Exhibit 99.3
STUDENT TRANSPORTATION INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of the Financial Condition and Results of Operations of Student Transportation Inc., is supplemental to, and should be read in conjunction with, the financial statements and footnotes for the period ended June 30, 2016. These financial statements can be found on SEDAR atwww.sedar.com. As an SEC issuer (as defined under applicable Canadian securities laws), Student Transportation Inc.’s financial statements are prepared in accordance with United States generally accepted accounting principles (“US GAAP”). The information in this Management’s Discussion and Analysis of the Financial Condition and Results of Operations is effective September 14, 2016. Additional information about, and the Annual Information Form filed by, Student Transportation Inc., is also available on SEDAR atwww.sedar.com.
All references to “$” or “US$” are to U.S. dollars and all references to “Cdn $” are to Canadian dollars. All references to the Company are to either Student Transportation Inc. or to STI and its subsidiaries, as the context requires. Unless the context requires otherwise, references to years are to the Company’s fiscal year ended June 30.
Forward-Looking Statements
Certain statements in this Management’s Discussion and Analysis (“MD&A”), including without limitation in the sections of this MD&A entitled “Results of Operations”, “Liquidity and Capital Resources” and “Subsequent Events” are “forward-looking statements” within the meaning of applicable securities laws, which reflect the expectations of management regarding the Company’s revenues, expense levels, seasonality, liquidity, profitability of new business acquired or secured through bids, borrowing availability, ability to renew or refinance various loan facilities as they become due, ability to execute the Company’s growth strategy and cash distributions, as well as their future growth, results of operations, performance and business prospects and opportunities. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may”, “will”, “expect”, “intend”, “estimate”, “anticipate”, “believe”, “should”, “plans” or “continue” or similar expressions, and negative forms thereof, suggesting future outcomes or events.
These forward-looking statements reflect the Company’s current expectations regarding future events and operating performance and speak only as of the date of this Management Discussion and Analysis. Actual results may vary from the forward-looking statements. Specifically, forward-looking statements involve significant risks and uncertainties, should not be read as guarantees of future performance or results, and will not necessarily be accurate indications of whether or not or the times at or by which such performance or results will be achieved. A number of factors could cause actual results to differ materially from the results discussed in theforward-looking statements, including, but not limited to, the factors referred to and incorporated by reference under the heading “Risk Factors” such as an inability to control the Company’s operating expenses, significant capital expenditures, the Company’s ability to retain or renew its customer contracts, find suitable business for acquisition and identify conversion opportunities and win bid contracts on profitable terms, the Company’s consolidated indebtedness and restrictive covenants related thereto, the Company’s ability to make payments on its convertible debentures, the Company’s acquisition strategy, increased industry competition and consolidation, reliance on certain key personnel, the possibility that a
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greater number of employees will join unions, rising insurance costs, a lack of insurance coverage for certain losses, new governmental laws and regulations, environmental requirements, seasonality of the industry in which the Company operates, any inability to maintain letters of credit and performance bonds, the termination of certain of the Company’s contracts for reasons beyond management’s control, uncertain risks associated with the Company’s oil and gas operations, the Company’s status as a public company, foreign private issuer and emerging growth company status for U.S. federal securities law purposes, reduced spending by school districts and governmental agencies, terrorism attacks, man-made or natural disasters, cyber terrorism and data security breeches and risks related to the Company’s capital structure. Material factors and assumptions that were relied upon in making the forward-looking statements include contract and customer retention, current and future expense levels, availability of quality acquisition, bid and conversion opportunities, current borrowing availability and financial ratios, as well as current and historical results of operations and performance. Although the forward-looking statements contained in this Management Discussion and Analysis are based upon what the Company believes to be reasonable assumptions, investors cannot be assured that actual results will be consistent with these forward-looking statements, and the differences may be material. These forward-looking statements are made as of the date of this Management Discussion and Analysis and the Company assumes no obligation to update or revise them to reflect new events or circumstances, except as specifically required by applicable law.
General
Student Transportation Inc. (“STI” or the “Company”) is a corporation established under the laws of the Province of Ontario. STI, together with its indirect subsidiary Student Transportation of America ULC (“STA ULC” and together with STI, the “Issuer”), initially issued income participating securities (“IPSs”) pursuant to the Issuer’s initial public offering in December 2004 (the “IPS Offering”). Each IPS consisted of one common share of STI and Cdn $3.847 principal amount of 14% subordinated notes of STA ULC. On December 21, 2009, the Company redeemed the remaining 14% subordinated notes, originally issued as a component of the IPSs, as the final step in the process of converting from the IPS structure to a traditional common share structure.
STI owns 100% of the Class A common shares of Student Transportation of America Holdings, Inc. (“STA Holdings”). Management owns 100% of the Class B Series Three common shares (collectively the “Class B common shares”) of STA Holdings pursuant to the grant of shares under the STA Holdings Equity Incentive Plan. Following the redemption of the Subordinated Notes, STA ULC has been inactive. STI currently holds a 97.5% interest in STA Holdings as at June 30, 2016, through its ownership of the Class A shares of STA Holdings. The Company also owns 100% of the outstanding shares of Parkview Transit Inc. (“Parkview Transit”). STA Holdings, through its wholly owned subsidiary, Student Transportation of America, Inc. (“STA, Inc.”), combined with Parkview Transit, is the third largest provider of school bus transportation services in North America.
On July 13, 2011, the Company filed a Form 40-F registration statement with the United States Securities and Exchange Commission (the “SEC”) and a listing application with the NASDAQ-OMX, both in connection with the Company’s initial US listing of its common stock on the NASDAQ Global Select Market.
On September 1, 2011 the NASDAQ-OMX formally approved the Company’s listing application, and on September 2, 2011, the SEC formally declared effective the Company’s Form 40-F registration statement. As such, the Company became a “foreign private issuer” under applicable U.S. federal securities laws. On September 6, 2011, the Company’s common shares commenced trading on the NASDAQ Global Select Market under the trading symbol STB. The Company’s common stock and convertible debentures continue to be listed on the Toronto Stock Exchange.
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Convertible Debentures
On June 21, 2010, STI closed its offering of Cdn$ 6.75% convertible subordinated unsecured debentures (the “Cdn$ 6.75% Convertible Debentures”) due June 30, 2015, at a price of Cdn $1,000 per debenture, for total gross proceeds of $48.2 million (Cdn $50.0 million) (see “Liquidity and Capital Resource-Convertible Debentures”). The Company repaid the remaining Cdn$ 6.75% Convertible Debentures at June 30, 2015, as discussed below.
On June 7, 2011, the Company issued US$ 6.25% convertible subordinated unsecured debentures (the “US$ 6.25% Convertible Debentures”) due June 30, 2018, at a price of US $1,000 per debenture, for total gross proceeds of $60.0 million. Subsequent to June 30, 2016, the Company exercised its right to redeem the US$ 6.25% Convertible Debentures in their entirety, (see Subsequent Events).
On November 12, 2013, the Company closed its offering of Cdn$ 6.25% convertible subordinated unsecured debentures due June 30, 2019 (the “Cdn$ 6.25% Convertible Debentures”), at a price of Cdn $1,000 per debenture, for total gross proceeds of $71.4 million (Cdn $75.0 million).
The Cdn$ 6.75% Convertible Debentures, which were repaid June 30, 2015, the US$ 6.25% Convertible Debentures and the Cdn$ 6.25% Convertible Debentures are collectively referred to as the “Convertible Debentures”. During fiscal year 2015, Cdn$ 0.1 million of the Company’s Cdn$ 6.75% Convertible Debentures were converted into 18,342 shares of common stock. The remaining Cdn$ 6.75% Convertible Debentures were repaid on June 30, 2015, (see “Liquidity and Capital Resource-Convertible Debentures”). The net proceeds from the issuances of the Convertible Debentures were used to repay indebtedness under the senior credit facilities, which provided additional borrowing capacity, and for general corporate purposes.
Each outstanding Convertible Debenture is convertible into common shares of the Company at the option of the holder at any time prior to the close of business on the earlier of the business day immediately preceding the maturity date or, if called for redemption, on the business day immediately preceding the date fixed for redemption, at a conversion price of US $9.50 per common share (the “US$ 6.25% Convertible Debenture Conversion Price”) which is equivalent to 105.2632 common shares for each US $1,000 principal amount of US$ 6.25% Convertible Debentures and at a conversion price of Cdn $9.05 per common share (the “Cdn$ 6.25% Convertible Debenture Conversion Price”) which is equivalent to 110.4972 common shares for each Cdn $1,000 principal amount of Cdn$ 6.25% Convertible Debentures.
The US$ 6.25% Convertible Debentures were not redeemable prior to June 30, 2014. The Company has the right, at its option, to redeem the US$ 6.25% Convertible Debentures in whole or in part, from time to time, after July 1, 2014, but prior to June 30, 2016, on at least 30 days’ prior notice at a redemption price equal to par plus accrued and unpaid interest, provided that the weighted average trading price of the common shares on a recognized exchange for the 20 consecutive trading days ending five trading days prior to the date on which the redemption notice is given is at least 125% of the US$ 6.25% Convertible Debenture Conversion Price. After June 30, 2016 and prior to maturity, the Company will have the right, at its option, to redeem the US$ 6.25% Convertible Debentures in whole or in part, from time to time, on at least 30 days prior notice at a redemption price equal to par plus accrued and unpaid interest. Subsequent to June 30, 2016, the Company exercised its right to redeem the US$ 6.25% Convertible Debentures in their entirety, (see Subsequent Events).
The Cdn$ 6.25% Convertible Debentures are not redeemable prior to June 30, 2017. The Company will have the right, at its option, to redeem the Cdn$ 6.25% Convertible Debentures in whole or in part, from time to time, on or after June 30, 2017 but prior to June 30, 2018, on at least 30 days prior notice at a redemption price equal to par plus accrued and unpaid interest, provided that the
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weighted average trading price of the common shares on a recognized exchange for the 20 consecutive trading days ending five trading days prior to the date on which the redemption notice is given is at least 125% of the Cdn$ 6.25% Convertible Debenture Conversion Price. After June 30, 2018 and prior to maturity the Company will have the right, at its option to redeem the Cdn$ 6.25% Convertible Debentures in whole or in part, from time to time, on at least 30 days prior notice at a redemption price equal to par plus accrued and unpaid interest.
The Company may at its option, subject to applicable regulatory approval, elect to satisfy its obligation to pay the outstanding principal amount of the Convertible Debentures in whole by issuing and delivering common shares for each US $1,000 principal amount of the US$ 6.25% Convertible Debentures and for each Cdn $1,000 principal amount of the Cdn$ 6.25% Convertible Debentures. The amount of common shares delivered is obtained by dividing each principal amount of Convertible Debentures by 95% of the current market price of the common shares on the date set for redemption or the maturity date.
The Company may elect, subject to applicable regulatory approval, to issue and deliver common stock of the Company to the indenture trustee under the Convertible Debenture indentures, to sell in the open market, to satisfy the Company’s obligation to pay interest on the Convertible Debentures on each interest payment date. The Convertible Debenture holders will receive a cash payment in satisfaction of the interest obligation equal to the interest payable from the sale of such common shares.
The Company must commence, within 30 days of a Change of Control (as defined in the Convertible Debentures indentures), an offer to purchase all of the Convertible Debentures then outstanding at a purchase price equal to 101% of the principal amount of the Convertible Debentures, plus accrued and unpaid interest thereon.
STI Common Shares
The Company renewed its normal course issuer bid (“NCIB”) on October 21, 2015. Pursuant to the notice, the Company is permitted to acquire up to a maximum amount of Common Shares equal to 8,403,185 Common Shares in the twelve month period commencing October 26, 2015 and ending on October 26, 2016, subject to the Company’s senior debt agreement requirements. During the 2016 and 2015 fiscal years, the Company purchased and cancelled 575,226 and 161,415 common shares, respectively, having a value of $2.3 million and $0.8 million, respectively, pursuant to the NCIB that was in effect at the time.
On April 11, 2016, pursuant to a block trade, the Company acquired and cancelled the remaining 5.0 million shares held by SNCF-Participations (“SNCF-P”), formerly the Company’s largest shareholder, for approximately $23.5 million. SNCF-P had originally invested in the Company in 2008, and had sold four million shares in August 2015. In April 2016, SNCF-P sold an additional 6.4 million shares through a combination of a private transaction and a separate sale to a bank syndicate. The disposal of shares by SNCF-P was part of their previously announced strategy to divest a group of transportation and logistics companies considered as “non-core assets” in their investment portfolio.
During the 2016 fiscal year, the Company issued a total of 309,161 shares having an approximate value of $1.0 million in connection with the acquisition of the two transportation consulting and management services firms (see Liquidity and Capital Resources).
On March 6, 2015, the Company issued 11,983,000 common shares pursuant to a bought deal for total gross cash proceeds of $69.1 million (Cdn $86.3 million) (the “2015 Bought Deal”). The net proceeds of $66.7 million (Cdn $ 83.2 million) after commission and fees, were used to redeem the remaining $40.1 million in principal amount of Cdn$ 6.75% Convertible Debentures, with the balance used to pay down debt on the Company’s senior credit facility.
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On May 8, 2015, the Board of Directors of the Company approved a change in the currency of the monthly dividend from Canadian dollars to U.S dollars, effective July 1, 2015, with the first U.S. dollar dividend payable August 17, 2015 to shareholders of record on July 31, 2015.
During fiscal year 2015, Cdn$ 0.1 million of the Company’s Cdn$ 6.75% Convertible Debentures were converted into 18,342 shares of common stock. The remaining Cdn$ 6.75% Convertible Debentures were repaid on June 30, 2015, as discussed above (see “Liquidity and Capital Resource-Convertible Debentures”).
Dividend Reinvestment Plan
The Company established a dividend reinvestment plan (the “Plan”) in May 2009 to enable eligible shareholders of the Company to reinvest dividends on their common shares to acquire additional common shares of the Company. The common shares issued under the Plan are issued directly from the treasury of STI at a price based on the volume weighted average of the Canadian dollar closing price of the common shares for the five trading days immediately preceding the relevant dividend date, less a 3% discount and converted into U.S. dollars at the daily Bank of Canada noon exchange rate posted on the last trading day of such 5 trading day period. Pursuant to the Plan, the Company issued 1,028,064 common shares during the twelve months ended June 30, 2016, which represent non-cash dividends having a value of $4.2 million. The Plan can be amended, suspended or terminated at any time, but such action would have no retroactive effect that would prejudice the interests of any participants.
Equity Incentive Plan – Class B Shares
The shareholders of the Company approved the adoption by STA Holdings of the Equity Incentive Plan (“EIP”), at the annual general meeting held on December 8, 2005. As part of the 2005 EIP plan formation, the shareholders of STI approved an initial allotment of 717,747 Class B Series Two common shares of STA Holdings. On November 13, 2008, an additional allotment of 1,446,291 Class B Series Two common shares was approved by the shareholders. All of these shares have been granted to management. These shares are accounted for as a liability upon issuance, as a result of a put option they contain.
On March 5, 2010, STA Holdings amended its Certificate of Incorporation in order to differentiate those Class B common shares issued pursuant to the EIP while the Company was under the IPS structure from those issued subsequent to the end of the IPS structure. Pursuant to the amendment, the authorized Class B Series Two common shares were split into Class B Series Two common shares, which had been issued pursuant to the EIP during the period the IPS structure was in place, and Class B Series Three common shares, which have been utilized for all share grants under the EIP subsequent to March 5, 2010. On November 8, 2012, an additional allotment of 2,265,000 Class B Series Three common shares was approved by the shareholders.
