10-K/A 1 a14-7623_110ka.htm 10-K/A

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K/A

 

Amendment No. 1

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended September 30, 2013

 

Commission File Number 001-08931

 

CUBIC CORPORATION

Exact Name of Registrant as Specified in its Charter

 

Delaware

 

95-1678055

State of Incorporation

 

IRS Employer Identification No.

 

 

9333 Balboa Avenue
San Diego, California 92123
Telephone (858) 277-6780

 

Securities registered pursuant to Section 12(b) of the Act:

 

Common Stock

 

New York Stock Exchange, Inc.

Title of each class

 

Name of exchange on which registered

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o  Yes  x  No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o  Yes  x  No

 

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. x  Yes  o  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). x  Yes  o  No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) o  Yes  x  No

 

The aggregate market value of 16,839,117 shares of common stock held by non-affiliates of the registrant was: $717,683,187 as of March 31, 2013, based on the closing stock price on that date. Shares of common stock held by each officer and director and by each person or group who owns 10% or more of the outstanding common stock have been excluded in that such persons or groups may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

Number of shares of common stock outstanding as of April 28, 2014 including shares held by affiliates is: 26,788,525 (after deducting 8,945,300 shares held as treasury stock).

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Portions of the Registrant’s definitive Proxy Statement filed with the Securities and Exchange Commission on January 9, 2014 pursuant to Regulation 14A in connection with its 2013 Annual Meeting of Shareholders are incorporated by reference into Part III.

 

 

 



Table of Contents

 

CUBIC CORPORATION

ANNUAL REPORT ON FORM 10-K/A

For the Year Ended September 30, 2013

 

TABLE OF CONTENTS

 

 

 

Page
No.

 

Part I

 

 

 

 

Item 1.

Business

5

Item 1A.

Risk Factors

16

Item 1B.

Unresolved Staff Comments

32

Item 2.

Properties

32

Item 3.

Legal Proceedings

34

Item 4.

Mine Safety Disclosures

34

 

 

 

 

Part II

 

 

 

 

Item 5.

Market for the Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

35

Item 6.

Selected Financial Data

35

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

37

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

77

Item 8.

Financial Statements and Supplementary Data

79

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

132

Item 9A.

Controls and Procedures

132

 

 

 

 

Part III

 

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

136

Item 11.

Executive Compensation

136

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

136

Item 13.

Certain Relationships and Related Transactions and Director Independence

136

Item 14.

Principal Accounting Fees and Services

136

 

 

 

 

Part IV

 

 

 

 

Item 15.

Exhibits, Financial Statement Schedules

136

 

SIGNATURES

138

 

2



Table of Contents

 

EXPLANATORY NOTE REGARDING RESTATEMENT

 

On February 10, 2014, the Audit and Compliance Committee of the Board of Directors of Cubic Corporation (“Company,” “we,” or “us”), after consultation with Ernst & Young LLP, our independent registered public accounting firm, determined that our financial statements for the fiscal years ended September 30, 2013 and 2012, and each of the quarters of 2013 and 2012 can no longer be relied upon as being in compliance with U.S. generally accepted accounting principles (GAAP), and that we would restate such financial statements to make the necessary accounting corrections.

 

This Amendment No. 1 on Form 10-K/A to our Annual Report on Form 10-K for the year ended September 30, 2013 is being filed to restate our previously filed consolidated financial statements and data (and related disclosures) for the fiscal years ended September 30, 2013 and 2012, and each of the quarters of 2013 and 2012, and includes certain immaterial corrections to our previously filed consolidated financial statements and data (and related disclosures) for periods prior to the fiscal year ended September 30, 2012.

 

Accordingly, this Form 10-K/A includes changes to (1) our consolidated balance sheets as of September 30, 2013 and 2012 and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the fiscal years ended September 30, 2013, 2012 and 2011; (2) our selected financial data as of, and for our fiscal years ended, September 30, 2013, 2012, 2011, 2010 and 2009, in Item 6 of this Form 10-K/A; (3) our management’s discussion and analysis of financial condition and results of operations as of and for our fiscal years ended September 30, 2013, 2012 and 2011, in Item 7 of this Form 10-K/A; (4) our unaudited quarterly financial information for each quarter in our fiscal years ended September 30, 2013 and 2012 in Note 18 “Summary of Quarterly Results of Operations (Unaudited)” of the Notes to Consolidated Financial Statements, in Item 8 of this  Form 10-K/A; (5) our Risk Factors, in item 1A of this Form 10-K/A; and (6) our disclosures and conclusions regarding Controls and Procedures in Item 9A in this Form 10-K/A. The restatement resulted from our identification of certain errors in our recognition of revenue at a wholly owned subsidiary. See below and Note 2, “Restatement of Consolidated Financial Statements” of the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K/A for a detailed discussion of the errors and effect of the restatement.

 

This Form 10-K/A amends and restates in its entirety our Annual Report on Form 10-K for the year ended September 30, 2013. We are filing this Form 10-K/A concurrently with our Quarterly Report on Form 10-Q for the quarter ended December 31, 2013, which was delayed due to the restatement, and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014. Financial information included in the reports on Form 10-K, Form 10-Q and Form 8-K filed by us for the fiscal years ended September 30, 2013 and 2012, and each of the quarters of 2013 and 2012, and all earnings press releases and similar communications issued by us for such periods, should not be relied upon and are superseded in their entirety by this Form 10-K/A.

 

The following tables present the summary impacts of the restatement adjustments on our previously reported consolidated retained earnings at September 30, 2010 and consolidated sales, operating income, net income and earnings per share for the years ended September 30, 2013, 2012 and 2011 (in thousands, except per share data):

 

Retained earnings at September 30, 2010 - As previously reported

 

$

553,452

 

Adjustments

 

(1,687

)

Retained earnings at September 30, 2010 - As restated

 

$

551,765

 

 

3



Table of Contents

 

September 30,

 

2013

 

2012

 

2011

 

Sales (previously reported)

 

$

1,360,723

 

$

1,381,495

 

$

1,295,581

 

Adjustments

 

684

 

22,589

 

6,003

 

Sales (as restated)

 

$

1,361,407

 

$

1,404,084

 

$

1,301,584

 

 

 

 

 

 

 

 

 

Operating income (previously reported)

 

$

36,392

 

$

128,022

 

$

113,508

 

Adjustments

 

4,343

 

8,183

 

5,075

 

Operating income (as restated)

 

$

40,735

 

$

136,205

 

$

118,583

 

 

 

 

 

 

 

 

 

Net income (previously reported)

 

$

19,798

 

$

91,900

 

$

83,594

 

Adjustments

 

5,288

 

5,527

 

2,450

 

Net income (as restated)

 

$

25,086

 

$

97,427

 

$

86,044

 

 

 

 

 

 

 

 

 

Earnings per share (previously reported)

 

$

0.74

 

$

3.44

 

$

3.13

 

Adjustments

 

0.20

 

0.20

 

0.09

 

Earnings per share (as restated)

 

$

0.94

 

$

3.64

 

$

3.22

 

 

Correction of Identified Errors

 

On February 20, 2014, we announced that we would be restating certain previously issued audited consolidated financial statements and unaudited condensed consolidated financial statements primarily to correct two errors in the recognition of revenue.

 

In 2012, we restated our financial statements for the years ended September 30, 2011, 2010 and 2009, the quarters ended March 31, 2012 and December 31, 2011 and each of the prior quarters of 2011 and 2010. This previous restatement was the result of our determination that we had made errors in the calculation of revenues for a significant number of our contracts due to incorrect application of GAAP. In the course of our financial statement closing process for the quarter ended December 31, 2013, we identified two errors related to revenue recognition for two contracts with the same customer that date back to the previous restatement period. The first error was related to the computation of revenues for a contract that was entered into in 2011. The error resulted from a miscalculation in a revenue recognition model that was created during the previous restatement activity. The second error relates to a contract entered into in 2007 and was the result of a failure to appropriately update the contract value in our revenue accounting system as well as a failure to properly account for a 2008 amendment to this contract. Upon modification of this second contract in 2008, the cost-to-cost percentage of completion method should no longer have been used, and revenue should have been recognized using a service-based model.

 

In addition to the errors described above, we also made adjustments related to other individually immaterial errors including certain corrections that had been previously identified but not recorded because they were not material, individually or in the aggregate, to the Company’s consolidated financial statements.. These corrections included: certain accrued liabilities and reserves and miscellaneous reclassification entries; adjustments to various income tax and indirect tax accrual accounts; and adjustments to sales and cost of sales to correct cutoff on immaterial revenue recognition transactions. While none of these other adjustments were individually material, they are being made as part of the restatement process.

 

For more information regarding the restatement, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Item 7 of this Form 10-K/A and Note 2, “Restatement of Consolidated Financial Statements,” and Note 18, “Summary of Quarterly Results of Operations (Unaudited),” of the Notes to Consolidated Financial Statements in Item 8 of this  Form 10-K/A.

 

In connection with the restatement, management has assessed the effectiveness of our disclosure controls and procedures and has included revised disclosure in Item 9A of this Form 10-K/A, “Controls and Procedures.” Management identified material weaknesses in our internal control over financial reporting with respect to the identified revenue recognition errors related to one of our wholly owned subsidiaries as described under “Management’s Report on Internal Control over Financial Reporting” in Item 9A of this Form 10-K/A. Solely as a result of these material weaknesses, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at a reasonable assurance level as of September 30, 2013. Management has taken and is taking steps, as described under “Management’s Remediation Initiatives” in Item 9A of this Form 10-K/A, to remediate the material weaknesses in our internal control over financial reporting. We believe that, as a result of management’s in-depth review of its accounting processes, and the additional procedures management has implemented, there are no material inaccuracies or omissions of material fact in this Form 10-K/A and, to the best of our knowledge, we believe that the consolidated financial statements in this Form 10-K/A fairly present in all material aspects the financial condition, results of operations and cash flows of the Company in conformity with GAAP.

 

4



Table of Contents

 

Item 15 of this Form 10-K/A has been amended to contain the currently-dated certifications from our principal executive officer and principal financial officer, as required by Section 302 and 906 of the Sarbanes-Oxley Act of 2002. Ernst & Young LLP has dual dated its reports on the consolidated financial statements and internal control over financial reporting to the board of directors and stockholders with regard to the effects on the consolidated financial statements of the restatement as described in Note 2 of the consolidated financial statements and the material weaknesses described previously and updated their consent to the date of this filing.

 

PART I

 

Item 1.  BUSINESS.

 

GENERAL

 

CUBIC CORPORATION (Cubic) is a leading international provider of cost-effective systems and solutions that address the mass transit and global defense markets’ most pressing challenges. We believe that we have significant transportation and defense industry expertise which, combined with our innovative technology capabilities, contributes to our leading customer positions and allows us to deepen and further expand each of our business segments in key markets. We operate in three reportable business segments across the global transportation and defense markets.

 

Our Cubic Transportation Systems (CTS) business accounted for approximately 39% of our sales in fiscal year 2013. CTS specializes in the design, development, production, installation, maintenance and operation of automated fare payment and revenue management infrastructure and technologies for transit operators. As part of our turnkey solutions, CTS also provides these customers with a comprehensive suite of business process outsourcing (BPO) services and expertise, such as card and payment media management, central systems and application support, retail network management, passenger call centers and financial clearing and settlement support. As transit authorities seek to optimize their operations by outsourcing bundled systems and services, CTS has transformed itself from a provider of automated fare collection (AFC) systems into a systems integrator and services company focused on the intelligent transportation market.

 

Our complementary defense businesses, Mission Support Services (MSS) and Cubic Defense Systems (CDS), provided approximately 61% of our sales in fiscal year 2013. MSS is a provider of live, virtual and constructive training services to all four branches of the U.S. military, including the special operations communities, as well as to allied nations. In addition, MSS offers a broad range of highly specialized national security solutions to the intelligence community. CDS is a leading provider of realistic, high-fidelity air, ground combat, surface, and cyber training systems for the U.S. and allied nations. These training solutions offer the latest live, virtual, constructive, and game-based technology, integrated to optimize training effectiveness. CDS is also a key supplier of secure communications solutions, including Intelligence, Surveillance and Reconnaissance (ISR) data links, Communications datalinks, Cyber products, and Asset Tracking systems.

 

We have a broad customer base across our businesses, with approximately 61% of our fiscal year 2013 sales generated from the U.S. federal, state and local governments. Approximately 5% of these domestic sales were attributable to Foreign Military Sales, which are sales to allied foreign governments facilitated by the U.S. government. The remainder of the fiscal year 2013 sales were attributable to sales to foreign government agencies. In fiscal year 2013, 59% of our total sales were derived from services, with product sales accounting for the remaining 41%. Headquartered in San Diego, California, we had approximately 8,200 employees working on 5 continents and in 26 countries as of September 30, 2013.

 

We were incorporated in the State of California in 1949 and began operations in 1951. In 1984, we moved our corporate domicile to the State of Delaware. Our internet address is www.Cubic.com. The content on our website is available for information purposes only. It should not be relied upon for investment purposes, nor is it incorporated by reference into this Form 10-K/A. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports can be found on our internet website under the heading “Investor Relations”. We make these reports readily available free of charge in a reasonably practicable time after we electronically file these materials with the Securities and Exchange Commission (the SEC).

 

5



Table of Contents

 

BUSINESS SEGMENTS

 

Information regarding the amounts of revenue, operating profit and loss and identifiable assets attributable to each of our business segments, is set forth in Note 17 to the Consolidated Financial Statements for the year ended September 30, 2013. Additional information regarding the amounts of revenue and operating profit and loss attributable to major classes of products and services is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which follows in Item 7 of this Form 10-K/A.

 

TRANSPORTATION SYSTEMS SEGMENT

 

CTS is a systems integrator of payment and information technology and services for intelligent travel solutions. We deliver integrated systems for transportation and traffic management, delivering tools for travelers to choose the smartest and easiest way to travel and pay for their journeys, and enabling transportation authorities and agencies to manage demand across the entire transportation network all in real time. We offer fare collection devices, software, systems and multiagency, multimodal integration technologies, as well as a full suite of operational services that help agencies and operators efficiently collect fares, manage operations, reduce revenue leakage and make transportation more convenient. Through our NextBus and ITMS businesses, respectively, we also deliver real-time passenger information systems for tracking bus arrival times and we are a leading provider of intelligent transport solutions and technology maintenance services to UK and international government road transport agencies.

 

CTS is comprised of approximately 2,100 employees working in major transportation markets worldwide. As an established partner with transportation authorities and operators worldwide, we have installed over 130,000 devices and deployed several central systems which in total process approximately 23 billion fare-related transactions per, generating more than $18 billion of revenue per year for such transportation authorities and operators. Products accounted for 47% of the segment’s fiscal year 2013 sales, with services accounting for the remaining 53%.

 

We believe that we hold the leading market position in large-scale automated fare payment and revenue management systems and services for major metropolitan areas. CTS has delivered over 20 regional back office operations which together integrate over 130 transport operators and serve over 38 million people every day in major markets around the world. We have implemented and, in many cases, operate automated fare payment and revenue management systems for some of the world’s largest public transit systems, such as London (Oyster®), the San Francisco Bay Area (Clipper®) and the Los Angeles region (TAP®). In addition, the segment has numerous active projects worldwide, including in the New York (Metrocard®) / New Jersey (PATCO®, PATH Smartlink®) region, Chicago (Ventra®), Vancouver, Sydney, Brisbane, the Frankfurt / RMV region, Sweden, the Washington, D.C. / Maryland / Virginia region, the San Diego region, Miami, Minneapolis / St. Paul and Atlanta. In addition to helping us secure similar projects in new markets, our comprehensive suite of new technologies and capabilities enables us to benefit from a recurring stream of revenues in established markets resulting from innovative new services, technology obsolescence, equipment refurbishment and the introduction of new or adjacent applications.

 

Consistent with our history of creating next-generation, state-of-the-art technologies and systems, we are in the process of developing and implementing components of our NextCity® initiative, which envisions integrated payment and information technology and services across all modes of transport and which has been furthered by our acquisitions of NextBus and ITMS. NextCity comprises a fully integrated solution offering innovative fare payment technologies, such as contactless bank cards, general purpose reloadable (GPR) cards, transit branded debit/credit cards and near field communication (NFC) phones directly at the point of travel, predictive data analytics, and intermodal compatibility across an entire transportation network. Two key information technology (IT) components of NextCity are the creation and distribution of real-time data through the integration of payment and information systems, ultimately enabling operators to manage demand and customers to manage their travel through improved data analytics and seamless access to predictive and relevant information, as well as the specialization in the development and supply of complex traffic management systems for the monitoring and control of urban and inter-urban road networks, encompassing integrated traffic and incident management, decision support, bus tracking and passenger information through integrated user interfaces.

 

Our hardware systems and services offerings are summarized as follows:

 

Devices

 

Systems

 

Services

·                  Point-of-sale

 

·                  Multimodal payment and revenue management

 

·                  Central system and application support

·                  Farebox

 

·                  Bus

 

·                  Systems operation and maintenance

·                  Driver control units

 

·                  Bus Rapid Transit

 

·                  Field asset management services

·                  Gates

 

·                  Rail

 

·                  Passenger call centers

·                  Validators

 

·                  Light rail

 

·                  Card and payment media management

·                  Vendor

·                  Back office encoders

 

·                  Commuter rail

·                  Heavy Rail

 

·                  Communications infrastructure management

·                  Depot computers

 

·                  Subway

 

·                  Financial clearing and settlement services

·                  ITS equipment

 

·                  Ferries

 

·                  Retail network management

 

 

·                  Regional

 

·                  Web support services

 

 

·                  Smart card-based

·                  Open payment

·                  Credit cards

 

·                  Technology maintenance services for international government road transport agencies

 

 

·                  NFC mobile phones

 

 

 

 

·                  GPR cards

 

 

 

 

·                  Central system and device level software

 

 

 

 

·                  Real-time passenger information

 

 

 

 

·                  Automatic vehicle location

 

 

 

 

·                  Traffic management systems

 

 

 

 

·                  Traffic safety enforcement systems

 

 

 

 

 

 

 

 

6



Table of Contents

 

Industry Overview

 

We define our addressable transportation market as large-scale, multi-modal AFC, Real-Time Passenger Information and Intelligent Transport systems and services and estimate this market to be approximately $3 billion annually. We project the long-term growth for this market to be driven primarily by technological obsolescence leading to replacement and upgrades. The average lifecycle of our automated fare collection systems is approximately 10 years, providing long-term recurring sales visibility and opportunities for future replacements and upgrades. Also, there are additional opportunities that stem from program expansion into new areas, such as intelligent transportation systems and services, analytics, mobile payment and information technologies, and revenue collection systems and services for other transportation applications such as tolling and parking, which we believe increase the global  addressable market from $3 billion to approximately $10 billion. We believe industry experience, past performance, technological innovation and price are the key factors customers consider in awarding programs and such factors can serve as barriers to entry to potential competitors when coupled with scale and the upfront investments required for these programs.

 

The AFC business is a niche market which is only capable of sustaining a relatively few number of suppliers. Due to the long life expectancy of these systems and the few companies with the capabilities to supply them, there is fierce competition to win new contracts, often resulting in low initial contract profitability.

 

Advances in communications, networking and security technologies are enabling interoperability of multiple modes of transportation within a single networked system, as well as interoperability of multiple transit operators within a single networked system. As such, there is a growing trend for regional payment systems, usually built around a large transit agency and including neighboring operators, all sharing a common regional transit payment media. Recent transit agency procurements for open payment fare systems will extend the acceptance of payment media from transit smart cards, to contactless bank cards and Near Field Communication (NFC) enabled smart phones.

