a result, is included in the Parent entities’ federal and state income tax returns. In the normal course of business, the Parent entities are subject to examination by taxing authorities throughout the United States. As a result of the Parent entities’ audits, with few exceptions, the Company is no longer subject to U.S. federal, state or local income tax examinations for years before 2014. The Parent amended its tax returns for tax years 2014 through 2016 to reflect refunds related to increased research tax credits, which are subject to audit. The Company is currently under audit for taxable years between 2016 and 2018 in Germany.
9. Pension and Postemployment Benefits
The Combined Financial Statements reflect the pension and post-retirement plans of the Company on a multi-employer basis. As a result, the assets and liabilities related to these plans are not reflected in the Combined Financial Statements.
A majority of the Company’s employees are participants in defined benefit pension plans as well as post-retirement plans administered and sponsored by the Parent. Benefits under the plans are based primarily on years of service and employees’ compensation. Pension entitlements are funded by contributions by the Parent to a separately administered pension fund. The Parent allocates costs associated with the pension plans to the Company primarily based on the annual service cost of the active participants. In certain jurisdictions, statutory regulations require the
23
transfer of certain of the Parent’s plan assets and related pension obligations which are not recorded in the Company’s financial statements to successor employers upon divestiture of the business.
Additionally, the Parent maintains a post-employment benefit plan to provide limited benefits to its former employees, including former employees of the Company, if they are involuntarily terminated. The duration of these benefits is generally based on the employee’s term of service with the Parent, and includes both severance compensation and other benefits, including medical coverage. The post-employment plan is published and is considered a benefit to employees which is earned over the employee’s term of service. As a result, the Parent recognizes the cost of this benefit as it is earned by the employee as required by ASC 712: Compensation - nonretirement postemployment benefits.
For the years ended December 31, 2020 and 2019, the Company was allocated $30,808 and $31,547, respectively, of pension costs under CAS and generated recovery based on these allocated costs under CAS. The CAS allocation of pension costs is included in the allocated functional service expenses and general corporate expenses. Refer to Note 4 for additional information.
The Company accounted for its employee pension and post-retirement plans in accordance with FAS for the purpose of these Combined Financial Statements. The Company’s pension adjustment included in the financial statements reflects the difference between CAS pension expense that was historically allocated to the Company and historical FAS pension expense as calculated by the Company.
The Company’s FAS pension and post-retirement expense for the years ended December 31, 2020 and 2019 was $11,700 and $10,413, respectively, and is reflected as an expense in the Combined Statements of Operations.
The following table presents the Company’s historical pension expense for the years ended December 31, 2020 and 2019:
| 2020 | 2019 | ||||||
| Allocated CAS pension expense | $ | 30,808 | $ | 31,547 | |||
| FAS/CAS pension adjustment | (11,700) | (10,413 | ) | ||||
| FAS pension expense | $ | 19,108 | $ | 21,134 | |||
The Combined Balance Sheet as of December 31, 2020 includes $5,811 of projected benefit obligation associated with a pension plan in Germany, of which $5,573 is included in Other long-term liabilities.
10. Revenue from Contracts with Customers
Disaggregation of Revenue
The Company disaggregates revenue by customer and by contract type. We believe these categories best depict how the nature, amount, timing and uncertainty of the Company’s revenue and cash flows are affected by economic factors.
The Company’s disaggregated revenue by customer for the years ended December 31, 2020 and 2019 is as follows:
| Customer | 2020 | 2019 | |||||
| Government | $ | 913,420 | $ | 1,287,529 | |||
| Commercial | 105,644 | 140,841 | |||||
| Revenues | $ | 1,019,064 | $ | 1,428,370 | |||
The Company’s disaggregated revenue by contract type for the years ended December 31, 2020 and 2019 is as follows:
| Contract Type | 2020 | 2019 | |||||
| Fixed Price | $ | 615,464 | $ | 821,835 | |||
| Cost Type | 403,600 | 606,535 | |||||
| Revenues | $ | 1,019,064 | $ | 1,428,370 | |||
24
Contract Assets and Liabilities
Contract assets reflect revenue recognized and performance obligations satisfied in advance of customer billing. Contract liabilities relate to payments received in advance of the satisfaction of performance under the contract. We receive payments from customers based on the terms established in our contracts.
Total contract assets and contract liabilities as of December 31, 2020 and 2019 are as follows:
| 2020 | 2019 | |||||
| Contract assets | $ | 154,084 | $ | 157,332 | ||
| Contract liabilities | (95,519) | (134,643) | ||||
| Net contract assets | $ | 58,565 | $ | 22,689 | ||
For the year ended December 31, 2020, contract assets and contract liabilities decreased by $3,248 and $39,124, respectively, primarily due to (i) the loss of the Warfighter and Opel and Vauxhall programs and (ii) decreases in sales for certain commercial training projects related to the impact of the COVID-19 pandemic.
For the years ended December 31, 2020 and 2019, the Company recognized revenues of $104,215 and $73,122 related to our Contract liabilities as of January 1, 2020 and January 1, 2019, respectively.
Contract assets consisted of the following as of December 31, 2020 and 2019:
| 2020 | 2019 | ||||||
| Unbilled | $ | 154,084 | $ | 157,332 | |||
| Progress payments | - | - | |||||
| Total contract assets | $ | 154,084 | $ | 157,332 | |||
The U.S. government has title to the assets related to unbilled amounts on U.S. government contracts that provide progress payments.
Contract assets can include retentions arising from contractual provisions. As of December 31, 2020, there were no such retentions.
Backlog
Backlog, which is equivalent to our remaining performance obligations, represents the expected transaction price allocated to our contracts that we expect to recognize as revenue in future periods when the Company performs under the contracts. These remaining obligations exclude unexercised contract options and potential orders under ordering-type contracts such as Indefinite Delivery, Indefinite Quantity contracts.
At December 31, 2020, the Company’s total backlog was $945,116, of which approximately 35% is not expected to be realized as sales in the next twelve months.
11. Commitments and Contingencies
Government Oversight
In the ordinary course of business, the Company is subject to regulatory and governmental examinations, information gathering requests, inquiries, investigations and threatened legal actions and proceedings. For example, we are now, and believe that, considering the current U.S. government contracting environment, we will continue to be the subject of one or more U.S. government investigations. Our contracts with the U.S. government are also subject to audits. Agencies that oversee contract performance include: the Defense Contract Audit Agency (“DCAA”), the Defense Contract Management Agency (“DCMA”), the Inspectors General of the U.S. Department of Defense (“DoD”) and other departments and agencies, the Government Accountability Office (“GAO”), the Department of Justice (“DOJ”), and Congressional Committees. Other areas of our business operations may also be subject to audit and investigation by these and other agencies. From time to time, agencies investigate or conduct audits to determine
25
whether our operations are being conducted in accordance with applicable requirements. Such investigations and audits may be initiated due to a number of reasons, including as a result of a whistleblower complaint. Such investigations and audits could result in administrative, civil or criminal liabilities, including repayments, fines, treble or other damages, forfeitures, restitution, or penalties being imposed upon us, the suspension of government export licenses or the suspension or debarment from future U.S. government contracting. U.S. government investigations often take years to complete. The U.S. government also reserves the right to debar a contractor from receiving new government contracts for fraudulent, criminal or other seriously improper conduct. The U.S. government could void any contracts found to be tainted by fraud. Like many defense contractors, we have received audit reports recommending the reduction of certain contract prices because, for example, cost or pricing data or cost accounting practices used to price and negotiate those contracts may not have conformed to government regulations. Some of these audit reports recommend that certain payments be repaid, delayed, or withheld, and may involve substantial amounts. We have made voluntary refunds in those cases we believe appropriate, have settled some allegations and, in some cases, continue to negotiate and/or litigate. The Company may be, and has been, required to make payments into escrow of disputed liabilities while the related litigation is pending. If the litigation is resolved in the Company’s favor, any such payments will be returned to the Company with interest. Our final allowable incurred costs for each year are also subject to audit and have, from time to time, resulted in disputes between us and the U.S. government, with litigation resulting at the Court of Federal Claims (“COFC”) or the Armed Services Board of Contract Appeals (“ASBCA”) or their related courts of appeals. In addition, the DOJ has, from time to time, convened grand juries to investigate possible irregularities by us. We also provide services to customers outside of the U.S., and those sales are subject to local government laws, regulations and procurement policies and practices. Our compliance with such local government regulations or any applicable U.S. government regulations (e.g., the Foreign Corrupt Practices Act (“FCPA”) and International Traffic in Arms Regulations (“ITAR”)) may also be investigated or audited. In addition, we accrue for liabilities associated with those matters that are probable and can be reasonably estimated. The most likely liability amount to be incurred is accrued based upon a range of estimates. Where no amount within a range of estimates is more likely, then we accrue the minimum amount. Other than as specifically disclosed in these Combined Financial Statements, we do not expect these audits, investigations or disputes to have a material effect on our financial position, results of operations or liquidity, either individually or in the aggregate.
Legal Proceedings
The Company is subject to various litigation matters across jurisdictions. Particularly, CDC, a subcontractor for construction of fencing and surveillance equipment for border security services in Jordan, submitted claims with a total value of $23,200 with respect to work that CDC alleges the Company or the Company’s customer requested CDC perform outside the scope of the Company’s purchase order with CDC, which had a period of performance from October 2015 through October 2018. The Company’s offer to settle and assessment of exposure related to the CDC claims was $888. Management believes that this offer was appropriate for the recognition of program costs in the Company’s Combined Financial Statements. As of the date the Company’s Combined Financial Statements were available to be issued, discussions between all parties remain ongoing. At this time, the Company is unable to predict the outcome, or the possible range of loss, if any, which could result from the resolution of this matter.
The Company is subject to other legal proceedings, both asserted and unasserted, that arise in the ordinary course of business. The Company cannot predict the ultimate outcome of such legal proceedings or in certain instances provide reasonable ranges of potential losses. However, as of the date of this report, the Company believes that none of these claims will have a material adverse effect on the Company’s financial position or results of operations. In the event of unexpected subsequent developments and given the inherent unpredictability of these matters, there can be no assurance that the Company’s assessment of any claim will reflect the ultimate outcome, and an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company’s financial position or results of operations in the particular period.
12. Subsequent Events
The Company evaluated events and transactions occurring subsequent to December 31, 2020 through October 11, 2021, the date that the Combined Financial Statements were available to be issued.
The U.S. Army Contracting Command selected Raytheon to train the Afghanistan Air Force in aircraft maintenance and to provide tailored training for the Afghanistan Air Force pilots, including classroom, fixed-wing and rotary aircraft instruction in August 2019, and May 2020, respectively. Four task orders under the aforementioned
26
contracts are performed by the Business and have been included in the historical results of operations, financial position and cash flows of the Company presented in these Combined Financial Statements.
In August 2021, the United States Armed Forces completed their withdrawal from Afghanistan, increasing the risk of early termination to Afghan military training contracts. As of December 31, 2020, the full amount of funded backlog was $99,719 related to the four task orders that are served by the Business. In the event of contract termination, the Company expects to be paid in accordance with the contract’s terms for costs incurred, plus a reasonable profit and settlement expenses.
On September 8, 2021, Vertex Aerospace LLC signed a definitive agreement to acquire Raytheon Technologies Corporation’s Mission Critical Solutions and Training Services Business.
Events Subsequent to the Original Issuance of the Combined Financial Statements (Unaudited)
In connection with the reissuance of the Combined Financial Statements, the Company has evaluated subsequent events through September 1, 2022, the date that the Combined Financial Statements were available to be reissued.
On December 6, 2021, Raytheon Technologies Corporation and Vertex Aerospace LLC completed the previously announced Transaction.
27
Exhibit 99.4
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
Condensed Combined Financial Statements
As of and for the nine months ended September 30, 2021
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
TABLE OF CONTENTS
| Page No. | |||
| Condensed Combined Balance Sheet as of September 30, 2021 | 2 | ||
| Condensed Combined Statement of Operations for the nine months ended September 30, 2021 | 3 | ||
| Condensed Combined Statement of Comprehensive Income for the nine months ended September 30, 2021 | 4 | ||
| Condensed Combined Statement of Cash Flows for the nine months ended September 30, 2021 | 5 | ||
| Condensed Combined Statement of Changes in Net Parent Investment for the nine months ended September 30, 2021 | 6 | ||
| Notes to Condensed Combined Financial Statements as of and for the nine months ended September 30, 2021 | 7 | ||
1
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
CONDENSED COMBINED BALANCE SHEET
(Unaudited)
| As of | |||
| September 30, 2021 | |||
| (In Thousands) | |||
| Assets | |||
| Current assets | |||
| Cash and cash equivalents | $ | 26,689 | |
| Accounts receivable, less allowance for credit losses of $0 | 48,422 | ||
| Contract assets | 131,625 | ||
| Inventory, net | 1,314 | ||
| Prepaid expenses and other current assets | 3,064 | ||
| Total current assets | 211,114 | ||
| Fixed assets, net | 17,453 | ||
| Operating lease right-of-use assets | 3,128 | ||
| Other assets | 8,533 | ||
| Total assets | $ | 240,228 | |
| Liabilities and Net Parent Investment | |||
| Current liabilities | |||
| Accounts payable | $ | 40,339 | |
| Accrued employee compensation | 13,153 | ||
| Other accrued liabilities | 10,822 | ||
| Contract liabilities | 78,895 | ||
| Total current liabilities | 143,209 | ||
| Operating lease liabilities, non-current | 1,370 | ||
| Other long-term liabilities | 10,094 | ||
| Total liabilities | 154,673 | ||
| Commitments and Contingencies (Note 9) | |||
| Net Parent Investment: | |||
| Net parent investment | 88,156 | ||
| Accumulated other comprehensive loss | (2,601) | ||
| Total net parent investment | 85,555 | ||
| Total liabilities and net parent investment | $ | 240,228 | |
The accompanying notes are an integral part of these Condensed Combined Financial Statements.