In May 2015, the Company exchanged all of the remaining Class B Series Two common shares for Class B Series Three common shares, based on the fair market value of each class of shares. This non-cash exchange resulted in approximately 1.57 Class B Series Three common shares being issued for each Class B Series Two common share outstanding.
The holders of the Class B Series Three common shares are entitled to receive dividends, as and when declared by the board of directors of STA Holdings, approximately equivalent to the dividends paid to the holders of STI common shares. These shares are accounted for as a liability upon issuance, as a result of a put option they contain. Pursuant to the liquidity provisions of the EIP the holders of Class B Series Three common shares have an option to “put” up to one third of the shares awarded each year back to the Company, one year immediately following the grant.
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The Class B common shares granted are fully vested at the grant date. These shares are classified as a liability and re-measured at fair value at the end of each reporting period. Changes in fair value and dividends on the Class B common shares are recorded as a component of other income, net in the consolidated statement of operations. The Company recorded an expense of $1.4 million and income of $3.3 million for the years ended June 30, 2016 and 2015, respectively, associated with the change in fair value on the Class B common shares. The Company recorded $0.9 million in dividend payments on the Class B common shares for both of the years ended June 30, 2016 and 2015, which are recorded as a component of other income, net in the consolidated statement of operations.
During the twelve months ended June 30, 2016, STA Holdings granted 1,023,008 Class B Series Three common shares pursuant to the EIP. The Company recognized $4.0 million in non-cash stock-based compensation expense related to these grants during the twelve months ended June 30, 2016. In connection with these grants, 417,536 shares were withheld at the election of the participants to satisfy income tax withholdings. Pursuant to the liquidity provision of the EIP plan, 139,912 Class B Series Three common shares were “put” back to the Company, having a fair value of $0.7 million during the twelve months ended June 30, 2016. The total number of Class B Series Three common shares outstanding as at June 30, 2016 was 2,056,771. The fair value of the Class B Series Three common shares outstanding at June 30, 2016 represents a liability of $10.5 million, of which $7.7 million is recorded in other current liabilities and represents the current value of those shares eligible to be put in the next twelve months pursuant to the EIP plan. The remaining balance is recorded in Class B Series Three common share liability.
The Company entered into an equity hedge in April 2016 with a major Canadian bank to partially mitigate changes in the liability associated with the Class B shares outstanding pursuant to the Company’s EIP plan. The equity hedge has not been designated as a hedge for accounting purposes, therefore the changes in fair value of the equity hedge are recorded in the consolidated statement of operations. The Company recorded a non cash gain for the year ended June 30, 2016, of $1.1 million in connection with the changes in fair value of the hedge, which is included in the consolidated statement of operations as a component of other income. The value of the equity hedge at June 30, 2016 represents an asset of $1.1 million all of which is recorded in other assets.
During the twelve month ended June 30, 2015, there were 10,777 Class B Series Two shares “put” back to the Company, for which the Company paid $0.1 million. The remaining 50,689 Class B Series Two common shares were exchanged for 80,009 Class B Series Three common shares as discussed above. There are no Class B Series Two common shares outstanding at June 30, 2015 (or subsequently thereafter).
During the twelve months ended June 30, 2015, STA Holdings granted 663,620 Class B Series Three common shares pursuant to the EIP. The Company recognized $4.2 million in non-cash stock-based compensation expense related to these grants during the twelve months ended June 30, 2015. In connection with these grants, 236,241 shares were withheld at the election of the participants to satisfy income tax withholdings. An additional 80,009 Class B Series Three common shares were issued in exchange for the remaining Class B Series Two common shares outstanding as discussed above. Pursuant to the liquidity provision of the EIP plan, 322,019 Class B Series Three common shares were “put” back to the Company, having a fair value of $1.9 million during the twelve months ended June 30, 2015. The total number of Class B Series Three common shares outstanding as at June 30, 2015 was 1,591,211. The fair value of the Class B Series Three common shares outstanding at June 30, 2015 represents a liability of $7.3 million, of which $5.4 million is recorded in other current liabilities and represents the current value of those shares eligible to be put in the next twelve months pursuant to the EIP plan. The remaining balance is recorded in Class B Series Three common share liability.
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Results of Operations ($ in 000’s, except per share data)
As noted in the cautionary language concerning forward-looking disclosures under the heading “Forward-Looking Statements” in this management discussion and analysis, this section contains forward-looking statements, including with respect to the Company’s seasonality, fuel prices, currency and leasing alternatives. Such statements involve known and unknown risks, uncertainties and other factors outside of management’s control, including the risk factors set forth in this management discussion and analysis that could cause results to differ materially from those described or anticipated in the forward-looking statements.
| Three Months Ended June 30 | Twelve Months Ended June 30 | |||||||||||||||
| 2016 | 2015 | 2016 | 2015 | |||||||||||||
Revenues | $ | 166,190 | $ | 152,454 | $ | 600,194 | $ | 554,751 | ||||||||
Costs and expenses | ||||||||||||||||
Cost of operations | 122,971 | 113,107 | 457,743 | 427,536 | ||||||||||||
General and administrative | 15,772 | 13,532 | 61,897 | 54,749 | ||||||||||||
Non-cash stock compensation | — | — | 3,967 | 4,170 | ||||||||||||
Acquisition expense | — | — | 192 | 3 | ||||||||||||
Depreciation and depletion expense | 14,281 | 14,303 | 48,008 | 47,757 | ||||||||||||
Amortization expense | 793 | 943 | 3,153 | 3,374 | ||||||||||||
Impairment of oil and gas assets | 438 | — | 1,638 | — | ||||||||||||
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Total operating expenses | 154,255 | 141,885 | 576,598 | 537,589 | ||||||||||||
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Income from operations | 11,935 | 10,569 | 23,596 | 17,162 | ||||||||||||
Interest expense | 3,692 | 4,247 | 14,513 | 17,412 | ||||||||||||
Foreign currency (gain) loss | (140 | ) | 242 | 1,147 | (136 | ) | ||||||||||
Unrealized gain on foreign currency exchange contracts | — | (2,053 | ) | — | (83 | ) | ||||||||||
Non-cash (gain) loss on US$ 6.25% Convertible Debentures conversion feature | (109 | ) | (12 | ) | 177 | (231 | ) | |||||||||
Other income, net | (797 | ) | (736 | ) | (1,127 | ) | (3,481 | ) | ||||||||
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Income before income taxes and equity in net income (loss) of unconsolidated investment | 9,289 | 8,881 | 8,886 | 3,681 | ||||||||||||
Equity in net income (loss) of unconsolidated investment | — | 33 | (11 | ) | 58 | |||||||||||
Income tax provision | 3,011 | 1,934 | 2,838 | 84 | ||||||||||||
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Net income | $ | 6,278 | $ | 6,980 | $ | 6,037 | $ | 3,655 | ||||||||
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Basic and diluted net income per common share | $ | 0.07 | $ | 0.07 | $ | 0.06 | $ | 0.04 | ||||||||
Seasonality
The Company’s operations are seasonal and follow the school calendars of the public and private schools it serves. During the summer school break, revenue is derived primarily from summer camps and private charter services. Since schools are not in session, there is minimal school bus transportation revenue. Thus, the Company incurs operating losses during the first three months of the fiscal year, which encompass the summer school break. Depreciation of fixed assets occurs in the months during which schools are in session, which is generally September through June. A full year’s worth of depreciation is recorded in these ten months to correspond with the vehicles’ usage. In addition, the Company purchases a majority of its replacement capital expenditures, along with investment capital spending for new bids and contracts awarded for the upcoming school year in the same time period. These purchases have historically been funded by borrowings on the Company’s senior credit facility and through operating lease financings.
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Recent Market Fuel Price Trends
There has been a significant decrease in market fuel prices over the last twelve to twenty-four months in North America. The price of fuel in June 2016 was approximately $48 per barrel compared to approximately $60 per barrel in June 2015. In connection with the fuel exposure under the school district contracts, approximately 60% of such contracts include some form of fuel mitigation in connection with market fuel price increases, with approximately half of that reflecting the outright purchase of fuel by school district customers, while we look to lock in an additional 20% of total fuel exposure with fixed price contracts. The final 20% of total fuel exposure is fully subject to market price variations.
The Company is exposed to changes in the market price of fuel on our school transportation contracts in the ordinary course of business. The Company continues to have fuel mitigation features in approximately 60% of its school transportation revenue contracts that provide some measure of protection against market fuel price increases, ranging from the outright purchase of fuel by school districts to fuel reimbursements associated with fuel price caps / collars and fuel escalators. So while the Company is still exposed to some price risk under some of these fuel mitigation features when market fuel prices increase, it also benefits to some extent with a decline in market fuel prices as well.
In addition to the contract mitigation features related to fuel in the revenue contracts, over the last several years the Company also endeavored to lock in an approximate 20% of its fuel exposure by entering into fixed price contracts with its fuel vendors on an annual basis, with the final approximate 20% of fuel exposure at risk and fully subject to market price fluctuations. The Company started to lock in the 20% of fuel exposure for fiscal 2016 in October through December 2014, when the price of fuel was approximately $60 per barrel. Those lock-ins under fixed price contracts have lowered the diesel price per gallon by approximately 21% and the propane price per gallon by approximately 25%, compared to fiscal 2015, for the portion of the Company’s fuel that was locked in. In August 2014, the Company entered into fixed price contracts with fuel vendors to cover the approximate 20% of fuel exposure for fiscal year 2015. As such, the fixed price contracts for fiscal year 2015 reflected lock-in prices from the August 2014 time period, prior to the substantial market fuel price declines experienced in the November 2014 and December 2014 time periods. The Company has benefited from the continued market fuel price declines on the final 20% of fuel exposure fully subject to market price fluctuations.
In connection with the annual fixed price contracts for approximately 20% of the fuel exposure the Company endeavors to lock in annually, based on the continued decline in market fuel prices through the current date discussed above, the Company has secured fixed price contracts for fiscal year 2017. In August and November 2015 the Company locked in approximately 15% of fuel exposure for the 2017 fiscal year. In July 2016, the Company locked in one third of the approximately 20% of its fuel exposure for the 2018 fiscal year.
Foreign Currency Translation Impacts on Financial Reporting
The Company’s financial statements are reported in U.S. dollars, as the principal operations and cash flows of its subsidiaries are conducted in U.S. dollars. The Company’s reported results have been negatively impacted by the recent weakening of the Canadian dollar in connection with the translation of the Canadian operations into U.S. dollar. These negative impacts are purely financial statement reporting impacts and have no effect on the Company’s Canadian dollar operating results. The results of the Company’s Canadian operations (revenues and expenses) are translated into U.S. dollars using the average exchange rate during the period. The average Canadian dollar / U.S. dollar exchange rates for the twelve months ended June 30, 2016 and 2015 were 1.3258 and 1.1738, respectively. Revenue for the twelve months ended June 30, 2016 was negatively impacted by approximately $7.7 million as compared to the twelve months ended June 30, 2015 and operating income was negatively impacted by $0.3 million for the twelve months ended June 30, 2016 as compared to the twelve month ended June 30, 2015 related to the change in exchange rates between the Canadian dollar and the U.S. dollar.
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Managed and Leased Fleet Business
The Company’s school transportation services have historically included managed services contracts. These transportation services are structured as management services contracts under which the Company manages the transportation for the school district and the school district continues to own the school bus fleet. In addition, since the fiscal year 2007 the Company has financed a portion of its growth and replacement school vehicles through operating leases. Such managed services contracts and leased vehicles require lower up front capital investment (as the school district maintains ownership of the managed fleet and the lessor maintains ownership of the leased fleet) and thus results in lower annual depreciation expense on an ongoing basis. Currently, leased and managed buses account for approximately 31% and 5%, respectively, of the Company’s fleet. The Company intends to review leasing alternatives on an annual basis based on the economics of the lease financing.
During the fiscal year ended June 30, 2015, the Company entered into additional operating leases with seven major financial institutions to lease approximately $38.7 million in replacement school vehicles and $38.3 million in growth school vehicles for the 2014-2015 school year. The term of these leases is six years at effective fixed rates in the range of 2.7% to 4.4%. Annual lease payments on these additional leases will approximate $11.2 million per year for the term of the leases.
During the fiscal year ended June 30, 2016, the Company entered into additional operating leases with ten major financial institutions to lease approximately $58.3 million in replacement school vehicles and $22.0 million in growth school vehicles for the 2015-2016 school year. The term of these leases is six years at effective fixed rates in the range of 2.6% to 4.2%. Annual lease payments on these additional leases will approximate $11.3 million per year for the term of the leases.
Oil and Gas Interests
In January 2008, the Company closed the acquisition (the “Canadex Acquisition”) of all of the outstanding stock of Canadex Resources Limited (“Canadex”). Canadex was a transportation and energy company consisting of two separate business segments. The transportation segment represented school bus operations in Ontario, while the energy division held non-operating positions in oil and gas investments in the United States. The interests in oil and gas properties are held through Canadex’s wholly owned subsidiary, Canadex Resources Inc. (“CRI”). CRI invests as a non-operator in properties for the exploration and upstream production of crude oil, natural gas and condensates. It holds junior participations in approximately 500 wells primarily in Texas and Oklahoma, with a few located in Louisiana and Kansas in the United States. CRI’s co-investments with a range of operators provide flexibility to exploit a variety of exploration and development opportunities. The financial statements reflect the Company’s proportionate interest in the oil and gas activities as a non-operator. Canadex, through a series of amalgamations subsequent to the Canadex Acquisition, was renamed Parkview Transit Inc., which is a direct subsidiary of the Company.
The Company’s oil and gas revenues, on an annual basis, are approximately one quarter of one percent of consolidated Company revenues.
Three months ended June 30, 2016 Compared to Three months ended June 30, 2015
The Company’s core business is school bus transportation. As a result of the Canadex Acquisition, the Company has two reportable segments, school bus transportation and an oil and gas portfolio. The oil and gas portfolio represents approximately one-quarter of one percent of the Company’s revenue on an annual basis.
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The consolidated results for the fourth quarter of fiscal year 2016 include $0.3 million in oil and gas revenue, $0.5 million in related cost of operations, $0.1 million in depletion expense, $0.1 million gain on sale of wells and a $0.4 million non-cash impairment charge on the oil and gas assets as a result of the continued decline in fuel market prices. The consolidated results for the fourth quarter of fiscal year 2015 include $0.5 million in oil and gas revenue, $0.4 million in related cost of operations and $0.3 million in depletion expense. The revenue reduction for the fourth quarter of fiscal year 2016 compared to the fourth quarter of fiscal year 2015 was due to a reduction in both price and production, primarily related to the recent decline in fuel market prices.
The remaining discussion of the Company’s operating results through “Income from Operations” is related to the Company’s core school bus transportation segment. Discussion of items below “Income from Operations” reflects the consolidated results of the Company as these items are unallocated between the two reporting segments.
Revenues: Revenues for school bus transportation for the fourth quarter of fiscal year 2016 were $165.9 million compared to $152.0 million for the fourth quarter of fiscal year 2015, representing an increase of $13.9 million, or 9.1%. Revenue for the fourth quarter of fiscal year 2016 was negatively impacted by approximately $1.1 million related to the change in exchange rates between the Canadian dollar and the U.S. dollar from the fourth quarter of fiscal year 2015 to the fourth quarter of fiscal year 2016 in connection with the translation of the Company’s Canadian operations into U.S. dollars. In the first quarter of fiscal year 2016, the Company started operations on eleven new bid contracts (three of which were tuck-ins to existing locations) and completed the acquisitions of two transportation consulting and management services firms in the third quarter of fiscal year 2016. The Company did not renew four contracts for the fiscal year 2016.
