UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 29, 2017
or
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-35487
ENGILITY HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware | | 61-1748527 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| | |
4803 Stonecroft Blvd., Chantilly, VA | | 20151 |
(Address of principal executive offices) | | (Zip Code) |
(703) 633-8300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
| |
Large accelerated filer ☐ | Accelerated filer ☒ |
Non-accelerated filer (Do not check if a smaller reporting company) ☐ | Smaller reporting company ☐ |
Emerging growth company ☐ | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
There were 36,824,915 shares of Engility Holdings, Inc. common stock with a par value of $0.01 per share outstanding as of the close of business on October 27, 2017.
ENGILITY HOLDINGS, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
i
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENGILITY HOLDINGS, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
| | September 29, | | | December 31, | |
| | 2017 | | | 2016 | |
Assets: | | | | | | | | |
Current assets: | | | | | | | | |
Cash and cash equivalents | | $ | 51,978 | | | $ | 48,236 | |
Receivables, net | | | 341,713 | | | | 334,248 | |
Assets held for sale, current | | | — | | | | 20,242 | |
Other current assets | | | 22,754 | | | | 30,404 | |
Total current assets | | | 416,445 | | | | 433,130 | |
Property, plant and equipment, net | | | 44,428 | | | | 46,547 | |
Goodwill | | | 1,078,454 | | | | 1,078,454 | |
Identifiable intangible assets, net | | | 369,528 | | | | 393,891 | |
Deferred tax assets | | | 216,234 | | | | 232,283 | |
Assets held for sale | | | — | | | | 11,962 | |
Other assets | | | 4,440 | | | | 2,292 | |
Total assets | | $ | 2,129,529 | | | $ | 2,198,559 | |
Liabilities and Equity: | | | | | | | | |
Current liabilities: | | | | | | | | |
Current portion of long-term debt | | $ | 26,947 | | | $ | 26,947 | |
Accounts payable, trade | | | 50,413 | | | | 43,943 | |
Accrued employment costs | | | 96,727 | | | | 98,860 | |
Accrued expenses | | | 81,965 | | | | 76,870 | |
Advance payments and billings in excess of costs incurred | | | 31,905 | | | | 33,259 | |
Deferred income taxes, current and income tax liabilities | | | 518 | | | | 209 | |
Liabilities held for sale, current | | | — | | | | 4,341 | |
Other current liabilities | | | 22,396 | | | | 36,410 | |
Total current liabilities | | | 310,871 | | | | 320,839 | |
Long-term debt | | | 960,499 | | | | 1,039,993 | |
Income tax liabilities | | | 63,167 | | | | 64,852 | |
Liabilities held for sale | | | — | | | | 1,084 | |
Other liabilities | | | 62,839 | | | | 66,986 | |
Total liabilities | | | 1,397,376 | | | | 1,493,754 | |
Commitments and contingencies (Note 10) | | | | | | | | |
Equity: | | | | | | | | |
Preferred stock, par value $0.01 per share, 25,000 shares authorized, none issued or outstanding as of September 29, 2017 or December 31, 2016 | | | — | | | | — | |
Common stock, par value $0.01 per share, 175,000 shares authorized, 36,825 and 36,776 shares issued and outstanding as of September 29, 2017 and December 31, 2016, respectively | | | 368 | | | | 368 | |
Additional paid-in capital | | | 1,243,023 | | | | 1,237,826 | |
Accumulated deficit | | | (516,459 | ) | | | (541,702 | ) |
Accumulated other comprehensive loss | | | (5,504 | ) | | | (4,865 | ) |
Non-controlling interest | | | 10,725 | | | | 13,178 | |
Total equity | | | 732,153 | | | | 704,805 | |
Total liabilities and equity | | $ | 2,129,529 | | | $ | 2,198,559 | |
See Notes to Unaudited Consolidated Financial Statements
1
ENGILITY HOLDINGS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
| | Three Months Ended | | | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | September 29, 2017 | | | September 30, 2016 | |
Revenue | | $ | 487,144 | | | $ | 511,800 | | | $ | 1,467,030 | | | $ | 1,570,011 | |
Costs and expenses | | | | | | | | | | | | | | | | |
Cost of revenue | | | 417,581 | | | | 435,594 | | | | 1,255,603 | | | | 1,341,826 | |
Selling, general and administrative expenses | | | 33,308 | | | | 39,337 | | | | 107,303 | | | | 129,780 | |
Total costs and expenses | | | 450,889 | | | | 474,931 | | | | 1,362,906 | | | | 1,471,606 | |
Operating income | | | 36,255 | | | | 36,869 | | | | 104,124 | | | | 98,405 | |
Interest expense, net | | | 19,739 | | | | 50,855 | | | | 59,189 | | | | 109,358 | |
Other expenses, net | | | 49 | | | | — | | | | 212 | | | | 82 | |
Income (loss) before provision for income taxes | | | 16,467 | | | | (13,986 | ) | | | 44,723 | | | | (11,035 | ) |
Provision for income taxes | | | 5,611 | | | | 1,348 | | | | 16,671 | | | | 2,370 | |
Net income (loss) | | | 10,856 | | | | (15,334 | ) | | | 28,052 | | | | (13,405 | ) |
Less: Net income attributable to non-controlling interest | | | 1,051 | | | | 1,423 | | | | 3,683 | | | | 4,088 | |
Net income (loss) attributable to Engility | | $ | 9,805 | | | $ | (16,757 | ) | | $ | 24,369 | | | $ | (17,493 | ) |
| | | | | | | | | | | | | | | | |
Earnings (loss) per share attributable to Engility | | | | | | | | | | | | | | | | |
Basic | | $ | 0.27 | | | $ | (0.46 | ) | | $ | 0.66 | | | $ | (0.48 | ) |
Diluted | | $ | 0.26 | | | $ | (0.46 | ) | | $ | 0.65 | | | $ | (0.48 | ) |
| | | | | | | | | | | | | | | | |
Weighted average number of shares outstanding | | | | | | | | | | | | | | | | |
Basic | | | 36,809 | | | | 36,735 | | | | 36,831 | | | | 36,726 | |
Diluted | | | 37,348 | | | | 36,735 | | | | 37,354 | | | | 36,726 | |
See Notes to Unaudited Consolidated Financial Statements
2
ENGILITY HOLDINGS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
| | Three Months Ended | | | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | September 29, 2017 | | | September 30, 2016 | |
Net income (loss) | | $ | 10,856 | | | $ | (15,334 | ) | | $ | 28,052 | | | $ | (13,405 | ) |
Other comprehensive income (loss), net of tax: | | | | | | | | | | | | | | | | |
Pension liability adjustment, net of tax benefit of $7 and $84 for the three and nine months ended September 29, 2017, respectively, and net of tax expense of $253 for the nine months ended September 30, 2016 | | | (11 | ) | | | — | | | | (103 | ) | | | 632 | |
Unrealized gain (loss) on derivative instruments, net of tax benefit of $28 and $343 for the three and nine months ended September 29, 2017, respectively, and net of tax expense of $334 and $1,084 for the three and nine months ended September 30, 2016, respectively | | | (44 | ) | | | 523 | | | | (536 | ) | | | 1,699 | |
Other comprehensive income (loss), net of tax | | | (55 | ) | | | 523 | | | | (639 | ) | | | 2,331 | |
Comprehensive income (loss) | | | 10,801 | | | | (14,811 | ) | | | 27,413 | | | | (11,074 | ) |
Less: Net income attributable to non-controlling interest | | | 1,051 | | | | 1,423 | | | | 3,683 | | | | 4,088 | |
Comprehensive income (loss) attributable to Engility | | $ | 9,750 | | | $ | (16,234 | ) | | $ | 23,730 | | | $ | (15,162 | ) |
See Notes to Unaudited Consolidated Financial Statements
3
ENGILITY HOLDINGS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | |
Operating activities: | | | | | | | | |
Net income (loss) | | $ | 28,052 | | | $ | (13,405 | ) |
Share-based compensation | | | 6,052 | | | | 7,073 | |
Depreciation and amortization | | | 33,172 | | | | 35,951 | |
Loss (gain) on sale of property, plant and equipment | | | (306 | ) | | | 52 | |
Loss on extinguishment of debt | | | 432 | | | | 4,642 | |
Amortization of bank debt fees | | | 6,484 | | | | 3,428 | |
Deferred income taxes | | | 17,096 | | | | 4,190 | |
Excess tax deduction on share-based compensation | | | (191 | ) | | | — | |
Changes in operating assets and liabilities: | | | | | | | | |
Receivables | | | (7,465 | ) | | | 26,486 | |
Other assets | | | 7,894 | | | | (3,296 | ) |
Accounts payable, trade | | | 5,332 | | | | 2,777 | |
Accrued employment costs | | | (2,133 | ) | | | 30,413 | |
Accrued expenses | | | 5,093 | | | | (5,930 | ) |
Advance payments and billings in excess of costs incurred | | | (1,354 | ) | | | (12,372 | ) |
Other liabilities | | | (19,403 | ) | | | 4,735 | |
Net cash provided by operating activities | | | 78,755 | | | | 84,744 | |
Investing activities: | | | | | | | | |
Proceeds from sale of business, net of amount placed in escrow | | | 22,349 | | | | — | |
Proceeds from sale of property, plant and equipment | | | 2,902 | | | | — | |
Capital expenditures | | | (5,810 | ) | | | (17,942 | ) |
Net cash provided by (used in) investing activities | | | 19,441 | | | | (17,942 | ) |
Financing activities: | | | | | | | | |
Gross borrowings from issuance of long-term debt | | | — | | | | 1,180,000 | |
Repayment of long-term debt | | | (86,410 | ) | | | (1,199,018 | ) |
Gross borrowings from revolving credit facility | | | 270,000 | | | | 73,000 | |
Gross repayments of revolving credit facility | | | (270,000 | ) | | | (73,000 | ) |
Debt issuance costs | | | — | | | | (9,988 | ) |
Proceeds from share-based payment arrangements | | | — | | | | 214 | |
Payment of employee withholding taxes on share-based compensation | | | (1,501 | ) | | | (1,777 | ) |
Dividends paid | | | (407 | ) | | | (1,703 | ) |
Distributions to non-controlling interest member | | | (6,136 | ) | | | (3,865 | ) |
Net cash used in financing activities | | | (94,454 | ) | | | (36,137 | ) |
Net change in cash and cash equivalents | | | 3,742 | | | | 30,665 | |
Cash and cash equivalents, beginning of period | | | 48,236 | | | | 30,022 | |
Cash and cash equivalents, end of period | | $ | 51,978 | | | $ | 60,687 | |
See Notes to Unaudited Consolidated Financial Statements
4
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
Description of Business: Engility Holdings, Inc. (Engility) has provided mission critical services to the U.S. government for over six decades. Engility has a diversified portfolio that serves the U.S. Department of Defense (DoD), U.S. Department of Justice (DoJ), U.S. Department of State (DoS), Federal Aviation Administration (FAA), Department of Homeland Security (DHS), and space-related and intelligence community agencies, including the National Geospatial-Intelligence Agency (NGA), Defense Intelligence Agency (DIA), the National Reconnaissance Office (NRO), and National Aeronautical and Space Administration (NASA).
As used herein, the terms “Engility,” the “Company,” “we,” “us” or “our” refers to (i) Engility and its subsidiaries, for all periods prior to the closing of the TASC, Inc. (TASC) acquisition, and (ii) New Engility and its subsidiaries, for all periods following the TASC acquisition. The TASC acquisition was effected through a new holding company named New East Holdings, Inc. (New Engility). As a result of the business combination, New Engility succeeded to and continues to operate, directly or indirectly, the existing business of Engility and, indirectly, acquired the existing business of TASC.
We offer a broad range of services, including specialized technical consulting, program and business support, engineering and technology lifecycle support, information technology modernization and sustainment, supply chain services and logistics management and training and education to the U.S. government worldwide.
Engility has no operations other than owning 100% of the capital stock of Engility Corporation (formerly TASC, Inc.), a Massachusetts corporation, and the consolidated financial statements of Engility and its consolidated subsidiaries are identical in all respects to the consolidated financial statements of Engility Corporation and its consolidated subsidiaries.
Principles of Consolidation and Basis of Presentation: The Unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and in accordance with Article 10 of Regulation S-X of the U.S. Securities and Exchange Commission (SEC), and reflect the financial position, results of operations and cash flows of our businesses. Accordingly, they do not include all of the disclosures required by U.S. GAAP for a complete set of annual audited financial statements. All significant intercompany accounts and transactions are eliminated in consolidation.
The Unaudited Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries. The accompanying financial information should be read in conjunction with the consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K filed with the SEC on March 9, 2017 for the year ended December 31, 2016 (2016 Form 10-K). In the opinion of management, all adjustments (consisting of normal and recurring adjustments) considered necessary for a fair statement of the results for the interim periods presented have been included.
Non-controlling Interest: Engility holds a 50.1% majority interest in Forfeiture Support Associates, LLC (FSA). The results of operations of FSA are included in Engility’s Unaudited Consolidated Financial Statements. The non-controlling interest reported on the Unaudited Consolidated Balance Sheets represents the portion of FSA’s equity that is attributable to the non-controlling interest.
Accounting Estimates: The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates using assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. The most significant of these estimates include revenue and profit recognition for contracts accounted on a percentage-of-completion basis, the recoverability, useful lives and valuation of identifiable intangible assets and goodwill, income taxes and contingencies. Actual results experienced by the Company may differ materially from management's estimates.
Reporting Periods: Our fiscal year begins on January 1 and ends on December 31. Our 2017 fiscal quarters end on March 31, June 30, September 29 and December 31. Our 2016 fiscal quarters ended on April 1, July 1, September 30 and December 31.
Revenue Recognition: Substantially all of the Company’s revenue is derived from services provided to the U.S. government and its agencies, primarily by the Company’s consulting staff and, to a lesser extent, subcontractors. The Company generates its revenue from the following types of contractual arrangements: cost-reimbursable-plus-fee contracts, time-and-materials contracts, and fixed-price contracts.