2
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
CONDENSED COMBINED STATEMENT OF OPERATIONS
(Unaudited)
| Nine Months Ended | |||
| September 30, 2021 | |||
| (In Thousands) | |||
| Revenues | |||
| Revenues | $ | 612,259 | |
| Revenues – related party | 23,513 | ||
| Total revenues | 635,772 | ||
| Cost of revenues | |||
| Cost of services | 485,480 | ||
| Cost of services – related party | 21,030 | ||
| Total cost of revenues | 506,510 | ||
| Gross profit | 129,262 | ||
| Operating expenses | |||
| Selling, general and administrative | 28,692 | ||
| Total operating expenses | 28,692 | ||
| Operating profit | 100,570 | ||
| Non-operating expense (income), net | |||
| Non-service pension expense | 4,764 | ||
| Other income, net | (5,615) | ||
| Total non-operating expense (income), net | (851) | ||
| Income before income tax expense | 101,421 | ||
| Income tax expense | 22,660 | ||
| Net income | $ | 78,761 | |
The accompanying notes are an integral part of these Condensed Combined Financial Statements.
3
| MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS | ||
| (A Business of Raytheon Technologies Corporation) | ||
| CONDENSED COMBINED STATEMENT OF COMPREHENSIVE INCOME | ||
(Unaudited)
| Nine Months Ended | |||
| September 30, 2021 | |||
| (In Thousands) | |||
| Net income | $ | 78,761 | |
| Other comprehensive income (loss): | |||
| Foreign currency translation adjustments | (8,639) | ||
| Total other comprehensive income (loss) | (8,639) | ||
| Comprehensive income | $ | 70,122 | |
The accompanying notes are an integral part of these Condensed Combined Financial Statements.
4
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
CONDENSED COMBINED STATEMENT OF CASH FLOWS
(Unaudited)
| Nine Months Ended | |||
| September 30, 2021 | |||
| (In Thousands) | |||
| Cash flows from operating activities: | |||
| Net income | $ | 78,761 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | |||
| Depreciation | 2,600 | ||
| Gain on legal settlement | (5,680) | ||
| Stock-based compensation | 847 | ||
| Deferred income taxes | (2,722) | ||
| Changes in operating assets and liabilities: | |||
| Accounts receivable | 346 | ||
| Contract assets | 19,739 | ||
| Inventory, net | (285) | ||
| Prepaid expenses and other assets | 946 | ||
| Accounts payable | (29,390) | ||
| Accrued employee compensation | (158) | ||
| Accrued and other liabilities | (2,280) | ||
| Contract liabilities | (18,255) | ||
| Net cash provided by operating activities | 44,469 | ||
| Cash flows from investing activities: | |||
| Purchases of fixed assets | (4,394) | ||
| Net cash used in investing activities | (4,394) | ||
| Cash flows from financing activities: | |||
| Net transfers to Parent | (47,394) | ||
| Net cash used in financing activities | (47,394) | ||
| Effects of foreign exchange rate changes on cash and cash equivalents | (1,029) | ||
| Net decrease in cash and cash equivalents | (8,348) | ||
| Cash and cash equivalents, beginning of period | 35,037 | ||
| Cash and cash equivalents, end of period | $ | 26,689 | |
The accompanying notes are an integral part of these Condensed Combined Financial Statements.
5
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
CONDENSED COMBINED STATEMENT OF CHANGES IN NET PARENT INVESTMENT
(Unaudited)
| Accumulated | |||||||||||
| Other | |||||||||||
| Net Parent | Comprehensive | Total Net Parent | |||||||||
| Investment | Income (Loss) | Investment | |||||||||
| (In Thousands) | |||||||||||
| Balance January 1, 2021 | $ | 61,622 | $ | 6,038 | $ | 67,660 | |||||
| Net income | 78,761 | - | 78,761 | ||||||||
| Other comprehensive loss | - | (8,639) | (8,639) | ||||||||
| Net transfers to Parent | (52,227) | - | (52,227) | ||||||||
| Balance September 30, 2021 | $ | 88,156 | $ | (2,601) | $ | 85,855 | |||||
The accompanying notes are an integral part of these Condensed Combined Financial Statements.
6
MISSION CRITICAL SOLUTIONS AND TRAINING SERVICES BUSINESS
(A Business of Raytheon Technologies Corporation)
NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS
(Dollars in Thousands, unless otherwise indicated)
(Unaudited)
1. Nature of the Business
The Mission Critical Solutions and Training Services Business (the “Company” or the “Business”) is comprised of Raytheon Professional Services (“RPS”) and certain contracts within the portfolio of Raytheon Intelligence & Space (“RIS”) which operates as a principal business segment of Raytheon Company, a subsidiary of Raytheon Technologies Corporation (“RTX” or the “Parent”). The Company serves end users in the military, government and commercial segments, both domestically and internationally. The Company is comprised of four service lines, including:
| · | Engineering and Logistics and Senior and Platform Services, which provides equipment maintenance, repair and upgrades, testing and evaluations, logistics consulting, and operational support to government labs and facilities; | |
| · | Modernization and Sustainment, which provides aircraft and ground related depot and engineering services in Indianapolis, Indiana; | |
| · | Defense Training Solutions, which provides training of United States (“U.S.”) and international military personnel, as well as the management of complex global supply networks; and | |
| · | Commercial Training Solutions, which provides training content development and delivery, on-site and digital training, learning management systems and leadership development consulting. |
Risks and Uncertainties
The Company is subject to risks common to companies in the markets it serves, including, but not limited to, global economic and financial market conditions, fluctuations in government and customer demand, acceptance of new services, development by its competitors of new technological innovations, risk of disruption in its supply chain, the implementation of tariffs and export controls, dependence on key personnel, protection of proprietary technology, and compliance with domestic and foreign regulatory authorities and agencies.
In March 2020, COVID-19 was declared a pandemic by the World Health Organization and a national emergency by the U.S. government. The pandemic has negatively affected the U.S. and global economy, disrupted global supply chains and financial markets, and resulted in significant travel restrictions, mandated facility closures and shelter-in-place and social distancing orders in numerous jurisdictions around the world. The Company is taking all prudent measures to protect the health and safety of our employees, such as practicing social distancing, performing deep cleaning in all of our facilities, temperature screening, health questionnaires and enabling our employees to work from home where possible. We have also taken appropriate actions to help support our communities in addressing the challenges posed by the pandemic, including the donation of personal protective equipment.
| 2. | Basis of Presentation |
The Condensed Combined Financial Statements as of, and for the nine months ended, September 30, 2021 are unaudited, and in the opinion of management include adjustments of a normal recurring nature necessary for a fair statement of the results presented herein. RIS follows a 4-4-5 fiscal calendar while the Business uses a quarter calendar end of September 30, 2021. Throughout these Condensed Combined Financial Statements, when we refer to the period ended September 30, 2021, with respect to RIS, we are referring to their October 3, 2021 fiscal quarter end. The results reported in these Condensed Combined Financial Statements should not necessary be taken as indicative of results that may be expected for the entire year. The financial information included herein should be read in conjunction with the financial statements and notes in the Company’s Combined Financial Statements as of and for the years ended December 31, 2020 and 2019.
7
The Company has historically operated as a part of the Parent; consequently, stand-alone financial statements have not historically been prepared for the Company. These Condensed Combined Financial Statements reflect the results of operations, balance sheet, and cash flows of the Company as they were historically managed. These Condensed Combined Financial Statements have been derived from the consolidated financial statements and accounting records of the Parent and have been prepared in accordance with accounting principles generally accepted (“GAAP”) in the United States of America, collectively (“U.S. GAAP”).
The Condensed Combined Statement of Operations include all revenues and costs directly attributable to the Company, including costs for facilities, functions and services utilized by the Company. The Parent provides certain services such as accounting, legal, information technology, human resources and other infrastructure support, on behalf of the Company. Due to Federal Acquisition Regulation (“FAR”) rules that govern our U.S. government business and related Cost Accounting Standards (“CAS”), most types of costs are allocable to U.S. government contracts. Costs allocated to the Business include both costs considered allowable or allocable to U.S. government contracts under applicable CAS or FAR as well as incremental costs necessary to present the Company’s Condensed Combined Financial Statements in accordance with U.S. GAAP. The costs of these services have been allocated to the Company on a direct usage basis when identifiable, with the remainder allocated based on the proportion of expenses, headcount or other relevant measures, depending on the nature of the cost. All allocations for facilities, functions and services performed by the Parent have been deemed settled in cash by the Company to the Parent in the period in which the cost was recorded in the Condensed Combined Statement of Operations. Current and deferred income taxes have been determined based on the stand-alone results of the Company. However, because the Company filed as part of various tax groups in certain jurisdictions, the Company’s actual tax balances may differ from those reported. The Company’s portion of its current income taxes are deemed to have been settled in the period the current tax expense was recorded. A portion of state income taxes are included in Selling, general and administrative expenses as these costs can generally be recovered through the pricing of services to the U.S. government.
All intracompany accounts and transactions within the Company have been eliminated in the preparation of the Condensed Combined Financial Statements. The Condensed Combined Financial Statements of the Company include assets and liabilities that have been determined to be specifically or otherwise attributable to the Business.
RTX uses a centralized approach to cash management and financing its operations. Accordingly, none of the cash, third-party debt, or related interest expense of RTX has been allocated to the Business in the Condensed Combined Financial Statements. However, cash balances primarily associated with certain foreign RPS entities that do not participate in the Parent’s cash management program have been included in the Condensed Combined Financial Statements. While the Company participates in the Parent’s centralized cash management function, which results in the majority of its cash being controlled by the Parent, it has and is expected to generate positive operating cash flows to fund its operating and investing activities. Transactions between the Parent and the Business are deemed to have been settled immediately through Net Parent Investment. The net effect of these transactions is reflected in the Condensed Combined Statement of Cash Flows as Net transfers to Parent within financing activities and in the Condensed Combined Balance Sheet as Net Parent Investment.
All of the allocations and estimates in the Condensed Combined Financial Statements are based on assumptions that management believes are reasonable. However, the Condensed Combined Financial Statements included herein may not be indicative of the financial position, results of operations and cash flows of the Company in the future, or if the Company had been a separate, stand-alone entity during the period presented.
| 3. | Summary of Significant Accounting Policies |
Use of Estimates
The preparation of the Condensed Combined Financial Statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. In addition, estimates and assumptions may impact the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
The full extent to which the COVID-19 pandemic will directly or indirectly impact our business – including results of operations and financial condition, sales, expenses, reserves and allowances and asset recoverability – will
8
depend on future developments that are highly uncertain. This includes results from new information that may emerge concerning COVID-19 and any actions taken to contain or treat COVID-19, as well as the economic impact on local, regional, national, and international customers and markets. We have made estimates of the impact of COVID-19 within our financial statements and there may be changes to those estimates in future periods. Other future events, including COVID-19, and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to our Condensed Combined Financial Statements.
Foreign Currency Translation
The determination of the functional currency of the Company’s foreign subsidiaries is based on their financial and operational environment and is the local currency of all of the Company’s foreign subsidiaries. The subsidiaries’ assets and liabilities are translated into the reporting currency at period-end exchange rates, while revenue, expenses, gains and losses are translated at the average exchange rates during the period. The Company uses the U.S. dollar as its functional currency. The aggregate effects of translating the balance sheets of these subsidiaries are deferred within Accumulated other comprehensive income (loss) as a separate component of Net Parent Investment.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash deposits, cash equivalents and accounts receivable. All of the Company’s cash and cash equivalents are maintained by major financial institutions. The Company regularly monitors the creditworthiness of its customers and believes that it has adequately provided for exposure to potential credit losses.
Fair Value of Financial Instruments
The Company’s financial instruments consist of cash and cash equivalents, accounts receivable and accounts payable. The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate their fair value due to their short-term nature.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and highly liquid investments with original maturities of three months or less that are readily convertible to known amounts of cash. Cash and cash equivalents reported in the Condensed Combined Balance Sheet represent the cash and cash equivalents that are directly attributable to the Company and to which the Company is entitled.