The new bid-in contracts for fiscal year 2016 and the two acquisitions completed in third quarter of fiscal year 2016 , accounted for $11.5 million in new business growth in the fourth quarter of fiscal year 2016, which was partially offset by a $0.7 million revenue reduction resulting from the four contracts not renewed. The remaining $4.2 million increase in revenues resulted primarily from net increases in service requirements of existing contracts and contract rate increases.
Cost of Operations: Cost of operations for school bus transportation for the fourth quarter of fiscal year 2016 was $122.5 million as compared to $112.8 million for the fourth quarter of fiscal year 2015, representing an increase of $9.7 million or 8.6%. The new bid-in contracts for fiscal year 2016 along with the two acquisitions completed in the third quarter of fiscal year 2016, accounted for $7.6 million of the total increase in cost of operations which was partially offset by a $0.6 million reduction resulting from the four contracts not renewed. The remaining $2.7 million increase in cost of operations, net of new business and contracts not renewed for the fourth quarter of fiscal year 2016, resulted primarily from an increase in salaries and wages and operating costs, partially offset by a decrease fuel expense, fringe benefits and insurance costs. Salaries and wages, net of new business for the fourth quarter of fiscal year 2016, increased by $2.5 million primarily related to higher driver wages, maintenance wages and operations wages. As a percentage of revenue, driver wages increased to 34.4% in the fourth quarter of fiscal year 2016 from 34.0% in the fourth quarter of fiscal year 2015. Maintenance wages increased to 3.9% from 3.7%, and operations wages increased to 4.2% from 4.1% both in the fourth quarter of fiscal year 2016 compared to the fourth quarter of fiscal year 2015. Operating expenses, net of new business for the fourth quarter of fiscal year 2016, increased $2.2 million due primarily to an additional year of vehicle leasing costs. Fuel expense, net of new business for the fourth quarter of fiscal year 2016, decreased $1.8 million, primarily related to lower market prices. As a percentage of revenue, fuel decreased to 5.5% in the fourth quarter of fiscal year 2016 from 6.8% in the fourth quarter of fiscal 2015. Fringe benefits net of new business for the fourth quarter of fiscal year 2016 decreased $0.1 million due primarily to favorable claims experience in workers compensation, partially offset by higher employment taxes associated with higher rates and the wage increases noted above. As a percentage of revenue, fringe benefits
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decreased to 9.1% in the fourth quarter of fiscal year 2016 from 9.3% in the fourth quarter of fiscal year 2015. Insurance costs, net of new business for the fourth quarter of fiscal year 2016, decreased $0.1 million primarily due to favorable liability insurance claims development. As a percentage of revenue, insurance costs decreased to 3.1% from 3.2% in the fourth quarter of fiscal year 2016 compared to the fourth quarter of fiscal year 2015.
General and Administrative Expense: General and administrative expense for school bus transportation for the fourth quarter of fiscal year 2016 was $15.7 million compared to $13.5 million for the fourth quarter of fiscal year 2015, an increase of $2.2 million or 16.3%. As a percentage of revenue, total general and administrative expense increased to 9.5% of revenue in the fourth quarter of fiscal year 2016 from 8.9% in the fourth quarter of fiscal year 2015. The increase in general and administrative expenses is primarily due to the bid-in contracts completed during the fiscal year 2016, as well as higher administrative compensation and professional fees.
Depreciation Expense: Depreciation expense for school bus transportation for the fourth quarter of fiscal year 2016 was $14.2 million compared to $14.0 million for the fourth quarter of fiscal year 2015, an increase of $0.2 million. As a percentage of revenue, depreciation expense decreased to 8.6% for the fourth quarter of fiscal year 2016 from 9.2% for the fourth quarter of fiscal year 2015.
Amortization Expense: Amortization expense for school bus transportation was $0.8 million for the fourth quarter of fiscal year 2015 compared to $0.9 million for the fourth quarter of fiscal year 2015, a decrease of $0.1 million. As a percentage of revenue, amortization expense decreased to 0.5% for the fourth quarter of fiscal year 2016 from 0.6% for the fourth quarter of fiscal year 2015.
Income from Operations: Income from operations for school bus transportation was $12.7 million for the fourth quarter of fiscal year 2016 compared to $10.8 million for the fourth quarter of fiscal year 2015. The increase in income from operations of $1.9 million resulted from the operating line items discussed above and reflects a negative impact of $0.2 million in exchange rates between the Canadian dollar and the US dollar from the fourth quarter of fiscal year 2015 compared to the fourth quarter of fiscal year 2016 in connection with the translation of the Company’s Canadian operations into US dollars.
Interest Expense: Interest expense for the fourth quarter of fiscal year 2016 was $3.7 million compared to $4.2 million for the fourth quarter of fiscal year 2015. The decrease in interest expense of $0.5 million was due to a decrease in the weighted average interest rate, partially offset by an increase in the average debt outstanding, for the fourth quarter of fiscal year 2016, compared to the fourth quarter of fiscal year 2015.
Foreign Currency Gain (Loss):Foreign currency gain for the fourth quarter of fiscal year 2016 totaled $0.1 million compared to a foreign currency loss $0.3 million for the fourth quarter of fiscal year 2015. The increase in the foreign currency gain of $0.4 million results primarily from the gains realized upon the translation of the Company’s dividends into US dollars for the fourth quarter of fiscal year 2016.
Unrealized Gain on Foreign Currency Exchange Contracts: The Company liquidated the outstanding foreign currency exchange contracts in the fourth quarter of fiscal 2015 in connection with the change in currency of the dividend payment to U.S. dollars. The unrealized gain on foreign currency exchange contracts was $2.1 million for the fourth quarter of fiscal year 2015.
Non-cash Gain on US$ 6.25% Convertible Debentures Conversion Feature: Non-cash gain on the US$ 6.25% Convertible Debentures conversion feature was $0.1 million for the fourth quarter of fiscal year 2016 compared to a non-cash gain of twelve thousand dollars for the fourth quarter of fiscal year 2015. The increase in the gain of $0.1 million was related to the change in fair value of the embedded conversion feature derivative associated with STI’s issuance of the U.S. dollar
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denominated US$ 6.25% Convertible Debentures. The conversion feature on STI’s US$ 6.25% Convertible Debentures provides that the U.S. dollar denominated debentures can be converted at a U.S. dollar denominated strike price into common shares of the Issuer, a Canadian functional currency entity. Therefore, the conversion feature represents an embedded derivative that must be bifurcated and accounted for separately. The embedded conversion feature is recorded at fair value in other liabilities at each reporting period end with changes in fair value included in the consolidated statement of operations.
Other Income, Net: Other income totaled $0.7 million in both the fourth quarter of fiscal year 2016 and the fourth quarter of fiscal year 2015. Other income consists primarily of the change in the Class B share value, gain and loss on disposal of assets and unrealized foreign currency gains and loses.
Income before Income Taxes and Equity in Net Income of Unconsolidated Investment: Income before income taxes and Equity in Net Income of Unconsolidated Investment was $9.3 million for the fourth quarter of fiscal year 2016 compared to $8.9 million for the fourth quarter of fiscal year 2015. The increase in income of $0.4 million resulted primarily from, an increase in income from the school bus transportation segment of $1.9 million, a decrease in interest expense of $0.5 million, an increase in the foreign currency gain of $0.4 million and an increase in the gain on the US$ 6.25% Convertible Debenture conversion feature of $0.1 million, partially offset by a decrease in unrealized gains on foreign currency exchange contracts of $2.1 million, and a increase in the operating loss from the Company’s oil and gas portfolio of $0.4 million.
Equity in Net Income of Unconsolidated Investment: The Equity in Net Income of unconsolidated investment of thirty-three thousand dollars, in the fourth quarter of fiscal 2015, represents the Company’s share of the earnings of a consulting and management services firm, an investment which the Company completed in the third quarter of fiscal year 2015 (see “Liquidity and Capital Resource-Acquisitions and Investments”). The Company purchased the remaining portion of the transportation consulting and management service firm during the third quarter of fiscal year 2016.
Net Income:Net income for the Company for the fourth quarter of fiscal year 2016 totaled $6.3 million, which included an income tax expense of $3.0 million. Net income for the fourth quarter of fiscal year 2015 amounted to $7.0 million, which included an income tax expense of $1.9 million. The effective tax rates for the fourth quarter of fiscal year 2016 and the fourth quarter of fiscal year 2015 were 32.4% and 21.7%, respectively. The increase in the effective tax rate quarter over quarter was due primarily the mix of the statutory Canadian and U.S. tax rates and the apportionment of the Company’s income before income taxes resulting from the operations in each country and the prior year change in the state apportionment factors resulting from the transition to unitary filing in several states. Basic and diluted net income per common share was $0.07 for both the fourth quarter of fiscal year 2016 and the fourth quarter of fiscal year 2015.
Twelve months ended June 30, 2016 Compared to Twelve months ended June 30, 2015
The Company’s core business is school bus transportation. As a result of the Canadex Acquisition, the Company has two reportable segments, school bus transportation and an oil and gas portfolio. The oil and gas portfolio represents approximately one-quarter of one percent of the Company’s revenue on an annual basis.
The consolidated results for the fiscal year 2016 include $1.4 million in oil and gas revenue, $1.7 million in related cost of operations, $0.2 million in general and administrative expense, $1.0 million in depletion expense and $1.6 million non-cash impairment charge on the oil and gas assets as a result of the continued decline in fuel market prices. The consolidated results for the fiscal year 2015 include $2.9 million in oil and gas revenue, $2.0 million in related cost of operations, $0.2 million in general and administrative expense and $1.2 million in depletion expense. The revenue reduction for the fiscal year 2016 compared to the fiscal year 2015 was due to a reduction in both price and production, primarily related to the recent decline in fuel market prices.
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The remaining discussion of the Company’s operating results through “Loss from Operations” is related to the Company’s core school bus transportation segment. Discussion of items below “Loss from Operations” reflects the consolidated results of the Company as these items are unallocated between the two reporting segments.
Revenues: Revenues for school bus transportation for the fiscal year 2016 were $598.8 million compared to $551.9 million for the fiscal year 2015, representing an increase of $46.9 million, or 8.5%. Revenue for the fiscal year 2016 was negatively impacted by approximately $7.7 million related to the change in exchange rates between the Canadian dollar and the U.S. dollar from the fiscal year 2015 to the fiscal year 2016 in connection with the translation of the Company’s Canadian operations into U.S. dollars. In the first quarter of fiscal year 2016, the Company started operations on eleven new bid contracts (three of which were tuck-ins to existing locations) and completed the acquisitions of two transportation consulting and management services firms in the third quarter of fiscal year 2016. The Company did not renew four contracts for the fiscal year 2016.
The new bid-in contracts for fiscal year 2016, the two acquisitions completed in the third quarter of fiscal year 2016 and a bid in contract which started in the third quarter of fiscal year 2015 accounted for $42.2 million in new business growth in fiscal year 2016, which was partially offset by a $2.3 million revenue reduction resulting from the four contracts not renewed. The remaining $14.7 million increase in revenues resulted primarily from net increases in service requirements of existing contracts and contract rate increases.
Cost of Operations: Cost of operations for school bus transportation for the fiscal year 2016 was $456.0 million as compared to $425.5 million for the fiscal year 2015, representing an increase of $30.5 million or 7.2%. The new bid-in contracts for fiscal year 2016, the two acquisitions completed in the third quarter of fiscal year 2016 and a bid in contract which started in the third quarter of fiscal year 2015 accounted for $27.7 million of the total increase in cost of operations, which was partially offset by a $2.2 million reduction resulting from the four contracts not renewed. The remaining $5.0 million increase in cost of operations, net of new business and contracts not renewed for fiscal year 2016, resulted primarily from an increase in salaries and wages, operating costs, higher insurance costs and higher fringe benefit costs, partially offset by lower fuel costs and lower maintenance costs. Salaries and wages, net of new business and contracts not renewed for fiscal year 2016, increased by $6.7 million due primarily to higher driver, maintenance, operations and safety wages. As a percentage of revenue, driver wages increased to 35.0% in fiscal year 2016 from 34.8% in fiscal year 2015. Maintenance wages increased to 4.2% from 4.0%, operations wages increased to 4.6% from 4.5% and safety wages increased to 1.0% from 0.8% in fiscal year 2016 compared to fiscal year 2015. Operating cost, net of new business and contracts not renewed for fiscal year 2016 increased $6.2 million primarily due to an additional year of vehicle leasing costs. As a percentage of revenue, operating costs increased to 8.2% in fiscal year 2016 from 7.2% in fiscal year 2015. Insurance costs, net of new business for fiscal year 2016, increased $2.5 million primarily due to unfavorable liability insurance claims development. As a percentage of revenue, insurance costs increased to 3.8% in fiscal year 2016 from 3.4% in fiscal year 2015. Fringe benefit costs net of new business and contracts not renewed for fiscal year 2016, increased $1.0 million due to higher employment taxes associated with higher rates and the wage increases noted above. Fringe benefit costs increased as a percentage of revenue to 9.6% in fiscal year 2016 from 9.5% in fiscal year 2015. Fuel expense, net of new business and contracts not renewed for fiscal year 2016, decreased $9.9 million due primarily to lower fuel market prices. Fuel expense decreased as a percentage of revenue to 5.4% in fiscal year 2016 from 7.3% in fiscal year 2015. Maintenance expense, net of new business and contracts not renewed for fiscal year 2016, decreased $1.6 million due primarily to lower net parts expense and a reduction in outside repair expense. Maintenance expense decreased as a percentage of revenue to 4.4% in fiscal year 2016 from 4.8% in fiscal year 2015.
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General and Administrative Expense: General and administrative expense for school bus transportation for the fiscal year 2016 was $61.7 million compared to $54.5 million for the fiscal year 2015, an increase of $7.2 million or 13.2%. As a percentage of revenue, total general and administrative expense increased to 10.3% for the fiscal year 2016 compared to 9.9% for the fiscal year 2015. The increase in general and administrative expenses is primarily due to the bid in contracts and the two acquisitions completed during the fiscal year 2016 and increased administrative compensation.
Acquisition Expense: Acquisition expense for the fiscal year 2016 was $0.2 million Acquisition expense for the fiscal year 2015 was three thousand dollars. Acquisition expenses related to transaction costs associated with acquisitions are expensed as incurred under US GAAP.
Non-Cash Stock Compensation:Non-cash stock compensation expense for school bus transportation for the fiscal year 2016 was $4.0 million. The non-cash compensation expense was related to the issuance of 1,023,008 Class B Series Three common shares of STA Holdings in the fiscal year 2016. Non-cash stock compensation expense for school bus transportation for the fiscal year 2015 was $4.2 million. The non-cash compensation expense was related to the issuance of 663,620 Class B Series Three common shares of STA Holdings in the fiscal year 2015.
Depreciation Expense: Depreciation expense for school bus transportation for the fiscal year 2016 was $47.0 million compared to $46.6 million for the fiscal year 2015, an increase of $0.4 million. The increase was primarily related to the vehicles associated with the new bid in contracts that started operations in fiscal year 2016, partially offset by the deprecation savings due to the additional vehicles leased in fiscal 2016. As a percentage of revenue, depreciation expense decreased to 7.8% for the fiscal year 2016 from 8.4% for the fiscal year 2015.
Amortization Expense: Amortization expense for school bus transportation was $3.2 million for the fiscal year 2016 compared to $3.4 million in the fiscal year 2015. As a percentage of revenue, amortization expense decreased to 0.5% in the fiscal year 2016 from 0.6% in the fiscal year 2015.