Revenue on cost-reimbursable-plus-fee contracts is recognized as services are performed, generally based on allowable costs plus any recognizable earned fee. The Company considers fixed fees under cost-reimbursable-plus-fee contracts to be earned in proportion to the allowable costs incurred in performance of the contract. For cost-reimbursable-plus-fee contracts that include performance-based fee incentives, which are principally award fee arrangements, revenue and profit on award fees are recognized as work on the contracts is performed. We have significant history with the client for the majority of these contracts, and that history and management’s evaluation and monitoring of performance form the basis of estimated fees recorded. Estimates of the total fee to be
5
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
earned are made based on contract provisions, prior experience with similar contracts or clients, and management’s evaluation of the performance on such contracts.
Revenue for time-and-materials contracts is recognized as services are performed, generally on the basis of contract allowable labor hours worked multiplied by the contract-defined billing rates, plus allowable direct costs and indirect cost allocations associated with materials used and other direct expenses incurred in connection with the performance of the contract.
Revenue on fixed-price contracts is recognized using a percentage-of-completion method based on actual costs incurred relative to total estimated costs for the contract. These estimated costs are updated during the term of the contract, and may result in revision by the Company of recognized revenue and estimated costs in the period in which they are identified by cumulative catch-up adjustments. Profits on fixed-price contracts result from the difference between incurred costs and revenue earned.
Percentage-of-completion contract accounting requires significant judgment relative to assessing risks, estimating contract revenue and costs, and making assumptions for schedule and technical issues. Due to the size and nature of many of our contracts, developing total revenue and cost at completion estimates require the use of significant judgment. Contract costs include direct labor and billable expenses, an allocation of allowable indirect costs, and warranty obligations. Billable expenses are comprised of subcontracting costs and other direct costs that often include, but are not limited to, travel-related costs and telecommunications charges. We recognize revenue and billable expenses from these transactions on a gross basis. Assumptions regarding the length of time to complete the contract also include expected increases in wages and prices for materials. Estimates of total contract revenue and costs are monitored during the term of the contract and are subject to revision as the contract progresses. Anticipated losses on contracts are recognized in the period they are deemed probable and can be reasonably estimated. Anticipated contract losses recorded for the nine months ended September 29, 2017 and September 30, 2016 were immaterial.
For the three months ended September 29, 2017, the recognized amounts related to changes in estimates at completion represented a net increase to revenue and operating income of $4 million, of which $1 million was directly related to favorable performance on contract award fees. For the nine months ended September 29, 2017, the recognized amounts related to changes in estimates at completion represented a net increase to revenue and operating income of $9 million, of which $2 million was directly related to favorable performance on contract award fees. Amounts related to changes in estimates at completion for the three months ended September 30, 2016 represented a net increase to revenue and operating income of $5 million, of which $1 million was directly related to favorable performance on contract award fees. Amounts related to changes in estimates at completion for the nine months ended September 30, 2016 represented a net increase to revenue and operating income of $13 million, of which $3 million was directly related to favorable performance on contracts with award fees.
The Company’s contracts may include the delivery of a combination of one or more of the Company’s service offerings. In these situations, the Company determines whether such arrangements with multiple service offerings should be treated as separate units of accounting based on how the elements are bid or negotiated, whether the customer can accept separate elements of the arrangement, and the relationship between the pricing on the elements individually and combined.
Included in unbilled receivables, a component of receivables, net, are certain restructuring costs related to the performance of our U.S. government contracts which are required to be recorded under GAAP but are not currently allocable to contracts. Such costs are expensed outside of our indirect rates and recognized as revenue for the portion we expect to be recoverable in our rates. At September 29, 2017 and December 31, 2016, these receivables were approximately $10 million and $11 million, respectively, and are allocated to contracts when they are paid or otherwise agreed. We regularly assess the probability of recovery of these costs. This assessment requires us to make assumptions about the extent of cost recovery under our contracts and the amount of future contract activity. If the level of backlog in the future does not support the continued expensing of these costs, the profitability of our remaining contracts could be adversely affected.
Revenue and profit in connection with contracts to provide services to the U.S. government that contain collection risk because the contracts are incrementally funded and subject to the availability of funds appropriated are deferred until a contract modification is obtained, indicating that adequate funds are available to the contract or task order. The associated costs are deferred in other current assets in the accompanying consolidated balance sheets until funds are appropriated.
Income Taxes: As of September 29, 2017, management has determined it is more likely than not a portion of state deferred tax assets, charitable donations, and foreign tax credits will not be realized and has recorded a valuation allowance against them. A change in the ability of our operations to continue to generate future taxable income could affect our ability to realize the future tax deductions underlying our deferred tax assets, and require us to provide a valuation allowance against our deferred tax assets. The recognition of a valuation allowance would result in a reduction to net income and, if significant, could have a material impact on our effective tax rate, results of operations and financial position in any given period.
6
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
Earnings per Share: Basic earnings per share (EPS) is computed by dividing net income (loss) attributable to Engility by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the weighted average effect of all potentially dilutive securities outstanding during the periods. Diluted EPS includes the incremental effect of the employee stock purchase plan, restricted stock units (RSUs), stock options, performance shares, performance retention awards and performance units calculated using the treasury stock method. For the nine months ended September 29, 2017, 10,949 shares were excluded from diluted EPS due to their anti-dilutive effects. No shares were excluded from diluted EPS for the three months ended September 29, 2017. For the three and nine months ended September 30, 2016, 866,132 shares and 706,166 shares, respectively, were excluded from diluted EPS due to their anti-dilutive effects.
The calculation of basic and diluted EPS are presented in the table below (shares in thousands).
| | Three Months Ended | | | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | September 29, 2017 | | | September 30, 2016 | |
Net income (loss) attributable to Engility | | $ | 9,805 | | | $ | (16,757 | ) | | $ | 24,369 | | | $ | (17,493 | ) |
| | | | | | | | | | | | | | | | |
Weighted average number of shares outstanding – Basic | | | 36,809 | | | | 36,735 | | | | 36,831 | | | | 36,726 | |
Dilutive effect of share-based compensation outstanding after application of the treasury stock method | | | 539 | | | | — | | | | 523 | | | | — | |
Weighted average number of shares outstanding – Diluted | | | 37,348 | | | | 36,735 | | | | 37,354 | | | | 36,726 | |
| | | | | | | | | | | | | | | | |
Earnings (loss) per share attributable to Engility | | | | | | | | | | | | | | | | |
Basic | | $ | 0.27 | | | $ | (0.46 | ) | | $ | 0.66 | | | $ | (0.48 | ) |
Diluted | | $ | 0.26 | | | $ | (0.46 | ) | | $ | 0.65 | | | $ | (0.48 | ) |
Assets Held for Sale: The Company entered into two separate agreements during the second half of 2016 to sell certain assets and liabilities owned by the Company, both of which were completed in the first quarter of 2017. Depreciation for these assets ceased on the date they were designated as held for sale. The held for sale assets and liabilities were recorded at the lower of carrying value or estimated fair value, less an estimate of costs to sell. The estimate of fair value included unobservable inputs (Level 3 fair value). These assets and liabilities were designated as assets held for sale and liabilities held for sale in the accompanying consolidated balance sheets as of December 31, 2016.
On January 6, 2017, the Company completed the sale of its international development services business, International Resources Group Ltd. (IRG), for an initial purchase price of $25 million in cash, subject to working capital adjustments, that have not yet been finalized with the buyer. During the three months ended September 29, 2017, a cash adjustment of $1 million was recorded which reduced the purchase price. The sale was the result of the Company’s strategic review of its businesses and determination that the USAID portion of the Company’s international business no longer closely aligned with the Company’s future strategic direction. The Company received the proceeds from this sale, less an indemnity escrow of approximately $2 million, in the first quarter of 2017, which was used to pay down existing debt. The Company expects to receive the indemnity escrow on or about the second anniversary of the sale assuming no claims are made against the escrow funds.
During the first quarter of 2017, the Company completed its sale of long-term assets with carrying value totaling $2 million (net of accumulated depreciation of $1 million). The Company recorded a gain on sale of approximately $1 million which was recorded in selling, general and administrative expenses in the accompanying unaudited consolidated statement of operations.
2. | New Accounting Pronouncements |
In September 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-13, Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842). This update clarifies the definition of a public business entity for the application of the new revenue recognition and leasing standards. This update did not have an impact on our assessment of these standards, discussed below in connection with ASU 2014-09, and will not impact our implementation strategies. The revenue standard is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years, and the leasing standard is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities, which improves the financial reporting of hedging relationships to better align risk management activities in financial statements and make certain targeted improvements to simplify the application of the hedge accounting guidance in current
7
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
GAAP. The standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted for any interim and annual financial statements that have not yet been issued. The Company is currently in the process of evaluating the impact of this new pronouncement on its consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. ASU 2017-09 provides clarification on when modification accounting should be used for changes to the terms or conditions of a share-based payment award. This ASU does not change the accounting for modifications but clarifies that modification accounting guidance should only be applied if there is a change to the value, vesting conditions, or award classification and would not be required if the changes are considered non-substantive. ASU 2017-09 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, and early adoption is permitted, including in an interim period. ASU 2017-09 is to be applied on a prospective basis to an award modified on or after the adoption date. The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements.
In March 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The update requires employers to present the service cost component of the net periodic benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period. The other components of net benefit cost, including interest cost, expected return on plan assets, amortization of prior service cost/credit and actuarial gain/loss, and settlement and curtailment effects, are to be presented outside of any subtotal of operating income. Employers will have to disclose the line(s) used to present the other components of net periodic benefit cost, if the components are not presented separately in the income statement. ASU 2017-07 is effective for fiscal years and interim periods beginning after December 15, 2017, and early adoption is permitted. The Company is currently evaluating the impact this accounting standard will have on its consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test of Goodwill Impairment, which simplifies the subsequent measurement of goodwill by removing the second step of the two-step impairment test. The amendment requires an entity to perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendment should be applied on a prospective basis and is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Upon adoption of this accounting standard, there would only be an impact if the Company failed the first step and the impact, when adopted, would result in an impairment calculated as the difference between fair value and carrying value from the first step.
In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash—a consensus of the FASB Emerging Issues Task Force, which clarifies how entities should present restricted cash and restricted cash equivalents in the statement of cash flows. The new guidance requires entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. This update is effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted, including adoption in an interim period. Aside from conforming to new cash flow presentation and restricted cash disclosure requirements, we do not anticipate that the new standard will impact our consolidated financial statements.
In August 2016, the FASB issued Accounting Standards Update ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force). This ASU requires changes in the presentation of certain items including but not limited to debt prepayment or debt extinguishment costs; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies and distributions received from equity method investees. The guidance is effective for interim and annual periods beginning after December 15, 2017, and early adoption is permitted provided that all of the amendments are adopted in the same period. The guidance requires application using a retrospective transition method. The Company is currently evaluating the impact this accounting standard will have on its consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. Under this guidance, the areas of simplification involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, impact on earnings per share and classification on the statement of cash flows. We adopted ASU 2016-09 on January 1, 2017. As a result, all of the tax effects of share-based payments are now recorded in the income statement as a discrete adjustment. An income tax benefit of approximately $0.4 million was recognized in the first quarter of 2017, as a result of the adoption of ASU 2016-09. The treatment of forfeitures has changed as we have elected to discontinue our past process of estimating the number of forfeitures and now account for forfeitures as they occur. As such, this had a cumulative effect on retained earnings of approximately $0.9 million, net of tax. We have elected to present the cash flow statement on a retrospective transition method and prior periods have been adjusted to present the excess tax benefits as part of cash flows from
8
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
operating activities. Net operating losses related to excess tax benefits on stock-based awards are now recognized as deferred tax assets on the balance sheet and are subject to a valuation allowance if the asset is not realizable. An income tax expense of approximately $0.2 million was recognized in the second quarter of 2017. The excess tax benefits of $0.2 million recognized during the nine months ended September 29, 2017 as a reduction to tax expense in the consolidated statements of operations were classified as an operating activity in the statements of cash flows. During the nine months ended September 30, 2016, no excess tax benefits were present and therefore no adjustment was required.
In February 2016, the FASB issued ASU No. 2016-02, Leases, which revises the accounting related to lessee accounting. Under the new guidance, lessees will be required to recognize a lease liability and a right-of-use asset for all leases with terms greater than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The provisions of ASU 2016-02 are effective for fiscal years beginning after December 15, 2018 and should be applied through a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Early adoption is permitted. The Company is currently assessing the potential impact of this standard update on its consolidated financial statements. The Company anticipates the ASU will have a material impact on its assets and liabilities due to the addition of right-of-use assets and lease liabilities to the balance sheet, however it does not expect the ASU to have a material impact on its cash flows or results of operations.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 outlines a single comprehensive model for entities to use when accounting for revenue arising from contracts with customers, and it supersedes all current revenue recognition guidance, including industry-specific guidance. In August 2015, the FASB approved a one year deferral of the effective date of ASU No. 2014-09 to annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2017, with the option for early adoption as of the original effective date. In addition, five new ASUs have been issued in 2016 and 2017, amending or clarifying certain aspects of the new standard: ASU No. 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross Versus Net); ASU No. 2016-10, Identifying Performance Obligations and Licensing; ASU No. 2016-12, Revenue from Contracts with Customers – Narrow Scope Improvements and Practical Expedients; ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers and ASU No 2017-13. Entities have the option of using either a full retrospective or a modified approach to adopt the guidance. The new standard could impact the method and timing of revenue recognition for certain of our contracts, in addition to our business processes and information technology systems. Engility is currently evaluating the impact of adopting the new standard and the effect it will have upon the Company’s consolidated financial statements and operations. The Company will adopt the new standard in 2018 using the modified retrospective method. Currently a cross-functional implementation team is in place and the Company will complete its assessment of the cumulative effect of adopting the new standard by the end of 2017.