Accounts Receivable and Allowance for Credit Losses
Accounts receivable are stated at the net amount expected to be collected. The allowance for credit losses is established to provide for the expected lifetime credit losses by evaluating factors such as customer creditworthiness, historical payment and loss experiences, current economic conditions and the age, status of outstanding receivables, economic trends and historical experience. The Company reviews its allowance for credit losses on a quarterly basis and adjusts the balance based on the Company’s estimates of the receivables’ recoverability in the period the changes in estimates occur and become known. Accounts receivable balances are written off against the allowance for credit losses when the Company determines that the balances are not recoverable.
We can also be exposed to credit losses from off-balance sheet exposures, such as certain financial guarantees and financing commitments. The Company has assessed these potential exposures and concluded that no material credit losses existed as of September 30, 2021.
The following table details the Company’s accounts receivable, net balances arising from government contracts and non-government contracts as of September 30, 2021:
| As of September 30, 2021 | ||
| Accounts receivable, net from government contracts | $ | 33,867 |
| Accounts receivable, net from non-government contracts | 14,555 | |
| Total Accounts receivable, net | $ | 48,422 |
9
Contract Assets and Liabilities
Contract assets and liabilities represent the difference in the timing of revenue recognition from receipt of cash from our customers. Contract assets reflect revenue recognized and performance obligations satisfied or partially satisfied in advance of customer billing.
Contract assets, which are unbilled receivables, represent revenues that are not currently billable to the customer under the terms of the contract and include unbilled amounts under commercial contracts where payment is solely subject to the passage of time. These items are expected to be billed and collected in the normal course of business. Other unbilled receivables not just subject to the passage of time are included in Contract assets in the Condensed Combined Balance Sheet and are generally classified as current. Progress Based Payments are interim payments equal to a negotiated percentage of the contract price based on quantifiable measures of performance or on the achievement of specified events or milestones.
Contract liabilities relate to payments received in advance of the satisfaction of performance under the contract. The Company receives payments from customers based on the terms established in our contracts.
Contract assets and contract liabilities are generally classified as current as our operating cycle is generally longer than one year.
Inventory, net
Inventory is stated at the lower of cost or net realizable value determined on a first-in, first-out basis and includes the cost of materials prior to the approval of the related contract awarded to the Company. Valuation reserves for excess, obsolete, and slow-moving inventory are estimated by comparing the inventory levels of individual parts to both future sales forecasts and historical usage rates in order to identify inventory where the resale value or replacement value is less than inventoriable cost. Other factors that management considers in determining the adequacy of these reserves include whether individual inventory parts meet current specifications and can be substituted for a part currently being sold or used as a service part, overall market conditions, and other inventory management initiatives.
Fixed Assets, net
Fixed assets, net, are stated at cost less accumulated depreciation. Major improvements are capitalized, while expenditures for maintenance, repairs and minor improvements are expensed. Upon retirement or other disposal of fixed assets, the costs and related amounts of accumulated depreciation or amortization are eliminated from the asset and accumulated depreciation accounts, respectively. The difference, if any, between the net asset value and the proceeds are recorded in operating income.
For sales or asset retirements, the assets and related accumulated depreciation and amortization are eliminated from the accounts. Gains and losses on sales of our fixed assets are recorded in operating income.
| Estimated | |
| Useful Lives | |
| Buildings and improvements | 10 - 45 years |
| Machinery, tools and equipment | 3 - 10 years |
| Internal use software | 3 - 6 years |
| Other, including assets under construction | 4 – 8 years |
Depreciation expense related to fixed assets is recorded utilizing the straight-line or 150% declining balance method.
Leases
The Company accounts for leases in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 842: Leases. As a lessee, the Company records a right-of-use asset and a lease liability on the Condensed Combined Balance Sheet for all leases with terms longer than 12 months. Leases
10
are classified as either finance or operating, with classification affecting the pattern of expense recognition in the Condensed Combined Statement of Operations.
The Company enters into lease agreements for the use of real estate space, vehicles, information technology equipment, and certain other equipment under both operating and finance leases. The Company determines if an arrangement contains a lease at inception. Operating leases are included in Operating lease right-of-use assets, Other accrued liabilities for the current portion of the Company’s operating lease liabilities, and Operating lease liabilities, non-current in the Company’s Condensed Combined Balance Sheet. Finance leases are not considered significant to the Company’s Condensed Combined Balance Sheet or Condensed Combined Statement of Operations.
Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Lease right-of-use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of the Company’s leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments and use the implicit rate when readily determinable. We determine our incremental borrowing rate through market sources including relevant industry rates. Our lease right-of-use assets also include any initial direct costs and lease pre-payments made at or before the commencement date and are reduced for any lease incentives received at or before the commencement date. Certain of our leases include variable payments, which may vary based upon changes in facts or circumstances after the start of the lease. We exclude variable payments from lease right-of-use assets and lease liabilities, to the extent not considered fixed, and instead, expense variable payments as incurred. Variable lease expense and lease expense for short duration contracts are not a material component of lease expense. Some of our leases include the option to extend or terminate the lease. We include these options in the recognition of our right-of-use assets and lease liabilities when it is reasonably certain that we will exercise the option. Lease expense is generally recognized on a straight-line basis over the lease term.
Warranty Obligations
The Company offers warranties on the sales of certain of its services and records warranty obligations for estimated future claims at the time revenue is recognized within our Estimate at Completion (“EAC”). Warranty obligations are estimated based on historical experience and management’s estimate of the level of future claims.
Revenue Recognition
The Company generates revenue primarily from services under the four service lines described in Note 1. Under ASC 606, Revenue from Contracts with Customers (“ASC 606”), the Company recognizes revenue for the transfer of such promised services to customers in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those services. Revenue is recognized when or as the transfer of control of the underlying performance obligation occurs.
The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. For certain contracts that meet the foregoing requirements, primarily contracts that are directly with a foreign government, we are required to obtain certain regulatory approvals. In these cases, we recognize revenue based on the likelihood of obtaining regulatory approvals based upon all known facts and circumstances. A performance obligation is a promise in a contract with a customer to transfer a distinct good or service to the customer. Some of our contracts with customers contain a single performance obligation where contractual activities are highly interrelated with other activities such that no activity is distinct, while other contracts contain multiple performance obligations most commonly when a contract spans multiple phases of the project lifecycle such as maintenance and support or when there are distinct performance periods in a service arrangement such as an annual award fee score. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as the performance obligation is satisfied. When there are multiple performance obligations within a contract, we allocate the transaction price to each performance obligation based on its standalone selling price when available. If standalone selling price is not available, we estimate the standalone selling price of each performance obligation, which is generally based on an expected cost plus a margin approach.
11
We consider the contractual consideration payable by the customer and assess variable consideration that may affect the total transaction price, including contractual discounts, contract incentive payments, estimates of award fees or other customer usage activities on long term maintenance contracts, and other sources of variable consideration, when determining the transaction price of each contract. When reasonably able to estimate, we include variable consideration in the transaction price at the most likely amount to which we expect to be entitled. We include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. These estimates are based on historical experience, anticipated performance and our best judgment at the time. We also consider whether our contracts contain a significant financing component, which they generally do not.
Timing of the satisfaction of performance obligations varies across our businesses due to our diverse service mix, customer base, and contractual terms. However, as most of our revenues are generated from services performed, the majority of revenues are recognized over time.
Performance obligations are satisfied over-time if the customer receives the benefits as we perform work, if the customer controls the asset as it is being produced (continuous transfer of control), or if the service being produced for the customer has no alternative use and we have a contractual right to payment for performance to date. We recognize revenue on an over-time basis for substantially all service revenues where the U.S. government is the customer where arrangements are contracted under the FAR part 15 terms.
For performance obligations satisfied over time, revenue is recognized on a percentage of completion basis using costs incurred to date relative to total estimated costs at completion to measure progress. Incurred costs represent work performed, which correspond with and best depict transfer of control to the customer. Contract costs can include labor, materials, subcontractors’ costs, or other direct costs and indirect costs. The majority of costs incurred are related to labor as most of our contracts are service contracts. Our contracts with the U.S. government are typically subject to the FAR and are priced based on estimated or actual costs of producing goods or providing services. The FAR provides guidance on the types of costs that are allowable in establishing prices for goods and services provided under U.S. government contracts. The pricing for non-U.S. government contracts is based on the specific negotiations with each customer.
Under the typical payment terms of our U.S. government fixed-price contracts, the customer pays us either performance-based payments (“PBPs”) or progress payments. PBPs are interim payments equal to a negotiated percentage of the contract price based on quantifiable measures of performance or on the achievement of specified events or milestones. Progress payments are interim payments up to 80-90% of costs incurred as the work progresses. Because the customer retains a portion of the contract price until completion of the contract, our U.S. government fixed-price contracts generally result in revenue recognized in excess of billings which we present as Contract assets on the Condensed Combined Balance Sheet. For our U.S. government cost-type contracts, the customer generally pays us for our costs incurred within a short period of time. For non-U.S. government contracts, we typically receive interim payments as work progresses, although for some contracts, we may be entitled to receive an advance payment. Such advances are not considered a significant financing component because they are used to meet working capital demands that can be higher in the early stages of a contract and to protect us from the other party failing to adequately complete some or all of its obligations under the contract. We recognize a liability for advance payments in excess of revenue recognized and present it as Contract liabilities on the Condensed Combined Balance Sheet.
Contracts are often modified to account for changes in contract specifications or requirements. We consider contract modifications to exist when the modification either creates new or changes existing enforceable rights and obligations. Contract modifications for goods or services that are not distinct are accounted for as part of the existing contract either on a cumulative catch-up basis or prospective basis depending on the nature of the modification.
Loss provisions on contracts are recognized to the extent that estimated contract costs exceed the estimated consideration from the services contemplated under the contractual arrangement. For new commitments, we generally record loss provisions at contract signing. For existing commitments, anticipated losses on contractual arrangements are recognized in the period in which losses become evident. In estimating losses, services contemplated under contractual arrangements include firm quantities of services sold under contract as well as optional purchases to the extent the optional quantities would result in a loss.
12
We review our EACs on significant contracts on a periodic basis and for others, no less than annually or when a change in circumstances warrants a modification to a previous estimate. Due to the nature of the work required to be performed on many of the Company’s performance obligations, the estimation of total revenue and cost at completion is complex, subject to many variables and requires significant judgment by management on a contract-by-contract basis. As part of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities and the related changes in estimates of revenues and costs. The risks and opportunities relate to management’s judgment about the ability and cost to achieve the schedule, consideration of customer-directed delays or reductions in scheduled deliveries, practical requirements, customer activity levels and related variable consideration. Management’s judgment related to these considerations has become increasingly more significant given the current economic environment primarily caused by the COVID-19 pandemic. Management must make assumptions and estimates regarding contract revenue and costs, including estimates of labor productivity and availability, the complexity and scope of the work to be performed, the availability and cost of materials, the length of time to complete the performance obligation, execution by our subcontractors, the availability and timing of funding from our customer, overhead cost rates, and current and past maintenance cost. Efforts expended by our subcontractors are included in our EACs and subcontractor costs incurred drive revenue recognition to the extent that they’re incurred in satisfying the performance obligation. Subcontract costs are accrued at the end of the reporting period.
For long-term contracts where revenue is recognized over time, changes in estimates of Revenues, Cost of revenues and the related impact to Operating profit are recognized on a cumulative catch-up basis, which recognizes the cumulative effect of changes in estimates on current and prior periods based on a performance obligation’s percentage of completion in the current period. A significant change in one or more of these estimates could affect the profitability of one or more of our performance obligations, including resulting in a significant recognition or derecognition event in the current period depending on the nature of the change in estimate. The Company’s EAC adjustments also include the establishment of loss provisions on our contracts accounted for on a percentage of completion basis.
The following table presents the impact of Net EAC adjustments on the Company’s operating results for the nine months ended September 30, 2021:
| September 30, 2021 | ||
| Revenues | $ | 29,277 |
| Operating profit | 27,677 | |
| Net Income (1) | 21,865 |
| (1) | Amount reflects a U.S. statutory tax rate of 21%, which approximates the Company’s tax rate on our EAC adjustments. |
For the nine months ended September 30, 2021, revenue increased by a net of $29,277, for performance obligations satisfied (or partially satisfied) in previous periods. The increase relates to EAC adjustments that impacted revenue.
Cost of services
Cost of services represents direct cost of sales on programs.
Research and Development Expense
Company-sponsored research and development costs, including those costs related to the Company’s portion in connection with cost-sharing arrangements, are charged to expense as incurred and recovery on these cost-sharing arrangements is recorded as a reduction to research and development expense as earned. Customer-sponsored research and development projects performed under contracts with customers are accounted for as contract costs and reported as cost of sales on the related revenue generating contracts.
Stock-Based Compensation Expense
Certain employees of the Business participate in long-term incentive plans of the Parent, which authorize various types of market and performance-based incentive awards including stock options, stock appreciation rights, performance share units and other such awards. Stock-based compensation expense reflected in the accompanying
13
Condensed Combined Financial Statements relates to stock plan awards of the Parent that was allocated to the Business in conjunction with other functional service expenses and general corporate expenses and not stock awards of the Company as it does not grant stock awards.