Income from Operations: Income from operations for school bus transportation was $26.7 million for the fiscal year 2016 compared to $17.7 million for the fiscal year 2015. The increase in income from operations of $9.0 million resulted from the operating line items discussed above and reflects a negative impact of $0.3 million in exchange rates between the Canadian dollar and the US dollar from the fiscal 2015 compared to the fiscal 2016 in connection with the translation of the Company’s Canadian operations into US dollars.
Interest Expense: Interest expense for the fiscal year 2016 was $14.5 million compared to $17.4 million for the fiscal year 2015. An approximate $2.9 million decrease in interest expense was due to both a decrease in the average debt outstanding and a decrease in average interest rates in the fiscal year 2016 as compared to the fiscal year 2015.
Foreign Currency Loss (Gain): Foreign currency loss for the fiscal year 2016 totaled $1.1 million compared to a foreign currency gain of $0.1 million for the fiscal year 2015. The increase in the foreign currency loss of $1.2 million results primarily from the losses realized upon the translation of the Company’s dividends into US dollars for the 2016 fiscal year.
Unrealized Gain on Foreign Currency Exchange Contracts: The Company liquidated the outstanding foreign currency exchange contracts in the fourth quarter of fiscal 2015 in connection with the change in currency of the dividend payment to U.S. dollars. The unrealized gain on foreign currency exchange contracts was $0.1 million for fiscal year 2015.
Non-cash Loss (Gain) on US$ 6.25% Convertible Debentures Conversion Feature: Non-cash loss on the US$ 6.25% Convertible Debentures conversion feature was $0.2 million for the fiscal year 2016 compared to a non-cash gain of $0.2 million in the fiscal year 2015. The increase in the non-
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cash loss of $0.4 million was related to the change in fair value of the embedded conversion feature derivative associated with STI’s issuance of the U.S. dollar denominated US$ 6.25% Convertible Debentures. The conversion feature on STI’s US$ 6.25% Convertible Debentures provides that the U.S. dollar denominated debentures can be converted at a U.S. dollar denominated strike price into common shares of the issuer, a Canadian functional currency entity. Therefore, the conversion feature represents an embedded derivative that must be bifurcated and accounted for separately. The embedded conversion feature is recorded at fair value in other liabilities at each reporting period end with changes in fair value included in the consolidated statement of operations.
Other Income, net: Other income totaled $1.1 million in the fiscal year 2016 compared to other income of $3.5 million in the fiscal year 2015. The decrease in income of $2.4 million was due to an increase in the Class B Series Three share expense of $3.9 million, partially offset by an increase unrealized gains on foreign currency translations of $0.5 million and an increase in the gain on disposal of assets of $0.9 million in the fiscal year 2016 compared to the fiscal year 2015.
Income before Income Taxes and Equity in Net (Loss) Income of Unconsolidated Investment: Income before income taxes and Equity in Net (Loss) Income of Unconsolidated Investment was $8.9 million for the fiscal year 2016 compared to income of $3.7 million for the fiscal year 2015. The increase in the income of $5.2 million resulted primarily from an increase in the operating income for school bus operations of $9.0 million as discussed above and a decrease in interest expense of $2.9 million, partially offset by a decrease in other income of $2.4 million, an increase in the operating loss from the oil and gas segment of $2.6 million, a increase in foreign currency loss of $1.2 million, an increase in the non-cash loss on the US$ 6.25% Convertible Debenture conversion feature of $0.4 million and a decrease in gains on unrealized foreign currency exchange contracts of $0.1 million.
Equity in Net (Loss) Income of Unconsolidated Investment: The Equity in Net (Loss) of unconsolidated investments was eleven thousand dollars in fiscal year 2016. The Equity in Net income of unconsolidated investments was fifty eight thousand dollars in fiscal year 2015. These amounts represent the Company’s share of the earnings of a consulting and management services firm, an investment which the Company completed in fiscal year 2015. (see “Liquidity and Capital Resource-Acquisitions and Investments”). The Company purchased the remaining portion of the transportation consulting and management service firm during the third quarter of fiscal year 2016.
Net Income:Net income for the Company for the fiscal year 2016 totaled $6.0 million, which included an income tax expense of $2.8 million. Net income for the fiscal year 2015 amounted to $3.7 million, which included an income tax expense of $0.1 million. The effective tax rates for the fiscal year 2016 and the fiscal year 2015 were 32.0% and 2.2%, respectively. The increase in the full year effective income tax rate year over year was primarily due to the mix of the statutory Canadian and U.S. tax rates, the apportionment of the Company’s income before income taxes resulting from the operations in each country, as well as the change in the state apportionment factors resulting from the transition to unitary filing in several states recorded in the prior year. Basic and diluted net income per common share was $0.06 for the fiscal year 2016 compared to basic and diluted net income per share of $0.04 for the fiscal year 2015.
Liquidity and Capital Resources
As noted in the cautionary language concerning forward-looking disclosures under the heading “Forward-Looking Statements” in this management discussion and analysis, this section contains forward-looking statements, including with respect to the Company’s ability to renew or refinance its various loan facilities as they become due. Such statements involve known and unknown risks, uncertainties and other factors outside of management’s control, including the risk factors set forth in this management discussion and analysis that could cause results to differ materially from those described or anticipated in the forward-looking statements.
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General
School bus transportation revenue has historically been seasonal, based on the school calendar and holiday schedule. During the summer school break, revenue is derived primarily from summer camps and private charter services. As schools are not in session, there is no school bus transportation revenue during this period. The operations of the Company historically generate negative cash flow in the first quarter of the fiscal year reflecting the seasonality of the school bus transportation industry during the school summer break combined with a majority of replacement capital expenditures along with investment capital spending for new bids and contracts awarded for the upcoming school year occurring in the same time period. Replacement capital expenditures have historically been funded by a combination of borrowings on the Company’s senior credit facility and through operating lease financings. Investment capital spending for new bid and contract awards has historically been funded with proceeds from debt and equity financings along with operating lease financing and cash flow from operations. As the Company incurs operating losses during the first three months of the fiscal year, distributions are funded with non-operating cash flows for the first interim quarter of the fiscal year. The subsequent quarters of the fiscal year typically generate excess cash, as schools are in session and the majority of replacement capital expenditures and investment capital spending having occurred in the first quarter. Due to this seasonality, the Company views available cash flow on an annualized basis. The Company has historically funded its distributions with cash from operations on an annual basis.
During the twelve months ended June 30, 2016, net cash provided by operations totaled $68.2 million, which reflects a $3.8 million source of cash from net working capital. Net cash taxes refunded during the twelve months ended June 30, 2016 amounted to $0.2 million, which includes refunds of prior year’s tax payments. The Company’s investing activities for the twelve months ended June 30, 2016 resulted in a use of cash of $71.0 million. Included in these investing activities were, (i) capital expenditures related to the new bid contracts for fiscal year 2016 of $58.6 million (which includes $0.4 million for oil & gas investments in new wells), (ii) $8.4 million in capital expenditures related to replacement capital spending, (iii) $2.2 million in proceeds from sale of equipment and (iv) $6.2 million in funding for the two acquisitions that closed in the third quarter of the fiscal year. The Company’s financing activities for the twelve months ended June 30, 2016 represented a source of cash of $5.5 million. Included in these financing activities were (i) $220.5 million in credit agreement borrowings and $150.5 million in credit agreement repayments, (ii) $37.9 million in dividend payments made, (iii) $0.7 million in payments to repurchase Class B common shares, (iv) $2.3 million in NCIB payments to repurchase common shares and $23.5 million in a block trade payment to repurchase the SNCF-P common shares and (v) $0.1 million in financing fees.
Loan Facilities
Subsequent to June 30, 2016, the Company amended the Credit Agreement to further increase commitments and extend the maturity date (see Subsequent Events). On August 19, 2014, the Company amended its Third Amended and Restated Credit Agreement (as amended the “Credit Agreement”). The amendment increased commitments to $225.0 million from $165.0 million, extended the $100.0 million accordion feature and extended the maturity date of the Credit Agreement to August 19, 2019, or if earlier, 90 days prior to the maturity of the Senior Secured Notes, as defined below. The increase in the size of the facility resulted from the addition of two new lenders to the bank group and certain existing lenders increasing their commitments. The current commitments at June 30, 2016 include a US $180.0 million loan facility and a Cdn $45.0 million loan facility, both of which are available to fund working capital requirements and to fund acquisitions and investment requirements for new revenue and bid-in contracts.
Borrowings under the Credit Agreement may be Base Rate Loans or Eurodollar Loans, as defined in the Credit Agreement. Base Rate Loans bear interest at the base rate, as defined in the Credit Agreement (3.50% at June 30, 2016), plus the applicable margin, which ranges from 0.50% to 1.25% depending on STA Holdings’ senior leverage ratio on the pricing date. Eurodollar Loans bear
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interest at the adjusted LIBOR rate, as defined in the Credit Agreement (0.638350% at June 30, 2016), plus the applicable margin, which ranges from 1.75% to 2.50% depending on STA Holdings’ senior leverage ratio on the pricing date.
On November 10, 2011, the Company rolled over and extended the maturity of the $35 million Senior Secured Notes (as defined below) for a five year term. The Senior Secured Notes now reflect a fixed coupon of 4.246% and a maturity date of November 10, 2016. In December 2006, the Company initially issued the senior secured notes (the “Senior Secured Notes”) under a note purchase agreement (the “Note Purchase Agreement”) with two Canadian insurance companies. The Senior Secured Notes consisted of $35.0 million of five year, fixed rate senior secured notes at an original coupon of 5.941%. The Senior Secured Notes rankpari passu with borrowings under the Credit Agreement. Subsequent to June 30, 2016, the Company redeemed the Senior Notes prior to their maturity date of November 10, 2016, (see Subsequent Events).
Borrowings under the Credit Agreement are collateralized by the unencumbered assets of Parkview Transit, STA Holdings and its subsidiaries, and certain shares of the capital stock of STA Holdings and the capital stock of each of its subsidiaries. In addition, payment and performance of the obligations under the Credit Agreement are guaranteed by each of STA Holdings’ subsidiaries and by Parkview Transit. Borrowings under the Senior Secured Notes are collateralized by the unencumbered assets of STA Holdings and its U.S. subsidiaries, and certain shares of the capital stock of STA Holdings and the capital stock of each of its U.S. subsidiaries. In addition, payment and performance of the obligations under the Senior Secured Notes are guaranteed by each of STA Holdings’ U.S. subsidiaries.
At June 30, 2016, debt outstanding under the Credit Agreement and Senior Secured Notes totaled $120.1 million and $35.0 million, respectively. At June 30, 2016, the Company had approximately $102.8 million in borrowing availability under the loan facilities, subject to continued covenant compliance, of the Credit Agreement (excluding the $100.0 million accordion feature in additional commitments the Company may request under the Credit Agreement). In addition, at June 30, 2016, outstanding debt included approximately $117.7 million in Convertible Debentures.
Convertible Debentures
During the fiscal years ended June 30, 2010, 2011 and 2014, STI closed the Convertible Debentures offerings and on December 21, 2009, the Company redeemed for cash all of the outstanding 14% subordinated notes of STA ULC as discussed above under the heading “General”.
The Cdn$ 6.75% Convertible Debentures had a five year term, were denominated in Canadian dollars, and were due and payable on June 30, 2015. During fiscal year 2015, Cdn $0.1 million of the Company’s Cdn$ 6.75% Convertible Debentures were converted into 18,342 shares of common stock. On June 30, 2015, the Company repaid upon maturity the remaining Cdn $49.9 million in principal amount of Cdn$ 6.75% Convertible Debentures for US$ 40.1 million in cash. The US$ 6.25% Convertible Debentures have a seven year term, are denominated in U.S. dollars, are due and payable on June 30, 2018, and are callable by the Company beginning in July 2014 if certain conditions noted above, are met. The Company did not redeem and none of the holders have converted any of the US$ 6.25% Convertible Debentures as of June 30, 2016. The Cdn$ 6.25% Convertible Debentures have a five and a half year term, are denominated in Canadian dollars, are due and payable on June 30, 2019, and are callable by the Company beginning in July 2017, if certain conditions noted above, are met. None of the holders have converted any of the Cdn$ 6.25% Convertible Debentures as of June 30, 2016. Subsequent to June 30, 2016, the Company exercised its right to redeem the US$ 6.25% Convertible Notes in their entirely (see Subsequent Events).
The functional currency of STI is the Canadian dollar. The Cdn$ 6.75% Convertible Debentures were and the Cdn$ 6.25% Convertible Debentures of STI are denominated in Canadian dollars. As the functional currency of STI is the Canadian dollar, exchange gains or losses related to
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the Cdn$ 6.75% Convertible Debentures and the Cdn$ 6.25% Convertible Debentures on the translation of the STI financial statements into U.S. dollars, the reporting currency, are deferred as a separate component of shareholders’ equity. The US$ 6.25% Convertible Debentures of STI are denominated in U.S. dollars. As the functional currency of STI is the Canadian dollar, unrealized gains or losses on re-measurement of the US$ 6.25% Convertible Debentures into Canadian dollars are considered transaction gains and losses, at the STI level, and are included in the consolidated statement of operations. On April 1, 2013, the Company put in place an intercompany loan associated with the payments of proceeds on the US$ 6.25% Convertible Debentures by STI to STA Holdings. This intercompany loan is denominated in U.S. dollars, bears interest at a rate of 6.25% per annum and has a set maturity date of June 30, 2018. As such, this intercompany loan is considered a short-term intercompany loan (as the loan is for a definite term), and unrealized gains or losses on re-measurement of the STI intercompany loan receivable are considered transaction gains or losses as STI’s functional currency is the Canadian dollar and are included in the consolidated statement of operations. The re-measurement gains and losses resulting from this intercompany loan offset re-measurement gains and losses resulting from the US$ 6.25% Convertible Debentures in the consolidated statement of operations.
The Company expects to be able to repay, renew or refinance its various loan facilities and Convertible Debentures as they become due with other long term financing options (see “Forward-Looking Statements”).
Leasing Arrangements
During the fiscal year ended June 30, 2015, the Company entered into additional operating leases with seven major financial institutions to lease approximately $38.7 million in replacement school vehicles and $38.3 million in growth school vehicles for the 2014-2015 school year. The term of these leases is six years at effective fixed rates in the range of 2.7% to 4.4%. Annual lease payments on these additional leases will approximate $11.2 million per year for the term of the leases.
During the fiscal year ended June 30, 2016, the Company entered into additional operating leases with ten major financial institutions to lease approximately $58.3 million in replacement school vehicles and $22.0 million in growth school vehicles for the 2015-2016 school year. The term of these leases is six years at effective fixed rates in the range of 2.6% to 4.2%. Annual lease payments on these additional leases will approximate $11.3 million per year for the term of the leases.
During July and August 2016, the Company entered into additional operating leases with nine major financial institutions to lease approximately $34.8 million in replacement school vehicles and $10.0 million in growth school vehicles for the upcoming 2016-2017 school year. The term of these leases is six years at effective fixed rates in the range of 2.0% to 3.6%. Annual lease payments on these additional leases will approximate $6.0 million per year for the term of the leases.
Acquisitions and Investments
On December 5, 2014 the Company acquired certain assets and a contract of Dalton Bus Lines in Ontario, Canada, for approximately $0.4 million. Earnings of the acquired company were included in the Company’s results of operations from the acquisition date.