Our receivables principally relate to contracts with the U.S. government and prime contractors or subcontractors of the U.S. government. The components of contract receivables are presented in the table below.
| | September 29, | | | December 31, | |
| | 2017 | | | 2016 | |
Billed receivables | | $ | 102,255 | | | $ | 97,661 | |
Unbilled receivables | | | 250,764 | | | | 248,253 | |
Allowance for doubtful accounts | | | (11,306 | ) | | | (11,666 | ) |
Total receivables, net | | $ | 341,713 | | | $ | 334,248 | |
4. | Identifiable Intangible Assets |
Information on our identifiable intangible assets that are subject to amortization is presented in the table below.
| | | | September 29, 2017 | | | December 31, 2016 | |
| | Weighted Average Amortization Period | | Gross Carrying Amount | | | Accumulated Amortization | | | Net Carrying Amount | | | Gross Carrying Amount | | | Accumulated Amortization | | | Net Carrying Amount | |
| | (in years) | | | | | | | | | | | | | | | | | | | | | | | | |
Customer contractual relationships | | 17 | | $ | 545,229 | | | $ | 181,495 | | | $ | 363,734 | | | $ | 545,229 | | | $ | 157,482 | | | $ | 387,747 | |
Technology | | 15 | | | 7,000 | | | | 1,206 | | | | 5,794 | | | | 7,000 | | | | 856 | | | | 6,144 | |
Total | | | | $ | 552,229 | | | $ | 182,701 | | | $ | 369,528 | | | $ | 552,229 | | | $ | 158,338 | | | $ | 393,891 | |
9
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
Our amortization expense recorded for our identifiable intangible assets is presented in the table below.
| | Three Months Ended | | | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | September 29, 2017 | | | September 30, 2016 | |
Amortization expense | | $ | 8,121 | | | $ | 8,428 | | | $ | 24,363 | | | $ | 28,235 | |
5. | Share-Based Compensation |
For the Nine Months Ended September 29, 2017
Performance Units: During the nine months ended September 29, 2017, we granted a total of 189,351 performance units at target level of 100% (with the potential for the delivery of up to 568,053 shares of our common stock at the maximum performance level) to certain of our employees with a grant date fair value of $30.54 per unit. Performance units cliff vest after three years based on our performance at the end of a three-year period beginning January 1, 2017. The number of shares of our common stock that are ultimately vested are based on continued employment and delivered in respect of these performance units will range from 0% to 300% of the target grant amount. The vesting of performance units depends on the Company's performance, as approved by the Compensation Committee of our Board of Directors (the Compensation Committee), based on two metrics: book-to-bill and adjusted operating cash flow, each as measured over a three year performance period, and subject to adjustments based on the Company’s compounded annual growth rate for revenue over the same period. The performance units may be settled in cash or stock at the sole discretion of the Compensation Committee.
Restricted Stock Units: During the nine months ended September 29, 2017, we granted a total of 220,194 RSUs to certain employees with a grant date fair value of $30.44 per unit, of which 775 RSUs cliff vest on the first anniversary of the grant date, 12,137 RSUs cliff vest on the second anniversary of the grant date and 207,282 RSUs vest over a term of three years from the grant date, with one-third of the award vesting on each anniversary of the grant date. During the nine months ended September 29, 2017, we granted 29,431 RSUs to our independent directors with a grant date fair value of $28.25 per unit, which cliff vest on the first anniversary of the grant date. The number of shares of our common stock that are ultimately vested are based on continued employment or service as a director, as applicable. The RSUs may be settled in cash or stock at the sole discretion of the Compensation Committee.
For the Nine Months Ended September 30, 2016
Performance Units: During the nine months ended September 30, 2016, we granted 411,178 performance units at a target level of 100% (with the potential for the delivery of up to 822,356 shares at the maximum performance level) to certain employees with a grant date fair value of $19.33 per unit. Included in the total, 81,803 performance units were granted at target level of 100% (with the potential for the delivery of up to 163,606 shares of our common stock at the maximum performance level) to Lynn A. Dugle, our Chief Executive Officer, with a grant date fair value of $17.97 per unit. Performance units cliff vest after three years based on our performance at the end of a three-year period beginning January 1, 2016. The number of shares of our common stock that are ultimately vested and delivered in respect of these performance units will range from 0% to 200% of the target grant amount. The vesting of performance units depends initially on the Company’s performance, as approved by the Compensation Committee of our Board of Directors, based on two metrics: revenue and operating cash flow. The performance units may be settled in cash or stock at the sole discretion of the Compensation Committee.
Restricted Stock Units: During the nine months ended September 30, 2016, we granted 506,493 RSUs to certain employees with a grant date fair value of $18.70 per unit, of which 56,524 RSUs cliff vest on the second anniversary of the grant date, 175,852 RSUs cliff vest on the third anniversary of the grant date and 274,117 RSUs vest over a term of three years from the grant date, 25% on the first anniversary of the grant date, 25% on the second anniversary of the grant date and 50% on the third anniversary of the grant date. Included in the total, 104,619 RSUs were granted to Ms. Dugle with a grant date fair value of $17.97 per unit, of which 50,083 RSUs cliff vest on the second anniversary of the grant date and 54,536 RSUs vest over a term of three years from the grant date. During the nine months ended September 30, 2016, we granted 25,704 RSUs to certain of the non-management members of our Board of Directors with a grant date fair value of $23.34 per unit, which cliff vest on the first anniversary of the grant date. The RSUs may be settled in cash or stock at the sole discretion of the Compensation Committee.
10
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
The components of net periodic benefit costs for the Company’s defined benefit plans are as follows:
| | Three Months Ended | | | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | September 29, 2017 | | | September 30, 2016 | |
Service cost | | $ | 206 | | | $ | 201 | | | $ | 617 | | | $ | 604 | |
Interest cost on projected benefit obligation | | | 748 | | | | 753 | | | | 2,245 | | | | 2,258 | |
Expected return on plan assets | | | (954 | ) | | | (953 | ) | | | (2,862 | ) | | | (2,860 | ) |
Net loss amortization | | | 95 | | | | 73 | | | | 284 | | | | 219 | |
Net periodic benefit expense | | $ | 95 | | | $ | 74 | | | $ | 284 | | | $ | 221 | |
During the nine months ended September 29, 2017, the Company contributed approximately $3 million to fund the defined benefit plans.
On August 14, 2017 (the Second Amendment Effective Date), the Company and Engility Corporation (the Borrower) entered into Amendment No. 2 (the Second Amendment) to the Credit Agreement, dated as of August 12, 2016, and amended by Amendment No. 1 thereto, dated as of February 13, 2017, by and among the Borrower, the Company, the several lenders from time to time parties thereto and Morgan Stanley Senior Funding, Inc., as administrative agent and collateral agent.
The parties entered into the Second Amendment in order to reduce the interest rate margins applicable to (i) the Borrower’s senior secured term B1 loan facility in the original principal amount of $195 million (Existing Term B1 Loans) from 2.25% to 1.75%, in the case of alternate base rate loans, and from 3.25% to 2.75%, in the case of Eurocurrency loans, and (ii) the Borrower’s senior secured term B2 loan facility in the original principal amount of $608 million (Existing Term B2 Loans) from 2.75% to 2.25%, in the case of alternate base rate loans, and from 3.75% to 3.25%, in the case of Eurocurrency loans. The Second Amendment was accomplished by (i) the Borrower obtaining new term B1 loan commitments (Term B1 Loans) to refinance the Existing Term B1 Loans and Morgan Stanley making additional Term B1 Loans to the Borrower in a principal amount equal to $185 million minus the principal amount of any Existing Term B1 Loans outstanding on the Second Amendment Effective Date that were converted into Term B1 Loans on the Second Amendment Effective Date, and (ii) the Borrower obtaining new term B2 loan commitments (Term B2 Loans) to refinance the Existing Term B2 Loans and Morgan Stanley making additional Term B2 Loans to the Borrower in a principal amount equal to $579 million minus the principal amount of any Existing Term B2 Loans outstanding on the Second Amendment Effective Date that were converted into Term B2 Loans on the Second Amendment Effective Date. The proceeds of the Term B1 Loans and Term B2 Loans, respectively, will be applied to repay in full the Existing Term B1 Loans and Existing Term B2 Loans, respectively, outstanding as of the Second Amendment Effective Date.
On February 13, 2017 (the First Amendment Effective Date), the Company and Engility Corporation (the Borrower) entered into Amendment No. 1 (the First Amendment) to the Credit Agreement, dated as of August 12, 2016 (the 2016 Credit Facility), among the Borrower, the Company, the several lenders from time to time parties thereto and Morgan Stanley, as administrative agent and collateral agent.
The parties entered into the First Amendment in order to reduce the interest rate margin applicable to (i) the Borrower’s senior secured term B1 loan facility in the original principal amount of $200 million (Existing Term B1 Loans) from 3.25% to 2.25%, in the case of alternate base rate loans, and from 4.25% to 3.25%, in the case of Eurocurrency loans, and (ii) the Borrower’s senior secured term B2 loan facility in the original principal amount of $680 million (Existing Term B2 Loans) from 3.75% to 2.75%, in the case of alternate base rate loans, and from 4.75% to 3.75%, in the case of Eurocurrency loans. The First Amendment was accomplished by (i) the Borrower obtaining new term B1 loan commitments (New Term B1 Loans) to reprice the Existing Term B1 Loans and Morgan Stanley making additional New Term B1 Loans to the Borrower in a principal amount equal to $195 million minus the principal amount of any Existing Term B1 Loans outstanding on the First Amendment Effective Date that were converted into New Term B1 Loans on the First Amendment Effective Date, and (ii) the Borrower obtaining new term B2 loan commitments (New Term B2 Loans) to reprice the Existing Term B2 Loans and Morgan Stanley making additional New Term B2 Loans to the Borrower in a principal amount equal to $608 million minus the principal amount of any Existing Term B2 Loans outstanding on the First Amendment Effective Date that were converted into New Term B2 Loans on the First Amendment Effective Date. The proceeds of the New Term B1 Loans and New Term B2 Loans, respectively, were applied to repay in full the Existing Term B1 Loans and Existing Term B2 Loans, respectively, outstanding as of the First Amendment Effective Date. The transaction is expected to lower the Company’s fiscal
11
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
year 2017 interest expense by approximately $5 million after fees and expenses. In addition, the debt refinancing that we completed in August 2016 lowered our annualized interest expense by approximately $23 million at the time of the refinancing.
The 2016 Credit Facility provides for aggregate commitments of $1,045 million, consisting of (a) a $200 million senior secured term B1 loan facility (Term B1 Loan), (b) a $680 million senior secured term B2 loan facility (Term B2 Loan; the Term B1 Loan and the Term B2 Loan collectively are referred to as the Term Loans), and (c) a $165 million senior secured revolving credit facility (Revolver). The Revolver includes subfacilities for the issuance of letters of credit in an aggregate face amount of up to $35.0 million and a swingline commitment for swingline borrowings of up to $35.0 million at any time outstanding. The Term B1 Loan and the Term B2 Loan were fully drawn on August 12, 2016.
The 2016 Credit Facility, as amended, requires the Borrower to maintain compliance with a maximum ratio of consolidated first lien secured debt to consolidated EBITDA (the consolidated first lien net leverage ratio) of 6.125 to 1.00, with incremental step downs over time. The consolidated first lien net leverage ratio, which we believe is our most restrictive covenant, is the ratio of (a) (i) funded debt secured by liens as of such date minus (ii) the unrestricted cash as of such date to (b) consolidated bank EBITDA for the period of the four fiscal quarters most recently ended. As of September 29, 2017, we were in compliance with all covenants under the 2016 Credit Facility, and our consolidated first lien net leverage ratio was 3.27:1.00.
As of September 29, 2017 and December 31, 2016 the composition of our debt was as follows:
| | September 29, | | | December 31, | |
| | 2017 | | | 2016 | |
Term Loans | | $ | 737,000 | | | $ | 823,300 | |
8.875% Senior Notes due 2024 (the Notes) | | | 300,000 | | | | 300,000 | |
Other | | | 352 | | | | 461 | |
Total debt | | | 1,037,352 | | | | 1,123,761 | |
Less: current portion of long-term debt | | | (26,947 | ) | | | (26,947 | ) |
Less: unamortized original issue discount costs and financing fees | | | (49,906 | ) | | | (56,821 | ) |
Long-term debt | | $ | 960,499 | | | $ | 1,039,993 | |
Our availability under the revolving portion of the 2016 Credit Facility was $163 million as of September 29, 2017, with $2 million outstanding under letters of credit.
During the nine months ended September 29, 2017, we repaid a total of $86 million of debt under the 2016 Credit Facility, including the prepayment of $66 million of Term B2 Loan debt.
During the nine months ended September 29, 2017 we incurred approximately $3 million in fees related to the repricing of term loan debt in 2017. During the three and nine months ended September 30, 2016, we incurred a $10 million early termination penalty, recorded a loss on extinguishment of debt of $5 million and incurred a termination fee related to the interest rate swap of $2 million. In addition, the Company expensed approximately $11 million of debt issuances costs that did not qualify for deferral. These amounts are reflected in interest expense, net in the Consolidated Statement of Operations.
Our weighted average outstanding loan balance for the three months ended September 29, 2017 was $1,060 million which accrued interest at a weighted average borrowing rate of approximately 5.85%. Our weighted average outstanding loan balance for the nine months ended September 29, 2017 was $1,088 million, which accrued interest at a weighted average borrowing rate of approximately 5.97%.
Our weighted average outstanding loan balance for the three months ended September 30, 2016 was $1,145 million which accrued interest at a weighted average borrowing rate of approximately 7.58%. Our weighted average outstanding loan balance for the nine months ended September 30, 2016 was $1,149 million, which accrued interest at a weighted average borrowing rate of approximately 8.61%.