Stock-based compensation expense allocated to the Business was $847 for the nine months ended September 30, 2021.
Income Taxes
Income taxes as presented in the Condensed Combined Financial Statements of the Company attribute current and deferred income taxes of the Parent to the Company’s financial statements in a manner that is systematic, rational and consistent with the asset and liability method prescribed by FASB ASC Topic 740: Income Taxes. Accordingly, the Company’s income tax provision was prepared following the separate return method. The separate return method applies ASC 740 to the financial statements of each member of the consolidated group as if the group members were separate taxpayers. The calculation of the Company’s income taxes on a separate return basis requires a considerable amount of judgment and use of both estimates and allocations. As a result, actual transactions included in the consolidated financial statements of Parent entities may not be included in the Company’s Condensed Combined Financial Statements. Similarly, the tax treatment of certain items reflected in the Company’s Condensed Combined Financial Statements may not be reflected in the consolidated financial statements and tax returns of Parent entities. Therefore, items such as net operating losses, tax credit carry-forwards and valuation allowances may exist in the Company’s Condensed Combined Financial Statements that may or may not exist in the Parent’s consolidated financial statements. As such, the income taxes of the Company, as presented in the Condensed Combined Financial Statements, may not be indicative of the income taxes that the Company will generate in the future.
The Company and its domestic subsidiaries provide for federal income taxes on pretax accounting income at rates in effect under existing tax law. Foreign subsidiaries record provisions for income taxes at applicable foreign tax rates in a similar manner. Such provisions differ from the amounts currently payable because certain items of income and expense are recognized in different time periods for financial reporting purposes than for income tax purposes. Consistent with the Parent’s assertion, the Company no longer intends to reinvest certain undistributed earnings of its foreign subsidiaries that have been previously taxed in the U.S. As such, the Company recorded the taxes associated with the future remittance of these foreign earnings. For the remainder of the Company’s undistributed foreign earnings, unless tax effective to repatriate, the Company will continue to indefinitely reinvest these earnings. The state income tax provision (benefit) is allocated to contracts when it is paid (recovered) or otherwise agreed as allocable with the U.S. government. A portion of state income taxes are included in Selling, general and administrative expenses, as these costs can generally be recovered through the pricing of services to the U.S. government.
Operations of the Company have historically been included in a consolidated return with other Parent entities. Income taxes payable were deemed settled with the Parent for purposes of the Condensed Combined Financial Statements.
Current and deferred income taxes have been determined based on the stand-alone results of the Company. However, because the Company filed as part of the Parent’s tax groups in certain jurisdictions, the Company’s actual tax balances may differ from those reported. The Company’s portion of its current income taxes are deemed to have been settled in the period the current tax expense was recorded.
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the Condensed Combined Financial Statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Changes in existing tax laws and rates, their related interpretations, and the uncertainty generated by the current economic environment may affect the amounts of deferred tax liabilities or the valuations of deferred tax assets over time. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. In the event that we determine that we would be able to realize our deferred income tax assets in the future
14
in excess of the net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which impacts the provision for income taxes.
In the ordinary course of business, there is inherent uncertainty in quantifying income tax positions. The Company assesses its income tax positions and records tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available. For those tax positions where it is more-likely-than-not that a tax benefit will be sustained, the Company has recorded the amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more-likely-than-not that a tax benefit will be sustained, no tax benefit has been recognized. Where applicable, associated interest expense would be recorded in interest expense. Penalties, if incurred, would be recognized as a component of income tax expense.
The Tax Cuts and Jobs Act subjects the Company to a tax on global intangible low-taxed income ("GILTI"). GILTI is a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations, which the Company has elected to account for as a period cost.
Other Long-Lived Assets
We evaluate the potential impairment of other long-lived assets whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. If the carrying value of other long-lived assets held and used exceeds the sum of the undiscounted expected future cash flows, the carrying value is written down to fair value. In order for long-lived assets to be considered held for disposal, we must have committed to a plan to dispose of the assets. Once deemed held for disposal, the assets are stated at the lower of the carrying amount or fair value less costs to sell. The Company did not have any impairment of long-lived assets for the nine months ended September 31, 2021.
Recent Accounting Pronouncements
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The amendments in this update remove certain exceptions of Topic 740 including: exception to the incremental approach for intra-period tax allocation when there is a loss from continuing operations and income or gain from other items; exception to the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment; exception to the ability not to recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary; exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. There are also additional areas of guidance in regard to: franchise and other taxes partially based on income and the interim recognition of enactment of tax laws and rate changes. We adopted the new standard effective January 1, 2021. The adoption of this standard did not, and is not expected to have an impact on the Company’s Condensed Combined Financial Statements.
In August 2018, the FASB issued ASU 2018-14, Disclosure Framework – Changes to the Disclosure Requirements for Defined Benefit Plans, which amends ASC 715 to add, remove, and clarify disclosure requirements related to defined benefit pension and other postretirement plans. The amendments require additional disclosure for the weighted-average interest crediting rates, a narrative description of the reasons for significant gains and losses, and an explanation of any other significant changes in the benefit obligation or plan assets. The amendment removes disclosure requirement for accumulated other comprehensive income expected to be recognized over the next year, information about plan assets to be returned to the entity, and the effects of a one-percentage-point change on the assumed health care costs and the effect of this change in rates on service cost, interest cost, and the benefit obligation for postretirement health care benefits. The ASU is effective for fiscal years ending after December 15, 2020 for public business entities and for all other entities for fiscal years ending after December 15, 2021. Early adoption is permitted. The ASU does not amend the interim disclosure requirements of ASC 715-20. The Company is currently evaluating the impact that this guidance may have on its annual financial statements and related disclosures in future reporting periods.
Other new pronouncements issued but not effective until after September 30, 2021 did not and are not expected to have a material impact on our financial position, results of operations or liquidity.
15
4. Related Parties
The Condensed Combined Financial Statements have been prepared on a stand-alone basis and are derived from the consolidated financial statements and accounting records of the Parent.
The Parent incurs significant corporate costs for services provided to the Company as well as to other Parent-owned businesses. These services include accounting, legal, information technology, human resources and other infrastructure support. The costs associated with these services generally include all payroll and benefit costs, as well as overhead costs related to the support functions. The cost of these services has been allocated to the Business on a basis that the Company and the Parent consider a reasonable reflection of the benefits received by the Business. All such amounts have been deemed to have been incurred and settled by the Company in the period in which the costs were recorded.
The allocated functional service expenses and general corporate expenses for the nine months ended September 30, 2021 were $60,184, and are included in Cost of services and Selling, general and administrative expenses within the Condensed Combined Statement of Operations. In the opinion of management of the Parent and the Company, the expense and cost allocations have been determined on a basis considered to be a reasonable reflection of the utilization of services provided to or the benefits received by the Company during the nine months ended September 30, 2021. The amounts that would have been, or will be incurred, on a stand-alone basis could differ from the amounts allocated due to economies of scale, differences in management judgment, a requirement for more or fewer employees or other factors. In addition, the future results of operations, financial position and cash flows of the Company could differ materially from that of the historical results presented herein.
| 5. | Inventory, Net |
The following is a summary of inventory as of September 30, 2021:
| September 30, 2021 | ||
| Inventory | ||
| Raw materials | $ | - |
| Work-in-process | 1,314 | |
| Finished goods | - | |
| Inventory, net | $ | 1,314 |
| 6. | Income Taxes |
For the nine months ended September 30, 2021, the Company recognized income tax expense of $22,660, resulting in an effective tax rate of 22.3%. The effective tax rate differed from the U.S. statutory rate primarily due to state income tax expenses, which was partially offset by a benefit for foreign derived intangible income.
| 7. | Pension and Postemployment Benefits |
The Condensed Combined Financial Statements reflect the pension and post-retirement plans of the Company on a multi-employer basis. As a result, the assets and liabilities related to these plans are not reflected in the Condensed Combined Financial Statements.
A majority of the Company’s employees are participants in defined benefit pension plans as well as post-retirement plans administered and sponsored by the Parent. Benefits under the plans are based primarily on years of service and employees’ compensation. Pension entitlements are funded by contributions by the Parent to a separately administered pension fund. The Parent allocates costs associated with the pension plans to the Company primarily based on the annual service cost of the active participants. In certain jurisdictions, statutory regulations require the transfer of certain of the Parent’s plan assets and related pension obligations which are not recorded in the Company’s financial statements to successor employers upon divestiture of the business.
For the nine months ended September 30, 2021, the Company was allocated $22,179 of pension costs under CAS and generated recovery based on these allocated costs under CAS. The CAS allocation of pension costs is included in the allocated functional service expenses and general corporate expenses. Refer to Note 4 for additional information.
16
The Company accounted for its employee pension and post-retirement plans in accordance with Financial Accounting Standards (“FAS”) under U.S. GAAP for the purpose of these Condensed Combined Financial Statements. The Company’s pension adjustment included in the financial statements reflects the difference between CAS pension expense that was historically allocated to the Company and historical FAS pension expense as calculated by the Company.
The Company’s FAS pension and post-retirement expense for the nine months ended September 30, 2021 was $7,359 and is reflected as an expense in the Condensed Combined Statement of Operations. The following table presents the Company’s historical pension expense for the nine months ended September 30, 2021:
| September 30, 2021 | ||
| Allocated CAS pension expense | $ | 22,179 |
| FAS/CAS pension adjustment | (14,820) | |
| FAS pension expense | $ | 7,359 |
The Condensed Combined Balance Sheet as of September 30, 2021 includes $5,042 of projected benefit obligation associated with a pension plan in Germany, of which $4,817 is included in Other long-term liabilities.
| 8. | Revenue from Contracts with Customers |
Disaggregation of Revenue
The Company disaggregates revenue by customer and by contract type. We believe these categories best depict how the nature, amount, timing and uncertainty of the Company’s revenue and cash flows are affected by economic factors.
The Company’s disaggregated revenue by customer for the nine months ended September 30, 2021 is as follows:
| Customer | September 30, 2021 | |
| Government | $ | 557,811 |
| Commercial | 77,961 | |
| Revenues | $ | 635,772 |
The Company’s disaggregated revenue by contract type for the nine months ended September 30, 2021 is as follows:
| Contract Type | September 30, 2021 | |
| Fixed Price | $ | 446,524 |
| Cost Type | 189,248 | |
| Revenues | $ | 635,772 |
Contract Assets and Liabilities
Contract assets reflect revenue recognized and performance obligations satisfied in advance of customer billing. Contract liabilities relate to payments received in advance of the satisfaction of performance under the contract. We receive payments from customers based on the terms established in our contracts.
Total contract assets and contract liabilities as of September 30, 2021 are as follows:
| September 30, 2021 | ||
| Contract assets | $ | 131,625 |
| Contract liabilities | 78,895 | |
| Net contract assets | $ | 52,730 |
For the nine months ended September 30, 2021, the Company recognized revenues of $48,254 related to our Contract liabilities as of January 1, 2021.
17
Contract assets consisted of the following as of September 30, 2021:
| September 30, 2021 | ||
| Unbilled | $ | 131,625 |
| Progress payments | - | |
| Total contract assets | $ | 131,625 |
The U.S. government has title to the assets related to unbilled amounts on U.S. government contracts that provide progress payments.
Contract assets can include retentions arising from contractual provisions. As of September 30, 2021, there were no such retentions.
Backlog
Backlog, which is equivalent to our remaining performance obligations, represents the expected transaction price allocated to our contracts that we expect to recognize as revenue in future periods when the Company performs under the contracts. These remaining obligations exclude unexercised contract options and potential orders under ordering-type contracts such as Indefinite Delivery, Indefinite Quantity contracts.
At September 30, 2021, the Company’s total backlog was $1,029,801, of which approximately 48% is not expected to be realized as sales in the next twelve months.