On March 11, 2015 a wholly-owned subsidiary of the Company made a non-controlling investment in a consulting and management services firm for cash consideration of $1.7 million. The Company has accounted for this investment under the equity method, in accordance with ASC- 323, Investments-Equity Method and Joint Ventures.
During January and February 2016, a wholly-owned subsidiary of the Company purchased
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the remaining interest in the transportation consulting and management services firm and acquired a second consulting services firm. Combined, total consideration for both firms approximated $7.2 million, consisting of $6.2 million in cash and $1.0 million in common stock. The Company had previously invested $1.7 million in March 2015, to acquire a non-controlling interest in the first transportation consulting and management service firm as discussed above. Earnings of the acquired companies were included in the Company’s results of operations from the acquisition dates.
The Company intends to selectively acquire contracts through new bids and conversions and to pursue additional acquisitions to the extent that it is able to finance these from operating cash flows, available financing under our Credit Facility and the potential additional issuance of common shares and debt securities (see “Forward-Looking Statements”).
Fuel Prices
The Company operates a fleet of approximately 13,000 vehicles as at June 30, 2016 and consumes substantial amounts of fuel for its operations. While the Company currently has fuel mitigation features in approximately 60% of its contracts that provide some measure of fuel protection against price increases, ranging from reimbursement by the school district to outright purchase of fuel by school districts, there is no assurance that it will be able to adequately protect itself from increases in such costs other than those contractually obligated. The Company is still exposed to some market price fluctuations under some of these fuel mitigation features. As noted above, the Company also endeavors to lock in an additional 20% of its fuel exposure with fixed rate contracts, while the final 20% of fuel exposure is fully subject to market price variations. The Company, for fiscal year 2015, entered into fixed price contracts, in August of that fiscal year with fuel suppliers to cover the approximately 20% of its fuel exposure, prior to the decline in market prices that occurred in the October through December period of fiscal year 2015. For fiscal year 2016, the Company entered into fixed price contracts with fuel vendors starting in October 2014 (the period of fiscal 2015 when market prices started to decline), for the approximately 20% of its fuel exposure locked in for fiscal year 2016. In August and November 2015, the Company locked in approximately 15% of its fuel exposure for fiscal year 2017. In July 2016, the Company locked in one third of the approximately 20% of its fuel exposure for the 2018 fiscal year.
Segment Information ($ in 000’s)
As a result of the Canadex Acquisition, the Company has two reportable segments, a transportation segment and an oil and gas segment. The transportation segment provides school bus and management services to public and private schools in North America. The oil and gas segment represents the Company’s investments as a non-operator in oil and gas interests in the United States.
| For the three months ended June 30, 2016 | For the three months ended June 30, 2015 | For the twelve months ended June 30, 2016 | For the twelve months ended June 30, 2015 | |||||||||||||
Revenue | ||||||||||||||||
Transportation | $ | 165,860 | $ | 151,973 | $ | 598,807 | $ | 551,861 | ||||||||
Oil and gas | 330 | 481 | 1,387 | 2,890 | ||||||||||||
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| $ | 166,190 | $ | 152,454 | $ | 600,194 | $ | 554,751 | |||||||||
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Operating earnings (losses) | ||||||||||||||||
Transportation | $ | 12,652 | $ | 10,788 | $ | 26,733 | 17,702 | |||||||||
*Oil and gas | (717 | ) | (219 | ) | (3,137 | ) | (540 | ) | ||||||||
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| 11,935 | 10,569 | 23,596 | 17,162 | |||||||||||||
Unallocated expenses | 2,646 | 1,655 | 14,721 | 13,423 | ||||||||||||
Income tax expense | 3,011 | 1,934 | 2,838 | 84 | ||||||||||||
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Net income | $ | 6,278 | $ | 6,980 | $ | 6,037 | $ | 3,655 | ||||||||
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| * | The oil and gas operating results include an impairment charge of $0.4 million dollars and $1.6 million dollars for the quarter ended and fiscal year ended June 30, 2016, respectively. |
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| As at June 30, 2016 | As at June 30, 2015 | |||||||
Total Assets | ||||||||
Transportation | $ | 542,221 | $ | 527,291 | ||||
Oil and gas | 6,108 | 8,636 | ||||||
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| $ | 548,329 | $ | 535,927 | |||||
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Commitments and Contractual Obligations
Commitments and contractual obligations primarily include obligations associated with outstanding indebtedness and lease obligations. The following table shows contractual obligations and commitments related to the outstanding indebtedness as of June 30, 2016 and the related payment by period due.
Maturities of long-term debt are as follows ($ in 000’s) (see Subsequent Events):
| Third Amended Credit Facility | Convertible Debentures | Senior Secured Notes | Total | |||||||||||||
Year ending June 30, | ||||||||||||||||
2017 | $ | — | $ | — | $ | 35,000 | $ | 35,000 | ||||||||
2018 | — | 59,633 | — | 59,633 | ||||||||||||
2019 | — | 58,063 | — | 58,063 | ||||||||||||
2020 | 120,129 | — | — | 120,129 | ||||||||||||
2021 | — | — | — | — | ||||||||||||
thereafter | — | — | — | — | ||||||||||||
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| $ | 120,129 | $ | 117,696 | $ | 35,000 | $ | 272,825 | |||||||||
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The maturity date of the Credit Agreement was extended by amendment in August 2014 to August 19, 2019 or if earlier, 90 days prior to the maturity of the Senior Secured Notes. Subsequent to June 30, 2016, the Company amended the Credit Agreement to increase commitments and extend the maturity date back to five years (see Subsequent Events).
The following table represents future minimum rental payments and operating lease payments under non-cancelable operating leases as at June 30, 2016 ($ in 000’s):
| Facility Leases | Vehicle Leases | Total | ||||||||||
Year ending June 30, | ||||||||||||
2017 | $ | 15,039 | $ | 36,296 | $ | 51,335 | ||||||
2018 | 9,523 | 33,101 | 42,624 | |||||||||
2019 | 7,232 | 28,825 | 36,057 | |||||||||
2020 | 3,613 | 22,617 | 26,230 | |||||||||
2021 | 1,883 | 11,531 | 13,414 | |||||||||
2022 and thereafter | 1,846 | 1,215 | 3,061 | |||||||||
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Total minimum payments | $ | 39,136 | $ | 133,585 | $ | 172,721 | ||||||
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If the operating leases for vehicles were treated as capital leases, the senior debt and total debt would approximate $345.3 million and $463.0 million, respectively as at June 30, 2016. Further, the senior debt to EBITDA ratio (as defined in the Credit Agreement and adjusted for capitalization of vehicle leases) would increase 0.6:1, and the total debt to EBITDA ratio would increase 1.1:1.
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Outstanding Share Data
As at June 30, 2016, the Company had 91,903,515 issued and outstanding common shares, US $60.0 million principal amount of US$ 6.25% Convertible Debentures convertible into approximately 6.3 million common shares and Cdn $75.0 million principal amount of Cdn$ 6.25% Convertible Debentures convertible into approximately 8.3 million common shares. There are no preferred shares issued and outstanding. (see “Liquidity and Capital Resource-Convertible Debentures” and “Subsequent Events”).
Quantitative and Qualitative Disclosures About Market Risk
As noted in the cautionary language concerning forward-looking disclosures under the heading “Forward-Looking Statements” in this management discussion and analysis, this section contains forward-looking statements, including with respect to the Company’s anticipated dividends. Such statements involve known and unknown risks, uncertainties and other factors outside of management’s control, including the risk factors set forth in this management discussion and analysis that could cause results to differ materially from those described or anticipated in the forward-looking statements.
In the normal course of business, the Company is exposed to market risks arising from adverse changes in interest rates and the Cdn$/US$ foreign currency exchange rate. Market risk is defined for these purposes as the potential change in the fair market value of financial assets and liabilities resulting from an adverse movement in these rates. Except for the changes in the Cdn$/US$ foreign currency exchange rate during the fiscal year 2016, there have been no other material changes to the Company’s exposure to the above-mentioned market risks during the fiscal year 2016.
As at June 30, 2016, the Company’s material variable rate borrowings included the outstanding borrowings under the Credit Agreement. As at June 30, 2016, the Company had $120.1 million in outstanding indebtedness under the Credit Agreement. The Company has an interest rate swap in place for a notional amount of $50.0 million to swap the variable rate to a fixed rate for $50.0 million in borrowings under the Credit Agreement. (see “Liquidity and Capital Resource-Convertible Debentures”). A 100 basis point change in interest rates, applied to these net borrowings as at June 30, 2016 would result in approximately a $0.7 million annual change in interest expense and a corresponding change in cash flow.
In connection with the dividends on the common shares issued, the Company was exposed to fluctuations in the exchange rate between the Canadian dollar and the U.S. dollar because the anticipated dividends from STA, Inc. to STA Holdings are in U.S. dollars and the currently anticipated dividends on common shares were paid in Canadian dollars. The Company used foreign currency exchange contracts (“Forward Contracts”) to partially mitigate this exchange rate risk. Given that the majority of the Company’s cash flows continue to be denominated in U.S. dollars, in May 2015, the Board of Directors of the Company approved a change in the currency of the monthly dividend to U.S dollars, effective July 1, 2015. At that time the Forward Contracts outstanding, which had been used to mitigate the exchange risk, were liquidated.
The Cdn$ 6.25% Convertible Debentures due June 30, 2019 are denominated and payable, upon maturity, in Canadian dollars. The Company has not entered into any hedge arrangement with respect to the payment of the Cdn$ 6.25% Convertible Debentures upon maturity. The Company uses it cash flows from its Canadian operations to partially mitigate the exchange risk on the Convertible Debenture interest payments.
The Company is also exposed to changes in the market price of fuel in the ordinary course of business. As a partial mitigation of the impact of fuel price volatility on the Company’s results, approximately 60% of the Company’s revenue contracts have some form of mitigation against fuel
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price increase, ranging from reimbursement by the school district to outright purchase of fuel by school districts. The Company is still exposed to some market price fluctuations under some of these fuel mitigation features. The Company, for fiscal year 2015, entered into fixed price contracts, in August of that fiscal year with fuel suppliers to cover the approximately 20% of its fuel exposure, prior to the decline in market prices that occurred in the October through December period of fiscal year 2015. For fiscal year 2016, the Company entered into fixed price contracts with fuel vendors starting in October 2014 (the period of fiscal 2015 when market prices started to decline), for the approximately 20% of its fuel exposure locked in for fiscal year 2016. In August and November 2015, the Company locked in approximately 15% of its fuel exposure for fiscal year 2017. In July 2016, the Company locked in one third of the approximately 20% of its fuel exposure for the 2018 fiscal year.
Summary of Quarterly Results ($ in 000’s, except per share data)
| 1st Qtr 2015 | 2nd Qtr 2015 | 3nd Qtr 2015 | 4th Qtr 2015 | 1st Qtr 2016 | 2nd Qtr 2016 | 3rd Qtr 2016 | 4th Qtr 2016 | |||||||||||||||||||||||||
Revenues | $ | 88,532 | $ | 157,451 | $ | 156,314 | $ | 152,454 | $ | 93,383 | $ | 167,380 | $ | 173,241 | $ | 166,190 | ||||||||||||||||
Net income (loss) | $ | (8,755 | ) | $ | 3,537 | $ | 1,893 | $ | 6,480 | $ | (9,543 | ) | $ | 6,017 | $ | 3,769 | $ | 6,278 | ||||||||||||||
Net income (loss) per share | $ | (0.11 | ) | $ | 0.04 | $ | 0.02 | $ | 0.07 | $ | (0.10 | ) | $ | 0.06 | $ | 0.04 | $ | 0.07 | ||||||||||||||
Seasonality
School bus transportation revenue has historically been seasonal, based on the school calendar and holiday schedule. During the summer school break, revenue is derived primarily from summer camps and private charter services. As schools are not in session, there is minimal school bus transportation revenue during this period. Thus, the Company incurs operating losses during the first three months of the fiscal year, which encompass the summer school break. Depreciation of fixed assets occurs in the months during which schools are in session, which is generally September through June. A full year’s worth of depreciation is recorded in these ten months to correspond to the vehicle’s usage.
Disclosure Controls and Procedures and Internal Controls over Financial Reporting
Under the supervision of, and with the participation of the CEO and the CFO, management performed an evaluation of the effectiveness of the Company’s disclosure controls and procedures, which are designed to provide reasonable assurance that material information relating to the Company (including its subsidiaries) is made known to the CEO and the CFO by others within the Company. Based on that evaluation, the CEO and the CFO have concluded that the design and operation of these disclosure controls and procedures as of June 30, 2016 were effective.
Under the supervision of, and with the participation of, the CEO and the CFO of the Company, management performed an evaluation of the effectiveness of the Company’s internal controls over financial reporting in order to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Based on that evaluation, the CEO and the CFO have concluded that the design and operation of the internal controls over financial reporting as of June 30, 2016 were effective.
In addition, we have evaluated our internal controls over financial reporting and determined that no changes were made in the Company’s internal controls over financial reporting during the twelve months ended June 30, 2016, that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting. Management is, however, continually monitoring and seeking to improve the Company’s infrastructure and controls.
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Transactions with Related Parties
The Company utilized a transportation equipment dealer, primarily to assist in procurement and disposal of the Company’s fleet under the direction of the Company’s CFO. The transportation equipment dealer also provided consulting services to the Company, assisting with fleet valuations in its acquisition efforts. The transportation equipment dealer was a company controlled by a family member of the Company’s Chairman and CEO. Beginning in fiscal year 2015, the fleet procurement and disposal services were provided for an annual fee including a retainer amount plus a commission per vehicle amount not to exceed $0.5 million per annum. Prior to fiscal year 2015, these services were provided on a non-contractual basis. The Company paid the transportation equipment dealer $0.5 million for the ended June 30, 2015. In April 2015, the Company terminated the agreement and began to perform these services directly with internal resources.
These transactions were measured at the exchange amount which is the amount of consideration established and agreed to by the related parties.
Subsequent Events
As noted in the cautionary language concerning forward-looking disclosures under the heading “Forward-Looking Statements” in this management discussion and analysis, this section contains forward-looking statements, including with respect to the Company’s EIP and lease payments. Such statements involve known and unknown risks, uncertainties and other factors outside of management’s control, including the risk factors set forth in this management discussion and analysis that could cause results to differ materially from those described or anticipated in the forward-looking statements.
On July 2, 2016, STA Holdings granted 147,596 Class B Series Three common shares pursuant to the EIP. The Company will recognize non-cash stock-based expense related to these grants during the quarter ending September 30, 2016.
On July 27, 2016 the Company entered into a Fourth Amended and Restated Credit Agreement. The new amended credit facility increased the commitments to $340.0 million (US $290.0 million and Canadian $50.0 million), from the previous commitments of $225.0 million and extended the maturity date to July 27, 2021. The increase in the size of the facility resulted from the addition of two new lenders to the bank group and certain existing lenders increasing their commitments. The new amended facility also provides for a US$100 million “accordion feature”, which provides access to a larger facility should it be needed in the future. The Company used drawings under the credit agreement in part to repurchase the US $35 million Senior Secured Notes due November 10, 2016.
On August 1, 2016, the Company provided notice for the early redemption and settlement of the Senior Secured Notes due November 10, 2016. On September 1, 2016, the Company redeemed the Senior Secured Notes for $35.0 million in cash in accordance with the Note Purchase Agreement dated December 14, 2006, between the Company, Sun Life Assurance Company of Canada, London Life Insurance Company and Computershare Trust Company, N.A., governing the Senior Secured Notes.