The carrying value of the Term Loans, excluding original issue discount, and Notes approximated their fair value at September 29, 2017. The fair value of the Term Loans and Notes are based on quotes from a nationally recognized fixed income trading platform and is considered to be a Level 2 input, measured under U.S. GAAP hierarchy.
8. | Fair Value Measurements |
The Company enters into interest rate swap contracts to reduce its exposure to variability in cash flows relating to interest payments on a portion of its outstanding debt payments. These interest rate contracts are designated as cash flow hedges. The effective portion of the derivative’s gain or loss is initially reported in stockholders’ equity (as a component of accumulated other comprehensive income (loss)) and will be subsequently reclassified into earnings in the same period or periods during which the
12
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
hedged forecasted transaction affects earnings. The ineffective portion of the gain or loss of a cash flow hedge will be reported in earnings. The Company does not have any derivatives outstanding that are not designated as hedges.
During the first quarter of 2017, the Company entered into an interest rate swap agreement for contracts with an initial notional amount of $281 million. These contracts become effective December 29, 2017 and expire on December 31, 2020. The other terms of these instruments are as follows:
Contract received: | | Floating interest rate | | LIBOR (subject to minimum of 1.00%) |
Contract paid: | | Fixed interest rates | | 1.947% - 1.949% |
The following table presents our liabilities that are measured at fair value on a recurring basis:
| | | | | | September 29, | | | December 31, | |
| | Balance Sheet Classification | | Fair Value Hierarchy | | 2017 | | | 2016 | |
Interest rate swap liabilities | | Other current liabilities | | Level 2 | | $ | (835 | ) | | $ | — | |
Interest rate swap liabilities | | Other liabilities | | Level 2 | | $ | (44 | ) | | $ | — | |
The Company’s interest rate swap assets and liabilities were measured at fair value on a recurring basis and were aggregated by the level in the fair value hierarchy within which those measurements fall. The Company has agreements with each of its derivative counterparties that contain a provision where the Company could be declared in default on its derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to the Company’s default on the indebtedness. If the Company had breached any of these provisions at September 29, 2017, it could have been required to settle its obligations under the agreements at their termination value. As of September 29, 2017, the Company had not posted any collateral related to these agreements.
In connection with refinancing the 2015 Credit Facility (as defined in Note 11 to our audited consolidated financial statements in our 2016 Form 10-K), the Company terminated its interest rate swap agreements in the third quarter of 2016. The derivative instruments were comprised of contracts with an initial notional amount of $200 million. The other terms of these instruments were as follows:
Contract received: | | Floating interest rate | | LIBOR (subject to minimum of 1.25%) |
Contract paid: | | Fixed interest rates | | 3.09% - 3.18% |
The activity and balance of the restructuring liability account were as follows:
| | Severance and Related Costs | | | Other Restructuring Costs | | | Total | |
Balance as of December 31, 2015 | | $ | 4,006 | | | $ | 9,471 | | | $ | 13,477 | |
Additions | | | 9,357 | | | | 2,186 | | | | 11,543 | |
Cash payments | | | (12,059 | ) | | | (6,704 | ) | | | (18,763 | ) |
Other adjustments | | | — | | | | (2,429 | ) | | | (2,429 | ) |
Balance as of December 31, 2016 | | | 1,304 | | | | 2,524 | | | | 3,828 | |
Additions | | | — | | | | 1,859 | | | | 1,859 | |
Cash payments | | | (1,304 | ) | | | (3,323 | ) | | | (4,627 | ) |
Balance as of September 29, 2017 | | $ | — | | | $ | 1,060 | | | $ | 1,060 | |
As of September 29, 2017 and December 31, 2016, the restructuring liabilities were recognized within other current liabilities in the accompanying unaudited consolidated balance sheets. During the nine months ended September 29, 2017, we incurred other restructuring costs related to lease termination fees. As of September 29, 2017, the remaining liability primarily consisted of the costs incurred in the nine months ended September 29, 2017 and will be paid out by the end of 2017. The expenses related to the restructuring activity were contained within the selling, general and administrative expenses in the accompanying unaudited consolidated statement of operations for the appropriate period.
13
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
10. | Commitments and Contingencies |
Procurement Regulations: Most of our revenue is generated from providing services and products under legally binding agreements or contracts with U.S. government and foreign government customers. U.S. government contracts are subject to extensive legal and regulatory requirements, and from time to time, agencies of the U.S. government investigate whether such contracts were and are being conducted in accordance with these requirements.
In the ordinary course of business, we cooperate with the U.S. government on investigations from which civil or administrative proceedings have or could result and give rise to fines, penalties, compensatory and treble damages, restitution and/or forfeitures. We do not currently anticipate that any of these investigations will have a material adverse effect, individually or in the aggregate, on our consolidated financial position, results of operations or cash flows. However, under U.S. government regulations, our indictment by a federal grand jury, or an administrative finding against us as to our present responsibility to be a U.S. government contractor or subcontractor, could result in our suspension for a period of time from eligibility for awards of new government contracts or task orders or in a loss of export privileges. A conviction, or an administrative finding against us that satisfies the requisite level of seriousness, could result in debarment from contracting with the U.S. government for a specified term, which would have a materially adverse effect on our consolidated financial position, results of operations and cash flows.
In addition, all of our U.S. government contracts: (1) are subject to audit and various pricing and cost controls, (2) include standard provisions for termination for the convenience of the U.S. government or for default, and (3) are subject to cancellation if funds for contracts become unavailable. Foreign government contracts generally include comparable provisions relating to terminations for convenience and default, as well as other procurement clauses relevant to the foreign government.
Litigation and Other Matters: We are also subject to litigation, proceedings, claims or assessments and various contingent liabilities incidental to our businesses. Furthermore, in connection with certain business acquisitions, we have assumed some or all claims against, and liabilities of, such acquired businesses, including both asserted and unasserted claims and liabilities.
In accordance with the accounting standard for contingencies, we record a liability when management believes that it is both probable that a liability has been incurred and we can reasonably estimate the amount of the loss. Generally, the loss is recorded for the amount we expect to resolve the liability. The estimated amounts of liabilities recorded for pending and threatened litigation are recorded in other current liabilities in our consolidated balance sheets. Amounts recoverable from insurance contracts or third parties are recorded as assets when realized. At December 31, 2016 and September 29, 2017, we did not record any amounts for recoveries from insurance contracts or third parties in connection with the amount of liabilities recorded for pending and threatened litigation. Legal defense costs are expensed as incurred. We believe we have recorded adequate provisions for our litigation matters. We review these provisions quarterly and adjust these provisions to reflect the effect of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter.
The provision for income taxes for the three months ended September 29, 2017 was $6 million compared to $1 million for the three months ended September 30, 2016. The effective tax rate for the three months ended September 29, 2017 was 34.1% as compared to (9.6)% for the three months ended September 30, 2016. The increase in the provision for income taxes and the effective tax rate, which includes the effects of discrete items, was primarily due to the earnings impact from our joint venture relative to our overall increased earnings for the three months ended September 29, 2017 as compared to the three months ended September 30, 2016.
The provision for income taxes for the nine months ended September 29, 2017 was $17 million compared to $2 million for the nine months ended September 30, 2016. The effective tax rate for the nine months ended September 29, 2017 was 37.3% as compared to (21.5)% for the nine months ended September 30, 2016. The increase in the provision for income taxes and the effective tax rate, which includes the effects of discrete items, was primarily due to increased earnings and the sale of IRG in the first quarter of 2017.
The Company continues to benefit from tax attributes acquired with the acquisition of TASC, including net operating losses. These tax assets are expected to significantly reduce net cash tax payments through 2024.
12. | Separate Financial Information of Subsidiary Guarantor of Indebtedness |
The following tables present supplemental condensed consolidating financial statements of (a) Engility Holdings, Inc., as parent company guarantor, (b) Engility Corporation, as subsidiary issuer of the Notes; (c) on a combined basis, the subsidiary guarantors of the Notes; and (d) on a combined basis, the subsidiaries that are not guarantors of the Notes. Separate financial statements of the subsidiary guarantors are not presented because the parent company owns 100% of the outstanding voting stock of each of the subsidiary guarantors and the guarantee by each subsidiary guarantor is joint and several and full and unconditional, except for certain
14
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
customary limitations. These customary limitations, which are described in detail in the Indenture (as defined in Note 11 to our audited consolidated financial statements in our 2016 Form 10-K), include (i) the sale, exchange or transfer of a guarantor, (ii) the guarantor ceasing to guarantee the 2016 Credit Facility, (iii) the designation of a guarantor as a unrestricted subsidiary (iv) exercising the legal defeasance, covenant defeasance or discharge of the Indenture, and (v) the merger or consolidation of a guarantor with the issuer or another guarantor of the Indenture. As a result and in accordance with Rule 3-10(d) of Regulation S-X under the Securities Exchange Act of 1934, as amended, the Company includes the following tables in these notes to the condensed consolidated financial statements:
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
AS OF SEPTEMBER 29, 2017
| | Engility Holdings, Inc. | | | Engility Corporation | | | Subsidiary Guarantors | | | Subsidiary Non- guarantors | | | Consolidating Adjustments | | | Consolidated | |
Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Current assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | — | | | $ | 36,460 | | | $ | 126 | | | $ | 15,392 | | | $ | — | | | $ | 51,978 | |
Receivables, net | | | — | | | | 302,383 | | | | 22,126 | | | | 17,204 | | | | — | | | | 341,713 | |
Intercompany receivables | | | — | | | | 69,131 | | | | — | | | | 6,284 | | | | (75,415 | ) | | | — | |
Other current assets | | | — | | | | 20,603 | | | | 402 | | | | 1,749 | | | | — | | | | 22,754 | |
Total current assets | | | — | | | | 428,577 | | | | 22,654 | | | | 40,629 | | | | (75,415 | ) | | | 416,445 | |
Property, plant and equipment, net | | | — | | | | 38,004 | | | | 6,346 | | | | 78 | | | | — | | | | 44,428 | |
Goodwill | | | — | | | | 1,020,027 | | | | 58,427 | | | | — | | | | — | | | | 1,078,454 | |
Identifiable intangible assets, net | | | — | | | | 337,076 | | | | 32,452 | | | | — | | | | — | | | | 369,528 | |
Deferred tax assets | | | — | | | | 193,074 | | | | 23,160 | | | | — | | | | — | | | | 216,234 | |
Investment in subsidiaries | | | 732,153 | | | | 74,416 | | | | 30,349 | | | | — | | | | (836,918 | ) | | | — | |
Other assets | | | — | | | | 4,395 | | | | 45 | | | | — | | | | — | | | | 4,440 | |
Total assets | | $ | 732,153 | | | $ | 2,095,569 | | | $ | 173,433 | | | $ | 40,707 | | | $ | (912,333 | ) | | $ | 2,129,529 | |
Liabilities and Equity: | | | | | | | | | | | | | | | | | | | | | | | | |
Current liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Current portion of long-term debt | | $ | — | | | $ | 26,947 | | | $ | — | | | $ | — | | | $ | — | | | $ | 26,947 | |
Accounts payable, trade | | | — | | | | 50,293 | | | | 45 | | | | 75 | | | | — | | | | 50,413 | |
Intercompany payable | | | — | | | | 6,284 | | | | 69,131 | | | | — | | | | (75,415 | ) | | | — | |
Accrued employment costs | | | — | | | | 84,809 | | | | 2,955 | | | | 8,963 | | | | — | | | | 96,727 | |
Accrued expenses | | | — | | | | 81,593 | | | | — | | | | 372 | | | | — | | | | 81,965 | |
Advance payments and billings in excess of costs incurred | | | — | | | | 31,905 | | | | — | | | | — | | | | — | | | | 31,905 | |
Deferred income taxes, current and income tax liabilities | | | — | | | | 312 | | | | — | | | | 206 | | | | | | | | 518 | |