 

There is also an emerging trend for other applications to be added to these regional systems to expand the utility of the transit payment media, offering higher value and incentives to the end users, and lowering costs and creating new revenue streams through the integration of multi-modal and multi-operator systems for the regional system operators. As a result, these regional systems have created opportunities for new levels of systems support and services including customer support call centers and web support services, smart card production and distribution, financial clearing and settlement, retail merchant network management, transit benefit support, and software application support. In some cases, operators are choosing to outsource the ongoing operations and commercialization of these regional payment systems. This growing new market provides the opportunity to establish lasting relationships and grow revenues and profits over the long term.

 

Our NextBus business, uses a software-as-a-service solution, NextBus’ technologies provide transit passengers with accurate, real- time arrival information about buses, subways and trains, and include real-time management and dispatch tools that enable transit operators to effectively manage their systems.

 

Through the acquisition of Intelligent Transport Management Solutions Limited (ITMS), we have broadened our portfolio of information based solutions and transportation agency customers.  ITMS is a provider of traffic management systems technology, traffic and road enforcement and the maintenance of traffic signals, emergency equipment and other critical road and tunnel infrastructure. The ITMS acquisition is part of our NextCity vision and it expands CTS’ potential market beyond fare collection and real-time passenger information.

 

7



Table of Contents

 

Raw Materials — CTS

 

Raw materials used by CTS include sheet steel, composite products, copper electrical wire and castings. A significant portion of our end product is composed of purchased electronic components and subcontracted parts and supplies. We procure all of these items from third-party suppliers. In general, supplies of raw materials and purchased parts are adequate to meet our requirements.

 

Backlog — CTS

 

Funded sales backlog of CTS at September 30, 2013 and 2012 amounted to $1.526 billion and $1.656 billion, respectively. We expect that approximately $523 million of the September 30, 2013 backlog will be converted into sales by September 30, 2014.

 

CTS Competitive Environment:

 

We are one of several companies specializing in the provision of automated fare collection systems solutions and services for transportation operators worldwide. Our competitors include Thales, Xerox, and Scheidt & Bachmann. The requirements of recent open standards fare collection system procurements call for system integration with payment industry infrastructures and outsourcing of longer term IT support functions, which can be attractive to other IT system integrators such as Accenture and IBM. In addition, there are many smaller local competitors, particularly in European and Asian markets.

 

For large tenders, our competitors may form consortiums that could include telecommunications companies, financial institutions and consulting companies in addition to the fare collection and computer services companies noted above. These procurement activities are very competitive and require that we have highly skilled and experienced technical personnel to compete.

 

We believe that our competitive advantages include intermodal and interagency regional integration expertise, technical skills, past contract performance, systems quality and reliability, experience in the industry and long-term customer relationships.

 

MISSION SUPPORT SERVICES SEGMENT

 

MSS is a leading provider of training, operations, intelligence, maintenance, technical, and other support services to the U.S. government and its agencies and allied nations. These services complement the systems and solutions provided by the CDS segment. MSS is comprised of approximately 4,000 employees working in approximately 19 nations throughout the world. Our employees serve with clients in actual training and operational environments to help prepare and support forces through the provision of comprehensive training, exercises, staff augmentation, education, operational, intelligence, technical, and logistical assistance to meet the full scope of their assigned missions. The scope of mission support that we provide includes: training and rehearsals for both small and large scale combat operations; training and preparation of military advisor and training teams; combat and material development; military staff augmentation; information technology and information assurance; logistics and maintenance support for fielded and deployed systems; support to national intelligence and special operations activities; peacekeeping; consequence management; and humanitarian assistance operations worldwide. We also plan, prepare, execute and document realistic and focused mission rehearsal exercises (using both live and computer-based exercises) as final preparation of forces prior to deployment. In addition, we provide high level consultation and advisory services to the governments and militaries of allied nations.

 

U.S. government service contracts are typically awarded on a competitive basis with options for multiple years. We typically compete as a prime contractor to the government, but also team with other companies on select opportunities. During the past year we have experienced a number of challenges in our markets, including increased price competition, contract awards for shorter performance periods, and see an increased amount of required subcontracting to small businesses as a result of the U.S. government’s increased emphasis on meeting small business contracting mandates. In addition, some of the contracts where we were the prime contractor in the past have been set aside at re-compete for participation by small businesses only.

 

Much of our early work centered on battle command training and simulation in which military commanders are taught to make correct decisions in battlefield situations. Our comprehensive business base has broadened to include integrated live, virtual and constructive training support; advanced distance learning and other professional military education; comprehensive logistics and maintenance support; weapons effects and analytical modeling; analysis, training, and other support to the national security community, including intelligence and special operations forces; homeland security training and exercises; training and preparation of U.S. Army and   Marine Corps foreign service advisor teams; and military force modernization. Additionally, we support the deployment and re- deployment of both active and reserve component forces; and we provide in-country logistics, maintenance, operational and training support to U.S. Forces deployed in overseas locations.

 

8



Table of Contents

 

Our contracts include providing mission support services to all four of the U.S. Army’s major combat training centers (CTCs): Joint Readiness Training Center (JRTC) as prime contractor, the National Training Center (NTC) and Mission Command Training Program (MCTP) as a principal subcontractor and the Joint Multinational Readiness Center (JMRC) as prime contractor supporting  constructive simulations. These services include planning, executing and documenting realistic and stressful large scale exercises and mission rehearsals that increase the readiness of both active and reserve U.S. conventional and special operations forces by placing them in situations as close to actual combat as possible.

 

For the U.S. Armed Services, MSS is a principal member of the contractor team that supports and helps manage and execute all aspects of the operations of the Joint Coalition Warfare Center (JCWC), including support to worldwide joint exercises and the development and fielding of the Joint National Training Capability (JNTC). We provide training and professional military education support to the U.S. Army’s Quartermaster Center and School, the Signal School and to the Transportation School. We also provide contractor maintenance and instructional support necessary to operate and maintain a wide variety of flight simulation and training systems and other facilities worldwide, for U.S. and allied forces under multiple long-term contracts, including direct support to USMC aircrew training systems worldwide and instructional support services for the Chief of Naval Aviation Training program. In addition, we provide a broad range of operational support to the U.S. Navy for Anti-Submarine Warfare (ASW) and counter-mine operations and training.

 

We supported the Defense Threat Reduction Agency (DTRA) with technology-based engineering and other services necessary to accomplish DTRA’s mission of predicting and defeating the effects of chemical, biological, radiological, nuclear and high explosive (CBRNE) weapons. We support DTRA with modeling and simulations to analyze, assess and predict the effects of such weapons in combat and other environments. Additionally, we provide comprehensive support to help plan, manage and execute DTRA’s worldwide consequence management exercise program, which trains senior U.S. and allied civilian and military personnel, first responders and other users of DTRA products.

 

We provide Research, Development and Technical Engineering (RDTE) support to the U.S. Air Force Research Laboratories (AFRL) for assistance in the identification and application of current, new and emerging technologies leading to proof-of-principle evaluations of advanced operational concepts.

 

We have multiple contracts with all U.S. Armed Services and other government agencies to improve the quality and reach of training and education of individuals and small teams up through collective training of large organizations. Our services, products and capabilities include development and deployment of curriculum and related courseware, computer-based training, knowledge management and distribution, advanced distance learning (e-learning), serious military games for training and other advanced education programs for U.S. and allied forces.

 

An important part of our services business is to provide specialized teams of military experts to advise the governments and militaries of the nations of the former Warsaw Pact and Soviet Union, and other former communist countries in the transformation of their militaries to a NATO environment. These very broad defense modernization contracts involve both the nations’ strategic foundation and the detailed planning of all aspects of reform. We also develop and operate battle simulation centers for U.S. forces in Europe, as well as for select countries in Central and Eastern Europe.

 

Through the acquisitions of Abraxas Corporation (Abraxas) in December 2010 and certain assets of NEK Special Programs Group, LLC (which were placed in NEK Services, Inc.) (NEK) in December 2012, we have expanded our support services to the military and national intelligence communities, as well as for special operations, law enforcement and homeland security clients. With these acquisitions and our organic skillsets, we are broadening our service offerings across the U.S. Department of Defense (DoD) and national security markets to pursue prime contract opportunities.

 

We believe the combination and scope of our mission support services and training systems business is unique in the industry, permitting us to offer customers a complete training and combat readiness capability from one source.

 

Backlog — MSS

 

Funded sales backlog of our MSS segment at September 30, 2013 was $221 million compared to $248 million at September 30, 2012. Total backlog, including unfunded customer orders and options under multiyear service contracts, was $627 million at September 30, 2013 compared to $737 million at September 30, 2012. We expect that approximately $298 million of the September 30, 2013 total backlog will be converted into sales by September 30, 2014.

 

9



Table of Contents

 

DEFENSE SYSTEMS SEGMENT

 

CDS is focused on two primary lines of business: training systems and secure communications (SC) products. The first line of business, training systems, is well diversified and supplies to the DoD and more than 35 allied nations. It is a market leader in live and virtual military training systems and has launched an emerging and fast growing presence in game-based training systems. These training systems include customized military range instrumentation systems, live-fire range design and maintenance, laser-based training systems, virtual simulation systems, and game-based synthetic training environments. The second line of business, SC, includes SATCOM and ISR data links, power amplifiers, avionics systems, multi-band communication tracking devices, and cross domain products to solve data access challenges across multi-level security designations. CDS is comprised of approximately 1,600 employees working in 12 nations on 4 continents.

 

Training Systems

 

Our training systems business is a pioneer and market leader in the design, innovation, and manufacture of instrumented training systems and products for the US military and the militaries of allied nations. We design and manufacture realistic, high-fidelity air, ground, surface, and cyber training systems.  They are implemented in both live and synthetic training environments, and are used to effectively deliver a range of training objectives, such as training for fighter pilots, ground troops, infantry, armored vehicles, ship operation and maintenance personnel, cyber warriors, and special operations forces. These systems deliver stressful scenarios and weapons’ effects, collect event and tactical performance data, record simulated engagements and tactical actions, and deliver after actions reviews to evaluate individual and collective training effectiveness.

 

Strategically CDS is very well positioned to lead the increasing trend to fully integrated solutions that connect live, virtual, constructive, and game-based training environments into a seamless training event. Our training business portfolio is currently organized into air combat, ground combat, virtual training, cyber training, and game-based advanced learning systems.

 

Air Combat Training Systems

 

In air combat, Cubic was the initial developer and supplier of Air Combat Maneuvering Instrumentation (ACMI) capability during the Vietnam War, which provides advanced live training to fighter pilots around the world. The ACMI product line has progressed through five generations of technologies and capabilities.  The latest generation, the P5 ACMI, provides advanced air combat training capability to the U.S. Air Force, Navy and Marine Corps, and has solidified Cubic’s market leading position. We have also developed a broad international base for this product, particularly in Asia Pacific and the Middle East. In fiscal year 2013, Cubic was awarded an $18 million Low Rate Initial Production contract to extend this capability into an internal version of the P5 system for use on the F-35 Joint Strike Fighter (JSF). The F-35 JSF ACMI project is progressing towards full rate production in concert with the aircraft program. In addition to procuring the ACMI training system, many nations also rely on Cubic for on-site operations and maintenance support.

 

Ground Combat Training Systems

 

CDS is a leading provider of realistic, easy-to-use, high fidelity, reliable, and cost effective tactical engagement simulation systems  that minimize user set-up time and increase training effectiveness. Our leadership role in instrumented training was established during the 1990s when Cubic provided turnkey systems for U.S. Army training centers including the Joint Readiness Training Center (JRTC) at Fort Polk, Louisiana and the Combat Maneuver Training Center (CMTC) at Hohenfels, Germany, now known as the Joint Multinational Readiness Center. Since the completion of these original contracts, we have significantly expanded our market footprint with the sale of fixed, mobile and urban operation training centers to uniformed military and security forces in the U.S. and allied nations around the world. Our Laser-based tactical engagement simulation systems, widely known as the Multiple Integrated Laser Engagement Systems (MILES), are used at CTCs to enable realistic training without live ammunition. Cubic MILES are being utilized by all branches of the U.S. Armed Services, as well as the Department of Energy, and numerous international government customers. We have increased our focus on joint training solutions and those that can operate simultaneously in multiple simulation environments including live, virtual, constructive and gaming domains. In fiscal year 2013, we were awarded follow-on orders to our MILES Programs of Record within the US Army and US Marine Corps, receiving a $16 million award for infantry-based MILES and a $14 million award for combat vehicle MILES for the US Army, as well as a $29 million award under the Marines’ ITESS II program. We also received several large orders in the Asia Pacific region, including a $77 million contract to continue Operations & Maintenance support to an existing international customer on their training ranges. In fiscal year 2013 we acquired the assets of Advanced Interactive Systems (AIS), which provides live fire training solutions to US and international forces, further deepening our training capabilities and expanding our customer base.

 

Virtual Training Systems

 

Our Virtual Training product line provides virtual training systems for various applications, employing actual or realistic weapons and systems together with visual imagery to simulate battlefield environments. While our main product suite in this area is the Engagement Skills Trainer for small arms training, Cubic also provides maintenance trainers for combat systems and vehicles, as well as operational trainers for missiles, armored vehicles and naval applications. In fiscal year 2013, we significantly expanded our virtual training portfolio through a $298.5 million indefinite delivery/indefinite quantity (ID/IQ) award to provide immersive game based training for the Littoral Combat Ship (LCS). This award became the genesis of our Game-Based Learning Systems business described below.

 

10



Table of Contents

 

Cyber Training Systems

 

Driven by the highly dynamic and complex nature of cyber-attacks, cyber security solutions are transitioning from traditional perimeter defenses to integrated analytical tools to evaluate threats/intrusions in real-time.  The underlying shift to cloud-based services and “Big Data” places a premium on rapid detection and analysis of cyber threats particularly for military and intelligence customers. Cyber considerations are also assuming greater prominence in mission rehearsal and tactical exercises. Within the rapidly growing market, and in response to specific customer needs, CDS is developing a repository of threats, unique network topology modeling, and remote provisioning to simulate cyber effects on DoD systems/missions. Unlike expensive stovepipe hardware solutions, this approach allows the company to engage the market more broadly and with far greater flexibility. Ultimately, this solution can be offered to commercial entities as well.

 

Game-Based Learning Systems

 

The $298.5 million LCS courseware contract win by the Simulation Systems Division during 2013 has opened a large new market for CDS. A key discriminator in the LCS proposal was the use of a high fidelity gaming engine that allows Avatars to instruct students at their own pace in an immersive environment based on realistic graphics. By integrating instructional material into a gaming environment we have dramatically reduced instructor costs and provided a platform that is ideal for embedded training. These technologies are easily transferrable to different training domains and subject matter. The experiential learning environment can be augmented with intelligent tutoring and assessment tools increasing the value of this approach. At present the company is investing in the appropriate tool sets and staffing resources to meet the Navy’s requirements. Near-term opportunities include other Navy and  DoD customers, while longer-term applications under consideration exist in commercial markets such as education, health care, and retail.

 

Secure Communications

 

Our secure communications products business supplies secure data links, search and rescue avionics, high power RF amplifiers, cyber security appliances, and asset tracking solutions for the U.S. military, government agencies, and allied nations.

 

Data Links

 

Our data links portfolio originated with the U.S. Army/Air Force Joint STARS system during the 1980s, and we continue to supply ISR data links to US and international forces today. More recently we have focused on the supply of Common Data Link (CDL) products for shipborne applications, unmanned aerial vehicles (UAV), remote video terminals and hand-held products. Capitalizing on a multi-year internal research and development (R&D) program, we won a competitive contract in fiscal year 2003 to develop and produce the Common Data Link Subsystem (CDLS) for the U.S. Navy, and won a follow-on order in fiscal year 2013 to continue our work on that program. Smaller, tactical versions of our Common Data Link have been selected for both UAV and remote video terminal applications such as the U.K.’s Watchkeeper and the U.S. Navy’s Fire Scout MQ-8 UAV programs. In fiscal year 2013,  Cubic was awarded multiple orders to provide production units and spares for the MQ-8 program.

 

Personal Locator System and Power Amplifiers

 

Our Personnel Locator System (PLS) is standard equipment on U.S. aircraft with a search and rescue mission. PLS is designed to interface with all modern search and rescue system standards. These include systems used by the Canadian Coast Guard, the U.S. Navy, the U.S. Air Force and the French Army. We also supply high power amplifiers and direction finding systems to major prime contractors and end users for both domestic and international applications.

 

Cyber Cross-Domain

 

In June 2010 Cubic acquired Safe Harbor Holdings, a cyber security and information assurance company. This acquisition expanded our service offerings into areas including specialized security and networking infrastructure, system certification and accreditation, and enterprise-level network architecture and engineering services. We also provide cross-domain hardware solutions to address multi-level security challenges across common networks.

 

11



Table of Contents

 

Asset Tracking

 

In May 2010 Cubic acquired the assets of Impeva Labs and formed a new subsidiary called Cubic Global Tracking Solutions, Inc. (CGTS). CGTS global tracking technology is deployed with the DoD for tracking and monitoring DoD supply chain assets. The products employ satellite, GSM mobile communications and encrypted mesh network technologies. The company offers a Device Management Center that provides continuous, reliable, real-time monitoring and event notification without fixed infrastructure. CGTS was consolidated with the SC business unit at the beginning of fiscal year 2013.

 

Raw Materials — CDS

 

The principal raw materials used by CDS are sheet aluminum and steel, copper electrical wire and composite products. A significant portion of our end products are composed of purchased electronic components and subcontracted parts and supplies. We procure these items primarily from third-party suppliers. In general, supplies of raw materials and purchased parts are adequate to meet our requirements.

 

Backlog — CDS

 

Funded and total backlog of CDS at September 30, 2013 was $494 million compared to $417 million at September 30, 2012. We expect that approximately $198 million of the September 30, 2013 backlog will be converted into sales by September 30, 2014.

 

MSS and CDS Competitive Environment

 

Cubic’s broad defense business portfolio means we compete with numerous companies, large and small, across the globe. Well known competitors include Lockheed Martin, Northrop Grumman, General Dynamics, Boeing, L3 Communications, Saab Training Systems, SAIC, Leidos and Engility as well as other smaller companies. In many cases, we have also teamed with these same companies, in  both prime and subcontractor roles, on specific bid opportunities. While we are generally smaller than our principle competitors, we believe our competitive advantages include an outstanding record of past performance, strong incumbent relationships, the ability to control operating costs and the ability to rapidly focus technology and innovation to solve customer problems.

 

In the defense market, we continue to focus on expanding our domestic and international footprint in the global military simulation and training market as well as enabling the convergence and integration of live, virtual and constructive training technologies. U.S. federal budgetary decisions and constraints have put downward pressure on growth in the defense industry and has affected our business in 2013. Threats related to sequestration and margin compression were among the factors that resulted in a decline in the estimated fair value of MSS and a resulting $50.9 million goodwill impairment. However, we believe that much of our business is well positioned in areas that the DoD has indicated are areas of focus for future defense spending to help the DoD meet its critical future capability requirements for protecting U.S. security and the security of our allies in the years to come. For more information on the goodwill impairment recognized in 2013 and the accounting policies we have in place for impairment of goodwill, see our discussion under “Valuation of Goodwill” in Item 7 of this Form 10-K/A.