9. Commitments and Contingencies
Government Oversight
In the ordinary course of business, the Company is subject to regulatory and governmental examinations, information gathering requests, inquiries, investigations and threatened legal actions and proceedings. For example, we are now, and believe that, considering the current U.S. government contracting environment, we will continue to be the subject of one or more U.S. government investigations. Our contracts with the U.S. government are also subject to audits. Agencies that oversee contract performance include: the Defense Contract Audit Agency (“DCAA”), the Defense Contract Management Agency (“DCMA”), the Inspectors General of the U.S. Department of Defense (“DoD”) and other departments and agencies, the Government Accountability Office (“GAO”), the Department of Justice (“DOJ”), and Congressional Committees. Other areas of our business operations may also be subject to audit and investigation by these and other agencies. From time to time, agencies investigate or conduct audits to determine whether our operations are being conducted in accordance with applicable requirements. Such investigations and audits may be initiated due to a number of reasons, including as a result of a whistleblower complaint. Such investigations and audits could result in administrative, civil or criminal liabilities, including repayments, fines, treble or other damages, forfeitures, restitution, or penalties being imposed upon us, the suspension of government export licenses or the suspension or debarment from future U.S. government contracting. U.S. government investigations often take years to complete. The U.S. government also reserves the right to debar a contractor from receiving new government contracts for fraudulent, criminal or other seriously improper conduct. The U.S. government could void any contracts found to be tainted by fraud. Like many defense contractors, we have received audit reports recommending the reduction of certain contract prices because, for example, cost or pricing data or cost accounting practices used to price and negotiate those contracts may not have conformed to government regulations. Some of these audit reports recommend that certain payments be repaid, delayed, or withheld, and may involve substantial amounts. We have made voluntary refunds in those cases we believe appropriate, have settled some allegations and, in some cases, continue to negotiate and/or litigate. The Company may be, and has been, required to make payments into escrow of disputed liabilities while the related litigation is pending. If the litigation is resolved in the Company’s favor, any such payments will be returned to the Company with interest. Our final allowable incurred costs for each year are also subject to audit and have, from time to time, resulted in disputes between us and the U.S. government, with litigation resulting at the Court of Federal Claims (“COFC”) or the Armed Services Board of Contract Appeals (“ASBCA”) or their related courts of appeals. In addition, the DOJ has, from time to time, convened grand juries to investigate possible irregularities by us. We also provide services to customers outside of the U.S., and those sales are subject to local government laws, regulations and procurement policies and practices. Our compliance with such local government regulations or any applicable U.S. government regulations (e.g., the Foreign Corrupt Practices Act
18
(“FCPA”) and International Traffic in Arms Regulations (“ITAR”)) may also be investigated or audited. In addition, we accrue for liabilities associated with those matters that are probable and can be reasonably estimated. The most likely liability amount to be incurred is accrued based upon a range of estimates. Where no amount within a range of estimates is more likely, then we accrue the minimum amount. Other than as specifically disclosed in these Condensed Combined Financial Statements, we do not expect these audits, investigations or disputes to have a material effect on our financial position, results of operations or liquidity, either individually or in the aggregate.
Legal Proceedings
The Company is subject to various litigation matters across jurisdictions. Particularly, CDC, a subcontractor for construction of fencing and surveillance equipment for border security services in Jordan, submitted claims with a total value of $23,200 with respect to work that CDC alleges the Company or the Company’s customer requested CDC perform outside the scope of the Company’s purchase order with CDC, which had a period of performance from October 2015 through October 2018. The Company’s offer to settle and assessment of exposure related to the CDC claims was $888. Management believes that this offer was appropriate for the recognition of program costs in the Company’s Condensed Combined Financial Statements. As part of the transaction closing conditions in connection with RTX’s disposition of the Business on December 6, 2021, the Parent agreed to maintain this legal matter, and Vertex Aerospace LLC agreed to the payment of related settlement, judicial, or arbitration costs up to an amount not to exceed the aforementioned assessed exposure amount. As of the date the Company’s Condensed Combined Financial Statements were available to be issued, discussions between all parties remain ongoing. At this time, the Company is unable to predict the outcome, or the possible range of loss, if any, which could result from the resolution of this matter.
The Company is subject to other legal proceedings, both asserted and unasserted, that arise in the ordinary course of business. The Company cannot predict the ultimate outcome of such legal proceedings or in certain instances provide reasonable ranges of potential losses. However, as of the date of this report, the Company believes that none of these claims will have a material adverse effect on the Company’s financial position or results of operations. In the event of unexpected subsequent developments and given the inherent unpredictability of these matters, there can be no assurance that the Company’s assessment of any claim will reflect the ultimate outcome, and an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company’s financial position or results of operations in the particular period.
10. Subsequent Events
The Company evaluated events and transactions occurring subsequent to September 30, 2021 through September 1, 2022, the date that the Condensed Combined Financial Statements were available to be issued.
The U.S. Army Contracting Command selected Raytheon to train the Afghanistan Air Force in aircraft maintenance and to provide tailored training for the Afghanistan Air Force pilots, including classroom, fixed-wing and rotary aircraft instruction in August 2019, and May 2020, respectively. Four task orders under the aforementioned contracts are performed by the Business and have been included in the historical results of operations, financial position and cash flows of the Company presented in these Condensed Combined Financial Statements.
In August 2021, the United States Armed Forces completed their withdrawal from Afghanistan. As of November 2021, the U.S. Army terminated the four open task orders under the contracts that are performed by the Business to provide Afghan military training. As of September 30, 2021, the full amount of funded backlog was $35,275 related to the four task orders that are served by the Business. In connection with the contract termination, the Company was paid in accordance with the contract’s terms for costs incurred, plus a reasonable profit and settlement expenses.
On September 8, 2021, Vertex Aerospace LLC signed a definitive agreement to acquire Raytheon Technologies Corporation’s Mission Critical Solutions and Training Services Business. On December 6, 2021, Raytheon Technologies Corporation and Vertex Aerospace LLC completed the previously announced transaction.
19
Exhibit 99.5
V2X, Inc.
(giving effect to the merger)
Unaudited Pro Forma Combined Financial Information
As of and for the six months ended July 1, 2022 and the year ended December 31, 2021
Table of Contents
| Page | |
| Financial statements | |
| Pro Forma Combined Balance Sheets as of July 1, 2022 (unaudited) | 2 |
| Pro Forma Combined Statements of Income for the six months ended July 1, 2022 (unaudited) | 3 |
| Pro Forma Combined Statements of Income for the twelve months ended December 31, 2021 (unaudited) | 4 |
Notes to unaudited pro forma combined financial information |
5-16 |
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
The following unaudited pro forma combined financial information is presented to illustrate the estimated effects of the transactions on V2X and Vertex, as further described below, based on the historical financial position and results of operations of V2X, Vertex and the TTS Business. V2X and Vertex fiscal year ends on December 31. However, V2X and Vertex follow different interim period end conventions: V2X's convention is that all quarters other than the 4th quarter end on the Friday closest to the last day of the calendar quarter (July 1, 2022 for the second quarter of 2022). Vertex's convention is that all quarters other than the 4th quarter end on the Sunday closest to the last day of the calendar quarter (July 3, 2022 for the second quarter of 2022). There was no significant activity for Vertex during the two-day period that extended past V2X's second quarter period-end date. As such, management believes the periods are comparable.
The unaudited pro forma combined financial information is presented as follows:
● The unaudited pro forma combined balance sheet as of July 1, 2022 was prepared based on (i) the historical unaudited condensed consolidated balance sheet of V2X as of July 1, 2022 and (ii) the historical unaudited consolidated balance sheet of Vertex as of July 3, 2022.
● The unaudited pro forma combined statement of income for the six months ended July 1, 2022 was prepared based on (i) the historical unaudited condensed consolidated statement of income of V2X for the six months ended July 1, 2022 and (ii) the historical unaudited consolidated statement of income of Vertex for the six months ended July 3, 2022.
● The unaudited pro forma combined statement of income for the twelve months ended December 31, 2021 was prepared based on (i) the historical audited consolidated statement of income of V2X for the fiscal year ended December 31, 2021,(ii) the historical audited consolidated statement of income of Vertex for the fiscal year ended December 31, 2021, (iii) the unaudited statement of income of the TTS Business for the fiscal period from January 1, 2021 to September 30, 2021 and for the stub period from October 1, 2021 to December 6, 2021, the date of Vertex's acquisition of the TTS Business.
The mergers will be treated as a business combination under ASC 805, Business Combinations ("ASC 805"), with V2X as the deemed acquirer and Vertex as the deemed acquiree for accounting purposes. Specifically, the unaudited pro forma combined financial information set forth below primarily gives effect to the transactions, including the following:
● adjustments related to the differences within the accounting policies of Vertex and the TTS Business to those of V2X;
● the consummation of the mergers with the issuance of approximately 18.6 million shares of V2X common stock in exchange for all of the shares of Vertex common stock; and
● the debt financing obtained in connection with the mergers.
The unaudited pro forma combined financial information also reflects pro forma adjustments related to the Vertex acquisition of the TTS Business. These primarily relate to the amortization associated with the preliminary fair value of intangible assets acquired and interest expense related to the first lien facility and the second lien facility entered into by Vertex Borrower on December 6, 2021.
Assumptions underlying the pro forma adjustments are described in the accompanying notes, which should be read in conjunction with the unaudited pro forma combined financial information. The unaudited pro forma combined balance sheet data gives effect to the transactions as if they had occurred on July 1, 2022. The unaudited pro forma combined statement of income data for the six months ended July 1, 2022 and for the twelve months ended December 31, 2021, give effect to the transactions and Vertex's acquisition of the TTS Business as if they had occurred on January 1, 2021.
The unaudited pro forma combined financial information has been presented for informational purposes only and is not necessarily indicative of what the combined company's financial position or results of operations actually would have been had the transactions been completed as of the dates indicated. In addition, the unaudited pro forma combined financial information does not purport to project the future financial position or operating results of the combined company. As a result of displaying amounts in thousands, rounding differences may exist in the tables in this section. The accompanying unaudited pro forma combined statement of income does not include
any pro forma adjustments to reflect certain expected financial benefits of the mergers, such as tax savings, cost synergies or revenue synergies, or the anticipated costs to achieve those benefits, including the cost of integration activities, or restructuring actions which may be achievable.
The unaudited pro forma combined financial information has been prepared using the acquisition method of accounting under existing GAAP standards, which is subject to change. The acquisition accounting is dependent upon certain valuations and other studies that have yet to progress to a stage where there is sufficient information for a definitive measurement. The combined company will complete the valuations and other studies upon completion of the transactions and will finalize the purchase price allocation as soon as practicable within the measurement period, but in no event later than one year following the closing date of the mergers. The assets and liabilities of Vertex and other pro forma adjustments have been measured based on various preliminary estimates using assumptions that Vertex and V2X believe are reasonable, based on information that is currently available. Accordingly, the pro forma adjustments are preliminary. Differences between these preliminary estimates and the final acquisition accounting will occur and could be significant, and these differences could have a material impact on the accompanying unaudited pro forma combined financial information and the combined company's future results of operation and financial position.
The unaudited pro forma combined financial information has been compiled in a manner consistent with the accounting policies adopted by V2X. Upon completion of the mergers, the combined company will perform a detailed review of Vertex's accounting policies. As a result of that review, the combined company may identify additional differences between the accounting policies of the two companies that, when conformed, could have a material impact on the consolidated financial information of the combined company.
This unaudited pro forma combined financial information should be read in conjunction with the accompanying notes, as well as the following historical consolidated financial statements of V2X, Vertex, and the TTS Business.