On August 16, 2016, the Company issued the Cdn$ 5.25% convertible unsecured subordinated debentures due September 30, 2021 at a price of $1,000 per debenture, for total gross proceeds of $65.8 million (Cdn $85.0 million). The net proceeds of the 5.25% convertible unsecured subordinated debentures will primarily be used pay off existing long term debt and for general corporate purposes.
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On August 23, 2016, the Company announced that it called for the early redemption and settlement of the 6.25% US convertible unsecured subordinated debentures due June 30, 2018. On September 19, 2016 the Company will redeem the $60.0 million of 6.25% US convertible unsecured subordinated debentures for $60.0 million in cash in accordance with the Trust Indenture dated June 7, 2011, between STI and Computershare Trust Company of Canada governing the 6.25% US convertible unsecured debentures.
During July and August 2016, the Company entered into additional operating leases with nine major financial institutions to lease approximately $44.8 million in growth and replacement school vehicles for the upcoming 2016-2017 school year. The term of these leases is six years at effective fixed rates in the range of 2.0% to 3.6%. Annual lease payments on these additional leases will approximate $6.0 million per year for the term of the leases.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Some of the estimates and assumptions management is required to make relate to matters that are inherently uncertain as they may pertain to future events. Management bases these estimates on historical experience and on various other assumptions that it believes to be reasonable and appropriate. Actual results may differ significantly from these estimates. The following is a description of our accounting policies that we believe require subjective and complex judgments, and could potentially have a material effect on reported financial condition and results of operations.
Goodwill and Indefinite Lived- Intangibles.Goodwill represents the excess of cost over fair value of net assets acquired in business combinations accounted for under the purchase method. Goodwill and trade names are not amortized but rather assessed for impairment annually or more frequently if circumstances change and indicators of impairment are present. The annual impairment testing is performed in the fourth quarter.
When assessing goodwill impairment, the Company may at its option perform a qualitative assessment to first assess whether the fair value of a reporting unit is less than its carrying value. If the Company does not choose to perform a qualitative assessment, a two step impairment test is required. The Company first compares the fair value of the reporting unit with its carrying value, including goodwill. If the carrying value exceeds the fair value, the carrying value is then compared to the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss will be recognized in the statement of earnings in an amount equal to the difference and the implied fair value of goodwill becomes the new carrying value of goodwill for that reporting unit which is then used in future impairment tests.
When assessing the impairment for trade names, if the carrying value exceeds the fair value, an impairment loss will be recognized in the statement of earnings in an amount equal to the excess.
Fair values are derived by using discounted cash flow analyses which requires, among other factors, estimates of the amount and timing of projected cash flows and the appropriate discount rate.
Other identifiable intangible assets consist of contract rights and covenants not to compete. Contract rights, which include customer relationships, are amortized on a straight-line basis over an estimated useful life of 20 to 23 years. The useful life for contract rights was determined based on third party valuation reports prepared for the Company. The valuations took into account the average length of the contracts, the expected renewal periods and assumptions regarding future renewals based upon historical customers lives. Covenants not to compete are amortized on a straight-line basis over an estimated useful life of two to five years.
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Impairment of Long-Lived Assets.Management continually evaluates whether events or circumstances have occurred that indicate that the remaining estimated useful lives of property and equipment, contract rights and covenants not to compete may warrant revision or that the remaining balances may not be recoverable. Events or circumstances that would trigger testing for impairment include, but are not limited to, the loss of a significant school district customer contract, a significant increase in the Company’s expense levels absent a corresponding increase in revenue that causes operating or cash flow losses or projected operating or cash flow losses, significant adverse changes in legal factors or the business climate in which the Company operates that could affect the value of long-lived assets, or the expectation that a long-lived asset will be sold or otherwise disposed of at a loss before the end of its previously estimated useful life. If this review indicates that the assets will not be recoverable, as determined based on the undiscounted future cash flows from the use of the assets, the carrying value of the assets will be reduced to their estimated fair value.
Insurance Reserves.The Company’s insurance reserves reflect the estimated deductible amounts the Company is responsible for under the workers’ compensation and vehicle liability insurance programs. Our insurance expense for these items is largely dependent on our claims experience and our ability to control such claims, the actuarial development of claims to their select ultimate, in addition to third party premiums/expenses associated with this coverage. We have recorded estimated insurance reserves for the anticipated losses on open claims under the workers’ compensation and vehicle liability programs based upon actuarial analysis prepared by an independent third party actuary. Although the estimates of these accrued liabilities are based on the factors mentioned above, it is possible that future cash flows and results of operations could be materially affected by changes in our assumptions or changes in claims experience and development.
Stock Based Compensation.The Company accounts for stock-based compensation and other stock-based payments using the fair value method. Under the fair value method, the fair value of the stock based compensation and other stock-based payments are estimated at the grant date and the total fair value is amortized over the vesting schedule of the awards as compensation expense. The Class B common shares issued by STA Holdings are fully vested on the grant date, and, as such, the Company recognizes compensation expense when the shares are issued. These shares are accounted for as a liability upon issuance and re-measured at fair value on a quarterly basis. Changes in fair value are recorded in the Consolidated Statement of Operations.
The Class B common shares are not traded in an active market and have certain restrictions on their transferability. These shares are accounted for as a liability upon issuance, as a result of a put option they contain. The put option provides for a fair market value of Class B Series Three common shares put at an amount equal to the weighted average trading price of the STI common shares for the ten consecutive trading days immediately prior to the date of put. Stock based compensation expense associated with the issuance of Class B Series Three common shares is based on the trading value of the STI common shares at the date of grant, similar to the fair value of such common shares in connection with the put option values described above.
Income Taxes.Income taxes have been computed utilizing the asset and liability approach, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using the currently enacted tax rates expected to be in effect for the years in which those taxes are expected to be realized or settled. A valuation allowance is recorded to reduce deferred tax assets to the amount that is believed to be more likely than not to be realized. The recorded deferred income tax liability results from a difference between the book and tax basis of certain transportation equipment, other equipment and intangible assets.
The Company uses judgment in determining income tax provisions and in evaluating its tax positions under the accounting guidance for income taxes. Additional provisions for income taxes are established when, despite the belief that tax positions are fully supportable, there remain certain
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positions that do not meet the minimum probability threshold, which is a tax position that is more-likely-than-not to be sustained upon examination by the applicable taxing authority. The Company and its subsidiaries are examined by various federal and state tax authorities. The Company regularly assesses the potential outcomes of these examinations and any future examinations for the current or prior years in determining the adequacy of its provision for income taxes. The Company continually assesses the likelihood and amount of potential adjustments and adjusts the income tax provision, the current tax liability and deferred taxes in the period in which the facts that give rise to a revision become known.
Accounting for Derivatives and Hedging Activities.The Company records its derivatives at fair value on the balance sheet, which requires that a company take into account its own credit risk and the credit risk of the counterparty when determining the fair value of financial assets and financial liabilities, including derivative instruments. Changes in fair value will be recorded in the statement of operations or through other comprehensive income depending on the nature of the derivative instrument. The Company did not elect hedge accounting for any of its derivative financial instruments and therefore records all changes in fair value in the income statement. The Company has offset the fair value amounts recorded on its forward foreign currency contracts executed with the same counterparty under an executed master netting arrangement.
Foreign Currency Translation:Monetary assets and liabilities denominated in a currency other than the functional currency are translated at the rate of exchange prevailing at the balance sheet date. Transactions denominated in a currency other than the functional currency are translated at the rate of exchange prevailing on the transaction date. Gains and losses on translation of these items are considered transaction gain and losses and are included in the consolidated statements of operations in foreign currency (gain) loss.
The functional currency of STI and the Company’s Canadian operations is the Canadian dollar. The functional currency of the Company’s operations in the United States is the U.S. dollar. The Company’s financial statements are reported in U.S. dollars, as the principal operations and cash flows of its subsidiaries are conducted in U.S. dollars. As a result, the assets and liabilities of the Company, and the Company’s Canadian operations are translated into U.S. dollars using the exchange rate in effect at the period end and revenues and expenses are translated at the average rate during the period. Exchange gains or losses on translation are deferred as a separate component of shareholders’ equity. The Cdn$ 6.75% Convertible Debentures were and the Cdn$ 6.25% Convertible Debentures of STI are denominated in Canadian dollars. As the functional currency of STI is the Canadian dollar, exchange gains or losses related to the Cdn$ 6.75% Convertible Debentures and the Cdn$ 6.25% Convertible Debentures on the translation of the STI financial statements into U.S. dollars, the reporting currency, are deferred as a separate component of shareholders’ equity. The US$ 6.25% Convertible Debentures of STI are denominated in U.S. dollars. As the functional currency of STI is the Canadian dollar, unrealized gains or losses on re-measurement of the US$ 6.25% Convertible Debentures into Canadian dollars are considered transaction gains and losses, at the STI level, and are included in the consolidated statement of operations.
Foreign currency transactions gains and losses, related to short-term related intercompany loans are recorded in the Consolidated Statement of Operations as incurred. Foreign currency transaction gains and losses for intercompany loans that are considered long-term in nature are recorded in Accumulated Other Comprehensive Loss as incurred.
Oil and Gas Reserve Estimates. Estimates of oil and gas reserves in the consolidated financial statements are prepared through reserve engineering, which is a subjective process of estimating underground accumulations of oil and natural gas that cannot be measured in an exact manner. The process relies on interpretations of available geographical, geophysical, engineering and production data. The accuracy of a reserve estimate is a function of the quality and quantity of available data, the interpretation of that data, the accuracy of various mandated economic assumptions and the judgment of the persons preparing the estimate.
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The Company’s reserve information is based on estimates prepared by independent oil and gas industry consultants. Estimates prepared by others may be different than these estimates. Because these estimates depend on many assumptions such as projected future rates of production, estimated commodity price forecasts and the timing of future expenditures, all of which may differ from actual results, reserve estimates may be different from the quantities of oil and gas that are ultimately recovered. In addition, the results of drilling, testing and production after the date of an estimate may justify revisions to the estimate.
The present value of future net oil and gas revenues should not be assumed to be the current market value of the Company’s estimated oil and gas reserves. Actual future prices, costs and reserves may be materially higher or lower than the prices, costs and reserves used for the future net revenue calculations. Reserve estimates can have a significant impact on earnings, as they are a key component in the calculation of oil and gas depreciation and depletion.
A downward revision in the reserve estimate could result in a higher depreciation and depletion charge to earnings. In addition, if the net capitalized costs are determined to be in excess of the calculated ceiling, which is based largely on reserve estimates, the excess must be written off as an expense charged against earnings.
Asset Retirement Obligations. The asset retirement obligation provision recorded in the consolidated financial statements is based on estimates of total costs for future restoration and abandonment of oil and natural gas wells and facilities, as well as estimates of when these costs will occur. The estimates are based on the Company’s net ownership interest in the wells. Estimating these future costs requires management to make estimates and judgments that are subject to future revisions based on numerous factors, including changing technology and political and regulatory environments.
Risk Factors
The following section describes both general and specific risks that could affect our financial performance. The risks described below are not the only risks facing the Company. Additional risks and uncertainties that are not currently known or that are currently considered to be immaterial may also materially and adversely affect the Company and our business operations. If any of these risks actually occur, the Company’s business, financial conditions, results of operations and cash flow could be adversely affected, in which case the trading prices of the Common Shares and the Convertible Debentures would decline.
Risks Related to our Business
We cannot control certain of our operating expenses
The price of fuel, insurance costs and maintenance costs are operating expenses over which we have little or no control. Although certain of our customer contracts provide for automatic price increases or other forms of protection against fuel price and/or insurance cost increases, significant increases in the price of fuel, insurance or maintenance could affect our costs as well as the affordability of our services to our customers of our services. Similarly, depending on the availability of qualified drivers and the level of competition with other businesses for their services, we may have little control over the labour costs for our drivers. Any difficulties in attracting and retaining qualified drivers could affect our costs and, ultimately, result in the loss of customer contracts due to the inability to service the contract. Accordingly, a significant escalation in our operating expenses or in the inability to attract and retain qualified drivers could have a material adverse effect on us, our financial condition, results of operations and cash flows.
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We have significant capital expenditure requirements
In order to maintain our school bus fleet, and to expand our business pursuant to our business strategy, we are required to make significant capital expenditures. There can be no assurance that cash flow from operations will enable us to acquire a sufficient number of new vehicles or make capital expenditures necessary to implement any expansion of service. If we are required to obtain additional financing, there can be no assurance that we can obtain financing on terms acceptable to us. Our inability to have sufficient cash flows or procure the financing necessary to acquire additional school buses or make needed capital improvements could delay or prevent us from implementing our business strategy and would have a material adverse effect on us. Future maintenance capital expenditures are dependent on a number of future events. The future replacement of school vehicles will be dependent on contract retention and renewal and will also be dependent on the number of new contracts secured through acquisitions, new bids and conversions and the renewal of current contracts. If current contracts are not renewed, or only a portion are renewed, i.e. the number of net new contracts is higher or lower than expected, the assumed level of maintenance capital expenditures will be significantly different from the level currently anticipated. In addition, future expenditures will also depend on future vehicle pricing, negotiating ability with regard to future vehicles pricing, and future vehicle specifications.
The Company’s consolidated indebtedness could negatively impact the business
On June 30, 2016, the Company had total indebtedness of $272.8 million (including $117.7 million indebtedness to holders of Debentures).
The degree to which the Company is leveraged on a consolidated basis could have important consequences to the holders of Common Shares and Debentures, including:
| • | the Company’s ability in the future to obtain additional financing for working capital, capital expenditures or other purposes may be limited; |
| • | the Company may be unable to refinance indebtedness on terms acceptable to it or at all; |
| • | a significant portion of the Issuer’s cash flow (on a consolidated basis) is likely to be dedicated to the payment of the principal of and interest on the Company’s indebtedness, including the Convertible Debentures, thereby reducing funds available for future operations, capital expenditures and/or dividends on the Common Shares; |
| • | the Company may be more vulnerable to economic downturns and be limited in our ability to withstand competitive pressures; |
| • | the Company may be limited in its ability to plan for or react to changes in its business or the industry in which it operates; and |
| • | the Company may be at a competitive disadvantage to its competitors that have less indebtedness. |
The restrictive covenants in the Credit Agreement could impact the Company’s business and affect its ability to pursue its business strategies
The Credit Agreement features restrictive covenants that limit the Company’s ability, among other things, to:
| • | incur additional indebtedness; |
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| • | pay dividends and make distributions in respect of the Company’s equity or to make certain other restrictive payments or investments; |
| • | sell assets; |
| • | consolidate, merge, sell or otherwise dispose of all or substantially all of the Company’s assets; |
| • | enter into transactions with the Company’s and/or the Issuer’s affiliates; |
| • | create liens; and |
| • | enter into new lines of businesses. |
In addition, the Credit Agreement also includes other and more restrictive covenants and prohibits the Company and certain of its affiliates from prepaying its other indebtedness, while debt under the Credit Agreement is outstanding. The Credit Agreement also requires the Company to achieve specified financial and operating results and maintain compliance with specified financial ratios. The Company’s ability to comply with these ratios may be affected by events beyond its control.
A breach of any of the restrictive covenants in the Credit Agreement or in the Company’s ability to comply with the required financial ratios could result in a default under the Credit Agreement. If a default occurs, the lenders under the Credit Agreement may elect to declare all borrowings outstanding under the facility, together with accrued interest and other fees, to be immediately due and payable.
We may not be able to make all principal payments on the Convertible Debentures
The Cdn$ 6.25% Convertible Debentures will mature on June 30, 2019 and the Cdn$ 5.25% Convertible Debentures will mature on September 30, 2021. STI may not be able to refinance the principal amount of the Convertible Debentures in order to repay the principal outstanding or may not have generated enough cash from operations to meet this obligation. There is no guarantee that STI will be able to repay the outstanding principal amount upon maturity of the Convertible Debentures.