 

We are also well-positioned in large, relatively stable markets. According to Visiongain’s 2013 report, the global military simulation and training market is expected to reach $16 billion annually by 2023, growing at a 5.6% compound annual growth rate over the next ten years, with the U.S. market comprising approximately $5.8 billion in 2013. In the U.S., we believe that there are near term pressures on training budgets for systems and services due to cost pressures resulting from sequestration. However, we believe that changes in training doctrine and the use of new types of training that are cost effective will be essential for the military to fulfill its mission. Globally, we are focused on the emerging economies within the Asia-Pacific region and the Middle East, which are expected to be strong markets for simulation and training products and services with projected growth rates in excess of the overall market. In addition, new platforms and the significant increase in unmanned vehicles and other advanced weapon systems could generate significant demand for operator training on these new platforms.

 

Our secure communications products address the large and broadly defined Command, Control, Communications, Computers, Intelligence, Surveillance, Reconnaissance (C4ISR) market, with an estimated addressable market of approximately $2 billion annually. We believe that our products and technologies address mission critical requirements such as: integrated communications suites for unmanned aerial vehicles (UAV), ships and the dismounted soldier; battlefield awareness; secure and encrypted communications and asset tracking and location services. We believe that these technologies will continue to experience strong demand as the U.S. military maintains a smaller, more agile force structure

 

12



Table of Contents

 

BUSINESS STRATEGY

 

Our objective is to consistently grow sales, improve profitability and deliver attractive returns on capital. We intend to expand our position as the leading provider of automated payment and fare collection systems and services to transportation authorities worldwide and build on our position with U.S. and foreign governments as the leading full spectrum supplier of training systems and mission support services. Our strategies to achieve these objectives include:

 

Maintain Niche Market Leadership

 

We seek to defend our leadership positions in core markets by ensuring all our businesses are absolutely customer facing, thereby maintaining our long-term relationships with our customers. By achieving this goal, we can leverage our returns through follow-on business with existing customers and expand our presence in the market through sales of similar systems at competitive prices to new customers. The length of relationship with many of our customers exceeds 30 years and further supports our industry-wide leadership and technological capabilities. In addition, as a result of maintaining a high level of performance, we continue to provide a combination of support services for our long-term customers. Such long-term relationships include the following:

 

Business Area

 

Year

Automated Fare Collection

 

1972, provided the San Francisco Bay Area Rapid Transit (BART) ticket encoding and vending technology.

Air Combat Training

 

1973, supplied first “Top Gun” Air Combat Maneuvering Instrumentation system for the Marine Corps Air Station at Yuma, AZ.

Ground Combat Training

 

1990, pioneered the world’s first turnkey ground combat-instrumentation system at Hohenfels, Germany for the U.S. Army.

MILES

 

1995, won a contract for our first laser engagement simulation system for the U.S. Army.

Korea Battle Simulation Center (KBSC)

 

1991, won a contract to design, stand up and operate this large and complex training center to support all U.S. Forces in Korea. Have provided continuous support since 1991.

Joint Warfighting Center (JWFC), now Joint Coalition Warfare Center (JCWC)

 

1994, won a contract to design, stand up and operate this large and complex training center to support U.S. joint forces worldwide. Have provided continuous support since 1994.

 

Superior Operational Performance

 

Our businesses will continue to achieve high levels of performance on current contracts, delivering world-class solutions on schedule and on budget.  Achieving this level of performance will deliver high value to our customers, employees, and shareholders. Superior program execution will help us defend our positions in core markets and expand to new customers by leveraging solid past performance.

 

Strategic Reinvestment of Capital

 

We target markets that have the potential for above-average growth where domain expertise, innovation, technical competency and contracting dynamics can help to create meaningful barriers to entry. We will strategically reinvest our cash in key program captures, internal R&D, and acquisitions to target new priority markets, ensure market leader positions and improve shareholder equity.

 

Innovation

 

We continue to invest in R&D to maintain a leadership role in the technological evolution within our core focus areas of the global transportation and defense markets. We are committed to using innovation and technology to address our customers’ most pressing problems and demanding requirements. We have made meaningful and recognized contributions to technological advancements within our industries.

 

The cost of company sponsored R&D activities was $24.4 million, $28.7 million, and $25.3 million in 2013, 2012 and 2011, respectively. In addition to internally funded R&D, a significant portion of our new product development occurs in conjunction with the performance of work on our contracts. The amount of contract-required engineering and product development activity was approximately $68.3 million in 2013 compared to $81.2 million in 2012 and $72.4 million in 2011; however, these costs are included in cost of sales as they are directly related to contract performance. In fiscal year 2013, we spent 1.8% of our sales on internally funded R&D, primarily focused in our CDS and CTS segments.

 

In addition to R&D initiatives, our innovation portfolio covers design of public private partnerships (P3s) and innovative program financing in the transportation segment. Through public private partnerships, public transportation agencies are able to modernize their system infrastructures without draining precious capital budgets or increasing transit fares and losing ridership. This structure will also allow the agencies to transfer operational costs and risks to the private sector while maintaining controls through program acceptance criteria and operational performance requirements.

 

13



Table of Contents

 

Pursue Strategic Acquisitions

 

We have sought out strategic acquisitions that help us overcome existing barriers in target markets with the goal of accelerating our growth. We are focused on finding attractive acquisitions that enhance our market positions, provide expansion into complementary growth markets and ensure sustainable long-term profitability. We have developed an acquisition strategy that focuses on specific consolidation and growth opportunities in the defense and transportation markets. Over the last several years, we have completed multiple acquisitions as a means to diversify our customer base and expand our systems and services offerings.

 

For example, through the acquisitions of Abraxas and NEK, we have expanded our reach within the military and national intelligence communities through the addition of intelligence, special operations, law enforcement and homeland security expertise.

 

Enhance Services Business

 

We view services as a core element of our business and we are working to expand our service offerings and customer base. In aggregate, approximately 59% of our sales in fiscal year 2013, were from service-related work. We believe that a strong base of service work helps to consistently generate profits and smooth the sales fluctuations inherent in systems work. Due to the technical complexities of operating electronic fare collection and payment systems, transportation agencies are turning to their system suppliers for IT services and other operational and maintenance services, such as regional settlement, card management and customer support services that would otherwise be performed by the agencies. As a result, we are transitioning from an AFC supplier to an intelligent transportation systems integrator and services company providing a suite of turnkey outsourced services for more than 20 transit authorities and cities worldwide.

 

Today, CTS delivers a wide range of services from customer support to financial management and technical support at its full service operation centers in Concord, California, Brisbane, and Sydney Australia and London, England. Our Tullahoma, Tennessee facility is used as an overflow service center of patron call support and help desk for both the East and West Coasts of the U.S. We deliver a number of customer services from key service facilities for multiple transportation authorities worldwide.

 

At MSS, we provide a combination of services to our many domestic and international customers. Multiple-award ID/IQ contracts are now the primary contract vehicle in the U.S. government services marketplace. We have increased our participation on ID/IQ contracts, giving us more opportunities to bid for work and increasing our chances to develop new customers, programs and capabilities. We expand our scope of opportunities by offering additional services to current customers and transferring our skill sets  to support similar programs for new customers. The broad spectrum of services we offer reinforces this strategy, and includes planning and support for theater and worldwide exercises, computer-based simulations, training and preparation of foreign military advisor and transition teams, mobilization and demobilization of deploying forces, range support and operations, logistics and maintenance operations, curriculum and leadership development, special operations forces (SOF) support, intelligence support, force modernization, open source data collection, as well as engineering and other technical support.

 

For CDS, increased services and operations and maintenance opportunities can reduce the volatility and timing uncertainties  associated with large equipment contracts and add depth to the revenue base. Compared to the U.S. market where small business requirements, omnibus contracts and local preferences create acquisition challenges, we believe the international market offers greater opportunities to bundle and negotiate multi-year, turnkey contracts. We believe these long-term contracts reinforce CDS’ competitive posture and enable the company to provide enhanced services through regular customer contact and increased visibility of product performance and reliability.

 

Through the acquisitions of Abraxas in December 2010 and NEK in December 2012, MSS has expanded Cubic’s support services capabilities to the national intelligence communities, as well as to additional domestic and international special operations, law enforcement, and security clients. With these acquisitions and organic skill sets, we have increased our addressable markets and related services offerings.

 

Expand International Footprint

 

We have developed a large global presence in our three business segments. CTS has delivered over 400 projects in 40 major markets on 5 continents to date. Approximately 74% of the CTS segment’s fiscal year 2013 sales were attributable to international customers. CTS has expanded in Australia with the award of a $341.0 million contract to design and build an Electronic Ticketing System for Sydney and to operate and maintain the system until 2024. The Australian operation is now one of three primary operating regions of CTS alongside North America and Europe, and will be the base for us to pursue opportunities in the Asia-Pacific region. In Germany, we have successfully implemented a new electronic ticketing system for the Transit Authority Rhein-Main-Verkehrsverbund, and are working on providing new ticketing applications using cell phone technologies.

 

14



Table of Contents

 

CDS has delivered systems in more than 35 allied nations. In fiscal year 2013, approximately 41% of CDS’ sales were to allied foreign governments, including projects funded by the U.S. government pursuant to Foreign Military Sales and Foreign Military Financing arrangements. During fiscal year 2013, we expanded our presence in the UK, Canada, and the United Arab Emirates in response to growing opportunities.  These complement a well-established and sound presence in Singapore, Australia, New Zealand, and Italy.

 

In fiscal year 2013, approximately 17% of MSS sales were to international customers, including its long-term force modernization programs supporting multiple Central and Eastern European countries.  MSS is now coordinating with CTS and CDS to use their broader international presence to help identify additional global service opportunities. We are actively working to leverage MSS’s significant domestic special operations forces (SOF) and related security capabilities and experience to develop new international customers.  The international SOF/Security markets, particularly in the area of training support, offer strong potential for near-term and sustained growth for the foreseeable future.

 

INTELLECTUAL PROPERTY

 

We seek to protect our proprietary technology and inventions through patents and other proprietary-right protection, and also rely on trademark laws to protect our brand. However, we do not regard ourselves as materially dependent on patents for the maintenance of our competitive position. We also rely on trade secrets, proprietary know-how and continuing technological innovation to remain competitive.

 

REGULATION

 

Our businesses must comply with and are affected by various government regulations that impact our operating costs, profit margins and our internal organization and operation of our businesses. We deal with numerous U.S. government agencies and entities, including all branches of the U.S. military and the DoD. Therefore, we must comply with and are affected by laws and regulations relating to the formation, administration, and performance of U.S. government and other contracts. These laws and regulations, among other things, include the Federal Acquisition Regulations and all department and agency supplements, which comprehensively  regulate the formation, administration and performance of U.S. government contracts. Other federal regulations require certification and disclosure of cost or pricing data in connection with contract negotiations for certain types of contracts, define allowable and unallowable costs, govern reimbursement rights under cost-based contracts, and restrict the use, dissemination and exportation of products and information classified for national security purposes. For additional discussion of government contracting laws and regulations and related matters, see “Risk factors” and “Business—Industry Considerations” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies, Estimates and Judgments—Revenue Recognition” with respect to pricing and revenue under government contracts.

 

Our business is subject to a range of foreign, federal, state and local laws and regulations regarding environmental protection and employee health and safety, including those that govern the emission and discharge of hazardous or toxic materials into the environment and the generation, storage, treatment, handling, use, transportation and disposal of such materials. From time to time, we have been named as a potentially responsible party at third-party waste disposal sites. We do not currently expect compliance with  such laws and regulations to have a material effect upon our capital expenditures, earnings or competitive position. However, such  laws and regulations are complex, change frequently and have tended to become increasingly stringent over time. Accordingly, we cannot assure you that such laws and regulations will not have a material effect on our business in the future.

 

OTHER MATTERS

 

We do not engage in any business that is seasonal in nature. Since our revenues are generated primarily from work on contracts performed by our employees and subcontractors, first quarter revenues tend to be lower than the other three quarters due to our policy of providing many of our employees seven holidays in the first quarter, compared to one or two in each of the other quarters of the year. This is not necessarily a consistent pattern as it depends upon actual activities in any given year.

 

We employed approximately 8,200 persons at September 30, 2013.

 

Our domestic products and services are sold almost entirely by our employees. Overseas sales are made either directly or through representatives or agents.

 

15



Table of Contents

 

Item 1A. RISK FACTORS.

 

Risks relating to our business

 

We have restated our prior consolidated financial statements, which may lead to additional risks and uncertainties, including shareholder litigation, loss of investor confidence and negative impacts on our stock price.

 

As discussed in Note 2 to our consolidated financial statements included in Item 8 of this Form 10-K/A, we have restated our consolidated financial statements as of and for the years ended September 30, 2013 and 2012 and for the quarterly periods within the fiscal years ended September 30, 2013 and 2012. The determination to restate these consolidated financial statements and the unaudited interim condensed consolidated financial statements was made by our Audit and Compliance Committee upon management’s recommendation following the identification of errors related to our method of recognizing revenues on two contracts at one of our wholly-owned subsidiaries. We previously restated our historical financial statements in 2012 following the identification of errors, which related primarily to the misapplication of GAAP for certain methods of revenue recognition.

 

As a result of these events, we have become subject to a number of additional risks and uncertainties, including substantial unanticipated costs for accounting and legal fees in connection with or related to the restatement and potential shareholder litigation. If litigation did occur, we may incur additional substantial defense costs regardless of the outcome of such litigation. Likewise, such events might cause a diversion of our management’s time and attention. If we do not prevail in any such litigation, we could be required to pay substantial damages or settlement costs. In addition, the fact that we have completed two restatements in the last two years may lead to a loss of investor confidence and have negative impacts on the trading price of our common stock.

 

We have identified material weaknesses in our internal control over financial reporting which could, if not remediated, result in additional material misstatements in our financial statements.

 

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended. As disclosed in Item 9A of this Form 10-K/A, management identified material weaknesses in our internal control over financial reporting based upon our identification of certain errors in our recognition of revenue at a wholly owned subsidiary. A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. As a result of these material weaknesses, our management concluded that our internal control over financial reporting was not effective based on criteria set forth by the Committee of Sponsoring Organization of the Treadway Commission in Internal Control—An Integrated Framework. We are actively engaged in developing a remediation plan designed to address these material weaknesses. If our remedial measures are insufficient to address the material weaknesses, or if additional material weaknesses or significant deficiencies in our internal control are discovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results, which could lead to substantial additional costs for accounting and legal fees and shareholder litigation.

 

Our business and stock price may be adversely affected if our internal control over financial reporting is not effective.

 

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended. As part of this process, we are required to document and test our internal control over financial reporting; our management is required to assess and issue a report concerning our internal control over financial reporting; and our independent registered public accounting firm is required to attest to and report on the effectiveness of our internal control over financial reporting. Management’s assessment of our internal control over financial reporting as of September 30, 2012, identified material weaknesses in our internal control over financial reporting related to accounting for revenue  on certain types of contracts. A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. We previously concluded that we had remediated such material weaknesses as of September 30, 2013. However, as described in “Controls and Procedures—Management’s Report on Internal Control Over Financial Reporting” in Item 9A of this Form 10-K/A, management has identified additional material weaknesses in our internal control over financial reporting related to accounting for revenue on certain contracts for one of our wholly-owned subsidiaries. We are in the process of adding resources and have begun developing and implementing new processes and procedures to remediate the material weaknesses that existed in our internal control over financial reporting as of September 30, 2013. We will need to monitor and  evaluate these procedures to ensure that they are operating effectively. We may be at risk for future material weaknesses, particularly  if these new procedures do not operate effectively. The existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements, which could cause us to fail to meet our reporting obligations,  lead to a loss of investor confidence and have negative impacts on the trading price of our common stock.

 

16



Table of Contents

 

We depend on government contracts for substantially all of our revenues and the loss of government contracts or a delay or decline in funding of existing or future government contracts could decrease our backlog or adversely affect our sales and cash flows and our ability to fund our growth.

 

Our revenues from contracts, directly or indirectly, with foreign and U.S. state, regional and local governmental agencies represented substantially all of our total revenues in fiscal year 2013. Although these various government agencies are subject to common budgetary pressures and other factors, many of our various government customers exercise independent purchasing decisions. As a result of the concentration of business with governmental agencies, we are vulnerable to adverse changes in our revenues, income and cash flows if a significant number of our government contracts, subcontracts or prospects are delayed or canceled for budgetary or other reasons.

 

The factors that could cause us to lose these contracts and could decrease our backlog or otherwise materially harm our business, prospects, financial condition or results of operations include:

 

·                  budget constraints affecting government spending generally, or specific departments or agencies such as U.S. or foreign defense and transit agencies and regional transit agencies, and changes in fiscal policies or a reduction of available funding;

 

·                  re-allocation of government resources as the result of actual or threatened terrorism or hostile activities or for other reasons;

 

·                  disruptions in our customers’ ability to access funding from capital markets;

 

·                  curtailment of governments’ use of outsourced service providers and governments’ in-sourcing of certain services;

 

·                  the adoption of new laws or regulations pertaining to government procurement;

 

·                  government appropriations delays or blanket reductions in departmental budgets;

 

·                  suspension or prohibition from contracting with the government or any significant agency with which we conduct business;

 

·                  increased use of shorter duration awards by the federal government in the defense industry, which increases the frequency we may need to recompete for work;

 

·                  impairment of our reputation or relationships with any significant government agency with which we conduct business;

 

·                  impairment of our ability to provide third-party guarantees and letters of credit; and

 

·                  delays in the payment of our invoices by government payment offices.

 

In addition, some of our international work is done at the request and at the expense of the U.S. government and its agencies. Therefore, risks associated with performing work for the U.S. government and its agencies may also apply to our international contracts.

 

Government spending priorities and terms may change in a manner adverse to our businesses.

 

At times, our businesses have been adversely affected by significant changes in U.S. and foreign government spending during periods of declining budgets. A significant decline in overall spending, or the decision not to exercise options to renew contracts, or the loss of or substantial decline in spending on a large program in which we participate could materially adversely affect our business, prospects, financial condition or results of operations. For example, the U.S. defense and national security budgets in general, and spending in specific agencies with which we work, such as those that are a part of the DoD, have declined from time to time for extended periods, resulting in program delays, program cancellations and a slowing of new program starts. Future levels of expenditures and authorizations for defense-related programs by the U.S. and foreign governments may decrease, remain constant or shift to programs  in areas where we do not currently provide products or services, thereby reducing the chances that we will be awarded new contracts.

 

Even though our contract periods of performance for a program may exceed one year, Congress and certain foreign governments must usually approve funds for a given program each fiscal year and may significantly reduce funding of a program in a particular year. Significant reductions in these appropriations or the amount of new defense contracts awarded may affect our ability to complete contracts, obtain new work and grow our business. Congress and such foreign governments do not always enact spending bills by the beginning of the new fiscal year. Such delays leave the affected agencies under-funded which delays their ability to contract. Future delays and uncertainties in funding could impose additional business risks on us.

 

17



Table of Contents

 

In addition, the DoD has recently increased its emphasis on awarding contracts to small businesses and awarding shorter duration contracts, each of which has the potential to reduce the amount of revenue we could otherwise earn from such contracts. Shorter duration contracts lower our backlog numbers and increase the risk associated with recompeting for a contract, as we would need to do so more often. In addition, as we may need to expend capital resources at higher levels upon the award of a new contract, the shorter the duration of the contract, the less time we have to recoup such expenditures and turn a profit under such contract.

 

Sequestration may adversely affect our businesses which are dependent on federal government funding.