1
| Pro Forma Combined Balance Sheets | |||||||
As of July 1, 2022 (Unaudited) | |||||||
| As of July 1, 2022 | As of July 3, 2022 | ||||||
| (in thousands) | V2X,
Inc. Historical |
Vertex
Aerospace Services Holding Corp. Historical |
Transaction Accounting Adjustments (Note 5) |
Ref. | Pro forma Combined | ||
| Assets | |||||||
| Current assets | |||||||
| Cash and cash equivalents | $ 31,760 | $ 21,199 | $ 48,545 | A | $ 101,504 | ||
| Restricted cash | 3,311 | - | - | 3,311 | |||
| Receivables | 374,980 | 394,454 | (44,962) | B | 724,472 | ||
| Inventories, net | - | 41,742 | - | 41,742 | |||
| Prepaid expenses | 26,262 | 11,619 | - | 37,881 | |||
| Other current assets | 10,646 | 4,709 | - | 15,355 | |||
| Total current assets | 446,959 | 473,723 | 3,583 | 924,265 | |||
| Property, plant, and equipment, net | 23,530 | 43,107 | 10,393 | C | 77,030 | ||
| Goodwill | 321,734 | 883,675 | 323,205 | D | 1,528,614 | ||
| Intangible assets, net | 62,159 | 220,900 | 301,100 | E | 584,159 | ||
| Right-of-use-assets | 39,705 | 16,141 | - | 55,846 | |||
| Deferred tax assets, net | - | 8,296 | (8,296) | F | - | ||
| Other non-current assets | 11,760 | 5,108 | - | 16,868 | |||
| Total non-current assets | 458,888 | 1,177,227 | 626,402 | 2,262,517 | |||
| Total assets | $ 905,847 | $ 1,650,950 | $ 629,985 | $ 3,186,782 | |||
| Liabilities and Shareholders’ Equity | |||||||
| Current liabilities | |||||||
| Accounts payable | $ 244,080 | $ 124,158 | $ - | $ 368,238 | |||
| Compensation and other employee benefits | 82,534 | 30,710 | - | 113,244 | |||
| Short-term debt | 10,400 | 62,250 | (7,800) | H | 64,850 | ||
| Other accrued liabilities | 48,322 | 121,241 | 5,939 | G | 175,502 | ||
| Total current liabilities | 385,336 | 338,359 | (1,861) | 721,834 | |||
| Long-term debt, net | 78,884 | 1,067,031 | 162,644 | H | 1,308,559 | ||
| Deferred tax liabilities, net | 32,489 | - | 34,590 | I | 67,079 | ||
| Operating lease liability | 30,719 | 10,996 | - | 41,715 | |||
| Other non-current liabilities | 14,941 | 30,301 | 31,000 | J | 76,242 | ||
| Total non-current liabilities | 157,033 | 1,108,328 | 228,234 | 1,493,595 | |||
| Total liabilities | 542,369 | 1,446,687 | 226,373 | 2,215,429 | |||
| Commitments and contingencies | |||||||
| Shareholders’ equity | |||||||
| Preferred stock | - | - | - | - | |||
| Common stock | 118 | 3 | 183 | K | 304 | ||
| Additional paid in capital- common stock | 91,464 | 301,486 | 328,964 | L | 721,914 | ||
| Additional paid in capital- preferred stock | - | 64,000 | (64,000) | M | - | ||
| Retained earnings (accumulated deficit) | 281,081 | (157,301) | 134,540 | N | 258,320 | ||
| Accumulated other comprehensive loss | (9,185) | (3,925) | 3,925 | O | (9,185) | ||
| Total shareholders’ equity | 363,478 | 204,263 | 403,612 | 971,353 | |||
| Total liabilities and shareholders’ equity | $ 905,847 | $ 1,650,950 | $ 629,985 | $ 3,186,782 | |||
| See accompanying notes to unaudited pro forma combined financial information. | |||||||
2
| Pro Forma Combined Statements of Income | |||||||
For the Six Months Ended July 1, 2022 (Unaudited) | |||||||
| For the Six Months Ended July 1, 2022 | For the Six Months Ended July 3, 2022 | ||||||
| (in thousands, except for per share data) | V2X,
Inc. Historical |
Vertex
Aerospace Services Holding Corp. Historical |
Transaction Accounting Adjustments (Note 6) |
Ref. | Pro Forma Combined | ||
| Revenue | $ 954,537 | $ 775,581 | $- | $ 1,730,118 | |||
| Cost of revenue | 872,581 | 671,102 | (5,700) | A | 1,537,983 | ||
| Selling, general, and administrative expenses | 61,699 | 63,320 | 41,067 | B,C,D | 166,086 | ||
| Operating Income (Loss) | 20,257 | 41,159 | (35,367) | 26,049 | |||
| Interest expense, net | (3,643) | (33,852) | (4,924) | F | (42,419) | ||
| Gain on disposal of fixed assets | - | 44 | - | 44 | |||
| Income (loss) from operations before income taxes | 16,614 | 7,351 | (40,291) | (16,326) | |||
| Income tax expense (benefit) | 3,287 | 2,006 | (8,904) | G | (3,611) | ||
| Net Income (Loss) | $ 13,327 | $ 5,345 | $ (31,387) | $ (12,715) | |||
| Earnings per share: | |||||||
| Basic | $ 1.13 | $ (0.41) | |||||
| Diluted | $ 1.12 | $ (0.41) | |||||
| Weighted average shares outstanding: | |||||||
| Basic | 11,793 | 19,245 | H | 31,038 | |||
| Diluted | 11,917 | 19,121 | H | 31,038 | |||
| See accompanying notes to unaudited pro forma combined financial information. | |||||||
3
| Pro Forma Combined Statements of Income | ||||||||||||||
For the Twelve Months Ended December 31, 2021 (Unaudited) | ||||||||||||||
| (in thousands, except for per share data) | V2X, Inc. Historical |
Vertex Aerospace Services Holding Corp. Historical |
TTS Business for the Nine Months Ended September 30, 2021 Historical |
TTS Business for the Period October 1, 2021 to December 6, 2021 Historical |
Pro Forma Adjustments related to the Vertex Acquisition of TTS (Note 7) |
Ref. | Total Vertex Aerospace Services Holding Corp. (Pro Forma) |
Pro Forma Adjustments related to the V2X acquisition of Vertex (Note 6) |
Ref. | Pro Forma Combined | ||||
| Revenue | $ 1,783,665 | $ 813,159 | $ 635,772 | $ 139,232 | $ - | $ 1,588,163 | $- | $ 3,371,828 | ||||||
| Cost of revenue | 1,623,245 | 719,169 | 506,510 | 109,769 | - | 1,335,448 | (8,700) | A | 2,949,993 | |||||
| Selling, general, and administrative expenses | 98,400 | 48,220 | 28,692 | 5,023 | 9,611 | A | 91,546 | 131,106 | B,C,D,E,I | 321,052 | ||||
| Operating Income (Loss) | 62,020 | 45,770 | 100,570 | 24,440 | (9,611) | 161,169 | (122,406) | 100,783 | ||||||
| Interest expense, net | (7,985) | (19,546) | - | - | (44,747) | B | (64,293) | (13,817) | F | (86,095) | ||||
| Loss on disposal of fixed assets | - | (1,303) | - | - | - | (1,303) | - | (1,303) | ||||||
| Loss on extinguishment of debt | - | (7,295) | - | - | - | (7,295) | - | (7,295) | ||||||
| Non-service pension expense | - | - | (4,764) | - | - | (4,764) | - | (4,764) | ||||||
| Other income (expense), net | - | - | 5,615 | (1,162) | - | 4,453 | - | 4,453 | ||||||
| Income (loss) from operations before income taxes | 54,035 | 17,626 | 101,421 | 23,278 | (54,358) | 87,967 | (136,223) | 5,779 | ||||||
| Income tax expense (benefit) | 8,307 | 5,977 | 22,660 | 5,121 | (12,013) | C | 21,745 | (30,105) | G | (53) | ||||
| Net Income (Loss) | $ 45,728 | $ 11,649 | $ 78,761 | $ 18,157 | $ (42,345) | $ 66,222 | $ (106,118) | $ 5,832 | ||||||
| Earnings per share: | ||||||||||||||
| Basic | $ 3.91 | $ 0.19 | ||||||||||||
| Diluted | $ 3.86 | $ 0.19 | ||||||||||||
| Weighted average shares outstanding: | ||||||||||||||
| Basic | 11,705 | 18,848 | H | 30,553 | ||||||||||
| Diluted | 11,836 | 18,982 | H | 30,818 | ||||||||||
| See accompanying notes to unaudited pro forma combined financial information. | ||||||||||||||
4
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
Note 1. Description of the Merger Transactions
On July 5, 2022, V2X, Inc., completed its business combination transaction pursuant to the merger agreement, dated as of March 7, 2022, by and among V2X, Vertex, Merger Sub Inc., and Merger Sub LLC. Pursuant to the terms of the merger agreement, at the first effective time, Merger Sub Inc. will merge with and into Vertex, with Vertex surviving the first merger as a direct, wholly owned subsidiary of V2X and immediately following the first merger, at the second effective time, Vertex will merge with and into Merger Sub LLC, with Merger Sub LLC surviving the second merger as a direct, wholly owned subsidiary of V2X. For financial reporting and accounting purposes, V2X will be the acquirer of Vertex upon completion of the mergers. Refer to Note 3 for additional discussion.
V2X specializes in base operations services, supply chain and logistics, information technology and security whereas Vertex core capabilities include aviation maintenance, systems engineering and integration and training programs for both public and private sector clientele. The combined company will operate as one segment delivering a comprehensive suite of integrated solutions across the operations and logistics, aerospace, training and technology markets to national security, defence, civilian and international clients.
In consideration for the mergers, each share of Vertex common stock that is issued and outstanding immediately prior to the first effective time will be converted into the right to receive several fully paid and nonassessable shares of V2X common stock with such number of shares determined pursuant to the exchange ratio set forth in the merger agreement, subject to any withholding of taxes required by law. See Note 5 for the exchange ratio used in the unaudited pro forma combined financial information.
As a result of the mergers, the holders of equity interests of V2X as of immediately prior to the first effective time will collectively own approximately 37.75% of the outstanding shares of the common stock of the combined company, on a fully diluted basis, and the holders of equity interests of Vertex as of immediately prior to the first effective time will collectively own approximately 62.25% of the outstanding shares of the common stock of the combined company, on a fully diluted basis.
Note 2. Description of the Debt Financing
Incremental Term Loan Commitment
On December 6, 2021, Vertex Borrower entered into (1) the First Lien Facility and (2) the Second Lien Term Loan Facility. In connection with the consummation of the merger agreement on July 5, 2022, Vertex Borrower amended its First Lien Term Loan Facility. Pursuant to the First Lien Term Loan Facility parties lent, severally but not jointly, to Vertex Borrower an aggregate amount up to $260.0 million in the form of the incremental term facility. The proceeds of the incremental term facility were used to fund (1) payments contemplated to be made under the merger agreement, (2) the repayment in full of the indebtedness of V2X under the existing V2X credit agreement, (3) the redemption of certain preferred stock of Vertex, (4) fees and expenses in connection with the foregoing transaction and (5) working capital and general corporate purposes. Vertex Borrower incurred approximately $14.1 million in fees in connection with the incremental term facility.
The incremental term facility represents additional lending to Vertex Borrower by Royal Bank of Canada and RBC Capital Markets, LLC and does not modify any existing debt agreements of Vertex Borrower. The incremental term facility requires quarterly payments equal to 0.25% of the original principal amount of the facility beginning September 30, 2022.
Incremental ABL Commitment
Additionally, in connection with the consummation of the merger agreement on July 5, 2022, Vertex has amended the ABL Credit Agreement, whereby the ABL commitment party has agreed to increase its commitment from $100 million to $200 million. The proceeds of the $200 million ABL facility will be available to fund general corporate purposes, including, without limitation, the transactions. The financing commitments of the ABL commitment party are subject to various customary conditions set forth in the ABL facility. No draws are expected to be made on the ABL facility in connection with the mergers, and Vertex has incurred approximately $1.8 million in fees in connection with the ABL facility.
With the consummation of the merger on July 5, 2022, V2X and its subsidiaries became Loan Parties to the Term Loan and ABL credit facilities.
5
Note 3. Basis of Presentation
The accompanying unaudited pro forma combined financial information is prepared in accordance with Article 11 of SEC Regulation S-X. In May 2020, the SEC adopted Release No. 33-10786 "Amendments to Financial Disclosures about Acquired and Disposed Businesses," or the "Final Rule". The Final Rule became effective on January 1, 2021 and the unaudited pro forma combined financial information is presented in accordance therewith.
The mergers will be treated as a business combination under ASC 805, with V2X as the deemed accounting acquirer and Vertex as the deemed acquiree for accounting purposes. Therefore, the historical basis of V2X's assets and liabilities will not be affected by the mergers. In identifying V2X as the acquiring entity, V2X considered the structure of the mergers, the chief executive officer and chief financial officer's roles and the composition of the combined company's board of directors.
The unaudited pro forma combined financial information was prepared using the acquisition method of accounting in accordance with ASC 805, which requires, among other things, that assets acquired and liabilities assumed in a business combination be generally recognized at their fair values as of the acquisition date.
The acquisition method of accounting uses the fair value concepts defined in ASC 820, “Fair Value Measurement” (“ASC 820”). Fair value is defined in ASC 820 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Market participants are assumed to be buyers or sellers in the most advantageous market for the asset or liability. Fair value measurement for an asset assumes the highest and best use by these market participants.
Fair value measurements can be highly subjective, and it is possible the application of reasonable judgment could develop different assumptions resulting in a range of alternative estimates using the same facts and circumstances.
Fair value estimates were determined based on preliminary discussions between V2X and Vertex management, due diligence efforts and information available in public filings. The allocation of the aggregate merger consideration used in the preliminary unaudited pro forma combined financial information is based on preliminary estimates. The estimates and assumptions are subject to change as of the first effective time. The final determination of the allocation of the aggregate merger consideration will be based on the actual tangible and intangible assets and the liabilities of Vertex at the first effective time. Refer to Note 5 for additional information.
The initial allocation of the consideration in these unaudited pro forma combined financial statements is based upon a consideration of approximately $634.0 million, inclusive of approximately $630.6 million related to equity-based awards to be issued. This amount is based on the common shares that V2X issued to holders of Vertex common stock in connection with the mergers, the number of shares of Vertex common stock outstanding as of March 7, 2022, and the V2X exchange ratio of 67.8668567 provided in the merger agreement, less shares reserved to be issued as replacement and cash settled awards. The consideration has been prepared, based on the share price of V2X common stock on July 1, 2022, equal to $33.92 per share. V2X issued 18,591,868 shares of its common stock to holders of Vertex common stock based on the number of shares of Vertex common stock outstanding as of March 7, 2022, less shares reserved to be issued as replacement and cash settled awards.
The unaudited pro forma combined balance sheet data gives effect to the transactions as if they had occurred on July 1, 2022. The unaudited pro forma combined statement of income data for the six months ended July 1, 2022, and for the twelve months ended December 31, 2021, gives effect to the transactions and Vertex's acquisition of the TTS Business as if they had occurred on January 1, 2021.
The unaudited pro forma combined financial information is provided for informational purpose only and is not necessarily indicative of what the combined company’s financial position and results of operations would have actually been had the merger been completed on the dates used to prepare the unaudited pro forma combined financial information. The adjustments to fair value and the other estimates reflected in the accompanying unaudited pro forma combined financial information may be materially different from those reflected in the combined company’s consolidated financial information subsequent to the mergers. In addition, the unaudited pro forma combined financial information does not purport to project the future financial position or results of operations of the combined companies. Additional reclassifications and adjustments may be required if changes to Vertex’s financial presentation are needed to conform Vertex’s accounting policies to the accounting policies of V2X. The unaudited pro forma combined financial information does not give effect to any anticipated synergies, operating efficiencies or cost savings that may be associated with the mergers. The unaudited pro forma combined financial information also does not include any integration costs the combined company may incur related to the merger as part of combining the operations of the companies.