Other current liabilities | | | — | | | | 21,643 | | | | 11 | | | | 742 | | | | | | | | 22,396 | |
Total current liabilities | | | — | | | | 303,786 | | | | 72,142 | | | | 10,358 | | | | (75,415 | ) | | | 310,871 | |
Long-term debt | | | — | | | | 960,499 | | | | — | | | | — | | | | — | | | | 960,499 | |
Income tax liabilities | | | — | | | | 63,167 | | | | — | | | | — | | | | — | | | | 63,167 | |
Other liabilities | | | — | | | | 35,964 | | | | 26,875 | | | | — | | | | — | | | | 62,839 | |
Total liabilities | | | — | | | | 1,363,416 | | | | 99,017 | | | | 10,358 | | | | (75,415 | ) | | | 1,397,376 | |
Shareholders' equity | | | 732,153 | | | | 732,153 | | | | 74,416 | | | | 30,349 | | | | (836,918 | ) | | | 732,153 | |
Total liabilities and equity | | $ | 732,153 | | | $ | 2,095,569 | | | $ | 173,433 | | | $ | 40,707 | | | $ | (912,333 | ) | | $ | 2,129,529 | |
15
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2016
| | Engility Holdings, Inc. | | | Engility Corporation | | | Subsidiary Guarantors | | | Subsidiary Non- guarantors | | | Consolidating Adjustments | | | Consolidated | |
Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Current assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | — | | | $ | 31,124 | | | $ | 385 | | | $ | 16,727 | | | $ | — | | | $ | 48,236 | |
Receivables, net | | | — | | | | 280,709 | | | | 34,655 | | | | 18,884 | | | | — | | | | 334,248 | |
Intercompany receivables | | | — | | | | 83,739 | | | | — | | | | 758 | | | | (84,497 | ) | | | — | |
Assets held for sale, current | | | — | | | | 2,332 | | | | 17,910 | | | | — | | | | — | | | | 20,242 | |
Other current assets | | | — | | | | 27,437 | | | | 506 | | | | 2,461 | | | | — | | | | 30,404 | |
Total current assets | | | — | | | | 425,341 | | | | 53,456 | | | | 38,830 | | | | (84,497 | ) | | | 433,130 | |
Property, plant and equipment, net | | | — | | | | 40,071 | | | | 6,345 | | | | 131 | | | | — | | | | 46,547 | |
Goodwill | | | — | | | | 1,020,027 | | | | 58,427 | | | | — | | | | — | | | | 1,078,454 | |
Identifiable intangible assets, net | | | — | | | | 359,465 | | | | 34,426 | | | | — | | | | — | | | | 393,891 | |
Deferred tax assets | | | — | | | | 213,296 | | | | 18,987 | | | | — | | | | — | | | | 232,283 | |
Assets held for sale | | | — | | | | — | | | | 11,962 | | | | — | | | | — | | | | 11,962 | |
Investment in subsidiaries | | | 704,805 | | | | 89,543 | | | | 29,248 | | | | — | | | | (823,596 | ) | | | — | |
Other assets | | | — | | | | 2,292 | | | | — | | | | — | | | | — | | | | 2,292 | |
Total assets | | $ | 704,805 | | | $ | 2,150,035 | | | $ | 212,851 | | | $ | 38,961 | | | $ | (908,093 | ) | | $ | 2,198,559 | |
Liabilities and Equity: | | | | | | | | | | | | | | | | | | | | | | | | |
Current liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Current portion of long-term debt | | $ | — | | | $ | 26,947 | | | $ | — | | | $ | — | | | $ | — | | | $ | 26,947 | |
Accounts payable, trade | | | — | | | | 43,848 | | | | 37 | | | | 58 | | | | — | | | | 43,943 | |
Intercompany payable | | | — | | | | 758 | | | | 83,739 | | | | — | | | | (84,497 | ) | | | — | |
Accrued employment costs | | | — | | | | 87,199 | | | | 4,530 | | | | 7,131 | | | | — | | | | 98,860 | |
Accrued expenses | | | — | | | | 76,520 | | | | — | | | | 350 | | | | — | | | | 76,870 | |
Advance payments and billings in excess of costs incurred | | | — | | | | 33,259 | | | | — | | | | — | | | | — | | | | 33,259 | |
Deferred income taxes, current and income tax liabilities | | | — | | | | — | | | | — | | | | 230 | | | | (21 | ) | | | 209 | |
Liabilities held for sale, current | | | — | | | | — | | | | 4,341 | | | | — | | | | — | | | | 4,341 | |
Other current liabilities | | | — | | | | 34,398 | | | | 47 | | | | 1,944 | | | | 21 | | | | 36,410 | |
Total current liabilities | | | — | | | | 302,929 | | | | 92,694 | | | | 9,713 | | | | (84,497 | ) | | | 320,839 | |
Long-term debt | | | — | | | | 1,039,993 | | | | — | | | | — | | | | — | | | | 1,039,993 | |
Income tax liabilities | | | — | | | | 64,852 | | | | — | | | | — | | | | — | | | | 64,852 | |
Liabilities held for sale | | | — | | | | — | | | | 1,084 | | | | — | | | | — | | | | 1,084 | |
Other liabilities | | | — | | | | 37,456 | | | | 29,530 | | | | — | | | | — | | | | 66,986 | |
Total liabilities | | | — | | | | 1,445,230 | | | | 123,308 | | | | 9,713 | | | | (84,497 | ) | | | 1,493,754 | |
Shareholders' equity | | | 704,805 | | | | 704,805 | | | | 89,543 | | | | 29,248 | | | | (823,596 | ) | | | 704,805 | |
Total liabilities and equity | | $ | 704,805 | | | $ | 2,150,035 | | | $ | 212,851 | | | $ | 38,961 | | | $ | (908,093 | ) | | $ | 2,198,559 | |
16
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
FOR THE THREE MONTHS ENDED SEPTEMBER 29, 2017
| | Engility Holdings, Inc. | | | Engility Corporation | | | Subsidiary Guarantors | | | Subsidiary Non- guarantors | | | Consolidating Adjustments | | | Consolidated | |
Revenue | | $ | — | | | $ | 430,261 | | | $ | 22,199 | | | $ | 34,684 | | | $ | — | | | $ | 487,144 | |
Costs and expenses | | | | | | | | | | | | | | | | | | | | | | | | |
Cost of revenue | | | — | | | | 360,520 | | | | 25,343 | | | | 31,718 | | | | — | | | | 417,581 | |
Selling, general and administrative expenses | | | — | | | | 29,240 | | | | 2,925 | | | | 1,143 | | | | — | | | | 33,308 | |
Total costs and expenses | | | — | | | | 389,760 | | | | 28,268 | | | | 32,861 | | | | — | | | | 450,889 | |
Operating income (loss) | | | — | | | | 40,501 | | | | (6,069 | ) | | | 1,823 | | | | — | | | | 36,255 | |
Interest expense, net | | | — | | | | 19,739 | | | | — | | | | — | | | | — | | | | 19,739 | |
Other expenses (income), net | | | — | | | | (7 | ) | | | (1 | ) | | | 57 | | | | — | | | | 49 | |
Income (loss) in equity investments in subsidiaries | | | 9,805 | | | | (5,534 | ) | | | 715 | | | | — | | | | (4,986 | ) | | | — | |
Income (loss) before income taxes | | | 9,805 | | | | 15,235 | | | | (5,353 | ) | | | 1,766 | | | | (4,986 | ) | | | 16,467 | |
Provision for income taxes | | | — | | | | 5,430 | | | | 181 | | | | — | | | | — | | | | 5,611 | |
Net income (loss) | | | 9,805 | | | | 9,805 | | | | (5,534 | ) | | | 1,766 | | | | (4,986 | ) | | | 10,856 | |
Less: Net income attributable to non-controlling interest | | | — | | | | — | | | | — | | | | 1,051 | | | | — | | | | 1,051 | |
Net income (loss) attributable to Engility | | $ | 9,805 | | | $ | 9,805 | | | $ | (5,534 | ) | | $ | 715 | | | $ | (4,986 | ) | | $ | 9,805 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net income (loss) | | $ | 9,805 | | | $ | 9,805 | | | $ | (5,534 | ) | | $ | 1,766 | | | $ | (4,986 | ) | | $ | 10,856 | |
Other comprehensive loss | | | — | | | | (44 | ) | | | (11 | ) | | | — | | | | — | | | | (55 | ) |
Comprehensive income (loss) | | | 9,805 | | | | 9,761 | | | | (5,545 | ) | | | 1,766 | | | | (4,986 | ) | | | 10,801 | |
Less: Net income attributable to non-controlling interest | | | — | | | | — | | | | — | | | | 1,051 | | | | — | | | | 1,051 | |
Comprehensive income (loss) attributable to Engility | | $ | 9,805 | | | $ | 9,761 | | | $ | (5,545 | ) | | $ | 715 | | | $ | (4,986 | ) | | $ | 9,750 | |
17
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2016
| | Engility Holdings, Inc. | | | Engility Corporation | | | Subsidiary Guarantors | | | Subsidiary Non- guarantors | | | Consolidating Adjustments | | | Consolidated | |
Revenue | | $ | — | | | $ | 428,217 | | | $ | 45,689 | | | $ | 37,894 | | | $ | — | | | $ | 511,800 | |
Costs and expenses | | | | | | | | | | | | | | | | | | | | | | | | |
Cost of revenue | | | — | | | | 348,629 | | | | 52,537 | | | | 34,428 | | | | — | | | | 435,594 | |
Selling, general and administrative expenses | | | — | | | | 29,549 | | | | 8,980 | | | | 808 | | | | — | | | | 39,337 | |
Total costs and expenses | | | — | | | | 378,178 | | | | 61,517 | | | | 35,236 | | | | — | | | | 474,931 | |
Operating income (loss) | | | — | | | | 50,039 | | | | (15,828 | ) | | | 2,658 | | | | — | | | | 36,869 | |
Interest expense, net | | | — | | | | 50,855 | | | | — | | | | — | | | | — | | | | 50,855 | |
Other expenses (income), net | | | — | | | | (66 | ) | | | — | | | | 66 | | | | — | | | | — | |
Income (loss) in equity investments in subsidiaries | | | (16,757 | ) | | | (14,710 | ) | | | 1,169 | | | | — | | | | 30,298 | | | | — | |
Income (loss) before income taxes | | | (16,757 | ) | | | (15,460 | ) | | | (14,659 | ) | | | 2,592 | | | | 30,298 | | | | (13,986 | ) |
Provision for income taxes | | | — | | | | 1,297 | | | | 51 | | | | — | | | | — | | | | 1,348 | |
Net income (loss) | | | (16,757 | ) | | | (16,757 | ) | | | (14,710 | ) | | | 2,592 | | | | 30,298 | | | | (15,334 | ) |
Less: Net income attributable to non-controlling interest | | | — | | | | — | | | | — | | | | 1,423 | | | | — | | | | 1,423 | |
Net income (loss) attributable to Engility | | $ | (16,757 | ) | | $ | (16,757 | ) | | $ | (14,710 | ) | | $ | 1,169 | | | $ | 30,298 | | | $ | (16,757 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net income (loss) | | $ | (16,757 | ) | | $ | (16,757 | ) | | $ | (14,710 | ) | | $ | 2,592 | | | $ | 30,298 | | | $ | (15,334 | ) |
Other comprehensive income | | | — | | | | 523 | | | | — | | | | — | | | | — | | | | 523 | |
Comprehensive income (loss) | | | (16,757 | ) | | | (16,234 | ) | | | (14,710 | ) | | | 2,592 | | | | 30,298 | | | | (14,811 | ) |
Less: Net income attributable to non-controlling interest | | | — | | | | — | | | | — | | | | 1,423 | | | | — | | | | 1,423 | |
Comprehensive income (loss) attributable to Engility | | $ | (16,757 | ) | | $ | (16,234 | ) | | $ | (14,710 | ) | | $ | 1,169 | | | $ | 30,298 | | | $ | (16,234 | ) |
18
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
FOR THE NINE MONTHS ENDED SEPTEMBER 29, 2017
| | Engility Holdings, Inc. | | | Engility Corporation | | | Subsidiary Guarantors | | | Subsidiary Non- guarantors | | | Consolidating Adjustments | | | Consolidated | |
Revenue | | $ | — | | | $ | 1,283,964 | | | $ | 75,596 | | | $ | 107,470 | | | $ | — | | | $ | 1,467,030 | |
Costs and expenses | | | | | | | | | | | | | | | | | | | | | | | | |
Cost of revenue | | | — | | | | 1,075,098 | | | | 83,613 | | | | 96,892 | | | | — | | | | 1,255,603 | |
Selling, general and administrative expenses | | | — | | | | 94,430 | | | | 9,766 | | | | 3,107 | | | | — | | | | 107,303 | |
Total costs and expenses | | | — | | | | 1,169,528 | | | | 93,379 | | | | 99,999 | | | | — | | | | 1,362,906 | |
Operating income (loss) | | | — | | | | 114,436 | | | | (17,783 | ) | | | 7,471 | | | | — | | | | 104,124 | |
Interest expense, net | | | — | | | | 59,189 | | | | — | | | | — | | | | — | | | | 59,189 | |
Other expenses (income), net | | | — | | | | (19 | ) | | | (3 | ) | | | 234 | | | | — | | | | 212 | |
Income (loss) in equity investments in subsidiaries | | | 24,369 | | | | (15,024 | ) | | | 3,554 | | | | — | | | | (12,899 | ) | | | — | |
Income (loss) before income taxes | | | 24,369 | | | | 40,242 | | | | (14,226 | ) | | | 7,237 | | | | (12,899 | ) | | | 44,723 | |
Provision for income taxes | | | — | | | | 15,873 | | | | 798 | | | | — | | | | — | | | | 16,671 | |
Net income (loss) | | | 24,369 | | | | 24,369 | | | | (15,024 | ) | | | 7,237 | | | | (12,899 | ) | | | 28,052 | |
Less: Net income attributable to non-controlling interest | | | — | | | | — | | | | — | | | | 3,683 | | | | — | | | | 3,683 | |
Net income (loss) attributable to Engility | | $ | 24,369 | | | $ | 24,369 | | | $ | (15,024 | ) | | $ | 3,554 | | | $ | (12,899 | ) | | $ | 24,369 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net income (loss) | | $ | 24,369 | | | $ | 24,369 | | | $ | (15,024 | ) | | $ | 7,237 | | | $ | (12,899 | ) | | $ | 28,052 | |
Other comprehensive loss | | | — | | | | (536 | ) | | | (103 | ) | | | — | | | | — | | | | (639 | ) |
Comprehensive income (loss) | | | 24,369 | | | | 23,833 | | | | (15,127 | ) | | | 7,237 | | | | (12,899 | ) | | | 27,413 | |
Less: Net income attributable to non-controlling interest | | | — | | | | — | | | | — | | | | 3,683 | | | | — | | | | 3,683 | |
Comprehensive income (loss) attributable to Engility | | $ | 24,369 | | | $ | 23,833 | | | $ | (15,127 | ) | | $ | 3,554 | | | $ | (12,899 | ) | | $ | 23,730 | |
19
ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2016
| | Engility Holdings, Inc. | | | Engility Corporation | | | Subsidiary Guarantors | | | Subsidiary Non- guarantors | | | Consolidating Adjustments | | | Consolidated | |
Revenue | | $ | — | | | $ | 1,303,403 | | | $ | 148,117 | | | $ | 118,491 | | | $ | — | | | $ | 1,570,011 | |
Costs and expenses | | | | | | | | | | | | | | | | | | | | | | | | |
Cost of revenue | | | — | | | | 1,068,725 | | | | 165,385 | | | | 107,716 | | | | — | | | | 1,341,826 | |
Selling, general and administrative expenses | | | — | | | | 103,581 | | | | 23,873 | | | | 2,326 | | | | — | | | | 129,780 | |
Goodwill impairment | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
Total costs and expenses | | | — | | | | 1,172,306 | | | | 189,258 | | | | 110,042 | | | | — | | | | 1,471,606 | |
Operating income (loss) | | | — | | | | 131,097 | | | | (41,141 | ) | | | 8,449 | | | | — | | | | 98,405 | |
Interest expense, net | | | — | | | | 109,358 | | | | — | | | | — | | | | — | | | | 109,358 | |
Other expenses (income), net | | | — | | | | (99 | ) | | | — | | | | 181 | | | | — | | | | 82 | |
Income (loss) in equity investments in subsidiaries | | | (17,493 | ) | | | (40,289 | ) | | | 4,180 | | | | — | | | | 53,602 | | | | — | |
Income (loss) before income taxes | | | (17,493 | ) | | | (18,451 | ) | | | (36,961 | ) | | | 8,268 | | | | 53,602 | | | | (11,035 | ) |
Provision (benefit) for income taxes | | | — | | | | (958 | ) | | | 3,328 | | | | — | | | | — | | | | 2,370 | |
Net income (loss) | | | (17,493 | ) | | | (17,493 | ) | | | (40,289 | ) | | | 8,268 | | | | 53,602 | | | | (13,405 | ) |