 

Pursuant to a law passed in August 2011, which went into effect on March 1, 2013, there have been deep and automatic cuts in defense budgets and other non-defense budgets.  Although there are proposals in Congress to mitigate the impact of these cuts, it is unknown what additional programs will be cut, over what time period and by what amount. Unless this legislation is reversed, annual automatic spending cuts will be enacted through 2021. Some programs may be cancelled in their entirety.

 

All of our U.S. defense contracts are at risk of being cut or terminated. Our domestic transportation contracts could be materially harmed if transit agencies do not receive expected federal funds and are required to curtail their plans to expand or upgrade their fare collection systems.

 

In 2013, threats related to sequestration and margin compression were among the factors that resulted in a decline in the estimated fair value of MSS and a resulting $50.9 million goodwill impairment. For more information on the goodwill impairment recognized in 2013 and the accounting policies we have in place for impairment of goodwill, see our discussion under “Valuation of Goodwill” in Item 7 of this Form 10-K/A.

 

Failure to raise the national debt limit may cause the U.S. government to be unable to pay funds due to us.

 

Congress and the executive branch may reach an impasse on increasing the national debt limit which would restrict the U.S. government’s ability to pay contractors for prior work. A failure to receive such payments for an extended period of time could result in substantial layoffs of our employees, drawdowns of our credit lines and our inability to pay debts when due, which could materially adversely affect our business, prospects, financial condition or results of operations.

 

A deadlock in the U.S. Congress over budgets and spending could cause another partial shutdown of the U.S. government, which could result in a termination or suspension of some or all of our contracts with the U.S. government.

 

Congress may fail to pass a budget or continuing resolution, which would result in a partial shutdown of the U.S. government and cause the termination or suspension of our contracts with the U.S. government. We would be required to furlough affected employees for an indefinite time. It is uncertain in such a circumstance if we would be compensated or reimbursed for any loss of revenue during such a shutdown. If we were not compensated or reimbursed, it could result in significant adverse effects on our revenues, operating costs and cash flows.

 

Our contracts with government agencies may be terminated or modified prior to completion, which could adversely affect our business.

 

Government contracts typically contain provisions and are subject to laws and regulations that give the government agencies rights and remedies not typically found in commercial contracts, including providing the government agency with the ability to unilaterally:

 

·                  terminate our existing contracts;

 

·                  reduce the value of our existing contracts;

 

·                  modify some of the terms and conditions in our existing contracts;

 

·                  suspend or permanently prohibit us from doing business with the government or with any specific government agency;

 

·                  control and potentially prohibit the export of our products;

 

18



Table of Contents

 

·                  cancel or delay existing multi-year contracts and related orders if the necessary funds for contract performance for any subsequent year are not appropriated;

 

·                  decline to exercise an option to extend an existing multi-year contract; and

 

·                  claim rights in technologies and systems invented, developed or produced by us.

 

Most U.S. government agencies and some other agencies with which we contract can terminate their contracts with us for convenience, and in that event we generally may recover only our incurred or committed costs, settlement expenses and profit on the work completed prior to termination. If an agency terminates a contract with us for default, we may be denied any recovery and may be liable for excess costs incurred by the agency in procuring undelivered items from an alternative source. We may receive show- cause or cure notices under contracts that, if not addressed to the agency’s satisfaction, could give the agency the right to terminate those contracts for default or to cease procuring our services under those contracts.

 

In the event that any of our contracts were to be terminated or adversely modified, there may be significant adverse effects on our revenues, operating costs and income that would not be recoverable.

 

Changes in future business or other market conditions could cause business investments and/or recorded goodwill or other long- term assets to become impaired, resulting in substantial losses and write-downs that would reduce our results of operations.

 

As part of our strategy, we will, from time to time, acquire a minority or majority interest in a business. These investments are made upon careful analysis and due diligence procedures designed to achieve a desired return or strategic objective. These procedures often involve certain assumptions and judgment in determining acquisition price. After acquisition, unforeseen issues could arise which adversely affect the anticipated returns or which are otherwise not recoverable as an adjustment to the purchase price. Even after careful integration efforts, actual operating results may vary significantly from initial estimates. We evaluate our recorded goodwill balances for potential impairment annually as of July 1, or when circumstances indicate that the carrying value may not be recoverable. The goodwill impairment test is performed by comparing the fair value of each reporting unit to its carrying value, including recorded goodwill. In the fourth quarter of fiscal 2013, we recognized a goodwill impairment in our MSS segment of $50.9 million. This goodwill impairment, and any impairment that might be necessary in the future, is measured by comparing the implied fair value of goodwill to its carrying value, and any impairment determined is recorded in the current period. Any future impairment could result in substantial losses and write-downs that would reduce our results of operations. For more information on the goodwill impairment recognized in 2013 and the accounting policies we have in place for impairment of goodwill, see our discussion under “Valuation of Goodwill” in Item 7 of this Form 10-K/A.

 

Failure to retain existing contracts or win new contracts under competitive bidding processes may adversely affect our revenue.

 

We obtain most of our contracts through a competitive bidding process, and substantially all of the business that we expect to seek in the foreseeable future likely will be subject to a competitive bidding process. Competitive bidding presents a number of risks, including:

 

·                  the need to compete against companies or teams of companies with more financial and marketing resources and more experience in bidding on and performing major contracts than we have;

 

·                  the need to compete against companies or teams of companies that may be long-term, entrenched incumbents for a particular contract for which we are competing and that have, as a result, greater domain expertise and better customer relations;

 

·                  the need to compete to retain existing contracts that have in the past been awarded to us on a sole-source basis or as to which we have been incumbent for a long time;

 

·                  the U.S. government’s increased emphasis on awarding contracts to small businesses could preclude us from bidding on certain work or reduce the scope of work we can bid as a prime contractor and limit the amount of revenue we could otherwise earn as a prime contractor for such contracts;

 

·                  the award of contracts to providers offering solutions at the “lowest price technically acceptable” which may lower the profit we may generate under a contract awarded using this pricing method or prevent us from submitting a bid for such work due to us deeming such work to be unprofitable;

 

·                  the reduction of margins achievable under any contracts awarded to us;

 

19



Table of Contents

 

·                  the expense and delay that may arise if our competitors protest or challenge new contract awards;

 

·                  the need to bid on some programs in advance of the completion of their design, which may result in higher R&D expenditures, unforeseen technological difficulties, or increased costs which lower our profitability;

 

·                  the substantial cost and managerial time and effort, including design, development and marketing activities, necessary to prepare bids and proposals for contracts that may not be awarded to us;

 

·                  the need to develop, introduce and implement new and enhanced solutions to our customers’ needs;

 

·                  the need to locate and contract with teaming partners and subcontractors; and

 

·                  the need to accurately estimate the resources and cost structure that will be required to perform any fixed-price contract that we are awarded.

 

We may not be afforded the opportunity in the future to bid on contracts that are held by other companies and are scheduled to expire  if the agency decides to extend the existing contract. If we are unable to win particular contracts that are awarded through the competitive bidding process, we may not be able to operate in the market for services that are provided under those contracts for a number of years. If we win a contract, and upon expiration the customer requires further services of the type provided by the contract, there is frequently a competitive rebidding process and there can be no assurance that we will win any particular bid, or that we will be able to replace business lost upon expiration or completion of a contract.

 

As a result of the complexity and scheduling of contracting with government agencies, we occasionally incur costs before receiving contractual funding by the government agency. In some circumstances, we may not be able to recover these costs in whole or in part under subsequent contractual actions.

 

In addition, the customers currently serviced by our CTS segment are finite in number. The loss of any one of these customers, or the failure to win replacement awards upon expiration of contracts with such customers, such as our contract with Transport for London, which will be required to be re-competed in 2015, could have a materially adverse impact on our results of operations.

 

If we are unable to consistently retain existing contracts or win new contract awards, our business, prospects, financial condition and results of operations will be adversely affected.

 

Many of our U.S. government customers spend their procurement budgets through multiple-award or ID/IQ contracts, under which we are required to compete among the awardees for post-award orders. Failure to win post-award orders could affect our ability to increase our sales.

 

The U.S. government can select multiple winners under multiple-award contracts, federal supply schedules and other agency-specific ID/IQ contracts, as well as award subsequent purchase orders among such multiple winners. This means that there is no guarantee that these ID/IQ, multiple-award contracts will result in the actual orders equal to the ceiling value under the contract, or result in any actual orders. We are only eligible to compete for work (purchase orders and delivery orders) as an awardee pursuant to government- wide acquisition contracts already awarded to us. Our failure to compete effectively in this procurement environment could reduce our sales, which would adversely affect our business, results of operations and financial condition.

 

The U.S. government’s emphasis on awarding contracts to small businesses could preclude us from acting as a prime contractor and increase the number of contracts we receive as a subcontractor to small businesses, which could decrease the amount of our revenues from such contracts. Some of these small businesses may not be financially sound, which could adversely affect our business.

 

There is emphasis by the U.S. government on awarding contracts to small businesses, which may preclude companies the size of ours from obtaining certain work, other than as a subcontractor to these small businesses. There are inherent risks in contracting with small companies that may not have the capability or financial resources to perform these contracts or administer them correctly. If a small business with which we have a subcontract fails to perform, fails to bill the government properly or fails financially, we may have difficulty receiving timely payments or may incur bad debt write-offs if the small business is unable or unwilling to pay us for work we perform. In addition, being a subcontractor may limit the amount of revenue we could otherwise earn as a prime contractor for such contracts. When we only act as a subcontractor, we may only receive up to 49% of the value of the contract award, and such percentage may be less should the small business partner or partners be able to service a larger piece of the award. Failure to maintain good relationships with small business partners operating in our industries could preclude us from winning work as a subcontractor as part of a large contracting consultation. This could result in significant adverse effects on our revenues, operating costs and cash flows.

 

20



Table of Contents

 

Government audits of our contracts could result in a material charge to our earnings, have a negative effect on our cash position following an audit adjustment or adversely affect our ability to conduct future business.

 

U.S. government agencies, including the DoD and others, routinely audit and review a contractor’s performance on government contracts, indirect rates and pricing practices, and compliance with applicable contracting and procurement laws, regulations and standards. Based on the results of such audits, the auditing agency is authorized to adjust our unit prices if the auditing agency does not find them to be “fair and reasonable.” The auditing agency is also authorized to require us to refund any excess proceeds we received on a particular item over its final adjusted unit price.

 

The DoD, in particular, also reviews the adequacy of, and compliance with, our internal control systems and policies, including our purchasing, accounting, financial capability, pricing, labor pool, overhead rate and management information systems. Our failure to obtain an “adequate” determination of our various accounting and management internal control systems from the responsible U.S. government agency could significantly and adversely affect our business, including our ability to bid on new contracts and our competitive position in the bidding process. Failure to comply with applicable contracting and procurement laws, regulations and standards could also result in the U.S. government imposing penalties and sanctions against us, including suspension of payments and increased government scrutiny that could delay or adversely affect our ability to invoice and receive timely payment on contracts or perform contracts, or could result in suspension or debarment from competing for contracts with the U.S. government. In addition, we could suffer serious harm to our reputation if allegations of impropriety were made against us, whether or not true.

 

In addition, transit authorities have the right to audit our work under their respective contracts. If, as the result of an adverse audit finding, we were suspended or prohibited from contracting with the U.S. government, any significant government agency or a transit authority terminated its contract with us, or our reputation or relationship with such agencies and authorities was impaired or they otherwise ceased doing business with us or significantly decreased the amount of business done with us, it would adversely affect our business, results of operations and financial condition.

 

Our international business exposes us to additional risks, including exchange rate fluctuations, foreign tax and legal regulations and political or economic instability that could harm our operating results.

 

Our international operations subject us to risks associated with operating in and selling products or services in foreign countries, including:

 

·                  devaluations and fluctuations in currency exchange rates;

 

·                  changes in foreign laws that adversely affect our ability to sell our products or services or our ability to repatriate profits to the United States;

 

·                  increases or impositions of withholding and other taxes on remittances and other payments by foreign subsidiaries or joint ventures to us;

 

·                  increases in investment and other restrictions or requirements by foreign governments in order to operate in the territory or own the subsidiary;

 

·                  costs of compliance with local laws, including labor laws;

 

·                  compliance with anti-corruption laws, anti-money laundering laws and sanctions;

 

·                  export control regulations and policies which govern our ability to supply foreign customers;

 

·                  unfamiliar and unknown business practices and customs;

 

·                  domestic and foreign government policies, including requirements to expend a portion of program funds locally and governmental industrial cooperation requirements;

 

·                  the complexity and necessity of using foreign representatives and consultants or being prohibited from such use;

 

21



Table of Contents

 

·                  the uncertainty of the ability of foreign customers to finance purchases;

 

·                  imposition of tariffs or embargoes, export controls and other trade restrictions;

 

·                  potentially being prohibited from bidding for international work due to perceived conflicts or national security concerns resulting from the significant amount of work we do for the U.S. government and its agencies;

 

·                  the difficulty of management and operation of an enterprise in various countries; and

 

·                  economic and geopolitical developments and conditions, including ongoing instability in global economies and financial markets, international hostilities, acts of terrorism and governmental reactions, inflation, trade relationships and military and political alliances.

 

Our foreign subsidiaries generally enter into contracts and make purchase commitments that are denominated in foreign currencies. Accordingly, we are exposed to fluctuations in exchange rates, which could have a significant impact on our results of operations. We have no control over the factors that generally affect this risk, such as economic, financial and political events and the supply of and demand for applicable currencies. While we use foreign exchange forward and option contracts to hedge significant contract sales and purchase commitments that are denominated in foreign currencies, our hedging strategy may not prevent us from incurring losses due to exchange fluctuations.

 

We may not be able to receive the necessary licenses required for us to sell our export-controlled products and services overseas. In addition, the loss of our registration as either an exporter or a broker under International Traffic in Arms Regulations (ITAR), would adversely affect our business, results of operations and financial condition.

 

U.S. government agencies, primarily the Directorate of Defense Trade Controls within the State Department and the Bureau of Industry Security within the U.S. Department of Commerce, must license shipments of certain export-controlled products that we export. These licenses are required due to both the products we export and to the foreign customers we service. If we do not receive a license for an export-controlled product, we cannot ship that product. We cannot be sure of our ability to gain any licenses required to export our products, and failure to receive a required license would eliminate our ability to make that sale. A delay in obtaining the necessary licenses to sell our export-controlled products abroad could result in delayed deliveries and delayed recognition of revenue, which could cause us reputational damage and could result in a customer’s decision not to do business with us in the future. We may also be subject to inquiries by such U.S. government agencies relating to issues involving the export-controlled products and services we export and failure to satisfactorily resolve such inquiries would adversely affect our business, results of operations and financial condition.

 

In addition to obtaining a license for certain of our exports outside of the United States, we are also required to maintain a standing registry under ITAR as an exporter. We operate as an exporter when we ship certain products to our customers outside the United States. If we were to lose our registration as an exporter under ITAR, we would not be able to sell export-controlled products abroad, which would adversely affect our business, results of operations and financial condition.

 

Our operating margins may decline under our fixed-price contracts if we fail to accurately estimate the time and resources necessary to satisfy our obligations.

 

Approximately 75% of our revenues in fiscal year 2013 were from fixed-price contracts under which we bear the risk of cost overruns. Our profits are adversely affected if our costs under these contracts exceed the assumptions we used in bidding for the contract. We may therefore need to absorb any increases in our supply costs and may not be able to pass such costs increases along to our customers. Sometimes we are required to fix the price for a contract before the project specifications are finalized, which increases the risk that we will incorrectly price these contracts. The complexity of many of our engagements makes accurately estimating the time and resources required more difficult.

 

We may not receive the full amounts estimated under the contracts in our total backlog, which could reduce our sales in future periods below the levels anticipated and which makes backlog an uncertain indicator of future operating results.

 

As of September 30, 2013, our total backlog was $2,646.6 million. Orders may be cancelled and scope adjustments may occur, and we may not realize the full amounts of sales that we may anticipate in our backlog numbers. There can be no assurance that the projects underlying the contracts and purchase orders will be placed or completed or that amounts included in our backlog ultimately will be billed and collected. Additionally, the timing of receipt of sales, if any, on contracts included in our backlog could change. The failure to realize amounts reflected in our backlog could materially adversely affect our business, financial condition and results of operations in future periods.

 

22



Table of Contents

 

We may be liable for civil or criminal penalties under a variety of complex laws and regulations, and changes in governmental regulations could adversely affect our business and financial condition.

 

Our businesses must comply with and are affected by various government regulations that impact our operating costs, profit margins and our internal organization and operation of our businesses. These regulations affect how we do business and, in some instances, impose added costs. Any changes in applicable laws could adversely affect our business and financial condition. Any material failure to comply with applicable laws could result in contract termination, price or fee reductions or suspension or debarment from contracting. The more significant regulations include:

 

·                  the Federal Acquisition Regulations (FAR) and all department and agency supplements, which comprehensively regulate the formation, administration and performance of U.S. government contracts;

 

·                  the Truth in Negotiations Act and implementing regulations, which require certification and disclosure of all cost and pricing data in connection with contract negotiations;

 

·                 the ITAR, which control the export and import of defense related articles and services on the U.S. Munitions Control List;

 

·                  laws, regulations and executive orders restricting the use and dissemination of information classified for national security purposes and the exportation of certain products and technical data;

 

·                  regulations of most state and regional agencies and foreign governments similar to those described above;

 

·                  the trade sanctions laws and regulations administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control;

 

·                  the Foreign Corrupt Practices Act and the U.K. Bribery Act;

 

·                  the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Protection Act;

 

·                  healthcare reform laws and regulations, including those enacted under the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act of 2010;

 

·                  tax laws and regulations in the U.S. and in other countries in which we operate;

 

·                  the civil False Claims Act, which provides for substantial civil penalties for violations, including for submission of a false or fraudulent claim to the U.S. government for payment or approval;

 

·                  the Procurement Integrity Act, which requires evaluation of ethical conflicts surrounding procurement activity and establishing certain employment restrictions for individuals who participate in the procurement process; and

 

·                  the Small Business Act and the Small Business Administration, size status regulations, which regulate eligibility for performance of government contracts which are set aside for, or a preference is given in the evaluation process if awarded to, specific types of contractors such as small businesses and minority-owned businesses.

 

The FAR and many of our U.S. government contracts contain organizational conflicts of interest clauses that may limit our ability to compete for or perform certain other contracts. Organizational conflicts of interest arise when we engage in activities that provide us with an unfair competitive advantage. A conflict of interest issue that precludes our competition for or performance on a significant program or contract could harm our prospects and negative publicity about a conflict of interest issue could damage our reputation.

 

In addition, the U.S. and foreign governments may revise existing contract rules and regulations or adopt new contract rules and regulations at any time and may also face restrictions or pressure regarding the type and amount of services it may obtain from private contractors. For instance, Congressional legislation and initiatives dealing with procurement reform and shifts in the buying practices of U.S. government agencies resulting from those proposals could have adverse effects on government contractors, including us. Any of these changes could impair our ability to obtain new contracts or renew contracts under which we currently perform when those contracts are eligible for recompetition. Any new contracting methods could be costly or administratively difficult for us to implement, which would adversely affect our business, results of operations and financial condition.

 

23



Table of Contents

 

Our failure to identify, attract and retain qualified technical and management personnel could adversely affect our existing businesses, financial condition and results of operations.