6
Note 4. Accounting Policies
The accounting policies used in the preparation of the unaudited pro forma combined financial information are those described in V2X's audited consolidated financial statements as of and for the year ended December 31, 2021, and subsequent interim periods. V2X performed a preliminary review of Vertex's accounting policies to determine whether any adjustments were necessary to ensure comparability in the unaudited pro forma combined financial information.
V2X identified differences in Vertex’s application of Accounting Standards Codification Topic 606, Revenue (“ASC 606”), when compared to its own ASC 606 accounting policies. V2X identified a difference in the manner which Vertex measured contract losses and determined performance obligations within certain types of contracts under ASC 606, as discussed below. Certain amounts have been adjusted in the unaudited pro forma combined financial information to reflect Vertex’s provision of contract losses and identified performance obligations using V2X’s ASC 606 accounting policy. At this time, V2X is not aware of any other differences that would have a material effect on the unaudited pro forma combined financial information, including any differences in the timing of adoption of new accounting standards. However, V2X will continue to perform its detailed review of Vertex's accounting policies. Upon completion of that review, differences may be identified between the accounting policies of the two companies that, when conformed, could have a material impact on the unaudited pro forma combined financial information.
V2X and Vertex both apply ASC 606 for revenue recognition purposes. Vertex, however, does not account for the provision of contract losses in the same manner as V2X, which calculates the provision of contract losses using a broader scope of indirect costs allocable under government contract regulations as compared to Vertex’s estimate of provision for contract losses which excluded certain indirect costs in its measurement. This alignment using V2X’s indirect cost methodology results in an increase in the provision for loss contracts that is included within purchase accounting and the unaudited pro forma combined balance sheet as of July 1, 2022. Refer to Notes 5 and 6(A), respectively.
In certain large, complex, government contracts, Vertex identified multiple performance obligations (at the contract line item level), while V2X identified a single performance obligation for similar contracts. Under V2X’s view, the customer is contracting with the Company for a single service solution, whereby each contract line item is highly interrelated with the other promises in the contract and therefore are not distinct in the context of the contract under ASC 606. As a result, the contract is accounted for as one performance obligation under V2X’s application of its ASC 606 accounting policy as compared to multiple performance obligations previously determined by Vertex (identified at the contract line item level). The application of the performance obligation criteria is highly judgmental for these types of contracts and both V2X and Vertex have designed revenue recognition policies to arrive at a reasonable conclusion. As a result of this alignment of the performance obligation identification policy, the nature of the promise in a single large contract changed from arranging for other parties to provide a service to the customer, to providing an integrated service to the customer itself resulting in the presentation of revenue on a gross basis. The impact to the unaudited pro forma combined statements of income, to align the presentation of historical revenue with V2X’s ASC 606 accounting policy, would result in an increase to revenue with a corresponding increase to cost of revenue, resulting in an immaterial impact to operating income for the six months ended July 1, 2022, and the twelve months ended December 31, 2021. This also led to a reduction in the historic unbilled contract receivable and an increase to billings in excess of revenue, which are reflected in purchase accounting in Note 5 herein.
V2X adopted ASC 842 on January 1, 2019, whereas Vertex, as a private company, adopted ASC 842 on January 1, 2022. Based on a preliminary assessment, the primary impact of adopting the new standard for Vertex, relates to the recognition of operating lease right-of-use assets and operating lease liabilities. V2X did not identify any material impacts to the unaudited pro forma combined statement of operations for the twelve months ended December 31, 2021 and the six months ended July 1, 2022, contemplating Vertex's adoption of ASC 842 as of January 1, 2021. The acquired leases are included within the consideration allocation, as further described in Note 5 herein.
Note 5. Unaudited Pro Forma Combined Balance Sheet Adjustments
The following provides explanations of the various adjustments to the unaudited pro forma combined balance sheet.
As further described in Note 1, each share of Vertex common stock issued and outstanding immediately prior to the first effective time will be converted into 67.8668567 newly issued shares of V2X common stock. Below is a
7
preliminary estimate of the purchase consideration to V2X shareholders and the allocation of the purchase price to acquired identifiable assets and assumed liabilities.
| (in thousands) | |
| Consideration transferred (see table below) | $ 633,951 |
| Purchase price is allocated as follows: | |
| Total current assets (1) | 428,761 |
| Property, plant, and equipment (2) | 53,500 |
| Right of use assets | 16,141 |
| Other assets | 13,404 |
| Intangible assets | 522,000 |
| Total assets acquired | 1,033,806 |
| Other current liabilities (3) (4) | 350,623 |
| Deferred tax liabilities, net (5) | 49,343 |
| Long-term debt, net of current maturities | 1,067,031 |
| Other liabilities (3) | 72,297 |
| Total liabilities assumed | 1,539,294 |
| Preferred stock (6) | (67,441) |
| Goodwill | 1,206,880 |
| Total net assets to be acquired | $ 633,951 |
| (1) | Includes a reduction of $45.0 million in unbilled contract receivables as discussed in Note 4. |
| (2) | Includes an increase in the fair value per the valuation report of $10.4 million. Refer to Note 5(C). |
| (3) | Includes an increase in the provision for loss contracts to reflect a normalized profit and the impact of the change in the composition of expenses used to measure loss contracts as discussed in Note 4. Impact to other current liabilities is $5.5 million, impact to Other liabilities is $31.0 million as described in Notes 5(G) and 5(J). |
| (4) | Includes an increase of $6.8 million in billings in excess of earnings as discussed in Note 4. |
| (5) | Includes an increase in deferred tax liabilities of $68.8 million related to the acquired intangibles and increase in fair value of property plant and equipment, offset against the tax impact of the increase in the provision for loss contracts and a decrease in unbilled contract receivables of $19.5 million. Refer to Note 5(I). |
| (6) | Preferred stock was redeemed by V2X upon the closing of the transaction. |
| Consideration | |
| The consideration is calculated as follows: | |
| Number of Vertex ordinary shares outstanding as of March 7, 2022 | 273,950 |
| Option dilution as of March 7, 2022 | 20,886 |
| Total shares of Vertex common stock outstanding as of closing of the merger | 294,836 |
| V2X exchange ratio per merger agreement | 67.8668567 |
| V2X maximum common shares to be issued in the exchange (1) (2) | 20,009,574 |
| Less: Replacement and cash settlement awards issued to Vertex employees | 1,417,706 |
| Remaining V2X common shares to be issued in the exchange | 18,591,868 |
| V2X closing share price as of July 1, 2022 | $ 33.92 |
| Fair value of common shares to be issued | 630,636 |
| Fair value of cash consideration (1) (3) (4) | 3,315 |
| Total consideration transferred | $ 633,951 |
8
(1) Due to rounding amounts may not calculate to exact numbers.
(2) Collectively former Vertex equity holders will own approximately 62.25% of the outstanding shares of the combined company common stock, on a fully diluted basis
(3) Refer to Note 6(D) for additional details.
(4) Calculated as the cash-settled shares (71,617) multiplied by V2X's closing share price on March 4, 2022 of $46.29. The March 4,2022 date is agreed among the parties and represents V2X's share price closest to the announcement date of the merger.
V2X's share price was used because, as a privately held company, Vertex does not have a readily observable market price at the time of this filing.
(A) Cash and Cash Equivalents
Cash and cash equivalents have been adjusted for the following:
| (in thousands) | Amount |
| Proceeds from new term loan financing (net of fees paid) | $ 245,878 |
| Fee associated with the ABL facility (See Note 2) | (1,750) |
| Payoff of V2X historical debt | (90,304) |
| Redemption of Preferred Stock | (67,441) |
| Cash settlement of certain Vertex stock options included within cash consideration | (3,315) |
| Excess savings plan payment | (172) |
| Cash paid for V2X and Vertex combined transaction costs | (34,351) |
| Total Pro Forma adjustment | $ 48,545 |
Total pro forma adjustment represents the proceeds from the issuance of the First Lien Term Loan Facility after the extinguishment of the legacy V2X outstanding debt, fees associated with the ABL facility, the redemption of Vertex preferred stock and cash consideration for settlement of stock options to certain former members of Vertex management. Refer to Note 2 for further details. The excess savings plan payment represents amounts distributed to specific V2X employees due to change in control provisions upon consummation of the mergers. Finally, it is reflective of the payment of transaction costs paid at closing.
(B) Receivables
Represents a reduction to the fair value of unbilled contract receivables as part of purchase accounting. Refer to Note 4 for additional details.
(C) Property, plant and equipment
Represents adjustments to record the preliminary estimated fair value of Property, plant and equipment of approximately $53.5 million, which is an increase of $10.4 million over Vertex’s book value of Property, plant and equipment prior to the mergers. The general categories of the acquired Property, plant and equipment are expected to be the following:
| (in thousands) | Estimated
Useful Life |
Preliminary
Fair Value | |
| Land | Indefinite | $ 3,600 | |
| Land improvements | 2.0 years | 200 | |
| Leasehold Improvements | 4.8 years | 16,100 | |
| Computer hardware and software | 3.1 years | 12,000 | |
| Furniture and fixtures | 2.6 years | 800 | |
| Office equipment | 5.5 years | 600 | |
| Machinery and equipment | 5.6 years | 14,600 | |
| Vehicles | 4.2 years | 1,900 | |
| Total fair value of Vertex’s tangible assets | 49,800 | ||
| Construction in progress and other assets | 3,700 | ||
| Less: Vertex historical tangible assets | 43,107 | ||
| Pro forma adjustment | $ 10,393 |
9
The fair value estimate for property, plant and equipment is preliminary and is based on assumptions that market participants would use in pricing an asset, based on the most advantageous market for the asset (i.e., its highest and best use). This preliminary fair value estimate could include assets that are not intended to be used, may be sold, or are intended to be used in a manner other than their best use. The final determination of fair value of property, plant and equipment, as well as estimated useful lives, remains subject to change. The finalization may have a material impact on the valuation of property, plant and equipment and the purchase price allocation, which is expected to be finalized subsequent to the mergers.
(D) Goodwill
Represents the excess of the purchase price over the preliminary fair value of the underlying net tangible and identifiable intangible assets net of liabilities and is estimated to be $1,206.9 million, which is an increase of $323.2 million over Vertex's book value of goodwill prior to the mergers. The estimated goodwill to be recognized is attributable to operational and general and administrative cost synergies, expanded market opportunities and other benefits that V2X believes will result from combining its operations with the operations of Vertex.
(E) Other Intangible Assets
Represents adjustments to record the preliminary estimated fair value of intangibles of approximately $522.0 million, which is an increase of $301.1 million over Vertex's book value of other intangible assets prior to the mergers. The general categories of the acquired identified intangible assets are expected to be the following:
| (in thousands) | Estimated
Useful Life |
Preliminary
Fair Value | |
| Customer related intangible | 14.0 years | $ 158,000 | |
| Backlog | 4.5 years | 364,000 | |
| Total fair value of Vertex’s intangible assets (other than Goodwill) | 522,000 | ||
| Less: Vertex historical intangible assets | 220,900 | ||
| Pro forma adjustment | $ 301,100 |
The fair value estimate for all identifiable intangible assets is preliminary and is based on assumptions that market participants would use in pricing an asset, based on the most advantageous market for the asset (i.e., its highest and best use). This preliminary fair value estimate could include assets that are not intended to be used, may be sold, or are intended to be used in a manner other than their best use. The final determination of fair value of intangible assets, as well as estimated useful lives, remains subject to change. The finalization may have a material impact on the valuation of intangible assets and the purchase price allocation, which is expected to be finalized subsequent to the mergers.
(F) Deferred Tax Assets, net
Represents the reversal of the historical Vertex deferred tax asset, which is presented net of the deferred tax liability of the combined company noted below in Note 5(I).