As a result of the subordinated nature of the guarantees of the Debentures, upon any distribution to creditors of the Company in a bankruptcy, liquidation or reorganization or similar proceeding relating to the Company or its property or assets, the holders of the Company’s senior indebtedness will be entitled to be paid in full in cash before any payment may be made with respect to the Debentures.
On August 23, 2016, the Company called for the redemption and settlement of the US$ 6.25% Convertible Debentures, which is scheduled to occur on September 19, 2016. To the extent the US$ 6.25% Convertible Debentures are not so redeemed and settled, references to the Convertible Debentures in these Risk Factors shall be deemed to also include the US$ 6.25% Convertible Debentures.
Our business objectives and growth strategy may be affected by factors outside of our control
Some of the factors that may affect our ability to successfully achieve our business objectives are the following:
| • | notwithstanding our high retention rate of renewable contracts, we may be unable to retain certain of our existing customer contracts, or we may only be able to renew them at minimal or no price increase, or price reductions, reducing profitability. Specifically, the decision to |
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renew contracts is not made solely by us and may be based upon factors beyond our control. Accordingly, there can be no assurance that any of our current or future contracts will be extended, or if extended, that the rates of compensation for such extensions will be acceptable to us. Moreover, there can be no assurance that the school districts that currently employ our services will not seek to satisfy their transportation needs in the future by alternative means, including reducing or eliminating transportation services. We had 114 contracts that were up for renewal for fiscal year 2016. The approximate percentages of fiscal year 2016 revenue that are up for renewal (including annual contract renewals in New Jersey) for fiscal years 2017 and 2018 are 28% and 29%, respectively. |
| • | we may be unable to find suitable businesses to acquire or to successfully complete acquisitions on profitable terms or to successfully integrate acquired businesses; and |
| • | we may be unable to identify conversion opportunities or win bid contracts on profitable terms or to find adequate facilities to operate conversion or bid contracts won. |
Please see “We face a number of risks in connection with our acquisition strategy” and “Some of our customer contracts may be terminated due to factors beyond our control” in these Risk Factors for a fuller discussion of these matters.
We face a number of risks in connection with our acquisition strategy
As part of our business strategy, we have expanded through acquisitions and will likely acquire additional businesses in the future. The acquisition and development of existing businesses to be operated by us will be dependent on our ability to identify, acquire and develop suitable acquisition targets in both new and existing markets. While we are careful in selecting the businesses that we acquire, and while the sellers of these businesses routinely execute indemnities in our favour relating to pre-closing liabilities, acquisitions involve a number of risks, including (i) the possibility that we, as successor owner, may be legally and financially responsible for liabilities of prior owners if the indemnities are inapplicable or the former owner has limited assets; (ii) the possibility that we pay more than the acquired company or assets are worth; (iii) the additional expense associated with completing an acquisition and amortizing any acquired intangible assets; (iv) the difficulty of assimilating the operations and personnel of the acquired business; (v) the challenge of implementing uniform standards, controls, procedures and policies throughout the acquired business; (vi) the inability to integrate, train, retain and motivate key personnel of the acquired business; (vii) the potential disruption of our ongoing business and the distraction of management from its day-to-day operations; and (viii) the inability to incorporate the acquired business successfully into our operations. Such risks, if they materialize, could have a material adverse effect on us, our financial condition, results of operations and cash flows.
In addition, we may not be able to maintain the levels of operating efficiency that any of the acquired businesses had achieved or might have achieved separately. Successful integration of each of their operations would depend upon our ability to manage those operations and to eliminate redundant and excess costs. As a result of difficulties associated with combining operations, we may not be able to achieve the cost savings and other benefits that we would hope to achieve with these acquisitions. Any difficulties in this process could disrupt our ongoing business, distract management, result in the loss of key personnel, increase our expenses and otherwise have a material adverse effect on our business, financial condition, results of operations and cash flows. There can be no assurance that the acquired businesses will achieve anticipated levels of profitability.
We may be adversely affected by substantial competition in the school bus transportation industry and increased consolidation within the industry
The school bus transportation industry is highly competitive and we expect that there will
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continue to be substantial competition for contract bidding and for prospective acquisitions. Such competition may decrease the profitability associated with any contract and increase the cost of acquisitions. Contracts are generally awarded pursuant to public bidding, where price is the primary criteria for a contract award. We have many competitors in the school bus transportation business, including transportation companies with resources and facilities substantially greater than ours and school districts that operate their own buses. There can be no assurance that we will be able to identify, acquire or profitably manage additional contracts or that the assumptions underlying the contract price and / or expense levels included in the bid process will be realized. Although we have historically been competitive in the market for new contracts as well as for acquisitions of other companies, there can be no assurance that we will be able to compete effectively in the future.
In particular, the school bus transportation industry is undergoing significant consolidation, which has intensified the competition for contracts and acquisitions. From time to time, we make unsolicited inquiries with respect to possible acquisitions. Whether such inquiries will result in further communications or, ultimately, an acquisition, has depended, and will continue to depend upon the facts and circumstances in each case, including whether our competitors make bids for such contracts and acquisitions. Any failure to compete effectively could have a material adverse effect on our company, our financial condition, results of operations and cash flows.
Our business depends on certain key personnel
We believe that our success depends, in part, on the retention of senior executive and regional management. There can be no assurance that we would be able to find qualified replacements for the individuals who make up our senior management team if their services were no longer available. The loss of services of one or more members of the senior management team could adversely affect our business, results of operations and our ability to effectively pursue our business strategy. We do not maintain key-man life insurance for any of our employees.
A greater number of our employees may join unions
Although some of our employees are subject to collective bargaining agreements, there are no assurances that the number of our employees who are members of unions will not increase in the future. A significant increase in the number of our employees becoming members of unions could result in increased labour costs and have a material adverse effect on us, our financial condition, results of operations and cash flows.
We may be adversely affected by rising insurance costs
Our cost of maintaining vehicle liability, personal injury, property damage and workers’ compensation insurance is significant. We could experience higher insurance premiums as a result of adverse claims experience or because of general increases in premiums by insurance carriers for reasons unrelated to our own claims experience. As an operator of school buses, we are exposed to claims for personal injury or death and property damage as a result of accidents. Generally, our insurance policies must be renewed annually. Our ability to continue to obtain insurance at affordable premiums also depends upon our ability to continue to operate with an acceptable safety record. A significant increase in the number of claims against us, the assertion of one or more claims in excess of our policy limits or the inability to obtain adequate insurance coverage at acceptable rates, or at all, could have a material adverse effect on us. In addition, the running of statutes of limitations for personal injuries to minor children typically is suspended during the children’s legal minority. Therefore, it is possible that accidents causing injuries to minors on school buses may not give rise to lawsuits until a number of years later, which could also have a material adverse effect on us.
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We may not be insured for certain losses
We may become subject to liabilities for claims for which insurance is not normally obtained, hazards that we cannot or may not elect to insure because of high premium costs or other reasons or for occurrences that exceed maximum coverage under our policies. For example, we do not have insurance to guard against claims for breach of contract. The occurrence of any liability for which we are not insured, any liability for a claim that exceeds our maximum coverage under our policies, or a multiplicity of otherwise insured claims for amounts within the deductible levels in our policies, could have a material adverse effect on us, our financial condition, results of operations and cash flows.
We may be adversely affected by current and new governmental laws and regulations
We are required to comply with laws and regulations relating to safety, driver qualifications, insurance, worker overtime and other matters promulgated by various federal, state, provincial and local regulatory agencies including, among others, state motor vehicle agencies, state departments of education, the Federal Highway and Safety Administration, the National Highway Traffic Safety Administration and the Occupational Safety and Health Administration. We are also required to comply with certain statutes, such as the Americans with Disabilities Act. We have incurred, and expect to incur, costs for our operations to comply with these legal requirements, and these costs could increase in the future. Many of these legal requirements provide for substantial fines, orders, including orders to cease operations, and criminal sanctions for violations. Although we believe that we are in material compliance with applicable safety laws and regulations, it is difficult to predict the future development of such laws and regulations or their impact on our business or results of operations. We anticipate that standards under these types of laws and regulations will continue to tighten and that compliance will require increased capital and other expenditures. Furthermore, we cannot predict whether new laws or regulations will be adopted and, if adopted, no assurance can be given that the implementation of such laws or regulations and any additional compliance costs associated therewith will not have a material adverse effect on us. Also, a significant order or judgment against us, the loss of a significant permit or license or the imposition of a significant fine or any other liability in excess of, or not covered by, our reserves or our insurance could adversely affect our business, financial condition and results of operations.
We may be adversely affected by environmental requirements
Our facilities and operations are subject to extensive and constantly evolving federal, state, provincial and local environmental and occupational health and safety laws and regulations, including laws and regulations governing air emissions, wastewater discharges, the storage and handling of chemicals and hazardous substances and cleanup of contaminated soil and groundwater. Additional expenditures, beyond those currently included in capital and operating budgets, may be incurred in order to comply with either new environmental legislation and regulations, new interpretations of existing laws and regulations or more rigorous enforcement of such laws and regulations, most of which are difficult to pass on to the customer. It is not possible to predict whether these new expenditures will be material. We are also subject to liability for the investigation and remediation of environmental contamination (including contamination caused by other parties) at properties that we own or operate and at other properties where we or our predecessors liabilities or environmental compliance or cleanup obligations will have a material adverse effect on our business or operations, there can be no assurance that such liabilities or compliance or cleanup obligations will not increase in the future or will not have a material adverse effect on us.
The school bus transportation industry is highly seasonal
The school bus transportation industry is subject to seasonal variations in operations. As a result, school bus contractors, including us, historically experience a significant decline in operating income
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during the summer months. Specifically, because customers often pay for the annual amount due under a contract in 10 installments ending in June, our revenues and cash flows sharply decrease in July and August. Additionally, many school districts have dramatically cut back on summer programs in recent years, including summer camp and charter programs, compounding this effect. Our quarterly operating results have also fluctuated due to a variety of factors, including variation in the number of school days in each quarter (which is affected by the timing of the first and last days of the school year, holidays, the month in which spring break occurs and adverse weather conditions, which can close schools). Consequently, interim results are not necessarily indicative of the full fiscal year and quarterly results may vary substantially, both within a fiscal year and between comparable fiscal years.
We may not be able to maintain letters of credit or performance bonds required by our transportation contracts
Our school bus transportation contracts generally provide for performance security in one or more of the following forms: performance bonds, letters of credit or cash retainages. The contracts also require the maintenance of minimum amounts of insurance coverage, the maintenance of appropriate facilities and transportation equipment, and the implementation of various operating rules and regulations. There can be no assurance that either letters of credit or performance bonds will continue to be available to us as security for our contracts or, if available, at a cost that does not adversely affect our margins or cash flow. If adequate performance security is not available or if the terms of such security are too onerous, our company, our financial condition, results of operations and cash flows could be materially adversely affected.
Some of our customer contracts may be terminated due to factors beyond our control
Some of our school bus transportation contracts may be terminated due to factors beyond our control, such as decreases in funding for our customers. All school bus contracts can also be terminated by school districts for not meeting certain performance criteria. Although we believe we have established strong relationships with our customers, there can be no assurance that our contracts will not be affected by circumstances beyond our control. The number of school buses to be provided under our contracts generally may decrease, and hence the revenues generated under such contracts may decrease based on the requirements of our customers.
We face uncertain risks associated with the Company’s oil and gas operations
The exploration of oil and gas involves risk that exploration efforts may not find oil and natural gas resources and even when they have been discovered, they may not be economically extracted. Factors affecting economic extraction of oil and natural gas include fluctuations in the price of oil and natural gas, technical extraction difficulties, the ability to bring the oil and natural gas to market, the quality of the oil and natural gas resources, the availability of water used in the extraction process, and the ability to dispose of water associated with the extraction process in an environmentally acceptable manner. In addition, other related uncertainties include and are not limited to geopolitical maneuvering on an international level, terrorist activities, governmental regulations and restrictions, functional obsolescence through widespread migration to alternative non petroleum based fuels, such as those that are hydrogen or nuclear based environmental and other considerations that are hypothetically possible. Oil and gas revenues are dependent on the commodity prices of oil and natural gas. Market changes in the price of these commodities will have a corresponding effect on the revenues and cash flows of the Company’s oil and gas segment.
As a foreign private issuer, we are subject to different U.S. securities laws and rules than a domestic U.S. issuer, which may limit the information publicly available to our shareholders
STI is a “foreign private issuer” under applicable U.S. federal securities laws and, therefore,
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we are not required to comply with all the periodic disclosure and current reporting requirements of the Exchange Act and related rules and regulations. As a result, we do not file the same reports that a U.S. domestic issuer would file with the SEC, although we are required to file or furnish to the SEC the continuous disclosure documents that we are required to file in Canada under Canadian securities laws. In addition, our officers, directors, and principal shareholders are exempt from the reporting and “short swing” profit recovery provisions of Section 16 of the Exchange Act. Therefore, our shareholders may not know on as timely a basis when our officers, directors and principal shareholders purchase or sell their Common Shares, as the reporting deadlines under the corresponding Canadian insider reporting requirements are longer and filing thresholds differ. In addition, as a foreign private issuer, we are exempt from the proxy rules under the Exchange Act.
We may lose our foreign private issuer status in the future, which could result in significant additional costs and expenses to us
We may in the future lose our foreign private issuer status if a majority of our Common Shares are held in the U.S. and we fail to meet the additional requirements necessary to avoid loss of foreign private issuer status. The regulatory and compliance costs to us under U.S. securities laws as a U.S. domestic issuer may be significantly more than the costs incurred as a Canadian foreign private issuer eligible to use the Multi-Jurisdictional Disclosure System (“MJDS”) adopted by the United States and Canada. If we are not a foreign private issuer, we would not be eligible to use the MJDS or other foreign issuer forms and would be required to file periodic and current reports and registration statements on U.S. domestic issuer forms with the SEC, which are generally more detailed and extensive than the forms available to a foreign private issuer.
We are an “emerging growth company” under the JOBS Act, and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our Common Shares less attractive to investors
We are an “emerging growth company,” as defined in the Jumpstart Our Business Start-ups Act of 2012 (“JOBS Act”), and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of section 404 of the Sarbanes-Oxley Act. In addition, should we remain an emerging growth company at a time we are no longer eligible to use the MJDS, we would be able to take advantage of reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our Common Shares less attractive because we rely or decide in the future to rely on these exemptions. If some investors find our Common Shares less attractive as a result, there may be a less active trading market for our Common Shares and our stock price may be more volatile.
We will remain an “emerging growth company” until June 30, 2017 (the last day of our fiscal year following the fifth anniversary of the first registered US public sale of our Common Stock), although we would lose that status sooner if our revenues exceed $1 billion, if we issue more than $1 billion in non-convertible debt in a three year period, or if the market value of our common stock that is held by non-affiliates exceeds $700 million as of May 30 of any year.