 

We may not be able to identify, attract or retain qualified technical personnel, including engineers, computer programmers and personnel with security clearances required for classified work, or management personnel to supervise such activities that are necessary for maintaining and growing our existing businesses, which could adversely affect our financial condition and results of operations. The technically complex nature of our operations results in difficulties finding qualified staff. In our defense businesses especially, experienced personnel possessing required security clearances are finite in number. A number of our employees maintain a top secret clearance level. Obtaining and maintaining security clearances for employees involves a lengthy process, and it is difficult to identify, recruit and retain employees who already hold security clearances. If our cleared employees lose or are unable to timely obtain security clearances or we lose a facility clearance, our U.S. government customers may terminate the contract or decide not to renew it upon its expiration. As a result, to the extent we cannot obtain or maintain the required security clearances for a particular contract, or we fail to obtain them on a timely basis, we may not generate the sales anticipated from the contract, which could harm our operating results. To the extent we are not able to obtain facility security clearances or engage employees with the required security clearances for a particular contract, we will be unable to perform that contract and we may not be able to compete for or win new awards for similar work.

 

Our business could be negatively affected by cyber or other security threats or other disruptions.

 

We face cyber threats, threats to the physical security of our facilities and employees, including senior executives, and terrorist acts, as well as the potential for business disruptions associated with information technology failures, damaging weather or other acts of nature, and pandemics or other public health crises, which may adversely affect our business.

 

We routinely experience cyber security threats, threats to our information technology infrastructure and attempts to gain access to our company sensitive information, as do our customers, suppliers, subcontractors and joint venture partners. We may experience similar security threats at customer sites that we operate and manage as a contractual requirement.

 

Prior cyber attacks directed at us have not had a material impact on our financial results, and we believe our threat detection and mitigation processes and procedures are robust. Due to the evolving nature of these security threats, however, the impact of any future incident cannot be predicted.

 

Although we work cooperatively with our customers and our suppliers, subcontractors, and joint venture partners to seek to minimize the impacts of cyber threats, other security threats or business disruptions, in addition to our internal processes, procedures and systems, we must also rely on the safeguards put in place by those entities.

 

The costs related to cyber or other security threats or disruptions may not be fully mitigated by insurance or other means. Occurrence of any of these events could adversely affect our internal operations, the services we provide to customers, loss of competitive advantages derived from our R&D efforts, early obsolescence of our products and services, our future financial results, our reputation or our stock price. The occurrence of any of these events could also result in civil and/or criminal liabilities.

 

We may incur significant costs in protecting our intellectual property which could adversely affect our profit margins. Our inability to obtain, maintain and enforce our patents and other proprietary rights could adversely affect our businesses’ prospects and competitive positions.

 

We seek to protect our proprietary technology and inventions through patents and other proprietary-right protection, and also rely on trademark laws to protect our brand. However, we may fail to obtain the intellectual property rights necessary to provide us with a competitive advantage, and any of our owned or licensed intellectual property rights could be challenged, invalidated, circumvented, infringed or misappropriated. We may also fail to apply for or obtain intellectual property protection in important foreign countries, and the laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the United States. If we are unable to obtain or maintain these protections, we may not be able to prevent third parties from using our technology and inventions, which could adversely affect our business. We may incur significant expense in obtaining, maintaining, defending and enforcing our intellectual property rights. We may fail to take the actions necessary to enforce our intellectual property rights and even if we attempt to enforce such rights we may ultimately be unsuccessful, and such efforts may result in our intellectual property rights being challenged, limited in scope, or declared invalid or unenforceable. Also, some aspects of our business and services may rely on technologies and software developed by or licensed from third parties, and we may not be able to maintain our relationships with such third parties or enter into similar relationships in the future on reasonable terms or at all.

 

We also rely on trade secrets, proprietary know-how and continuing technological innovation to remain competitive. We have taken measures to protect our trade secrets and know-how, including seeking to enter into confidentiality agreements with our employees, consultants and advisors, but the measures we have taken may not be sufficient. For example, confidentiality agreements may not provide adequate protection or may be breached. We generally control and limit access to our product documentation and other proprietary information, but other parties may independently develop our know-how or otherwise obtain access to our technology, which could adversely affect our businesses’ prospects and competitive position.

 

24



Table of Contents

 

Assertions by third parties that we violate their intellectual property rights could have a material adverse effect on our business, financial condition and results of operations.

 

Third parties may claim that we, our customers, licensees or parties indemnified by us are infringing upon or otherwise violating their intellectual property rights. Such claims may be made by competitors seeking to obtain a competitive advantage or by other parties. Additionally, in recent years, individuals and groups have begun purchasing intellectual property assets for the purpose of making claims of infringement and attempting to extract settlements from companies like ours. Any claims that we violate a third party’s intellectual property rights can be time consuming and costly to defend and distract management’s attention and resources, even if the claims are without merit. Such claims may also require us to redesign affected products and services, enter into costly settlement or license agreements or pay costly damage awards, or face a temporary or permanent injunction prohibiting us from marketing or providing the affected products and services. Even if we have an agreement to indemnify us against such costs, the indemnifying party may be unable to uphold its contractual obligations. If we cannot or do not license the infringed technology on favorable terms or cannot or do not substitute similar technology from another source, our revenue and earnings could be adversely impacted.

 

We compete primarily for government contracts against many companies that are larger, better capitalized and better known than us. If we are unable to compete effectively, our business and prospects will be adversely affected.

 

Our businesses operate in highly competitive markets. Many of our competitors are larger, better financed and better known companies who may compete more effectively than we can. In order to remain competitive, we must keep our capabilities technically advanced and compete on price and on value added to our customers. Our ability to compete may be adversely affected by limits on our capital resources and our ability to invest in maintaining and expanding our market share. Consolidation in the industries in which we operate and government budget cuts have led to pressure being placed on the margins we may earn on any contracts we win. In addition, should the transportation market move towards requiring contractors to provide up-front financing for contracts they are awarded (for example, our contract for the Chicago Open Standards Fare System), we may need to compete more heavily on the basis of our financial strength, which may limit the contracts we can service at any one time.

 

The terms of our financing arrangements may restrict our financial and operational flexibility, including our ability to invest in new business opportunities.

 

Our current $200.0 million unsecured revolving credit agreement expires in May 2017. The available line of credit on the agreement is reduced by any letters of credit issued under the agreement. As of September 30, 2013, there were no borrowings under the agreement; however, there were letters of credit outstanding under the agreement totaling $23.5 million, which reduced the available line of credit to $176.5 million at that date.

 

We also have a secured letter of credit facility agreement with a bank that has no expiration date and is cancellable by us at any time upon the completion of certain conditions to the satisfaction of the bank. As of September 30, 2013, there were letters of credit outstanding under this agreement of $54.4 million. In support of this facility, we placed $68.9 million of our cash on deposit in the U.K. as collateral in a restricted account with the bank providing the facility. We are required to leave the cash in the restricted account so long as the bank continues to maintain associated letters of credit under the facility. The maximum amount of letters of credit currently allowed by the facility is $62.6 million, and any increase above this amount would require bank approval and additional restricted funds to be placed on deposit. We may choose at any time to terminate the facility and move the associated letters of credit to another credit facility. Letters of credit outstanding under the facility do not reduce the available line of credit available under the revolving credit agreement described above.

 

On March 12, 2013, we entered into a note purchase and private shelf agreement, pursuant to which we agreed to issue and sell $100.0 million in aggregate principal amount of senior unsecured notes, bearing interest at a rate of 3.35%. Principal payments are due from 2021 through 2025. Notes with an aggregate principal amount of $50.0 million were issued on March 12, 2013 and the remaining aggregate principal amount of $50.0 million were issued on April 23, 2013. In addition, pursuant to the agreement, we may from time to time issue and sell, and the purchasers may in their sole discretion purchase, within the next three years, additional senior notes in aggregate principal amount of up to $25.0 million that will have terms, including interest rate, as we and the purchasers may agree upon at the time of issuance. The terms of the notes payable include provisions that require and/or limit, among other financial ratios and measurements, the permitted levels of debt, coverage of cash interest expense, and under certain circumstances, payments of dividends or other distributions to shareholders. As of September 30, 2013 this agreement does not restrict such distributions to shareholders.

 

Our development contracts may be difficult for us to comply with and may expose us to third-party claims for damages.

 

We are often party to government and commercial contracts involving the development of new products and systems. These contracts typically contain strict performance obligations and project milestones. We cannot assure you we will comply with these performance obligations or meet these project milestones in the future. If we are unable to comply with these performance obligations or meet these milestones, our customers may terminate these contracts and, under some circumstances, recover damages or other penalties from us.  If other parties elect to terminate their contracts or seek damages from us, it could materially harm our business and negatively impact our stock price.

 

25



Table of Contents

 

Our revenues could be less than expected if we are not able to deliver services or products as scheduled due to disruptions in supply.

 

Since our internal manufacturing capacity is limited, we use contract manufacturers. While we use care in selecting our manufacturers, we have less control over the reliability of supply, quality and price of products or components than if we manufactured them. In some cases, we obtain products from a sole supplier or a limited group of suppliers. Consequently, we risk disruptions in our supply of key products and components if our suppliers fail or are unable to perform because of shortages in raw materials, operational problems, strikes, natural disasters, financial condition or other factors. We may have disputes with our vendors arising from, among other things, the quality of products and services or customer concerns about the vendor. If any of our vendors fail to timely meet their contractual obligations or have regulatory compliance or other problems, our ability to fulfill our obligations may be jeopardized. Economic downturns can adversely affect a vendor’s ability to manufacture or deliver products. Further, vendors may also be enjoined from manufacturing and distributing products to us as a result of litigation filed by third parties, including intellectual property litigation. If we were to experience difficulty in obtaining certain products, there could be an adverse effect on our results of operations and on our customer relationships and our reputation. Additionally, our key vendors could also increase pricing of their products, which could negatively affect our ability to win contracts by offering competitive prices.

 

Any material supply disruptions could adversely affect our ability to perform our obligations under our contracts and could result in cancellation of contracts or purchase orders, penalties, delays in realizing revenues, payment delays, as well as adversely affect our ongoing product cost structure.

 

Failure to perform by our subcontractors could materially and adversely affect our contract performance and our ability to obtain future business.

 

Our performance of contracts often involves subcontractors, upon which we rely to complete delivery of products or services to our customers. We may have disputes with subcontractors. A failure by a subcontractor to satisfactorily deliver products or services can adversely affect our ability to perform our obligations as a prime contractor. Any subcontractor performance deficiencies could result in the customer terminating our contract for default, which could expose us to liability for excess costs of reprocurement by the customer and have a material adverse effect on our ability to compete for other contracts.

 

Our future success will depend on our ability to develop new products, systems and services that achieve market acceptance in our current and future markets.

 

Both our commercial and government businesses are characterized by rapidly changing technologies and evolving industry standards. Accordingly, our performance depends on a number of factors, including our ability to:

 

·                  identify emerging technological trends in our current and target markets;

 

·                  develop and maintain competitive products, systems and services;

 

·                  enhance our offerings by adding technological innovations that differentiate our products, systems and services from those of our competitors; and

 

·                  develop, manufacture and bring to market cost-effective offerings quickly.

 

We believe that, in order to remain competitive in the future, we will need to continue to develop new products, systems and services, which will require the investment of significant financial resources. The need to make these expenditures could divert our attention and resources from other projects, and we cannot be sure that these expenditures ultimately will lead to the timely development of new products, systems or services. In recent years, we have spent an amount equal to approximately 1% to 2% of our annual sales on internal R&D efforts. There can be no assurances that this percentage will not increase should we require increased innovations to successfully compete in the markets we serve. We may also experience delays in completing development and introducing certain new products, systems or services in the future due to their design complexity. Any delays could result in increased costs of development or redirect resources from other projects. In addition, we cannot provide assurances that the markets for our products, systems or services will develop as we currently anticipate, which could significantly reduce our revenue and harm our business. Furthermore, we cannot be sure that our competitors will not develop competing products, systems or services that gain market acceptance in advance of ours, or that cause our existing products, systems or services to become non-competitive or obsolete, which could adversely affect our results of operations.

 

26



Table of Contents

 

If we deliver products or systems with defects, our reputation will be harmed, revenue from, and market acceptance of, our products and systems will decrease and we could expend significant capital and resources as a result of such defects.

 

Our products and systems are complex and frequently operate in high-performance, challenging environments. Notwithstanding our internal quality specifications, our products and systems have sometimes contained errors, defects and bugs when introduced. If we deliver products or systems with errors, defects or bugs, our reputation and the market acceptance and sales of our products and systems would be harmed. Further, if our products or systems contain errors, defects or bugs, we may be required to expend significant capital and resources to alleviate such problems and incur significant costs for product recalls and inventory write-offs. Defects could also lead to product liability lawsuits against us or against our customers, and could also damage our reputation. We have agreed to indemnify our customers in some circumstances against liability arising from defects in our products and systems. In the event of a successful product liability claim, we could be obligated to pay damages significantly in excess of our product liability insurance limits.

 

We face certain significant risk exposures and potential liabilities that may not be covered adequately by insurance or indemnity.

 

We are exposed to liabilities that are unique to the products and services we provide. A significant portion of our business relates to designing, developing, manufacturing, operating and maintaining advanced defense and transportation systems and products. New technologies associated with these systems and products may be untested or unproven. In addition, certain activities in connection with which our training systems are used or our services are provided are inherently dangerous. While in some circumstances we may receive indemnification from U.S. and foreign governments, and we maintain insurance for certain risks, the amount of our insurance or indemnity may not be adequate to cover all claims or liabilities, and we may be forced to bear substantial costs from an accident or incident. It also is not possible for us to obtain insurance to protect against all operational risks and liabilities. Substantial claims resulting from an incident in excess of the indemnification we receive and our insurance coverage would harm our financial condition, results of operations and cash flows. Moreover, any accident or incident for which we are liable, even if fully insured, could negatively affect our standing with our customers and the public, thereby making it more difficult for us to compete effectively, and could significantly impact the cost and availability of adequate insurance in the future.

 

We may acquire other companies, which could increase our costs or liabilities or be disruptive to our business.

 

Part of our strategy involves the acquisition of other companies. For example, in December 2012, we acquired the operating assets of NEK Special Programs Group, LLC, a special operation forces training business, including more than 200 operational and technical experts and in January 2013, we acquired Nextbus, Inc., a business that provides real-time passenger information systems and services to transit agencies. We cannot assure you that we will be able to integrate acquired companies successfully without substantial expense, delay or operational or financial problems. Such expenses, delays or operational or financial problems may include the following:

 

·                  we may need to divert management resources to integration, which may adversely affect our ability to pursue other more profitable activities;

 

·                  integration may be difficult as a result of the necessity of coordinating geographically separated organizations, integrating personnel with disparate business backgrounds and combining different corporate cultures;

 

·                  we may not be able to eliminate redundant costs anticipated at the time we select acquisition candidates; and

 

·                  one or more of our acquisition candidates may have unexpected liabilities, fraud risk, or adverse operating issues that we fail to discover through our due diligence procedures prior to the acquisition.

 

As a result, the integration of acquired businesses may be costly and may adversely impact our results of operations and financial condition.

 

27



Table of Contents

 

Our employees may engage in misconduct or other improper activities, which could harm our business, financial condition and results of operations.

 

We are exposed to the risk of employee fraud or other misconduct. Employee misconduct could include intentionally failing to comply with U.S. government procurement regulations, engaging in unauthorized activities, attempting to obtain reimbursement for improper expenses, or submitting falsified time records, which could result in legal proceedings against us, lost contracts or reduced revenues. For example, see “Legal proceedings” in Item 3 of this Form 10-K/A for a discussion of certain litigation relating to misconduct by one of our former employees. Employee misconduct could also involve improper use of our customers’ sensitive or classified information, which could result in regulatory sanctions against us and serious harm to our reputation. Misconduct could also involve making payments to government officials or third parties which would expose us to being in violation of the Foreign Corrupt Practices Act, the UK Anti-Bribery Act or similar laws in other countries.

 

It is not always possible to deter employee misconduct, and the precautions we take to prevent and detect this activity may not be effective in controlling unknown or unmanaged risks or losses, which could harm our business, financial condition and results of operations. In addition, alleged or actual employee misconduct could result in investigations or prosecutions of employees engaged in the subject activities, which could result in unanticipated consequences or expenses and management distraction for us regardless of whether we are alleged to have any responsibility.

 

Unanticipated changes in our tax provisions or exposure to additional tax liabilities could affect our profitability.

 

Our business operates in many locations under government jurisdictions that impose taxes based on income and other criteria. Changes in domestic or foreign tax laws and regulations, or their interpretation, could result in higher or lower tax rates assessed, changes in the taxability of certain revenues or activities, or changes in the deductibility of certain expenses, thereby affecting our tax expense and profitability. In addition, audits by tax authorities could result in unanticipated increases in our tax expense.

 

Our results of operations have historically fluctuated and may continue to fluctuate significantly in the future, which could adversely affect our stock price.

 

Our results of operations are affected by factors such as the unpredictability of contract awards due to the long procurement process for most of our products and services, the potential fluctuation of governmental agency budgets, any timing differences between our work performed and costs incurred under a contract and our ability to recognize revenue and generate cash flow from such contract, the time it takes for the new markets we target to develop and for us to develop and provide products and services for those markets, competition and general economic conditions. Our contract type/product mix and unit volume, our ability to keep expenses within budget and our pricing affect our operating margins. Significant growth in costs to complete our contracts may adversely affect our results of operations in future periods and cause our financial results to fluctuate significantly on a quarterly or annual basis. In addition, certain contracts in our CTS segment are structured such that we incur significant expenses during the design and build phases of the contract that are not offset by revenue recognized or cash flows generated under the contract until we deliver a product or perform operational or maintenance services during the latter phases of the contract. Consequently, we do not believe that comparison of our results of operations from period to period is necessarily meaningful or predictive of our likely future results of operations. In future financial periods our operating results or cash flows may be below the expectations of public market analysts or investors, which could cause the price of our stock to decline significantly.

 

The funding and costs associated with our pension plans may cause our earnings, cash flows, and shareholders’ equity to fluctuate significantly from year to year.

 

Certain of our employees in the U.S. are covered by a noncontributory defined benefit pension plan and approximately one-half of our European employees are covered by a contributory defined benefit pension plan. The impact of these plans on our GAAP earnings may be volatile in that the amount of expense we record for our pension plans may materially change from year to year because those calculations are sensitive to changes in several key economic assumptions, including discount rates, inflation, salary growth, expected return on plan assets, retirement rates and mortality rates. Changes in these factors affect our plan funding, cash flows, earnings, and shareholders’ equity.

 

In recent years, we have taken certain actions to mitigate the effect of our defined benefit pension plans on our financial results. For example, benefits under the U.S. plan were frozen as of December 31, 2006, so no new benefits have accrued after that date, and benefits under the European plan were frozen as of September 30, 2010, though the European plan is a final pay plan, which means that benefits will be adjusted for increases in the salaries of participants until their retirement or departure from the company. U.S. and European employees hired subsequent to the dates of freezing of the respective plans are not eligible for participation in the defined benefit plans. For more information on how these factors could impact earnings, cash flows and shareholders’ equity, see “Pension costs” in Item 7 of this Form 10-K/A.

 

28



Table of Contents

 

Risks relating to our common stock

 

The price of our common stock may fluctuate significantly

 

An active, liquid and orderly market for our common stock may not be sustained, which could depress the trading price of our common stock.