Less: Net income attributable to non-controlling interest | | | — | | | | — | | | | — | | | | 4,088 | | | | — | | | | 4,088 | |
Net income (loss) attributable to Engility | | $ | (17,493 | ) | | $ | (17,493 | ) | | $ | (40,289 | ) | | $ | 4,180 | | | $ | 53,602 | | | $ | (17,493 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net income (loss) | | $ | (17,493 | ) | | $ | (17,493 | ) | | $ | (40,289 | ) | | $ | 8,268 | | | $ | 53,602 | | | $ | (13,405 | ) |
Other comprehensive income | | | — | | | | 1,699 | | | | 632 | | | | — | | | | — | | | | 2,331 | |
Comprehensive income (loss) | | | (17,493 | ) | | | (15,794 | ) | | | (39,657 | ) | | | 8,268 | | | | 53,602 | | | | (11,074 | ) |
Less: Net income attributable to non-controlling interest | | | — | | | | — | | | | — | | | | 4,088 | | | | — | | | | 4,088 | |
Comprehensive income (loss) attributable to Engility | | $ | (17,493 | ) | | $ | (15,794 | ) | | $ | (39,657 | ) | | $ | 4,180 | | | $ | 53,602 | | | $ | (15,162 | ) |
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ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 29, 2017
| | Engility Holdings, Inc. | | | Engility Corporation | | | Subsidiary Guarantors | | | Subsidiary Non- guarantors | | | Consolidating Adjustments | | | Consolidated | |
Operating activities: | | | | | | | | | | | | | | | | | | | | | | | | |
Net cash provided by operating activities | | $ | — | | | $ | 54,079 | | | $ | 14,349 | | | $ | 10,327 | | | $ | — | | | $ | 78,755 | |
Investing activities: | | | | | | | | | | | | | | | | | | | | | | | | |
Proceeds from sale of business, net of amount placed in escrow | | | — | | | | 22,349 | | | | — | | | | — | | | | — | | | | 22,349 | |
Proceeds from sale of property, plant and equipment | | | — | | | | 2,902 | | | | — | | | | — | | | | — | | | | 2,902 | |
Capital expenditures | | | — | | | | (5,810 | ) | | | — | | | | — | | | | — | | | | (5,810 | ) |
Net cash provided by investing activities | | | — | | | | 19,441 | | | | — | | | | — | | | | — | | | | 19,441 | |
Financing activities: | | | | | | | | | | | | | | | | | | | | | | | | |
Repayment of long-term debt | | | — | | | | (86,410 | ) | | | — | | | | — | | | | — | | | | (86,410 | ) |
Gross borrowings from revolving credit facility | | | — | | | | 270,000 | | | | — | | | | — | | | | — | | | | 270,000 | |
Repayments of revolving credit facility | | | — | | | | (270,000 | ) | | | — | | | | — | | | | — | | | | (270,000 | ) |
Payment of employee withholding taxes on share-based compensation | | | (1,501 | ) | | | — | | | | — | | | | — | | | | — | | | | (1,501 | ) |
Dividends paid | | | (407 | ) | | | — | | | | — | | | | — | | | | — | | | | (407 | ) |
Distributions to non-controlling interest member | | | — | | | | — | | | | — | | | | (6,136 | ) | | | — | | | | (6,136 | ) |
Due (to) from subsidiaries | | | 1,908 | | | | 18,226 | | | | (14,608 | ) | | | (5,526 | ) | | | — | | | | — | |
Net cash used in financing activities | | | — | | | | (68,184 | ) | | | (14,608 | ) | | | (11,662 | ) | | | — | | | | (94,454 | ) |
Net change in cash and cash equivalents | | | — | | | | 5,336 | | | | (259 | ) | | | (1,335 | ) | | | — | | | | 3,742 | |
Cash and cash equivalents, beginning of period | | | — | | | | 31,124 | | | | 385 | | | | 16,727 | | | | — | | | | 48,236 | |
Cash and cash equivalents, end of period | | $ | — | | | $ | 36,460 | | | $ | 126 | | | $ | 15,392 | | | $ | — | | | $ | 51,978 | |
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ENGILITY HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts or where otherwise stated)
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2016
| | Engility Holdings, Inc. | | | Engility Corporation | | | Subsidiary Guarantors | | | Subsidiary Non- guarantors | | | Consolidating Adjustments | | | Consolidated | |
Operating activities: | | | | | | | | | | | | | | | | | | | | | | | | |
Net cash provided by (used in) operating activities | | $ | — | | | $ | 137,046 | | | $ | (64,341 | ) | | $ | 12,039 | | | $ | — | | | $ | 84,744 | |
Investing activities: | | | | | | | | | | | | | | | | | | | | | | | | |
Capital expenditures | | | — | | | | (17,942 | ) | | | — | | | | — | | | | — | | | | (17,942 | ) |
Net cash used in investing activities | | | — | | | | (17,942 | ) | | | — | | | | — | | | | — | | | | (17,942 | ) |
Financing activities: | | | | | | | | | | | | | | | | | | | | | | | | |
Gross borrowings from issuance of long-term debt | | | — | | | | 1,180,000 | | | | — | | | | — | | | | — | | | | 1,180,000 | |
Repayment of long-term debt | | | — | | | | (1,199,018 | ) | | | — | | | | — | | | | — | | | | (1,199,018 | ) |
Gross borrowings from revolving credit facility | | | — | | | | 73,000 | | | | — | | | | — | | | | — | | | | 73,000 | |
Repayments of revolving credit facility | | | — | | | | (73,000 | ) | | | — | | | | — | | | | — | | | | (73,000 | ) |
Debt issuance costs | | | — | | | | (9,988 | ) | | | — | | | | — | | | | — | | | | (9,988 | ) |
Proceeds from share-based payment arrangements | | | 214 | | | | — | | | | — | | | | — | | | | — | | | | 214 | |
Payment of employee withholding taxes on share- based compensation | | | (1,777 | ) | | | — | | | | — | | | | — | | | | — | | | | (1,777 | ) |
Dividends paid | | | (1,703 | ) | | | — | | | | — | | | | — | | | | — | | | | (1,703 | ) |
Distributions to non-controlling interest member | | | — | | | | — | | | | — | | | | (3,865 | ) | | | — | | | | (3,865 | ) |
Due (to) from subsidiaries | | | 3,266 | | | | (65,578 | ) | | | 65,413 | | | | (3,101 | ) | | | — | | | | — | |
Net cash provided by (used in) financing activities | | | — | | | | (94,584 | ) | | | 65,413 | | | | (6,966 | ) | | | — | | | | (36,137 | ) |
Net change in cash and cash equivalents | | | — | | | | 24,520 | | | | 1,072 | | | | 5,073 | | | | — | | | | 30,665 | |
Cash and cash equivalents, beginning of period | | | — | | | | 18,313 | | | | 29 | | | | 11,680 | | | | — | | | | 30,022 | |
Cash and cash equivalents, end of period | | $ | — | | | $ | 42,833 | | | $ | 1,101 | | | $ | 16,753 | | | $ | — | | | $ | 60,687 | |
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion of our results of operations and financial condition together with the Unaudited Consolidated Financial Statements and the notes thereto included in this Quarterly Report on Form 10-Q (this Form 10-Q), as well as the audited financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission (SEC) on March 9, 2017 (2016 Form 10-K), which provides additional information regarding our services, industry outlook and forward-looking statements that involve risks and uncertainties. See “Forward-Looking Statements” in this Form 10-Q. The financial information discussed below and included in this Form 10-Q may not necessarily reflect what our financial condition, results of operations or cash flows may be in the future.
Overview
Our business is focused on supporting the mission success of our customers by providing a full range of engineering, technical, analytical, advisory, training, logistics and support services. Our service offerings are organized around six core competencies: (i) specialized technical consulting; (ii) program and business support services; (iii) engineering and technology lifecycle support; (iv) information technology modernization and sustainment; (v) supply chain services and logistics management; and (vi) training and education.
Engility, through our predecessors, has provided mission critical services to the U.S. government for over six decades. We have a diversified portfolio that serves the U.S. Department of Defense (DoD), U.S. Department of Justice (DoJ), U.S. Department of State (DoS), Federal Aviation Administration (FAA), Department of Homeland Security (DHS), and space-related and intelligence community agencies, including the National Geospatial-Intelligence Agency (NGA), Defense Intelligence Agency (DIA), National Reconnaissance Office (NRO), and National Aeronautical and Space Administration (NASA).
Executive Summary
Our revenue is spread over a diverse mix of activities and services with no single program accounting for more than 10% of our revenue for the three and nine months ended September 29, 2017 and September 30, 2016. Revenue for the third quarter of 2017 was $487 million, a decrease of $25 million compared to the third quarter of 2016. Revenue decreased primarily as a result of the sale of International Resources Group Ltd. (IRG) in the first quarter of 2017, ongoing impact from contracts moving to small businesses, contracts that came to the end of their period of performance and new business and recompete wins that were not sufficient to replace the revenue on completed contracts. The primary drivers of this decline were $12 million in decreased DoD-related revenue and $22 million in decreased federal civilian-related contract revenue, which included a decrease of $13 million related to the sale of IRG, partially offset by $9 million in increased intelligence-related contract revenue.
Selling, general and administrative expenses for the third quarter of 2017 were $33 million, a decrease of $6 million compared to the third quarter of 2016. The decrease in selling, general and administrative expenses primarily resulted from lower costs in the third quarter of 2017 due to the sale of IRG and lower restructuring-related expenses.
Our operating income for the third quarter of 2017 and 2016 was $36 million and $37 million, respectively. The decrease in operating income was primarily due to the decline in revenue, partially offset by higher contract profit and lower selling, general and administrative expenses in the three months ended September 29, 2017 as compared to the three months ended September 30, 2016.
Economic Opportunities, Challenges, and Risks
Our cost plus percentage has continued to increase as our portfolio has become somewhat more concentrated in Intel customers. Generally speaking, profit margins tend to be higher on fixed-price and time-and-material type contracts due to the additional risk assumed by the contractor. The percentage of our revenue coming from cost-type contracts has continued to increase over time. This is due in part to a larger portion of our revenues coming from intelligence community customers, which tend to favor cost-type contracts. To date, we have been able to preserve our operating margins by driving increased efficiencies in our business. If however an increasing percentage of our contract portfolio continues to move to cost-type contracts, we could experience downward pressure on operating margins.
The U.S. government services market continues to encounter budget, funding, changing mission priorities, and political and legislative challenges, which have adversely impacted spending by both our DoD and Federal agency customers. Trends in the U.S. government contracting process, including a shift towards multiple-award contracts (in which certain contractors are preapproved using indefinite delivery/indefinite quantity (IDIQ) and General Services Administration contract vehicles), awarding contracts to small businesses, and a continued emphasis on cost efficient solutions, have also increased competition for U.S. government contracts. In addition, as we continue to pursue larger new awards, our competitors for these opportunities may have greater resources and/or stronger relationships with the target customers. In response to these pressures, we continue to take steps to reduce indirect labor and other costs in our business to increase our overall competitiveness.
Despite the budget and competitive pressures impacting the industry, we believe that our focus on organic growth and increasing our presence in enduring markets has positioned us to expand our customer penetration and benefit from opportunities that
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we have not previously pursued. We believe long-term competitiveness will likely require companies to offer highly specialized, enduring capabilities in niche markets and/or have sufficient breadth and size to weather future market volatility while continuing to provide cost-efficient services.
Key Performance Indicators
Total Backlog
| | September 29, | | | December 31, | |
| | 2017 | | | 2016 | |
| | (in millions) | |
Funded | | $ | 623.6 | | | $ | 700.0 | |
Unfunded | | | 3,089.2 | | | | 2,913.7 | |
Total | | $ | 3,712.8 | | | $ | 3,613.7 | |
We define total backlog as the value of firm orders received from customers, less the cumulative amount of revenue recognized on such orders and customer deobligations. Total backlog includes both funded backlog (firm orders for which funding is contractually obligated by the customer) and unfunded backlog (firm orders for which funding is not currently contractually obligated by the customer) including unexercised options on multi-year contracts. Total backlog excludes potential orders under multiple award IDIQ contracts. At December 31, 2016, total backlog included $188 million related to IRG which was removed from total backlog at the date of the sale. We expect that substantially all of our funded backlog at September 29, 2017 will generate revenue during the next twelve month period.
Net Bookings and Book-to-Bill
For the third quarter of 2017, net bookings were $541 million, representing a total net book-to-bill of 1.1x. Net bookings represent the estimated amount of revenue to be earned in the future from funded and negotiated unfunded contract awards that were received during the period. Our total net book-to-bill is calculated as net bookings divided by revenue.
Days Sales Outstanding
Days sales outstanding (DSO), net of advanced payments, was 57 days as of September 29, 2017 and 56 days as of December 31, 2016. DSO is calculated as net receivables less advance payments and billings in excess of costs incurred, divided by daily revenue (total revenue for the quarter divided by 90 days).