10
(G) Other Accrued Liabilities
Other accrued liabilities have been adjusted for the following:
| (in thousands) | Amount |
| Excess savings plan payment (Note 5(A)) | $ (172) |
| Cash paid for V2X and Vertex combined transaction costs (Note 5 (A)) | (34,351) |
| Incremental transaction related costs | 28,198 |
| Increase to billings in excess of revenue as described in Note 5 (purchase accounting) and Note 4 | 6,764 |
| Increase to fair value of provision for loss contracts as described in Note 5 (purchase accounting) and Note 4 | 5,500 |
| Pro forma adjustment | $ 5,939 |
(H) Debt Financing
Short-term and long-term debt have been adjusted for the following:
| (in thousands) | Short-term debt | Long-term debt | Total | ||
| Proceeds from new term loan financing, net (1) | $ 2,600 | $ 243,278 | $ 245,878 | ||
| Payoff of V2X historical debt (2) | (10,400) | (79,904) | (90,304) | ||
| New deferred debt issuance costs for ABL facility and other debt (3) | - | (1,750) | (1,750) | ||
| Write-off of V2X historical debt issuance costs (4) | - | 1,020 | 1,020 | ||
| Pro Forma adjustment | $ (7,800) | $ 162,644 | $ 154,844 |
| (1) | Represents the incremental term facility, net of debt issuance costs entered into in connection with the execution of the merger agreement. Refer to Note 2. For illustrative purposes of presenting the unaudited pro forma combined financial information, debt issuance costs have not been bifurcated between Long-term debt and Short-term debt. Instead, debt issuance costs have been included within Long-term debt. |
| (2) | Represents the elimination of V2X outstanding debt. |
| (3) | Represents additional debt issuance costs incurred for the amended ABL facility. |
| (4) | Represents the write-off of remaining deferred debt issuance costs associated with the extinguished V2X debt outstanding. |
(I) Deferred Tax Liabilities, net
Represents the preliminary adjustment to deferred tax liabilities based on a statutory rate of 22.1%. The pro forma adjustment is comprised of a $68.8 million increase associated with the fair value adjustment for property, plant and equipment and intangible assets excluding goodwill, offset by: (i) the historical Vertex deferred tax asset of $8.3 million, (ii) $6.2 million associated with the estimated transaction costs, (iii) $19.5 million related to the fair value increase in the provision for loss contracts and the decrease in unbilled contract receivables and billings in excess of revenue in purchase accounting, and (iv), $0.2 million related to the write-off of deferred financing costs, resulting in a net pro forma adjustment of $34.6 million.
(J) Other non-current liabilities
Represents an increase of $31.0 million to long-term provision for loss contracts for fair value determined in purchase accounting. Refer to Notes 4 and 5 for additional information.
(K) Common Stock
Common stock has been adjusted for the following:
| (in thousands) | Amount |
| Elimination of historical Vertex common stock | $ (3) |
| Adjustment for par value of consideration transferred | 186 |
| Total Pro Forma adjustment | $ 183 |
11
(L) Additional Paid in Capital- Common Stock
Additional paid in capital-common stock has been adjusted for the following:
| (in thousands) | Amount |
| Elimination of historical Vertex additional paid in capital | $ (301,486) |
| Adjustment for consideration transferred (less common stock) | 630,450 |
| Total Pro Forma adjustment | $ 328,964 |
(M) Additional Paid in Capital - Preferred Stock
Represents the redemption of the preferred stock of Vertex from the proceeds of the Incremental Term Facility (See Note 2). The preferred stock is redeemed at its carrying value which is equal to the original investment plus paid in kind dividends of 8% per year. The historical book value of the preferred stock of $64.0 million along with the dividend of $3.4 million was redeemed in cash as described in Note 5(A).
The par value of the preferred stock is $64.41 (equal to a per share par value of $0.001 with 64,407 shares issued).
(N) Retained Earnings
Retained earnings has been adjusted for the following:
| (in thousands) | Amount |
| Elimination of historical Vertex accumulated deficit | $ 157,301 |
| Estimated transaction costs | (21,966) |
| Write-off of V2X historical deferred financing costs | (795) |
| Pro Forma adjustment | $ 134,540 |
Amounts are presented net of tax, using a statutory tax rate of 22.1%
(O) Accumulated Other Comprehensive Loss
Represents the elimination of historical Vertex accumulated other comprehensive loss.
Note 6. Unaudited Pro Forma Combined Income Statement Adjustments
The following provides explanations of the various adjustments to the unaudited pro forma combined statement of income.
(A) Cost of Revenue
Represents the policy as described in Note 4 and the amortization of the increased value of the provision for loss contracts as described below:
| (in thousands) | For the six months ended July 1, 2022 |
For the twelve months ended December 31, 2021 |
| Amortization of fair value of provision for loss contracts | $(7,000) | $(14,400) |
| Reversal of historical amortization | 1,300 | 5,700 |
| Pro forma adjustment | $ (5,700) | $ (8,700) |
12
(B) Depreciation Expense
Represents an adjustment for the removal of historical depreciation expense offset by new depreciation expense, on a straight-line basis based on the preliminary fair value of the Property, plant and Equipment and the respective assigned estimated useful life for the six months ended July 1, 2022 and twelve months ended December 31, 2021.
| (in thousands) | Estimated Useful Life |
Preliminary Fair Value |
For the six months ended July 1, 2022 |
For the twelve months ended December 31, 2021 |
| Land | Indefinite | $3,600 | $- | $- |
| Land improvements | 2.0 years | 200 | 50 | 100 |
| Leasehold Improvements | 4.8 years | 16,100 | 1,677 | 3,354 |
| Computer hardware and software | 3.1 years | 12,000 | 1,935 | 3,871 |
| Furnitures and fixtures | 2.6 years | 800 | 154 | 308 |
| Office equipment | 5.5 years | 600 | 55 | 109 |
| Machinery and equipment | 5.6 years | 14,600 | 1,304 | 2,607 |
| Vehicles | 4.2 years | 1,900 | 226 | 452 |
| Total fair value of Vertex’s tangible assets | $49,800 | 5,401 | 10,801 | |
| Less: Historical Vertex depreciation | 5,175 | 8,626 | ||
| Pro forma adjustment | $226 | $2,175 |
(C) Amortization Expense
Represents an adjustment for the removal of historical amortization expense offset by new amortization expense, on a straight-line basis based on the preliminary fair value of the definite-lived intangible assets and the respective assigned estimated useful life for the six months ended July 1,2022 and twelve months ended December 31, 2021.
| (in thousands) | Estimated Useful Life |
Preliminary Fair Value |
For the six months ended July 1, 2022 |
For the twelve months ended December 31, 2021 |
| Customer related intangible | 14.0 years | $ 158,000 | $ 5,643 | $ 11,286 |
| Backlog | 4.5 years | 364,000 | 40,444 | 80,889 |
| Total fair value of Vertex’s intangible assets (other than Goodwill) | $ 522,000 | |||
| Less: Historical Vertex and TTS amortization | 12,269 | 24,056 | ||
| Pro forma adjustment | $ 33,818 | $ 68,119 |
(D) Stock-Based Compensation
Represents the incremental differences in stock-based compensation for replaced equity awards. Subject to the terms of the merger agreement, unvested Vertex service-based option awards will be replaced and converted into V2X time vested restricted stock unit awards, which vest primarily over a two-year period (see below for further details). In connection with the mergers, awards to certain former members of Vertex management will be settled in cash by V2X or one of its subsidiaries. The $3.3 million in estimated cash settlement awards are reflected as cash consideration of the mergers.
The fair value estimates are based upon the stock price of V2X common stock of $33.92 per share as of July 1, 2022.
Stock-based compensation expense for the six months ended July 1, 2022 and the twelve months ended December 31, 2021 is recognized based on the service period of the awards (in thousands except shares):
13
| Service Period | Awards | Preliminary Fair Value |
For the six months ended July 1, 2022 |
For the twelve months ended December 31, 2021 |
| None – Cash Settled Former Employee Awards | 71,617 | $ 3,315 (1) | NA | NA |
| Restricted stock units | ||||
| 6 months | 517,918 | $ 17,568 | - | $ 17,568 |
| 24 months | 828,171 | $ 28,092 | $ 7,023 | $ 14,046 |
| Total RSUs | 1,346,089 | $ 45,660 | $ 7,023 | $ 31,614 |
| Pro forma adjustment | $ 7,023 | $ 31,614 |
(1) Reflected as cash consideration in purchase price (rounded). Refer to Note 5.
(E) Transaction-Related Costs
Represents one-time transaction-related costs of $28.2 million for the twelve-month period ended December 31, 2021, anticipated to be incurred prior to, or concurrent with, the closing of the mergers including bank fees, legal fees, consulting fees, and other transaction expenses. This adjustment is in addition to the $14.0 million and $5.8 million included within the historical unaudited consolidated statements of income for V2X and Vertex, respectively, as of the six-month periods ended July 1, 2022.
(F) Interest Expense
Represents an increase to interest expense of $4.9 million and $13.8 million for the six months ended July 1, 2022 and the twelve months ended December 31, 2021, which includes the following:
| (in thousands) | For the six months ended July 1, 2022 |
For the twelve months ended December 31, 2021 | |
| Incremental term facility (1) | $ 8,397 | $ 16,286 | |
| Amortization of deferred issuance fees on ABL facility (2) | 220 | 439 | |
| Elimination of V2X historical expense (3) | (3,693) | (3,928) | |
| Write-off of V2X historical debt issuance costs (4) | - | 1,020 | |
| Pro forma adjustment | $ 4,924 | $ 13,817 |
| (1) | Represents the estimated interest expense on the incremental term facility. The loan is a variable rate and an increase of 1/8th percent in the interest rate results in an increase in interest expense of $0.2 million and $0.1 million during the twelve months ending December 31, 2021, and the six months ending July 1, 2022, respectively. A decrease in the rate by 1/8th percent results in a decrease in interest expense of $0.4 million and $0.2 million during the twelve months ending December 31, 2021, and the six months ending July 1, 2022, respectively. |
| (2) | Represents the amortization of deferred issuance on the amended ABL facility. |
| (3) | Represents the elimination of interest expense associated with the extinguished V2X debt outstanding, excluding revolver interest expense. |
| (4) | Represents the write-off of remaining deferred debt issuance costs associated with the extinguished V2X debt outstanding. |
(G) Provision for Income Taxes
Represents the income tax effect of the transaction accounting adjustments related to the mergers calculated using a statutory income tax rate of 22.1%. The effective tax rate of the combined company could be significantly different from what is presented in these unaudited pro forma combined financial information for a variety of reasons, including post-mergers activities. Adjustments to established deferred tax assets and liabilities as well as the recognition of additional deferred tax assets and liabilities upon detailed analysis of the acquired assets and assumed liabilities may occur in conjunction with the finalization of the purchase accounting, and these items could be material.
14
The combined company's ability to use net operating loss carry forwards to offset future taxable income for U.S. federal income tax purposes will be subject to limitations. In general, under Section 382 of the Code, a corporation that undergoes an "ownership change" is subject to limitations on its ability to utilize its pre-change net operating losses to offset future taxable income. In general, an ownership change occurs if the aggregate share ownership of certain shareholders (generally 5% shareholders, applying certain look-through rules) increases by more than 50 percentage points over such shareholder's lowest percentage ownership during the testing period (generally three years). In addition, the combination of two companies may also cause certain valuation allowances associated with one of the companies to no longer be necessary because on a combined basis, there may be new sources of future taxable income to support the reversal of pre-existing valuation allowances.
Generally, taxpayers can deduct interest expense paid or accrued in the taxable year. However, if section 163(j) applies, the amount of deductible business interest expense in a taxable year cannot exceed the sum of: the taxpayer's business interest income for the year; 30% of the taxpayer's adjusted taxable income (ATI) for the year; and the taxpayer's floor plan financing interest expense for the year.
V2X has generated substantial FDII benefits since the enactment of TCJA. However, Vertex has a history of tax losses where FDII benefit could not be realized. The combined company is expected to generate taxable income and related FDII benefits. V2X will undertake a process to determine what this benefit may be.
Currently, no adjustments to the unaudited pro forma combined financial statement of operations have been made as it relates to: (i) limitations the combined company might incur under Section 382 of the Code or ASC 740, (ii) interest deduction limitations under IRC 163(j) or (iii) impacts of foreign-derived intangible income (FDII).
(H) Earnings Per Share
Represents an adjustment to the basic and diluted weighted average common shares outstanding to reflect the anticipated issuance of 18,591,868 shares of V2X common stock to Vertex stockholders in consideration for the mergers (see Note 5); and effect of RSU replacement awards issued to former Vertex employees (see Note 6(D)).
(I) Retention payments
Represents $1.0 million in retention payments to V2X and Vertex employees to remain with the combined entity following the mergers. These payments relate to post-combination services and are clawed back if the employee exits before the specified term.
Note 7. Unaudited Pro forma Adjustments Related to the Vertex Acquisition of TTS Business
This note should be read in conjunction with other notes in the unaudited pro forma combined financial information. Adjustments included in the column under the heading "Pro forma adjustments related to the Vertex acquisition of TTS" represent the following:
(A) Selling, General and Administrative Expenses
Represents an adjustment of $9.6 million for the new amortization expense, on a straight-line basis based on the preliminary fair value of the definite-lived intangible assets of the TTS Business acquired and the respective assigned estimated useful life for the twelve months ended December 31, 2021.
(B) Interest Expense, Net
Represents an increase to interest expense of $44.7 million for the twelve months ended December 31, 2021, related to the first lien facility and the second lien facility entered into by Vertex on December 6, 2021. Refer to Note 4 for additional information. The adjustment includes the following:
| (in thousands) | For the twelve months ended December 31, 2021 |
| First lien facility | $ 43,938 |
| Second lien facility | 15,262 |
| Amortization of deferred issuance fees | 5,093 |
| Elimination of Vertex historical expense | (19,546) |
| Pro forma adjustment | $ 44,747 |
15
(C) Provision for Income Taxes
Represents the income tax effect of the pro forma adjustments calculated using a statutory income tax rate of 22.1%.
16