 

Volatility in the market price of our common stock may prevent you from being able to sell your shares at or above the price you paid for your shares or at all. The market price of our common stock could fluctuate significantly for various reasons, which include:

 

29



Table of Contents

 

·                  our quarterly or annual earnings or those of our competitors;

 

·                  the public’s reaction to our press releases, our other public announcements and our filings with the Securities and Exchange Commission;

 

·                  changes in earnings estimates or recommendations by research analysts who track our common stock or the stocks of our competitors;

 

·                  new laws or regulations or new interpretations of laws or regulations applicable to our business;

 

·                changes in accounting standards, policies, guidance, interpretations or principles;

 

·                changes in general conditions in the domestic and global economies or financial markets, including those resulting from war, incidents of terrorism or responses to such events;

 

·                  litigation involving our company or investigations or audits by regulators into the operations of our company or our competitors;

 

·                  strategic action by our competitors; and

 

·                  sales of common stock by our directors, executive officers and significant shareholders.

 

In addition, the stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors may seriously affect the market price of our common stock, regardless of actual operating performance. In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. If litigation is instituted against us, it could result in substantial costs and a diversion of our management’s attention and resources.

 

Our Executive Chairman of the Board of Directors beneficially owns a large percentage of our common stock and as a result can exert significant influence over us.

 

At April 28, 2014, Walter C. Zable, our Executive Chairman of the Board of Directors, and Karen F. Cox, Mr. Zable’s sister, beneficially owned an aggregate of 5,062,146 shares, or approximately 18.9%, of our outstanding common stock, including shares owned by trusts, of which Mr. Zable and Ms. Cox are co-trustees. In their capacities as co-trustees, Mr. Zable and Ms. Cox share voting and dispositive power over the shares owned by such trusts. Accordingly, Mr. Zable and Ms. Cox may be able to substantially influence all matters requiring approval by our shareholders, including the election of directors and the approval of mergers or other business combination transactions. Circumstances may arise in which the interests of these shareholders could conflict with the interests of our other shareholders. These shareholders could delay or prevent a change in control of Cubic even if such a transaction would be beneficial to our other shareholders.

 

Your percentage ownership in us may be diluted by future issuances of capital stock, which could reduce your influence over matters on which shareholders vote.

 

Our board of directors has the authority, without action or vote of our shareholders, to issue all or any part of our authorized but unissued shares of common stock, including shares issuable upon the exercise of options and the vesting of restricted stock units, shares that may be issued in the future under our 2005 Equity Incentive Plan or shares of our authorized but unissued preferred stock. Issuances of common stock or preferred voting stock could reduce your influence over matters on which our shareholders vote and, in the case of issuances of preferred stock, likely could result in your interest in us being subject to the prior rights of holders of that preferred stock.

 

Provisions in our charter documents and Delaware law could delay or prevent a change in control of Cubic.

 

Provisions of our amended and restated certificate of incorporation and amended and restated bylaws may discourage, delay or prevent a merger, acquisition or other change in control that shareholders may consider favorable, including transactions in which shareholders might otherwise receive a premium for their shares. In addition, these provisions may frustrate or prevent any attempt by our shareholders to replace or remove our current management by making it more difficult to replace or remove our board of directors. These provisions include:

 

30



Table of Contents

 

·                  prior to the date of the transaction, an affirmative vote of the holders of at least 662/3% of our outstanding common stock is required for the approval, adoption or authorization of a business combination;

 

·                  a prohibition on shareholder action through written consent;

 

·                  a requirement that special meetings of shareholders be called only by our board of directors or by a committee of our board of directors that has been duly designated to do so by our board of directors;

 

·                  the authority of our board of directors to issue preferred stock with such terms as our board of directors may determine; and

 

·                  a requirement for the affirmative vote of the holders of at least 662/3% of the total voting power of all outstanding shares of our voting stock to amend our amended and restated bylaws, or to amend specific provisions of our amended and restated certificate of incorporation.

 

In addition, Delaware law prohibits a publicly held Delaware corporation from engaging in a business combination with an interested shareholder, generally a person who, together with its affiliates, owns or within the last three years has owned 15% of our voting stock, for a period of three years after the date of the transaction in which the person became an interested shareholder, unless the business combination is approved in a prescribed manner. Accordingly, Delaware law may discourage, delay or prevent a change in control of our company.

 

If we are unable to pay semiannual dividends at the targeted level, our reputation and stock price may be harmed.

 

We have consistently paid cash dividends to our shareholders since 1971, and, in fiscal 2013, we paid $6.4 million of cash dividends to our shareholders.

 

The dividend program requires the use of a portion of our cash flows. Our ability to continue to pay semiannual dividends will depend on our ability to generate sufficient cash flows from operations in the future. This ability may be subject to certain economic,  financial, competitive and other factors that are beyond our control. Our board of directors may, at its discretion, decrease the targeted semiannual dividend amount or entirely discontinue the payment of dividends at any time. Any failure to pay dividends after we have announced our intention to do so may adversely affect our reputation and investor confidence in us, and negatively impact our stock price.

 

If securities or industry analysts cease to publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

 

The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.

 

CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING INFORMATION

 

This report, including the documents incorporated by reference herein, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are subject to the safe harbor created by such Act. Any statements about our expectations, beliefs, plans, objectives, assumptions, future events or our future financial and/or operating performance, including those concerning new programs and growth in the markets in which we do business, increases in demand for our products and for fully integrated systems, retention of existing contracts and receipt of new contracts, the development of new products, systems and services, expansion of our automated payment and fare collection systems and services, maintenance of long-term relationships with our existing customers, expansion of our service offerings and customer base for services, maintenance of a diversified business mix, expansion of our international footprint, strategic acquisitions, U.S. and foreign government funding, supplies of raw materials and purchased parts, cash needs, financial condition, liquidity, prospects, and the trends that may affect us or the industries in which we operate, are not historical and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “may,” “will,” “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “predict,” “potential,” “opportunity” and similar words or phrases or the negatives of these words or phrases. These forward-looking statements involve risks, estimates, assumptions and uncertainties, including those discussed in “Risk factors” and elsewhere throughout this report and in the documents incorporated by reference herein, that could cause actual results to differ materially from those expressed in these statements.

 

31



Table of Contents

 

Such risks, estimates, assumptions and uncertainties include, among others: unanticipated issues related to the restatement of our financial statements; our ability to develop and implement new processes and procedures to remediate the material weaknesses that exist in our internal control over financial reporting; our dependence on U.S. and foreign government contracts; delays in approving U.S. and foreign government budgets and cuts in U.S. and foreign government defense expenditures; the ability of certain government agencies to unilaterally terminate or modify our contracts with them; our ability to successfully integrate new companies into our business and to properly assess the effects of such integration on our financial condition; the U.S. government’s increased emphasis on awarding contracts to small businesses, and our ability to retain existing contracts or win new contracts under competitive bidding processes; negative audits by the U.S. government; the effects of politics and economic conditions on negotiations and business dealings in the various countries in which we do business or intend to do business; competition and technology changes in the defense and transportation industries; our ability to accurately estimate the time and resources necessary to satisfy obligations under our contracts; the effect of adverse regulatory changes on our ability to sell products and services; our ability to identify, attract and retain qualified employees; business disruptions due to cyber security threats, physical threats, terrorist acts, acts of nature and public health crises; our involvement in litigation, including litigation related to patents, proprietary rights and employee misconduct; our reliance on subcontractors and on a limited number of third parties to manufacture and supply our products; our ability to comply with our development contracts and to successfully develop, introduce and sell new products, systems and services in current and future markets; defects in, or a lack of adequate coverage by insurance or indemnity for, our products and systems; changes in U.S. and foreign tax laws, exchange rates or our economic assumptions regarding our pension plans; and other factors discussed elsewhere in this report.

 

Because the risks, estimates, assumptions and uncertainties referred to above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any forward-looking statements. In addition, past financial and/or operating performance is not necessarily a reliable indicator of future performance and you should not use our historical performance to anticipate results or future period trends. Further, any forward-looking statement speaks only as of the date on which it is made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

Item 1B. UNRESOLVED STAFF COMMENTS.

 

None

 

Item 2.  PROPERTIES.

 

We conduct our operations in approximately 2.0 million square feet of both owned and leased properties located in the United States and foreign countries. We own approximately 58% of the square footage, including 503,000 square feet located in San Diego, California and 467,000 square feet located in Orlando, Florida. All owned and leased properties are considered in good condition and, with the exception of the Orlando facility, adequately utilized. The following table identifies significant properties by business segment:

 

32



Table of Contents

 

Location of Property

 

Owned or Leased

Corporate Headquarters:

 

 

San Diego, CA

 

Owned

 

 

 

Investment properties:

 

 

New York, NY

 

Owned

Teterboro, NJ

 

Leased

 

 

 

Transportation Systems:

 

 

Arlington, VA

 

Leased

Atlanta, GA

 

Leased

Auburn, Australia

 

Leased

Brisbane, Australia

 

Leased

Chantilly, VA

 

Leased

Chicago, IL

 

Leased

Concord, CA

 

Leased

Emeryville, CA

 

Leased

Frankfurt, Germany

 

Leased

Greenford, London, England

 

Leased

Hamburg, Germany

 

Leased

Hyderabad, India

 

Leased

Inglewood, Australia

 

Leased

Kingswood, Australia

 

Leased

London, England

 

Leased

Malmo, Sweden

 

Leased

Mascot, Australia

 

Leased

Merthsham, Surrey, England

 

Leased

New York, NY

 

Leased

Norwalk, CA

 

Leased

Oakland, CA

 

Leased

Ontario, Canada

 

Leased

Perth, Australia

 

Leased

Salfords, Surrey, England

 

Owned

San Diego, CA

 

Leased and Owned

San Francisco, CA

 

Leased

Sydney, Australia

 

Leased

Tullahoma, TN

 

Leased and Owned

Vancouver, BC

 

Leased

Wollongong, Australia

 

Leased

 

 

 

Mission Support Services:

 

 

Annapolis, MD

 

Leased

Colorado Springs, CO

 

Leased

Columbus, GA

 

Owned

El Paso, TX

 

Leased

Fayetteville, NC

 

Leased

Hampton, VA

 

Leased

Herndon, VA

 

Leased

Honolulu, HI

 

Leased

Kingstowne, VA

 

Leased

Leavenworth, KS

 

Leased

Olympia, WA

 

Leased

Orlando, FL

 

Leased

Prince George, VA

 

Leased

San Diego, CA

 

Leased

Shalimar, FL

 

Leased

Tampa, FL

 

Leased

 

 

 

Defense Systems:

 

 

Abu Dhabi UAE

 

Leased

Aitkenvale, Australia

 

Leased

Arlington, VA

 

Leased

Auckland, New Zealand

 

Leased

Canberra, Australia

 

Leased

Heisingor, Denmark

 

Leased

Herndon, VA

 

Leased

Mexico City, Mexico

 

Leased

Orlando, FL

 

Owned

Panama City, FL

 

Leased

San Diego, CA

 

Owned

Santa Clara, CA

 

Leased

Singapore, Asia

 

Leased

St. Petersburg, FL

 

Leased

Tijuana, Mexico

 

Leased

Vienna, VA

 

Leased

Yerven, Armenia

 

Leased

 

33



Table of Contents

 

Item 3.  LEGAL PROCEEDINGS.

 

In November 2011, we received a claim from a public transit authority customer which alleges that the authority incurred a loss of transit revenue due to the inappropriate and illegal actions of one of our former employees, who has pled guilty to the charges. This individual was employed to work on a contract we acquired in a business combination in 2009 and had allegedly been committing these illegal acts from almost two years prior to our acquisition of the contract, until his arrest in May 2011. The transit system was designed and installed by a company unrelated to us. The claim currently seeks recoupment from us of a total amount of $3.9 million for alleged lost revenue, fees and damages. In March 2012, the county superior court entered a default judgment against our former employee and others for $2.9 million based upon the estimated loss of revenue by the public transit authority customer. In the quarter ended March 31, 2012, we recorded an accrued cost of $2.9 million within general and administrative expense in the transportation systems segment based upon the court’s assessment of these losses. We have not recorded expense for any amount in excess of the $2.9 million through September 30, 2013 as no other amount of loss is deemed probable. Insurance may cover all, or a portion, of any losses we could ultimately incur for this matter. However, any potential insurance proceeds will not be recognized in the financial statements until receipt of any such proceeds is probable.

 

In October and December of 2013, and January of 2014, lawsuits were filed the United States District Court for the Northern District of Illinois Eastern Division against us and one of our transit customers alleging variously, among other things, breach of contract, violation of the Illinois Consumer Fraud Act, unjust enrichment and violation of the Electronic Funds Act.  In January 2014 these cases were consolidated into a single case and the Plaintiffs are seeking to have the case certified as a class action. Plaintiffs variously claim, among other things, that: (i) they were wrongly charged for calling the call center that we operate for patrons of our transit customer, (ii) they were wrongly charged for a transfer and a second fare, (iii) they were not credited the cost of a transit card even after registration of the card, as is required under the terms of the cardholder agreement, and (iv) they were double charged for rides taken. We are undertaking the defense of the transit customer pursuant to our contractual obligations to that customer. We are investigating the matter and plan to vigorously defend this lawsuit. Due to the preliminary nature of this case, we cannot estimate the probability of loss or any range of estimate of possible loss.

 

Also in October 2013, a lawsuit was filed in the Circuit Court of Cook County, Illinois, County Department, Chancery Division against our same transit customer alleging conversion and unjust enrichment.  The plaintiff alleges his bank debit card was charged two dollars and twenty-five cents for his ride on the transit system rather than the ride being charged to his transit fare card. This plaintiff is also seeking to have his case certified as a class action for all patrons whose bank cards were charged in the same manner. We are investigating the matter and we are undertaking the defense pursuant to our contractual obligations to our transit customer. We plan to vigorously defend this lawsuit. Our Motion to Dismiss was granted on April 30, 2014 and the plaintiff has until May 27, 2014 to file an Amended Complaint. Due to the preliminary nature of this case, we cannot estimate the probability of loss or any range of estimate of possible loss.

 

In addition to the matters described above, we are subject to various claims and legal proceedings that arise in the ordinary course of our business from time to time, including claims and legal proceedings that have been asserted against us by customers, former employees and competitors. We have accrued for estimated losses in the accompanying audited consolidated financial statements for matters where we believe the likelihood of an adverse outcome is probable and the amount of the loss is reasonably estimable. Based on currently available information, management does not believe that the ultimate outcome of these unresolved matters, individually or in the aggregate, are likely to have a material adverse effect on our financial position, results of operations, or cash flows. However, litigation is subject to inherent uncertainties and our views on these matters may change in the future. Were an unfavorable outcome to occur in any one or more of those matters or the matters described above, over and above the amount, if any, that has been estimated and accrued in our audited consolidated financial statements, it could have a material adverse effect on our business, financial condition, results of operations and/or cash flows in the period in which the unfavorable outcome occurs or becomes probable, and potentially in future periods.

 

Item 4.  MINE SAFETY DISCLOSURES.

 

Not Applicable.

 

34



Table of Contents

 

PART II

 

Item 5.  MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

The principal market on which our common stock is being traded is the New York Stock Exchange under the symbol CUB. The closing high and low sales prices for the stock, as reported in the consolidated transaction reporting system of the New York Stock Exchange for the quarterly periods during the past two fiscal years, and dividend information for those periods, are as follows:

 

MARKET AND DIVIDEND INFORMATION

 

 

 

Sales Price of Common Shares

 

 

 

 

 

 

 

Fiscal 2013

 

Fiscal 2012

 

Dividends per Share

 

Quarter

 

High

 

Low

 

High

 

Low

 

Fiscal 2013

 

Fiscal 2012

 

First

 

$

50.67

 

$

46.25

 

$

48.25

 

$

37.16

 

 

 

Second

 

48.40

 

41.74

 

51.05

 

42.85

 

$

0.12

 

$

0.12

 

Third

 

49.52

 

40.90

 

48.22

 

42.23

 

 

 

Fourth

 

54.16

 

48.14

 

52.03

 

47.92

 

$

0.12

 

$

0.12

 

 

On April 28, 2014, the closing price of our common stock on the New York Stock Exchange was $47.47. There were 695 shareholders of record of our common stock as of April 28, 2014.

 

Item 6. SELECTED FINANCIAL DATA.

 

FINANCIAL HIGHLIGHTS AND SUMMARY OF CONSOLIDATED OPERATIONS

 

(amounts in thousands, except per share data)

 

The following selected statement of income data for the years ended September 30, 2013, 2012 and 2011 and balance sheet data as of September 30, 2013 and 2012 are derived from our consolidated financial statements appearing elsewhere in this Form 10-K/A. The following selected statement of income data for the years ended September 30, 2010 and 2009 and balance sheet data as of September 30, 2011, 2010 and 2009 are derived from our financial statements not appearing elsewhere in this Form 10-K/A. The following selected financial data have been restated to reflect adjustments that are further discussed in Note 2 to the consolidated financial statements included in Item 8 of this Form 10-K/A. These tables should be read in conjunction with Items 7 and 8 of this Form 10- K/A.

 

35



Table of Contents

 

 

 

Years Ended September 30,

 

 

 

2013

 

2012

 

2011

 

2010

 

2009

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Results of Operations:

 

 

 

 

 

 

 

 

 

 

 

Sales

 

$

1,361,407

 

$

1,404,084

 

$

1,301,584

 

$

1,200,623

 

$

1,026,525

 

Cost of sales

 

1,055,313

 

1,060,140

 

983,269

 

943,189

 

795,385

 

Selling, general and administrative expenses

 

165,230

 

164,189

 

159,791

 

124,306

 

119,108

 

Interest expense

 

3,427

 

1,602

 

1,541

 

1,760

 

2,082

 

Income taxes

 

14,502

 

40,332

 

34,119

 

38,106

 

33,573

 

Net income attributable to Cubic (1)

 

25,086

 

97,427

 

86,044

 

72,667

 

64,097

 

 

 

 

 

 

 

 

 

 

 

 

 

Per Share Data:

 

 

 

 

 

 

 

 

 

 

 

Net income per share, basic

 

$

0.94

 

$

3.64

 

$

3.22

 

$

2.72

 

$

2.40

 

Net income per share, diluted

 

0.94

 

3.64

 

3.22

 

2.72

 

2.40

 

Cash dividends

 

0.24

 

0.24

 

0.28

 

0.18

 

0.18

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares used in calculating net income per share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

26,736

 

26,736

 

26,736

 

26,735

 

26,731

 

Diluted

 

26,760

 

26,736

 

26,736

 

26,735

 

26,731

 

 

 

 

 

 

 

 

 

 

 

 

 

Year-End Data:

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity related to Cubic

 

$

716,946

 

$

677,171

 

$

580,627

 

$

512,305

 

$

446,472

 

Equity per share, basic

 

26.82

 

25.33

 

21.72

 

19.16

 

16.70

 

Total assets

 

1,108,375

 

1,014,550

 

963,650

 

868,608

 

760,642

 

Long-term debt

 

102,920

 

11,503

 

15,918

 

20,494

 

25,124

 

 


(1) Results for the year ended September 30, 2013 include a goodwill impairment charge of $50.9 million, before the impact of applicable income taxes. See Note 8 of the Consolidated Financial Statements in Item 8 of this Form 10-K/A for further discussion of the goodwill impairment.

 

36



Table of Contents

 

Item 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

Restatement

 

The accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations gives effect to certain adjustments made to the previously reported consolidated financial statements for the years ended September 30, 2013, 2012 and 2011 (including interim periods therein) in connection with the restatement of our previously filed consolidated financial statements and  data (and related disclosures) for the fiscal years ended September 30, 2013 and 2012, and each of the prior quarters of 2013 and 2012. For this reason the data set forth in this section may not be comparable to discussions and data in our previously filed Annual and Quarterly Reports.