Revenue by Contract Type
| | Three Months Ended | | | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | September 29, 2017 | | | September 30, 2016 | |
Cost plus | | | 66.7 | % | | | 61.5 | % | | | 64.7 | % | | | 60.2 | % |
Time and material | | | 16.7 | % | | | 18.3 | % | | | 17.7 | % | | | 19.4 | % |
Fixed price | | | 16.6 | % | | | 20.2 | % | | | 17.6 | % | | | 20.4 | % |
Total | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
Prime Contractor Revenue
| | Three Months Ended | | | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | September 29, 2017 | | | September 30, 2016 | |
Prime | | | 83.6 | % | | | 82.7 | % | | | 82.6 | % | | | 82.5 | % |
Sub | | | 16.4 | % | | | 17.3 | % | | | 17.4 | % | | | 17.5 | % |
Total | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
Revenue by Customer
| | Three Months Ended | | | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | September 29, 2017 | | | September 30, 2016 | |
DoD | | | 39.7 | % | | | 40.0 | % | | | 40.3 | % | | | 40.6 | % |
Federal Civilian | | | 23.0 | % | | | 26.2 | % | | | 23.3 | % | | | 26.6 | % |
Intel | | | 37.3 | % | | | 33.8 | % | | | 36.4 | % | | | 32.8 | % |
Total | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
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Results of Operations — Three Months Ended September 29, 2017 Compared to Three Months Ended September 30, 2016
The following tables provide our selected financial data for the three months ended September 29, 2017 and September 30, 2016.
| | Three Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Revenue | | $ | 487.1 | | | | 100.0 | % | | $ | 511.8 | | | | 100.0 | % | | $ | (24.7 | ) | | | (4.8 | )% |
Revenue: For the three months ended September 29, 2017, revenue was $487 million compared to revenue for the three months ended September 30, 2016 of $512 million, a decline of $25 million, or 4.8%. Revenue decreased primarily as a result of the sale of IRG, ongoing impact from contracts moving to small businesses, contracts that came to the end of their period of performance and new business and recompete wins that were not sufficient to replace the revenue on completed contracts. The primary drivers of this revenue decline were $12 million in decreased DoD-related revenue and $22 million in decreased federal civilian-related contract revenue, which included a decrease of $13 million related to the sale of IRG, partially offset by $9 million in increased intelligence-related contract revenue.
| | Three Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Cost of revenue | | $ | 417.6 | | | | 85.7 | % | | $ | 435.6 | | | | 85.1 | % | | $ | (18.0 | ) | | | (4.1 | )% |
Cost of revenue: Total cost of revenue was $418 million for the three months ended September 29, 2017, a decrease of 4.1%, compared to $436 million for the three months ended September 30, 2016. The decrease in cost of revenue was driven by a decline in revenue of $25 million, or 4.8%, for the three months ended September 29, 2017 compared to the three months ended September 30, 2016. Cost of revenue as a percentage of total revenue was 85.7% for the three months ended September 29, 2017 compared to 85.1% for the three months ended September 30, 2016.
| | Three Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Selling, general and administrative expenses | | $ | 33.3 | | | | 6.8 | % | | $ | 39.3 | | | | 7.7 | % | | $ | (6.0 | ) | | | (15.3 | )% |
Selling, general and administrative expenses: For the three months ended September 29, 2017, selling, general and administrative expenses were $33 million compared to $39 million for the three months ended September 30, 2016. Selling, general and administrative expenses as a percentage of revenue was 6.8% for the three months ended September 29, 2017, compared to 7.7% for the three months ended September 30, 2016. The decrease in selling, general and administrative expenses and as a percentage of revenue primarily resulted from lower costs in the third quarter of 2017 due to the sale of IRG and lower restructuring-related expenses.
| | Three Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Operating income | | $ | 36.3 | | | | 7.4 | % | | $ | 36.9 | | | | 7.2 | % | | $ | (0.6 | ) | | | (1.7 | )% |
Operating income and operating margin: Operating income for the three months ended September 29, 2017 and September 30, 2016 was $36 million and $37 million, respectively. Operating margin was 7.4% for the three months ended September 29, 2017, compared to 7.2% for the three months ended September 30, 2016. The decrease in operating income was primarily due to the decline in revenue, partially offset higher contract profit and lower selling, general and administrative expenses in the three months ended September 29, 2017, as compared to the three months ended September 30, 2016.
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| | Three Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Interest expense, net | | $ | 19.7 | | | | 4.1 | % | | $ | 50.9 | | | | 9.9 | % | | $ | (31.1 | ) | | | (61.2 | )% |
Interest expense: During the three months ended September 29, 2017, net interest expense was $20 million, compared to $51 million for the three months ended September 30, 2016. The decrease in net interest expense was primarily due to costs recorded in the three months ended September 29, 2017 related to the repricing of our term loan debt in the third quarter of 2017 of approximately $1 million compared to $28 million of costs recorded in the three months ended September 30, 2016 in conjunction with the refinancing of the Company’s credit facilities. Lower weighted average borrowing rates and debt balances in the three months ended September 29, 2017 also contributed to the decrease in interest expense. Our weighted average outstanding loan balance for the three months ended September 29, 2017 was $1,060 million, which accrued interest at a weighted average borrowing rate of approximately 5.85%. Our weighted average outstanding loan balance for the three months ended September 30, 2016 was $1,145 million, which accrued interest at a weighted average borrowing rate of approximately 7.58%.
| | Three Months Ended |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change |
| | (in millions; except percentage of revenue) |
Income (loss) before provision for income taxes | | $ | 16.5 | | | | 3.4 | % | | $ | (14.0 | ) | | | (2.7 | )% | | $ | 30.5 | | | NM |
Provision for income taxes | | | 5.6 | | | | 1.2 | % | | | 1.3 | | | | 0.3 | % | | | 4.3 | | | NM |
Net income (loss) | | $ | 10.9 | | | | 2.2 | % | | $ | (15.3 | ) | | | (3.0 | )% | | $ | 26.2 | | | NM |
Effective tax rate | | | 34.1 | % | | | | | | | (9.6 | )% | | | | | | | | | | |
*NM = Not meaningful
Provision for income taxes and effective income tax rate: The provision for income taxes for the three months ended September 29, 2017 was $6 million as compared to $1 million for the three months ended September 30, 2016. The effective tax rate for the three months ended September 29, 2017 was 34.1% as compared to (9.6)% for the three months ended September 30, 2016. The increase in the provision for income taxes and the effective tax rate, which includes the effects of discrete items, was primarily due to the earnings impact from our joint venture relative to our overall increased earnings for the three months ended September 29, 2017 as compared to the three months ended September 30, 2016.
The Company intends to file income tax exemption requests with the Afghanistan Revenue Department of the Ministry of Finance with regards to its prime and subcontractor contracts in that jurisdiction. If successful, the Company will reverse income tax reserves in the period the exemptions are received. The reversal of the income tax reserves will be primarily offset by a reversal of the associated deferred tax assets with the remaining difference benefiting our provision for income taxes.
| | Three Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Net income (loss) attributable to Engility | | $ | 9.8 | | | | 2.0 | % | | $ | (16.8 | ) | | | (3.3 | )% | | $ | 26.6 | | | | (158.5 | )% |
Net income (loss) attributable to Engility: Net income attributable to Engility was $10 million for the three months ended September 29, 2017 compared to a net loss attributable to Engility of $17 million for the three months ended September 30, 2016. The increase in net income attributable to Engility for the three months ended September 29, 2017 compared to the same period in 2016 was a result of reasons previously mentioned, as well as an increase in income from our joint venture.
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Results of Operations — Nine Months Ended September 29, 2017 Compared to Nine Months Ended September 30, 2016
The following tables provide our selected financial data for the nine months ended September 29, 2017 and September 30, 2016.
| | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Revenue | | $ | 1,467.0 | | | | 100.0 | % | | $ | 1,570.0 | | | | 100.0 | % | | $ | (103.0 | ) | | | (6.6 | )% |
Revenue: For the nine months ended September 29, 2017, revenue was $1,467 million compared to $1,570 million for the nine months ended September 30, 2016, a decrease of $103 million, or 6.6%. Revenue decreased primarily as a result of the sale of IRG, ongoing impact from contracts moving to small businesses, contracts that came to the end of their period of performance and new business and recompete wins that were not sufficient to replace the revenue on completed contracts. The primary drivers of this revenue decline were $47 million in decreased DoD-related revenue and $75 million in decreased federal civilian-related contract revenue, which included a decrease of $43 million related to the sale of IRG, partially offset by $19 million in increased intelligence-related contract revenue.
| | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Cost of revenue | | $ | 1,255.6 | | | | 85.6 | % | | $ | 1,341.8 | | | | 85.5 | % | | $ | (86.2 | ) | | | (6.4 | )% |
Cost of revenue: Total cost of revenue was $1,256 million for the nine months ended September 29, 2017, a decrease of 6.4%, compared to $1,342 million for the nine months ended September 30, 2016. The decrease in cost of revenue was driven by a decrease in revenue of $103 million, or 6.6%, for the nine months ended September 29, 2017 compared to the nine months ended September 30, 2016. Cost of revenue as a percentage of total revenue was 85.6% for the nine months ended September 29, 2017, compared to 85.5% for the nine months ended September 30, 2016.
| | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Selling, general and administrative expenses | | $ | 107.3 | | | | 7.3 | % | | $ | 129.8 | | | | 8.3 | % | | $ | (22.5 | ) | | | (17.3 | )% |
Selling, general and administrative expenses: For the nine months ended September 29, 2017, selling, general and administrative expenses were $107 million, compared to $130 million for the nine months ended September 30, 2016. Selling, general and administrative expenses as a percentage of revenue was 7.3% for the nine months ended September 29, 2017, compared to 8.3% for the nine months ended September 30, 2016. The decrease in selling, general and administrative expenses and as a percentage of revenue primarily resulted from lower costs in the nine months ended September 29, 2017 due to the sale of IRG, lower acquisition, restructuring and amortization-related expenses and reductions in expenses to maintain our overall competitiveness. Acquisition and restructuring expense for the nine months ended September 29, 2017 were $4 million as compared to $8 million for similar expenses for the nine months ended September 30, 2016. Amortization expense related to identifiable intangible assets obtained in conjunction with the acquisitions of TASC and Dynamics Research Corporation (DRC) for the nine months ended September 29, 2017 and September 30, 2016 were $19 million and $22 million, respectively.
| | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Operating income | | $ | 104.1 | | | | 7.1 | % | | $ | 98.4 | | | | 6.3 | % | | $ | 5.7 | | | | 5.8 | % |
Operating income and operating margin: Operating income for the nine months ended September 29, 2017 was $104 million, compared to $98 million for the nine months ended September 30, 2016. Operating margin was 7.1% for the nine months ended September 29, 2017, compared to 6.3% for the nine months ended September 30, 2016. The increase in operating income and operating margin was primarily due to the decrease in selling, general and administrative expenses, partially offset by the decline in revenue in the nine months ended September 29, 2017, as compared to the nine months ended September 30, 2016.
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| | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Interest expense, net | | $ | 59.2 | | | | 4.0 | % | | $ | 109.4 | | | | 7.0 | % | | $ | (50.2 | ) | | | (45.9 | )% |
Interest expense, net: During the nine months ended September 29, 2017, net interest expense was $59 million compared to $109 million for the nine months ended September 30, 2016. The decrease in net interest expense was primarily due to costs recorded in the nine months ended September 29, 2017 related to the repricing of our term loan debt in 2017 of approximately $3 million compared to $28 million of costs recorded in the nine months ended September 30, 2016 in conjunction with the refinancing of the Company’s credit facilities. Lower weighted average borrowing rates and debt balances in the nine months ended September 29, 2017 also contributed to the decrease in interest expense. Our weighted average outstanding loan balance for the nine months ended September 29, 2017 was $1,088 million, which accrued interest at a weighted average borrowing rate of approximately 5.97%. Our weighted average outstanding loan balance for the nine months ended September 30, 2016 was $1,149 million, which accrued interest at a weighted average borrowing rate of approximately 8.61%.
| | Nine Months Ended |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change |
| | (in millions; except percentage of revenue) |
Income (loss) before provision for income taxes | | $ | 44.7 | | | | 3.0 | % | | $ | (11.0 | ) | | | (0.7 | )% | | $ | 55.8 | | | NM |
Provision for income taxes | | | 16.7 | | | | 1.1 | % | | | 2.4 | | | | 0.2 | % | | | 14.3 | | | NM |
Net income (loss) | | $ | 28.1 | | | | 1.9 | % | | $ | (13.4 | ) | | | (0.9 | )% | | $ | 41.5 | | | NM |
Effective tax rate | | | 37.3 | % | | | | | | | (21.5 | )% | | | | | | | | | | |
*NM = Not meaningful
Provision for income taxes and effective income tax rate: The provision for income taxes for the nine months ended September 29, 2017 was $17 million compared to $2 million for the nine months ended September 30, 2016. The effective tax rate for the nine months ended September 29, 2017 was 37.3% as compared to (21.5)% for the nine months ended September 30, 2016. The increase in the provision for income taxes and the effective tax rate, which includes the effects of discrete items, was primarily due to increased earnings and the sale of IRG in the first quarter of 2017.
The Company intends to file income tax exemption requests with the Afghanistan Revenue Department of the Ministry of Finance with regards to its prime and subcontractor contracts in that jurisdiction. If successful, the Company will reverse income tax reserves in the period the exemptions are received. The reversal of the income tax reserves will be primarily offset by a reversal of the associated deferred tax assets with the remaining difference benefiting our provision for income taxes.
| | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | | | Dollar Change | | | Percentage Change | |
| | (in millions; except percentage of revenue) | |
Net income (loss) attributable to Engility | | $ | 24.4 | | | | 1.7 | % | | $ | (17.5 | ) | | | (1.1 | )% | | $ | 41.9 | | | | (239.3 | )% |
Net income (loss) attributable to Engility: Net income attributable to Engility was $24 million for the nine months ended September 29, 2017 compared to a net loss attributable to Engility of $17 million for the nine months ended September 30, 2016. The increase in net income attributable to Engility for the nine months ended September 29, 2017 compared to the same period in 2016 was a result of reasons previously mentioned, as well as an increase in income from our joint venture.