The financial reporting obligations of being a public company in the U.S. are expensive and time consuming, and place significant additional demands on our management
With the listing of our Common Shares on the NASDAQ Global Select Market in September 2011, we became subject to public company reporting obligations in the United States. The additional obligations of being a public company in the United States require significant additional expenditures
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and place additional demands on our management. In particular, at such time we are no longer an “emerging growth company” under the JOBS Act, section 404 of the Sarbanes-Oxley Act of 2002 and the SEC rules and regulations implementing section 404 will require an annual evaluation of our internal controls over financial reporting to be attested to by an independent auditing firm. If an independent auditing firm is unable to provide us with an attestation and an unqualified report as to the effectiveness of our internal controls, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our Common Shares. In addition, future acquisitions of companies by us may create challenges in implementing the required processes, procedures and controls in the acquired operations, as acquired companies (in particular, privately held companies) may not have disclosure controls and procedures or internal control over financial reporting that are as thorough or effective as those required under the securities law applicable to STI.
Economic and financial market conditions have resulted in reduced spending by school districts and other governmental agencies
The 2008 global economic crisis and continuing economic instability resulted in a reduction in revenues to various state and local governmental entities, including school districts and other purchasers of our services. This reduction in revenues to our customers may negatively affect the revenues received by the Company in connection with annual rate increases on its school district customer contracts and non contracted ancillary revenues due to potential cutbacks by customers in these spending areas. If the Company’s financial condition is materially impacted, then impairment charges with respect to the Company’s goodwill and other long-lived assets could be necessary.
We may be adversely affected by terrorism attacks and, man-made or natural disasters
The potential for terrorism exists in the countries in which we operate. Public transportation has previously been subject to terrorist attacks and may be the target of future attacks, which could have a negative impact on our operations. Man-made and natural disasters, including adverse weather conditions, from which we are experiencing greater and more frequent disruptions, could negatively impact our operations through, among other things, increased costs, business disruptions and increased accidents. The occurrence of any of these events could have a material adverse effect on us, our financial condition, results of operations and cash flows.
We may be adversely affected by cyber terrorism or other data security breaches and are subject to data privacy risks
In the normal course of our business we rely on information technology systems. These systems, among other things, collect and safeguard confidential information regarding our employees, customers and the users of our services, including information collected through our SafeStopTM application. Cyber terrorists, hackers and data thieves have become increasingly sophisticated and have the ability to operate large-scale and complex data attacks that could lead to breaches of our systems and the security of our data and information. These attacks could also lead to other significant disruptions. Such breaches and disruptions may result in service interruptions or the loss of confidential information and could give rise to unwanted media attention, material damage to our customer relationships and reputation and fines or lawsuits. The occurrence of any of these events could have a material adverse effect on us, our financial condition, results of operations and cash flows.
Risks Related to the Capital Structure
The Company is dependent on STA Holdings and Parkview Transit for all cash available for dividends and interest
STI is dependent on the operations and assets of STA Holdings and Parkview Transit the
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ownership of common shares. Cash distributions to the holders of Common Shares and the Convertible Debentures will be dependent on the ability of STA Holdings and Parkview Transit to make dividend payments on its Common Shares held by STI. The actual amount of cash available for payments to holders of Common Shares and the Convertible Debentures will depend upon numerous factors relating to the business of STA Holdings and Parkview Transit, including profitability, changes in revenue, fluctuations in working capital, capital expenditure levels, applicable laws, compliance with contracts and contractual restrictions contained in the instruments governing any indebtedness. Any reduction in the amount of cash available for distribution, or actually distributed, by the Company will reduce the amount of cash available to STI for dividends to holders of Common Shares. Cash dividends by STI on the Common Shares are not guaranteed and will fluctuate with the performance of the business of STA Holdings and Parkview Transit. Cash available for distribution is not intended to be representative of cash flow or results of operations determined in accordance with generally accepted accounting principles in the United States and does not have a standardized meaning prescribed by US GAAP.
A significant amount of our cash is distributed, which may restrict potential growth
The payout of substantially all of our operating cash flow will make additional capital and operating expenditures dependent on increased cash flow or additional financing in the future. Lack of these funds could limit the Company’s future growth and its cash flow. In addition, the Company may be precluded from pursuing otherwise attractive acquisitions or investments because they may not be accretive on a short-term basis.
STI may not receive dividends from STA Holdings and Parkview Transit provided for in the dividend policy adopted by the board of directors of the Company, or any dividends at all
STI’s only source of cash flow for payment of dividends on the Common Shares and interest payments on the Convertible Debentures is distributions on its equity ownership of STA Holdings and Parkview Transit. The board of directors of STI may, in its discretion, amend or repeal the dividend policy. STI’s board of directors may decrease the level of dividends provided for in this dividend policy or entirely discontinue the payment of dividends. Future dividends with respect to the common shares of STI, if any, will depend on, among other things, the results of operations, cash requirements, financial condition, contractual restrictions, business opportunities, provisions of applicable law and other factors that the board of directors of STI may deem relevant. The Credit Agreement contains significant restrictions on the Company’s ability to make dividend payments.
Fluctuations in the exchange rate may impact the amount of cash available to the Company for distribution and the Company’s results of operations
The Cdn$ 6.25% Convertible Debentures and the Cdn$ 5.25% Convertible Debentures are denominated in Canadian dollars, and payment of these Debentures upon maturity will be payable in Canadian dollars. The Company has not entered into any hedge arrangement with respect to the payment of these Debentures upon maturity in 2019 and 2021, respectively. Interest payments on the Cdn$ 6.25% Convertible Debentures and the Cdn$ 5.25% Convertible Debentures are denominated in Canadian dollars. Conversely, approximately 82.5% of the Company’s revenue and expenses for fiscal year 2016, together with distributions received from the Company’s subsidiaries are denominated in U.S. dollars. As a result, the Company is exposed to currency exchange rate risks.
Although the Company intends to fund the interest payment on the Cdn$ 6.25% Convertible Debentures and Cdn$ 5.25% Convertible Debentures with cash flows from the Company’s Canadian operations to mitigate the exchange rate risk with respect to the total amount of currently anticipated interest payments on those Convertible Debentures, there can be no assurance that these arrangements will be sufficient to fully protect against this risk. If the Canadian dollar cash flow do not fully protect against this risk, changes in the currency exchange rate between U.S. and Canadian dollars could have a material adverse effect on the Company’s financial condition, results of operations and cash flow, and may adversely affect the Company’s cash distributions.
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In addition, the Company prepares its financial statements in U.S. dollars. In connection with the Company’s Canadian operations, approximately 17.5% of the Company’s consolidated income before taxes for fiscal year 2016 is incurred in Canadian dollars. The results of the Canadian operations are translated into U.S. dollars for financial statement reporting purposes. Changes in the Canadian dollar / U.S. dollar currency exchange rate from period to period will impact the translated U.S. dollar equivalent results of the Canadian operations. A weakening Canadian dollar will have a negative impact on the translation of the results of the Canadian operations in U.S. dollars for financial reporting purposes. Conversely, a strengthening Canadian dollar will have a positive impact on the translation of the results of the Canadian operations in U.S. dollars for financial reporting purposes.
Changes in the Company’s creditworthiness may affect the value of the Common Shares and Convertible Debentures
The perceived creditworthiness of the Issuer, the Company and their respective subsidiaries may affect the market price or value and the liquidity of the Common Shares and the Convertible Debentures.
Future sales or the possibility of future sales of a substantial amount of Common Shares may impact the price of the Common Shares and could result in dilution
Future sales or the possibility of future sales of a substantial amount of Common Shares in the public market by the Company or an existing shareholder could adversely affect the prevailing market price of the Company’s Common Shares, and could impair the Issuer’s ability to raise capital through future sales of those securities.
For example, SNCF Participations S.A. (“SNCF-P”), which held approximately 15.0 million of the Company’s Common Shares on June 30, 2015, sold 4.0 million of those shares on August 6, 2015 in market transactions at a discount to the market trading price at that time. On April 11, 2016, the Company announced that SNCF-P had sold approximately 6.4 million of its remaining Common Shares, and following those sales, the Company acquired SNCF-P’s remaining Common Shares, which were subsequently cancelled. We believe SNCF-p’s sale transactions had an adverse impact on the price of the Common Shares.
Additionally, the issuance of additional Common Shares may dilute an investor’s investment in the Issuer and reduce distributable cash per Common Share. The Company may issue Common Shares or other securities from time to time, in order to raise capital or as consideration for future acquisitions and investments. If an acquisition or investment is significant, the number of Common Shares or the number or aggregate principal amount, as the case may be, of other securities that may be issued may in turn be significant. In addition, the Issuer may also grant registration rights covering those Common Shares or other securities in connection with any acquisitions or investments.
Further, the Company may determine to redeem outstanding Debentures for Common Shares or to repay outstanding principal amounts thereunder at maturity of the Convertible Debentures by issuing additional Common Shares. The issuance of additional Common Shares may have a dilutive effect on shareholders and an adverse impact on the price of Common Shares.
Investment eligibility
There can be no assurance that the Common Shares will continue to be qualified investments for trusts governed by registered retirement savings plans, registered retirement income funds, registered disability savings plans, deferred profit sharing plans and registered education savings plans and for arrangements that are tax-free savings accounts.
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The Company may not be able to make all interest payments on the Convertible Debentures
The likelihood that holders of the Convertible Debentures will receive the payments owing to them in connection with the Convertible Debentures will be dependent upon the financial health and creditworthiness of the Company and the ability of the Company to earn revenues.
The Company may not be able to purchase the Convertible Debentures on a change of control
The Company will be required to offer to purchase all outstanding Convertible Debentures upon the occurrence of a change of control. However, it is possible that following a change of control, the Company will not have sufficient funds at that time to make the required purchase of outstanding Convertible Debentures or that restrictions contained in other indebtedness will restrict those purchases.
Redemption prior to maturity
The Convertible Debentures may be redeemed in accordance with their respective terms, upon payment of the principal, together with any accrued and unpaid interest. Holders of Convertible Debentures should assume that this redemption option will be exercised if the Company is able to refinance at a lower interest rate or it is otherwise in the interest of the Company to redeem the Convertible Debentures.
Conversion following certain transactions
In the case of certain transactions, each Convertible Debenture will become convertible into securities, cash or property receivable by a holder of Convertible Debentures in the kind and amount of securities, cash or property into which the Convertible Debenture was convertible immediately prior to the transaction. This change could substantially lessen or eliminate the value of the conversion privilege associated with the Convertible Debentures in the future.
Prevailing yields on similar securities
Prevailing yield on similar securities will affect the market value of the Convertible Debentures. Assuming all other factors remain unchanged, the market value of the Convertible Debentures will decline as prevailing yields for similar securities rise, and will increase as prevailing yields for similar securities decline.
There is a limited active public market for the Common Shares and Convertible Debentures and holders may have limited liquidity
Although the Common Shares and Convertible Debentures are listed and posted for trading on the TSX and the Common Shares also trade on the NASDAQ Global Select Market, they trade in markets with modest trading volumes. Although the Issuer has taken a number of steps to increase the liquidity of the Common Shares through additional common share offerings and debt to equity exchanges, there is no guarantee that an active trading market will further emerge and/or continue.
The market price for the Common Shares or Convertible Debentures may be volatile
Factors such as variations in the Company’s financial results, announcements by the
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Company or others, developments affecting the Company’s business or the North America school bus transportation industry, general interest rate levels, general fuel price levels, the market price of the Common Shares and general market volatility could cause the market price of the Common Shares or the Convertible Debentures to fluctuate significantly.
Our status as an “emerging growth company” under the JOBS Act may make it more difficult to raise capital as and when we need it
Because of the exemptions from various reporting requirements provided to us as an “emerging growth company” under the JOBS Act, we may be less attractive to investors, which may make it more difficult for us to raise additional capital as and when we need it. If we are unable to raise additional capital as and when we need it, our financial condition and results of operations may be materially and adversely affected.
STA Holdings’ interest deductions on the 14% subordinated notes originally issued by STA ULC in connection with the IPS Offering were likely “dual consolidated losses” for U.S. federal income tax purposes and may result in disallowance of interest deductions under U.S. tax law if certain “triggering events” occur
Pursuant to Section 1503(d) of the Code and the Treasury Regulations thereunder, the interest deductions generated on the 14% subordinated notes (the last of which were redeemed in December 2009) likely generated a “dual consolidated loss” (“DCL”) for U.S. federal income tax purposes and therefore were deductible by STA Holdings only if STA Holdings and STA ULC made the appropriate election and complied with all applicable requirements, including annual reporting and certification requirements. STA Holdings and STA ULC made, and intend to continue to make, such election and have complied with all applicable requirements to date. Even though such an election was made, however, if any of several “triggering events” occurs (e.g., the use of such losses to offset the income of any other non-U.S. person, or, in certain circumstances, a disposition of STA ULC stock or assets), STA Holdings will generally be required to report the amount of any prior interest deductions on the Notes (plus interest thereon) as gross income in the year of the triggering event. STA Holdings and STA ULC intend to comply with all of the DCL reporting and certification requirements and to conduct their affairs such that no DCL triggering event occurs. However, if STA Holdings and STA ULC fail to satisfy such reporting and certification requirements, or if a DCL triggering event occurs and no exception applies, STA Holdings’ taxable income may be increased and if so, it’s U.S. federal income tax liability would be increased, perhaps materially. This would adversely affect the Company’s financial position, cash flow, and liquidity, and could affect the Issuer’s ability to make interest or dividend payments on the Debentures and the Common Shares and the Company’s ability to continue as a going concern.
Application of U.S. federal income tax corporate “inversion” rules is uncertain
U.S. federal income tax legislation enacted in October 2004 dealing with corporate “inversions” (e.g., certain transactions in which a non-U.S. corporation acquires substantially all of the equity interests in, or the assets of, a U.S. corporation or partnership, if, after the transaction, former equity owners of the U.S. corporation or partnership own a specified level of stock in the non-U.S. corporation) provides in certain cases that a non-U.S. corporation may be treated as a U.S. corporation for U.S. federal income tax purposes. As enacted, this legislation does not appear to apply to STI, because the Existing Investors did not own any stock in STI as a result of the original offering and related transactions or subsequent IPS or Common Share offerings. The legislation grants authority to the U.S. Treasury, however, to write implementing regulations, which could, if exercised broadly and retroactively, cause the inversion provisions to apply to STI and result in, among other things, U.S. withholding taxes being imposed on dividends paid on the Common Shares to non-U.S. Holders, and the potential inability of U.S. holders to claim a foreign tax credit for Canadian withholding tax on dividends paid on the Common Shares to them. The Internal Revenue Service
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subsequently issued regulations to provide further guidance on when a non-U.S. corporation may be treated as a U.S. corporation for U.S. federal income tax. Those regulations would not cause STI to be treated as a U.S. corporation for U.S. federal income tax purposes, but there can be no assurance such regulation may not be modified in the future.
Application of possible new related party debt rules is uncertain
The Internal Revenue Service recently issued proposed regulations regarding intercompany cross-border debt held by related parties. The proposed regulations primarily affect: (i) issuances of debt for cash between related parties, (ii) distributions of debt instruments by corporations to their related corporate shareholders, (iii) certain issuances of debt instruments as consideration in an exchange involving an intragroup asset reorganization and (iv) issuances of debt instruments by corporations to related parties in exchange for stock of an affiliated corporation. The proposed regulations would permit the Internal Revenue Service to treat an instrument as part debt and part equity, in any of the foregoing situations, which could have an adverse tax effect on both the creditor and the debtor. However, in the case of issuances of debt for cash between related parties, as the proposed regulations are currently contemplated, it is unlikely there would be a recharacterization of the debt if it is properly documented and the parties can demonstrate the financial ability of the debtor to repay the creditor. In general, the proposed regulations would not be effective until issued in final form. At this point, pending issuance of the final regulations, it is not possible to determine whether the regulations, if finalized in their current form, would have any adverse U.S. (or foreign) tax effect on STI or STA Holdings or any of their related U.S. and non-U.S. affiliates.
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