 

The restatement results from our review of revenue recognition practices. See “Explanatory Note Regarding Restatement” immediately preceding Item 1 of this Form 10-K/A and Note 2, “Restatement of Consolidated Financial Statements” of the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K/A for a detailed discussion of the review and effect of the restatement.

 

Company Overview

 

We are a leading international provider of cost-effective systems and solutions that address the mass transit and global defense markets’ most pressing and demanding requirements. We are engaged in the design, development, manufacture, integration, and sustainment of advanced technology systems and products. We also provide a broad range of engineering, training, technical, logistic, and information technology services. We serve the needs of various federal and regional government agencies in the U.S. and allied nations around the world with products and services that have both defense and civil applications. Our main areas of focus are in mass transit automated fare payment and revenue management infrastructure, defense, intelligence, homeland security, and information technology, including cyber security. For the fiscal year ended September 30, 2013, 39% of sales were derived from transportation systems and related services, while 61% were derived from defense systems and services. The U.S. government remains our largest customer, accounting for approximately 51% of sales in 2013, 50% of sales in 2012, and 56% of sales in 2011. In fiscal year 2013, 59% of our total sales were derived from services, with product sales accounting for the remaining 41%.

 

We operate in three reportable business segments: transportation systems, mission support services and defense systems. We organize our business segments based on the nature of the products and services offered.

 

We are operating in an environment that is characterized by continuing economic pressures in the U.S. and globally. A significant component of our strategy in this environment is to focus on program execution, improving the quality and predictability of the delivery of our products and services, and providing opportunities for customers to outsource services where we can provide a lower cost and more effective solution. Recognizing that many of our U.S. based customers are resource constrained, we are continuing our focus on developing and extending our portfolio in international and adjacent markets. Our international sales, including Foreign Military Sales (FMS), comprised 46% of our total sales for fiscal year 2013. International sales from Cubic Transportation Systems (CTS) amounted to 74% of total CTS sales for fiscal year 2013. International sales from Mission Support Services (MSS) comprised 17% of total MSS sales for fiscal year 2013. International sales from Cubic Defense System (CDS) amounted to 41% of total CDS sales for fiscal year 2013. To the extent our business and contracts include operations in foreign countries, other risks are introduced into our business, including changing economic conditions, fluctuations in relative currency values, regulation by foreign countries, and the potential for deterioration of political relations.

 

We expect sales from domestic CTS contracts to increase as a percentage of total CTS sales in 2014, as we begin to realize revenues from a major contract with the Chicago Transit Authority. However, we expect international sales from CDS to increase in future periods due to the number of international opportunities we are currently pursuing.

 

We continuously strive to strengthen our portfolio of products and services to meet the current and future needs of our customers. We accomplish this in part by our independent R&D activities, and through acquisitions. Company-sponsored R&D spending totaled $24.4 million in 2013.

 

37



Table of Contents

 

We selectively pursue the acquisition of businesses that complement our current portfolio and allow access to new customers or technologies. In pursuing our business strategy, we routinely conduct discussions, evaluate targets, and enter into agreements regarding possible acquisitions. As part of our business strategy, we seek to identify acquisition opportunities that will expand or complement our existing products and services, or customer base, at attractive valuations. We have made a number of niche acquisitions of businesses during the past several years, including Abraxas Corporation (Abraxas) in December 2010, certain assets of NEK Special Programs Group, LLC (which were placed in NEK Services, Inc.) (NEK) in December 2012 and NextBus, Inc. in January 2013. Generally, these acquisitions are dilutive to earnings in the short-term due to acquisition related costs, integration costs, retention payments and often higher amortization of purchased intangibles in the early periods after acquisition. However, we expect that each of these recent acquisitions will be accretive to earnings in the long-term.

 

Industry Considerations

 

The U.S. government continues to focus on discretionary spending, entitlements, tax, and other initiatives to stimulate the economy, create jobs, and reduce the deficit. The current presidential administration and Congress will likely continue to debate the size and expected growth of the U.S. federal budget as well as the defense budget over the next few years and balance decisions regarding defense, homeland security, and other federal spending priorities in a constrained fiscal environment imposed by the Budget Control Act of 2011 (Budget Act), which, in part, reduces defense spending by a minimum of $487 billion over a ten-year period that began in fiscal year 2012.

 

On March 1, 2013, the sequestration of appropriations in fiscal year 2013 imposed by the Budget Act was implemented by the federal government. While the ultimate effects of sequestration still cannot be determined, these reductions have had an impact upon our customers’ procurement of products and services and will continue to have significant impact on the defense industry. These budgetary considerations may also impact funding to our U.S. mass transit customers from the federal government for large infrastructure projects.

 

While these budgetary considerations have put downward pressure on growth in the defense industry and will likely continue to do so, we believe that much of our business is well positioned in areas that the DoD has indicated are areas of focus for future defense spending to help the DoD meet its critical future capability requirements for protecting U.S. security and the security of our allies in the years to come. In addition, our defense business has an immaterial amount of exposure to overseas contingency operations.

 

In transportation, we continue to believe that our products and services are critical to our customers to ensure that they maximize revenue and efficiencies in fare collection in a resource constrained environment. Some customers have responded to the current market environment by seeking financing for their projects from the system supplier. An example of this is our contract with the Chicago Transit Authority, awarded in late 2011. We are designing and manufacturing a new fare collection system for the Chicago Transit Authority and will receive monthly payments for the system over an approximate ten-year period expected to begin in the third quarter of fiscal 2014

 

While future defense plans, changes in defense spending levels and changes in spending for mass transit projects could have a materially adverse effect on our consolidated financial position, we have and plan to continue to make strategic investments and acquisitions to align our businesses in growth areas of our respective markets that we believe are the most critical priorities and mission areas for our customers.

 

Segment Overview

 

Cubic Transportation Systems

 

CTS is a systems integrator of payment and information technology and services for intelligent travel solutions. We deliver integrated systems for transportation and traffic management, delivering tools for travelers to choose the smartest and easiest way to travel and pay for their journeys, and enabling transportation authorities and agencies to manage demand across the entire transportation network — all in real time. We offer fare collection devices, software, systems and multiagency, multimodal integration technologies, as well   as a full suite of operational services that help agencies and operators efficiently collect fares, manage operations, reduce revenue leakage and make transportation more convenient. Through our NextBus and ITMS businesses, respectively, we also deliver real-time passenger information systems for tracking bus arrival times and we are a leading provider of intelligent transport solutions and technology maintenance services to UK and international government road transport agencies.

 

The transportation markets we serve are undergoing a substantial change. Mounting pressure on transportation authorities to stretch their operating budgets is fueling a trend toward outsourced services and payment systems that lower operating cost. We believe we are positioned at the forefront of this change.

 

38



Table of Contents

 

We provide a wide range of services for transportation authorities in major markets worldwide, including computer hosting services, call center and web services, payment media issuance and distribution services, retail point of sale network management, payment processing, financial clearing and settlement, software application support and outsourced asset operations and maintenance. Significant regions where we currently provide services include London, Sydney, Brisbane, Sweden, Washington D.C., Los Angeles, San Francisco and Atlanta. CTS operates full service operation centers in North America, Europe and Australia. In 2013, revenues from services provided by CTS were $282.8 million, or 53% of CTS sales in 2013.

 

CTS is a prime contractor and has active projects worldwide, including in the New York (Metrocard®) / New Jersey (PATCO®, PATH Smartlink®) region, Chicago (Ventra®), Vancouver, Sydney (Opal®), Brisbane (go card®), the Frankfurt / RMV region, Sweden, the Washington, D.C. / Maryland / Virginia region (SmarTrip®), the Los Angeles region, the San Diego region, Miami, Minneapolis / St. Paul and Atlanta. In addition to helping us secure similar projects in new markets, our comprehensive suite of new technologies and capabilities enable us to benefit from a recurring stream of revenues in established markets resulting from innovative new services, technology obsolescence, equipment refurbishment and the introduction of new or adjacent applications.

 

We are currently designing and building major new systems in Chicago, Sydney and Vancouver. Typically, profit margins during the design and build phase of major projects are lower than during the operate-and-maintain phase. This has in the past caused, and may in the future cause, swings in profitability from period to period. In addition, cash flows are often negative during portions of the design- and-build phase, until major milestones are reached and cash payments are received. This was the case in 2013, as we experienced negative cash flows from all three of these major projects. Each of these projects includes a ten-year operate and maintain period and we expect cash flows from these projects to be positive in future years.

 

Cash payment terms offered by our mass transit customers in a competitive environment are sometimes not favorable to us. The customers’ budget constraints often result in less funding available for the build of a new system, with more funds becoming available when the system becomes operational. This, coupled with the inherent risks in managing large infrastructure projects, can yield negative cash flows and lower and less predictable profit margins on contracts during the design and build phase. Conversely, during the operate-and-maintain phase, revenues and costs are typically more predictable and profit margins tend to be higher. Gross profit margins from services sales in CTS were 37% and 34% for fiscal years 2013 and 2012, respectively, and gross profit margin from product sales was 15% and 25% in 2013 and 2012, respectively. Thus, the trend toward more services revenues has helped to generate higher profit margins from the segment in recent years than in the past. The mix of product and services sales can produce fluctuations in margin from period-to-period; however, we expect the trend of increasing services sales to continue in the next several years.

 

Most of our sales in CTS for fiscal year 2013 were from fixed-price contracts. However, some of our service contracts provide for variable payments, in addition to the fixed payments, based on meeting certain service level requirements and, in some cases, based on system usage. Service level requirements are generally contingent upon factors that are under our control, while system usage payments are contingent upon factors that are generally not under our control, other than basic system availability. Development and system integration contracts in CTS are usually accounted for on a percentage-of-completion basis using the cost-to-cost method to measure progress toward completion, which requires us to estimate our costs to complete these contracts on a regular basis. Our actual results can vary significantly from these estimates and changes in estimates can result in significant swings in revenues and profitability from period to period. Generally, we are at risk for increases in our costs, unless an increase results from customer- requested changes. At times, there can be disagreement with a customer over who is responsible for increases in costs. In these situations we must use judgment to determine if it is probable that we will recover our costs and any profit margin.

 

Revenue under contracts for services in CTS is generally recognized either as services are performed or when a contractually required event has occurred, depending on the contract. Revenue under such contracts is generally recognized on a straight-line basis over the period of contract performance, unless evidence suggests that the revenue is earned or the obligations are fulfilled in a different pattern. Costs incurred under these services contracts are expensed as incurred, and may vary from period to period. Incentive fees included in some of our CTS service contracts are recognized when they become fixed and determinable based on the provisions of the contract. As described above, often these fees are based on meeting certain contractually required service levels or based on system usage levels. Contractual terms can also result in variation of both revenues and expenses, resulting in fluctuations in earnings from period to period.

 

For our contract for the new fare collection system for the Chicago Transit Authority, the contract specifies that we will not be paid until we enter the service period. In accordance with authoritative accounting literature, we did not begin recognizing revenue on this contract until it entered the service period in August 2013. As of September 30, 2013, we had capitalized $69.0 million in direct costs associated with developing the new fare collection system. Selling, general and administrative (SG&A) costs associated with this contract are not being capitalized, but are being expensed as incurred. Capitalized costs are being amortized into cost of sales based upon the ratio of revenue recorded during a period compared to the revenue expected to be recognized over the term of the contract.

 

39



Table of Contents

 

In January 2013, we announced the acquisition of NextBus as well as certain contracts from its parent company, Webtech Wireless. The purchase consideration was approximately $20.2 million. NextBus provides real-time passenger information systems using a software-as-a-service solution. The NextBus acquisition is part our NextCity vision and it expands CTS’ potential market beyond fare collection to information-based solutions.

 

For fiscal year 2013, NextBus had $7.8 million of revenue and was slightly dilutive to our earnings per share, after consideration of costs for transaction integration, retention and the amortization of purchased intangibles.

 

On November 26, 2013 we acquired all of the outstanding capital stock of Intelligent Transport Management Solutions Limited (ITMS), a wholly owned U.K. subsidiary of Serco Limited. ITMS is a provider of traffic management systems technology, traffic and road enforcement and maintenance of traffic signals, emergency equipment and other critical road and tunnel infrastructure. The total acquisition-date fair value of consideration transferred for ITMS was approximately $70 million.

 

Mission Support Services

 

MSS is a leading provider of highly specialized support services to the U.S. government and allied nations. Services provided include live, virtual and constructive training, real-world mission rehearsal exercises, professional military education, intelligence support, information technology, information assurance and related cyber support, development of military doctrine, consequence  management, infrastructure protection and force protection, as well as support to field operations, force deployment and redeployment and logistics.

 

MSS is a highly specialized and customer centric business which we believe knows how to meet the unique requirements of each of its many customers. In the government services marketplace, reputation, quality and relationships are always important. We uphold our credentials for professional excellence by consistently providing high-value and cost-effective support for our customers.

 

MSS is focused on customers within the U.S. government, extending to the DoD, all branches of the U.S. Armed Services, the Department of Homeland Security, non-military agencies, and allied nations under FMS contracts funded by the U.S. government. MSS is the prime contractor at more than 40 military training and support facilities and supports more than 200,000 exercises and training events per year. The segment supports all four of the U.S. Army’s combat training centers (CTCs) comprised of: the Joint Readiness Training Center (JRTC) in Fort Polk, Louisiana, which is the nation’s premier training center for light infantry forces; the National Training Center (NTC) in Fort Irwin, California, the Army’s premier heavy maneuver CTC; the Joint Multinational Readiness Center (JMRC) in Hohenfels, Germany, which is the U.S. Army Europe’s combat maneuver training center for realistic training from the individual to the brigade level; and the Mission Command Training Program (MCTP) in Fort Leavenworth, Kansas, which delivers mission command training to the Army’s senior commanders and is the Army’s only worldwide deployable CTC. We also currently provide and/or have provided defense modernization support for 13 NATO entrants in Central and Eastern Europe under FMS contracts.

 

We are adapting to a new era in defense and national security spending practices. In the past, many of the contracts we were awarded in MSS were long-term in nature, spanning periods of five to ten years. The DoD now relies heavily upon indefinite delivery/indefinite quantity (ID/IQ) and small business set aside contracts. For us that means a lower backlog of long-term service contracts due to the shorter term nature of these ID/IQ Task Order awards. Shorter-term contracts combined with this tougher competitive environment, where the “lowest price technically acceptable” bids usually win, have resulted in a trend toward lower profit margins from the segment in recent periods. For example, the gross profit margin in MSS was 11% in 2013 and 2012 compared to 13% in 2011. Threats related to sequestration and margin compression were among the factors that resulted in a decline in the estimated fair value of MSS and a resulting $50.9 million goodwill impairment in 2013. We must continue to work to keep our costs low to remain competitive under these market conditions. These conditions also provide the opportunity for us to increase our market share of the large DoD services market. To maximize our business opportunities under ID/IQ contract vehicles, we often seek new work both as a prime contractor and a subcontractor. By increasing our participation in multiple award ID/IQ contracts we improve our chances to develop new customers, programs and capabilities. Retaining customers is a critical component of our success; we remain vigilant in maintaining a high win rate on re-compete contracts to retain our customers. Despite the trend toward small business awards by the U.S. government, where we must take a role as a subcontractor, 88% of our revenues in fiscal year 2013 were as a prime contractor.

 

MSS expanded and deepened its training services through the acquisition of Omega Training Group in 2008, which positioned the segment at key locations, such as Fort Lee, Virginia, Fort Bliss, Texas, and Fort Benning, Georgia, which were recipients of work from the 2005 Base Realignment and Closure (BRAC). In addition, MSS has been focused on diversifying its business over the last three years to the national security market. The acquisition of Abraxas in fiscal year 2011, and NEK in December 2012, adds to the segment’s specialized skills and further diversifies the business to new customers and markets which are directly aligned with DoD’s emphasis on intelligence and the special operations forces communities where trusted credentials are a high barrier to entry. NEK provides special forces training-related services to the U.S. Army and other national security related customers, and we expect NEK to provide a platform to expand MSS’ work both in the U.S. and to key foreign allies. We acquired select assets of NEK for approximately $52.6 million in total consideration. As part of the acquisition, we hired more than 200 employees with substantial experience in the Special Forces community.

 

40



Table of Contents

 

For fiscal year 2013, NEK was slightly dilutive to our earnings per share after consideration of costs for transaction integration, retention, and the amortization of purchased intangibles. In fiscal year 2014, we anticipate that this acquisition should be accretive, and that NEK should contribute $45.0 million to $50.0 million in sales.

 

Cost reimbursable and time and materials contracts accounted for 59% of our sales in MSS for fiscal year 2013, with the remaining sales derived from fixed-price contracts. Revenues under cost reimbursable contracts are recognized as costs are incurred, plus the estimated fee earned under the contract terms. Often these are structured as award fees based on performance and are generally accrued during the performance of the contract based on our historical experience with such awards. Revenues under time and materials contracts are recognized as services are delivered based on the terms of the contract. Revenues under our fixed-price service contracts with the U.S. government are recorded under the cost-to-cost percentage-of-completion method.

 

Cubic Defense Systems

 

CDS is focused on two primary lines of business: training systems and secure communications. The segment is a diversified supplier of live and virtual military training systems, and secure communication systems and products to the DoD, other U.S. government agencies and allied nations. We design and manufacture instrumented range systems for fighter aircraft, armored vehicles and infantry force-on-force live training weapons effects simulations, laser-based tactical and communication systems, and precision gunnery solutions. Our secure communications products are aimed at intelligence, surveillance, asset tracking and search and rescue markets.

 

CDS is building upon its role as a leader in air and ground combat training systems worldwide. Our products and systems help our customers to retain technological superiority with cost-effective solutions. We design, innovate, manufacture and field a diverse range of technologies that are critical to combat readiness, supply chain logistics and national security for the U.S. and allied nations. Our primary lines of business include air combat training ranges and after action review software, ground combat training systems, including a full range of laser engagement simulation systems, virtual small arms training systems, Intelligence, Surveillance and Reconnaissance (ISR) data links, personnel locator systems, multi-band communication tracking devices and cross domain appliances for cyber security. We also provide ongoing support services for systems we have built for several of our international customers.

 

Our established international footprint in more than 35 allied nations is a key ingredient to our strategy. Our global footprint helps to insulate us from possible shifts or downturns in DoD spending. Sales from international customers of CDS have become a major part of our business with $148.5 million, or 41% of sales, in 2013 from international customers. In addition, expansion into adjacent markets gives us an effective means to add scale to our business. We look for attractive acquisition candidates to expand our product offerings and we invest in the development of innovative new products that deliver real value to our customers. Through acquisitions made in 2010, and our additional investment in product development, we now supply asset visibility solutions for military and commercial supply chain logistics. This includes container tracking, yard management and shipment monitoring. In 2010, we also acquired cyber products that include a range of certified and accredited cross-domain transfer appliances that ensure secure and appropriate access to data and services from unclassified to top secret for defense, intelligence and homeland security customers. We have delivered training and simulation offerings to seven nations in the Asia-Pacific region and have positioned ourselves for certain anticipated contracts with the Australian Defense Forces. Through business acquisitions we made in 2013 we now offer live fire training solutions to US and international forces, further deepening our training capabilities and expanding our customer base, and we acquired a specialist engineering business with strong project management competencies in training range design, operations, communications, and safety requirements.