Liquidity and Capital Resources
Our primary cash needs are for debt service, working capital, and strategic investments or acquisitions. Under our debt obligations, our average quarterly required payments include principal of $7 million and estimated interest of approximately $15 million. We currently believe that our cash from operations, together with our cash on hand and available borrowings under the 2016 Credit Facility, are adequate to fund our operating needs for at least the next twelve months. As of September 29, 2017, our availability under the revolving portion of our 2016 Credit Facility was $163 million, net of outstanding letters of credit.
Accounts receivable is the principal component of our working capital and is generally driven by our level of revenue with other short-term fluctuations related to payment practices by our customers. Our accounts receivable reflect amounts billed to our customers, as well as the revenue that was recognized in the preceding month, which is generally billed in the following month as of each balance sheet date.
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The total amount of our accounts receivable can vary significantly over time but is generally very sensitive to recent revenue levels. Total accounts receivable typically range from 55 to 60 DSO, calculated on trailing three months of revenue. Our DSO, net of advance payments, was 57 days as of September 29, 2017 and 56 days as of December 31, 2016.
The following table represents cash flows for the nine months ended September 29, 2017 and September 30, 2016.
| | Nine Months Ended | |
| | September 29, 2017 | | | September 30, 2016 | |
| | (in millions) | |
Net cash provided by operating activities | | $ | 78.8 | | | $ | 84.7 | |
Net cash provided by (used in) investing activities | | | 19.4 | | | | (17.9 | ) |
Net cash used in financing activities | | | (94.5 | ) | | | (36.1 | ) |
Net change in cash and cash equivalents | | $ | 3.7 | | | $ | 30.7 | |
Cash Provided by Operating Activities
We generated $79 million of cash from operating activities during the nine months ended September 29, 2017, compared to cash generated of $85 million during the nine months ended September 30, 2016. The decrease in cash generated from operating activities primarily reflects higher employment and benefit related payments and higher accounts receivable, partially offset by lower cash interest payments in the nine months ended September 29, 2017 compared to the nine months ended September 30, 2016.
Cash Provided by (Used in) Investing Activities
During the nine months ended September 29, 2017 cash provided by investing activities was $19 million compared to cash used in investing activities of $18 million in the nine months ended September 30, 2016. Cash provided by investing activities for the nine months ended September 29, 2017 primarily consisted of proceeds of $22 million received from the sale of IRG, which excludes an indemnity escrow of approximately $2 million. During the nine months ended September 29, 2017 and September 30, 2016, cash used in investing activities for the payments of capital expenditures was $6 million and $18 million, respectively.
Cash Used in Financing Activities
Net cash used in financing activities for the nine months ended September 29, 2017 and September 30, 2016 was $94 million and $36 million, respectively. During the nine months ended September 29, 2017, we repaid a total of $86 million of debt under the 2016 Credit Facility, including the prepayment of $66 million of Term B2 Loan debt. The repayment of debt included $20 million from proceeds of the sale of IRG. During the nine months ended September 30, 2016, in addition to regular mandatory principal payments we purchased $10 million of second lien term loan debt and prepaid $20 million of term loan debt.
2016 Credit Facility
In February 2017, we repriced our existing term loans under the 2016 Credit Facility in order to reduce the interest rate margin applicable thereto, and in August 2017 we further repriced our existing term loans under the 2016 Credit Facility. In the aggregate, the February 2017 and August 2017 repricing of term loan debt are expected to lower our interest expense in 2017 by approximately $5 million after fees and expenses of approximately $3 million. In addition, the debt refinancing that we completed in August 2016 lowered our annualized interest expense by approximately $23 million at the time of the refinancing. For a summary of the terms of the 2016 Credit Facility, see Note 7 to the accompanying Unaudited Consolidated Financial Statements and Note 11 to our audited consolidated financial statement in our 2016 Form 10-K.
As of September 29, 2017 we did not have an outstanding balance on our revolving line of credit, and our availability under the revolving portion of the 2016 Credit Facility was $163 million, net of outstanding letters of credit.
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| | September 29, | | | December 31, | | | | | |
| | 2017 | | | 2016 | | | Change | |
| | (in millions) | |
Net debt | | | | | | | | | | | | |
Total debt | | $ | 1,037.4 | | | $ | 1,123.8 | | | $ | (86.4 | ) |
Less: Cash | | | (52.0 | ) | | | (48.2 | ) | | | (3.8 | ) |
Net debt | | $ | 985.4 | | | $ | 1,075.6 | | | $ | (90.2 | ) |
| | | | | | | | | | | | |
Available liquidity | | | | | | | | | | | | |
Cash | | $ | 52.0 | | | $ | 48.2 | | | $ | 3.8 | |
Revolver availability | | | 163.4 | | | | 163.1 | | | | 0.3 | |
Total available liquidity | | $ | 215.4 | | | $ | 211.3 | | | $ | 4.1 | |
Off-Balance Sheet Arrangements
At September 29, 2017, we had no significant off-balance sheet arrangements other than $2 million of outstanding letters of credit with financial institutions covering performance and financial guarantees per contractual requirements with certain customers. These letters of credit may be drawn upon in the event of Engility’s nonperformance.
Critical Accounting Policies
There have been no material changes to our critical accounting policies disclosed in our 2016 Form 10-K.
Cautionary Statement Regarding Forward-Looking Statements
This Form 10-Q contains forward-looking statements, including, without limitation, in the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” that are based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include the information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, potential growth opportunities, potential operating performance improvements, the effects and expected benefits of acquisitions and competition, expected interest savings from our debt refinancing and the effects of future legislation or regulations. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words “believe,” “expect,” “plan,” “intend,” “anticipate,” “estimate,” “predict,” “potential,” “continue,” “may,” “might,” “should,” “could” or the negative of these terms or similar expressions.
Forward-looking statements involve risks, uncertainties and assumptions. Actual outcomes and results may differ materially from what is expressed or forecast in these forward-looking statements. Risks, uncertainties and other factors that might cause such differences, some of which could be material, include, but are not limited to: (a) the loss or delay of a significant number of our contracts, or unexpected delays in customer payments under our contracts; (b) a decline in or a redirection of the U.S. budget for government services; (c) future shutdowns of the U.S. government, or a failure of the U.S. Congress to approve increases to the Federal debt ceiling; (d) the Department of Defense’s wide-ranging efficiencies initiative, which targets affordability and cost growth; (e) the intense competition for contracts in our industry, as well as the frequent protests by unsuccessful bidders; (f) our IDIQ contracts, which are not firm orders for services, and could generate limited or no revenue; (g) our government contracts, which contain unfavorable termination provisions and are subject to a government audit and modification; (h) the mix of our cost-plus, time-and-material and fixed-price type contracts; (i) our ability to attract and retain key management and personnel; (j) the impairment of our goodwill, other intangible assets or long-lived assets which represent a significant portion of the assets on our balance sheet; (k) changes in regulations or any negative findings from a U.S. government audit or investigation; (l) current and future legal and regulatory proceedings; (m) risks associated with our international operations; (n) information security threats and other information technology disruptions; (o) our significant level of indebtedness, our ability to comply with the terms of our debt agreements and our ability to finance our future operations, if necessary; (p) U.S. Federal income tax assets and liabilities that relate to the distribution in the 2012 spin-off of Engility from L-3 Communications Holdings, Inc. and the acquisition of TASC; and (q) other factors set forth under the heading “Risk Factors” in the 2016 Form 10-K. There may be other risks and uncertainties that we are unable to predict at this time or that we currently do not expect to have a material adverse effect on our business. Any such risks could cause our results to differ materially from those expressed in forward-looking statements.
For a more detailed discussion of these factors, see the information under the heading “Risk Factors” in the 2016 Form 10-K and Part II, Item 1A of this report. Forward-looking statements are made only as of the date hereof, and we undertake no obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, historical information should not be considered as an indicator of future performance.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk relates to changes in interest rates for borrowings under our 2016 Credit Facility. A hypothetical 1% increase in interest rates would have increased our interest expense by approximately $8 million for the nine months ended September 29, 2017 and likewise decreased our income and cash flows.
We are exposed to market risk related to changes in interest rates, and we periodically enter into interest rate swap agreements to manage our exposure to these fluctuations. Our interest rate swap agreements involve the exchange of fixed and variable rate interest payments between two parties, based on common notional principal amounts and maturity dates. The notional amounts of the swap agreements represent balances used to calculate the exchange of cash flows and are not our assets or liabilities. Our credit risk related to these agreements is considered low because the swap counterparties are creditworthy financial institutions. The interest payments under these agreements are settled on a net basis. These derivatives have been recognized in the financial statements at their respective fair values. Changes in the fair values of these derivatives, which are designated as cash flow hedges, are included in other comprehensive income. We do not have any derivatives outstanding that are not designated as hedges.
We are subject to credit risks associated with our cash and accounts receivable. We believe that the concentration of credit risk with respect to cash and cash equivalents is limited due to the high credit quality of the institutions at which we hold cash and cash equivalents. We also believe that our credit risk associated with accounts receivable is limited as they are primarily with the U.S. federal government or prime contractors working for the U.S. federal government.
We have limited exposure to foreign currency exchange risk as the substantial majority of our business is conducted in U.S. dollars.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed with the objective of providing reasonable assurance that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934, as amended (the Exchange Act), is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer (principal executive officer) (CEO) and chief financial officer (principal financial officer) (CFO), as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
Management, with the participation of our CEO and our CFO, evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15-15(e) of the Exchange Act, as of September 29, 2017, the end of the period covered by this Form 10-Q. Based on their evaluation, our CEO and CFO concluded that, as of September 29, 2017, our disclosure controls and procedures were effective at a reasonable assurance level.
Changes in Internal Control Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the third quarter of 2017 that materially affected, or are likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information required with respect to this item can be found in Note 10 to the accompanying Unaudited Consolidated Financial Statements contained in this report and is incorporated by reference into this Part II, Item 1.
ITEM 1A. RISK FACTORS
While we attempt to identify, manage, and mitigate risks and uncertainties associated with our business to the extent practical under the circumstances, some level of risk and uncertainty will always be present. The “Risk Factors” section of our 2016 Form 10-K describes risk and uncertainties associated with our business. These risks and uncertainties have the potential to materially affect our business, financial condition, results of operations, cash flows, projected results, and future prospects. With the exception of the updated risk factor below, we believe that there have been no material changes to the risk factors previously disclosed in our 2016 Form 10-K.
Our results of operations and cash flows are substantially affected by our mix of cost-plus, time-and-material and fixed-price type contracts.
Our revenue is transacted using written revenue arrangements, or contracts, which are generally cost-plus, time-and-material, or fixed-price. For a description of our revenue recognition policies, see Note 1 to the accompanying Consolidated Financial Statements.
On a cost-plus type contract, we are paid our allowable incurred costs plus a profit which can be fixed or variable depending on the contract’s fee arrangement up to predetermined funding levels determined by our customers. Cost-plus type contracts with award fee provisions are our primary variable contract fee arrangement. Award fees provide for a fee based on actual performance relative to contractually specified performance criteria.
On a time-and-material type contract, we are paid on the basis of direct labor hours expended at specified fixed-price hourly rates (that include wages, overhead, allowable general and administrative expenses and profit) and materials at cost.
On a fixed-price type service contract, we agree to perform the contractual statement of work for a predetermined sales price. Although a fixed-price type contract generally permits us to retain profits if the total actual contract costs are less than the estimated contract costs, we bear the risk that increased costs may reduce our profit or cause us to sustain losses on the contract. This may result in greater risk to our business than under a cost-plus type and time and- material type contracts where we generally do not bear the risks of unexpected cost overruns, provided that we do not incur costs that exceed the predetermined funded amounts.
Generally speaking, profit margins tend to be higher on fixed-price and time-and-material type contracts due to the additional risk assumed by the contractor. The percentage of our revenue coming from cost-type contracts has continued to increase over time. This is due in part to a larger portion of our revenues coming from intelligence community customers, which tend to favor cost-type contracts. To date, we have been able to preserve our operating margins by driving increased efficiencies in our business. If however an increasing percentage of our contract portfolio continues to move to cost-type contracts, we could experience downward pressure on operating margins.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
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ITEM 6. EXHIBITS
Exhibit No. | | Description of Exhibits |
10.1 | | Second Amendment to Credit Agreement, dated August 14, 2017, by and among Engility Holdings, Inc., Engility Corporation, the Guarantors party thereto, the Lenders party thereto and Morgan Stanley Senior Funding, Inc., as Administrative Agent, Collateral Agent, Swingline Lender and Issuing Bank (incorporated herein by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K, as filed with the Commission on August 15, 2017 (file No. 001-35487)). |
| | |
*31.1 | | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended. |
| | |
*31.2 | | Certification of Senior Vice President and Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended. |
| | |
**32.1 | | Certification of Chief Executive Officer and Senior Vice President and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
*101.INS | | XBRL Instance Document. |
| | |
*101.SCH | | XBRL Taxonomy Extension Schema Document. |
| | |
*101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document. |
| | |
*101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document. |
| | |
*101.LAB | | XBRL Taxonomy Extension Label Linkbase Document. |
| | |
*101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document. |
| | |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ENGILITY HOLDINGS, INC. |
| | |
By: | | /s/ Lynn A. Dugle |
| | Lynn A. Dugle |
| | Chief Executive Officer |
| | |
| | /s/ Wayne M. Rehberger |
| | Wayne M. Rehberger |
| | Senior Vice President and Chief Financial Officer |
Date: November 2, 2017
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