 

Fixed-price contracts accounted for 92% of CDS revenue for fiscal year 2013. Development and system integration contracts in CDS are generally accounted for on a percentage-of-completion basis using the cost-to-cost method to measure progress toward  completion, which requires us to estimate our costs to complete these contracts on a regular basis. Our actual results can vary significantly from these estimates and changes in estimate can result in significant swings in revenues and profitability from period to period. Generally, we are at risk for increases in our costs, unless an increase results from customer-requested changes. At times, there can be disagreement with a customer over who is responsible for increases in costs. In these situations we must use judgment to determine if it is probable that we will recover our costs and any profit margin.

 

CDS also has many long-term, fixed-price production contracts that do not require substantial development effort. For these contracts we use the units-of-delivery percentage-of-completion method as the basis to measure progress toward completing the contract and recognizing sales. The units-of-delivery measure recognizes revenues as deliveries are made to the customer generally using unit sales values in accordance with the contract terms. We estimate profit as the difference between total estimated revenue and total estimated cost of a contract and recognize that profit over the life of the contract based on deliveries.

 

41



Table of Contents

 

Increasingly, CDS is receiving contracts from foreign customers to not only develop and deliver a system, but to maintain the system for a period of years after the delivery. While service contracts have not historically been a significant part of our CDS business, this type of multiple-element contract has become more common in recent years. Revenues under contracts for services in CDS are generally recognized as services are performed on a straight-line basis over the period of contract performance. Costs incurred under these services contracts are expensed as incurred, and may vary from period to period, resulting in fluctuations in earnings.

 

Gross profit margins from CDS were higher in 2012 and 2011 than in previous periods primarily due to favorable profit margins from certain foreign contracts. The gross profit margin in fiscal 2013 was 32%, compared to 35% in 2012 and 33% in 2011. While we expect to win significant new work in foreign markets in the future, we do not expect gross profit margins to match 2012 levels. We expect the gross profit margin to average 30% to 32% in the next several years. At times, particularly favorable or unfavorable contracts can cause variation in this ratio, due to competition and the prevalence of fixed-price arrangements. Fixed-price contracts create both the risk of cost growth and the opportunity to increase margins if we are able to reduce our costs.

 

In January 2013, we were notified that we had been selected as a single source awardee on three ID/IQ contracts aggregating $298.5 million from the U.S. Navy. We expect the period of performance to be over five years for these contracts, which involve developing virtual training related technology and curriculum for the U.S. Navy littoral combat ships.

 

Comparison of fiscal years ended September 30, 2013 and 2012 and September 30, 2012 and 2011

 

Operating overview

 

Sales in 2013 were $1.361 billion compared to $1.404 billion in 2012, a decrease of 3%. Decreases in sales for MSS and CDS of 5% and 7%, respectively, were partially offset by a 1% increase in CTS sales. Consolidated sales in 2013 would have decreased by 5% without the addition of NEK, NextBus and two smaller businesses that were acquired during 2013. The average exchange rates between the prevailing currencies in our foreign operations and the U.S. dollar resulted in a decrease in sales of $5.6 million in 2013 from 2012.

 

Sales increased 8% in fiscal 2012 over 2011, primarily due to sales growth of 21% and 3% in CTS and MSS, respectively, while CDS sales were essentially flat. Sales increased to $1.404 billion in 2012, compared to $1.302 billion in 2011, with all of the growth  coming from existing businesses. The average exchange rates between the prevailing currencies in our foreign operations and the U.S. dollar resulted in a decrease in sales of $1.6 million in 2012 from 2011. See the segment discussions below for further information about segment sales.

 

Operating income was $40.7 million in 2013 compared to $136.2 million in 2012, a decrease of 70%. Operating income and operating margin percentages decreased in all three of our business segments. Decreased operating profits on decreased sales in Europe, as well as cost growth on contracts in Sydney and Vancouver contributed to the decrease in operating margins for CTS. CDS operating profits were negatively impacted in 2013 by lower margins on lower sales from a ground training system in the Far East, a $2.8 million write- down of inventory in our global asset tracking product line and $7.8 million of restructuring charges incurred in 2013. MSS recorded a $50.9 million goodwill impairment in 2013 as discussed in the MSS segment disclosures below. MSS also experienced a decrease in gross margins on a decrease in sales, particularly in the fourth quarter of 2013 due to lower training activity and continued pressure on bid prices. MSS bid rates have recently been impacted by the tougher competitive environment, where the “lowest price technically acceptable” bid often wins the contract award. The average exchange rates between the prevailing currencies in our foreign operations and the U.S. dollar resulted in a decrease in operating income of $0.2 million for 2013.

 

Operating income increased 15% to $136.2 million in 2012 compared to $118.6 million in 2011. CTS and CDS each contributed to the growth in operating income in 2012, while MSS operating income was down in 2012 from 2011. Growth in CTS sales was the  primary reason for the increase in operating income, while CDS operating income grew primarily due to a decrease in our investment  in cross domain and global asset tracking products in 2012 compared to 2011. The current competitive environment in the government services industry is driving MSS profit margins lower than in recent years, resulting in lower operating income. Operating results for MSS include an operating loss from Abraxas of $1.3 million in 2012, including amortization of intangible assets of $9.3 million, compared to a loss of $3.5 million in 2011, which included amortization of intangible assets of $8.2 million and acquisition costs of $0.7 million. The average exchange rates between the prevailing currencies in our foreign operations and the U.S. dollar resulted in a decrease in operating income of $0.7 million for 2012. See the segment discussions below for further information about segment operating income.

 

42


 


Table of Contents

 

Net income attributable to Cubic decreased to $25.1 million ($0.94 per share) in 2013 from $97.4 million ($3.64 per share) in 2012. The decrease in net income attributable to Cubic was primarily due to the decrease in operating income as the result of a goodwill impairment charge of $50.9 million in 2013 and an increase in interest expense due to a higher average debt balance in 2013. Net income attributable to Cubic increased to $97.4 million ($3.64 per share) in 2012 from $86.0 million ($3.22 per share) in 2011. Higher net income year-over-year resulted primarily from the improvements in operating income, as described above.

 

The gross margin from product sales was 24% in 2013 compared to 31% in 2012. The decrease in gross margin percentage was primarily due to cost growth on transportation contracts in Sydney and Vancouver as well as a change in estimate that had occurred during 2012 related to a ground combat training range contract. Prior to 2012 we had been working for more than a year under an arrangement without a firm contract price or scope of work and had been recognizing sales equal to costs. We reached agreement with the customer on a price and scope of work in the third quarter of 2012, resulting in higher sales and operating income of $12.5 million in 2012 because of this favorable change in estimate. Declining sales from more profitable CDA training system contracts were also responsible for the decrease in the product sales gross margin percentage in 2013. The gross margin from service sales was 21% in 2013 compared to 18% in 2012. The increase in service gross margin percentage was primarily caused by the change in mix of service sales between segments. More profitable CTS and CDA service sales increased in 2013 as a percentage of total service sales as compared to a heavier weighting of MSS sales as a percentage of service sales in 2012.

 

The gross margin from product sales was 31% in 2012, compared to 30% in 2011. Improved performance from our transportation systems business in 2012 in addition to the favorable change in estimate on the CDA training system contract described above primarily accounted for the increase. The gross margin from service sales was 18% in 2012 compared to 19% in 2011. Competitive pressures in the defense services business in 2012 contributed to the decrease in gross margin from 2011.

 

SG&A expenses increased to $165.2 million or 12% of sales in 2013 from $164.2 million or 12% of sales in 2012. The increase in SG&A expenses in 2013 was primarily due to $3.0 million of stock-based compensation recorded as SG&A expense during 2013 related to our long-term equity incentive award program which began in March 2013. In addition, $1.1 million of professional services costs were recognized in the first quarter of 2013 related to the restatement of our financial statements for the year ended September 30, 2012 and previous periods. In addition, we incurred $0.9 million of expenses in 2013 related to our secondary offering of outstanding shares that were sold by certain of our shareholders. Partially offsetting these increases in SG&A expenses was a 2013 reduction of SG&A expenses of $1.4 million related to proceeds from an insurance claim for losses that we incurred over the period from fiscal 2010 to fiscal 2012. SG&A expenses increased to $164.2 million or 12% of sales in 2012, compared to $159.8 million or 12% of sales in 2011. The increase in SG&A expenses in 2012 reflects the overall growth of the business.

 

Company-sponsored R&D spending, related primarily to new transportation and defense technologies we are developing, totaled $24.4 million in 2013 compared to $28.7 million in 2012. Company-sponsored R&D spending for CDS decreased $5.8 million in 2013 while Company-sponsored R&D spending for CTS increased by $1.6 million in 2013. Company-sponsored R&D spending totaled $28.7 million in 2012 compared to $25.3 million in 2011. The increase in R&D expenditures in 2012 came from the transportation systems business, which increased R&D spending from $4.0 million in 2011 to $8.3 million in 2012. A significant portion of our product development spending is incurred in connection with the performance of work on our contracts. The amount of contract-required engineering and development activity in 2013 was approximately $68.3 million compared to $81.2 million in 2012 and $72.2 million in 2011; however, these costs are included in cost of sales, rather than R&D, as they are directly related to contract performance.

 

Amortization expense increased to $16.7 million in 2013 compared to $14.8 million in 2012 and $14.7 million in 2011. The increase in 2013 over 2012 and 2011 was primarily due to our acquisitions of NEK and NextBus in 2013.

 

Interest and dividend income was $1.6 million in 2013 compared to $3.0 million in 2012 and $2.6 million in 2011. The changes in interest and dividend income between these years were generally correlated with changes in the average cash balances held by our wholly owned subsidiaries in New Zealand and Australia. These foreign currency investments earned a higher interest rate than our other cash and short term investments.

 

Other income (expense) netted to income of $0.9 million in 2013 compared to $0.4 million in 2012 and $0.9 million in 2011. Fluctuations in other income are caused primarily by the impact of foreign currency exchange rate changes on cash advances to our foreign subsidiaries that are not hedged. Interest expense was $3.4 million in 2013 compared to $1.6 million in 2012 and $1.5 million in 2011. The increase in interest expense in 2013 was due to an increase in our long-term borrowings.

 

Our effective tax rate for fiscal 2013 was 36% compared to 29% in fiscal 2012 and 28% in fiscal 2011. The increase in the effective tax rate between 2013 and 2012 reflects the unfavorable impact related to the goodwill impairment loss, because a large portion of our goodwill is not deductible for tax purposes and an increase in the valuation allowance against deferred tax assets, as described below. The American Taxpayer Relief Act of 2012 was enacted into law during fiscal year 2013 and reinstated the U.S. R&D tax credit retroactively from January 1, 2012 through December 31, 2013. The effective tax rate for fiscal 2013 reflects a benefit of $1.9 million related to fiscal 2012 resulting from the retroactive extension of the U.S. R&D tax credit. The annual effective tax rate for fiscal 2012 only reflected the U.S. R&D credit generated through December 31, 2011, the date on which the credit expired.

 

43



Table of Contents

 

As of September 30, 2013, we evaluated our net deferred income tax assets, including an assessment of the cumulative income or loss over the prior three-year and future periods by each jurisdiction, to determine if a valuation allowance is required. With respect to Australia, a significant negative factor in our assessment at September 30, 2013 was the determination that our Australian operations had a three-year historical cumulative loss as of the end of the year. After considering our recent history of losses and future sources of taxable income in the near-term, we recorded a valuation allowance on our net deferred tax assets related to Australia, with a corresponding charge to our income tax provision, of approximately $4.0 million in the quarter ended September 30, 2013. We will continue to assess the need for a valuation allowance on deferred tax assets by evaluating both positive and negative evidence that   may exist.

 

Our effective tax rate increased in 2012 over 2011, primarily because of the expiration of the U.S. R&D tax credit on December 31, 2011 and additional tax of $2.8 million related to the repatriation of foreign earnings. In addition, fiscal 2012 reflected a benefit of $2.5 million due to the reversal of uncertain tax positions relating to statute expirations and settlements with tax authorities compared to $1.2 million in fiscal 2011. In addition, the fiscal 2011 effective tax rate reflected a tax benefit of $1.4 million related to fiscal 2010 resulting from the retroactive extension of the U.S. R&D tax credit.

 

Our effective tax rate could be affected in future years by, among other factors, the mix of business between U.S. and foreign jurisdictions, our ability to take advantage of available tax credits and audits of our records by taxing authorities.

 

Transportation Systems Segment

 

Years ended September 30,

 

2013

 

2012

 

2011

 

 

 

 

 

(in millions)

 

 

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Transportation Systems Sales

 

$

529.5

 

$

522.2

 

$

433.1

 

 

 

 

 

 

 

 

 

Transportation Systems Operating Income

 

$

66.8

 

$

84.6

 

$

72.0

 

 

CTS sales increased 1% to $529.5 million in 2013 compared to $522.2 million in 2012. CTS generated higher sales on a contract for a suburban bus system near Chicago, and transit system contracts in Minneapolis, New York, and Washington D. C. NextBus, a business we acquired in January 2013 that provides real-time passenger information products and services to transit agencies contributed sales of $7.8 million for the year. In addition, during fiscal 2013, CTS recognized sales of approximately $2.0 million as a result of a contract claim that was settled related to services that were provided to a European customer between December 2011 and the second quarter of fiscal 2013. In 2013, CTS realized lower sales both from a contract to design and build a system in Sydney, and due to reduced work on a contract to design and build a system in Vancouver, B.C. Canada. In 2012, revenues were higher on the Vancouver and Sydney projects as we were producing a significant amount of the hardware for the systems, while in 2013 we were moving into in the latter stages of delivery for these systems. Also, during 2013, sales to train operating companies in the U.K. decreased. The average exchange rates between the prevailing currency in our foreign operations and the U.S. dollar resulted in a decrease in sales of $6.7 million for 2013 compared to 2012.

 

CTS sales increased 21% to $522.2 million in 2012 compared to $433.1 million in 2011. The overall increase in sales was primarily from work on our contracts in Sydney and Vancouver. In addition, sales were somewhat higher from our contracts in the U.K. Partially offsetting these increases were lower sales from design and build projects in the U.S. that were completed in 2011. The average exchange rates between the prevailing currencies in our foreign operations and the U.S. dollar resulted in a decrease in sales of $2.6 million for 2012 compared to 2011.

 

CTS operating income decreased 21% in 2013 to $66.8 million compared to $84.6 million in 2012. During 2013 operating margins declined due to an increase in estimated costs to complete and implement systems in Sydney and Vancouver. The increased estimated costs for the Sydney contract primarily stems from an increase in estimated costs to install hardware on the customer’s transit system bus fleet, while the increased estimated costs on the Vancouver contract mainly relates to expected additional system software development costs. Changes in estimated costs on these two contracts decreased operating profit by approximately $16.2 million in the fourth quarter of 2013, and decreased net income by approximately $10.8 million ($0.41 per share). CTS operating margins were also affected by a decrease in work on U.K. development contracts in 2013. These decreases in operating income were partially offset by higher operating income on increased work on contracts in the U.S. previously described, as well as the sales recorded in the third quarter related to the European service contract claim settlement described above. In addition, operating income improved on a U.K. service contract due to higher annual system usage incentives. The operating loss from NextBus was $0.4 million for 2013 including acquisition-related costs of $0.2 million and amortization of intangible assets of $1.2 million. The average exchange rates between the prevailing currency in our foreign operations and the U.S. dollar resulted in a decrease in CTS operating income of $0.4 million for 2013 compared to 2012.

 

44



Table of Contents

 

CTS operating income improved to $84.6 million in 2012 from $72.0 million in 2011, an increase of 18%. Improvements in operating income resulted from higher sales in Canada and the U.K. as mentioned above. In addition, profit margins improved from a service contract in California, where we received higher revenues based on increased system usage. Lower sales in the U.S. from the contracts that were completed in 2011 partially offset the growth in operating income, in addition to cost growth of $5.3 million on contracts in the U.S. and Europe. We also increased R&D spending in 2012 to $8.3 million, compared to $4.0 million in 2011, which limited growth in operating income. We are working on next generation transportation technologies that we believe will enhance our leading position in the industry. The average exchange rates between the prevailing currencies in our foreign operations and the U.S. dollar resulted in a decrease in operating income of $1.0 million for 2012 compared to 2011.

 

Mission Support Services Segment

 

Years ended September 30,

 

2013

 

2012

 

2011

 

 

 

 

 

(in millions)

 

 

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Mission Support Services Sales

 

$

468.7

 

$

491.4

 

$

476.5

 

 

 

 

 

 

 

 

 

Mission Support Services Operating Income (Loss)

 

$

(36.1

)

$

21.1

 

$

23.9

 

 

MSS sales decreased 5% to $468.7 million in 2013 compared to $491.4 million in 2012. Sales in 2013 were lower on certain contracts due to a decrease in activity, including a contract to provide deployment/redeployment services and from training contracts for the U.S. military, and lower Abraxas sales.  The decrease in sales was also caused by the loss of contracts due to lower bids by competitors. These decreases in sales were partially offset by sales generated by NEK, a Special Operation Forces training business acquired in December 2012 that added sales of $31.6 million for 2013. MSS sales would have decreased 11% without the acquisition of NEK. The current environment in defense services, including increased competition, an emphasis on small business awards, and the impact of spending cuts from sequestration, has led to contraction in MSS operations and may continue to do so in the near term.

 

MSS sales increased 3% to $491.4 million in 2012 compared to $476.5 million in 2011. Sales were higher from Abraxas in 2012, both due to growth of the business and because we acquired the business during the first quarter of 2011 and thus did not realize a full year of sales that year. Sales were also higher from our contract at the Joint Readiness Training Center (JRTC) in Fort Polk, Louisiana and from our defense modernization business in Eastern Europe. The loss of training work for flight simulators, and at the U.S. Army Quartermaster Center and School, partially offset these sales increases.

 

MSS recorded an operating loss of $36.1 million in 2013 compared to operating income of $21.1 million in 2012. The change in the MSS operating income (loss) was primarily related to a $50.9 million goodwill impairment recorded in the fourth quarter of fiscal 2013. Our annual impairment test is performed each year as of July 1, or when circumstances indicate that the carrying value may not be recoverable. The impacts of sequestration and other changes in the business environment did not cause significant impacts on MSS until late in 2013. During our strategic and financial planning process late in 2013, we made downward revisions in our estimates of future revenues and margins. As a result, in the fourth quarter of 2013 we estimated that there was a decline in the estimated fair value of MSS, which resulted in the recognition of an impairment of goodwill of $50.9 million. Excluding the goodwill impairment, in 2013, the decrease in operating income resulted from increased personnel costs on a flight simulator training contract, operating losses at NEK and Abraxas and the sales decreases described above. The NEK operating loss was $0.8 million for 2013, including acquisition-related costs of $0.6 million and amortization of intangible assets of $3.0 million. The Abraxas operating loss increased to $2.6 million in 2013 from $1.3 million in 2012 due to decreased activity and lower profit margins. In addition, MSS’ competitive environment has forced us to bid somewhat lower margins than in recent years in order to acquire positions on new contracts and retain positions on our existing contracts.

 

MSS operating income decreased 12% to $21.1 million in 2012 from $23.9 million in 2011. The loss of the contracts mentioned above contributed to lower operating income in 2012. The operating loss from Abraxas improved to $1.3 million in 2012, including amortization of intangible assets of $9.3 million, compared to $3.5 million in 2011, which included amortization of intangible assets   of $8.2 million and acquisition costs of $0.7 million.

 

Amortization of purchased intangibles included in the MSS results amounted to $12.5 million, $12.0 million, and $11.7 million in 2013, 2012 and 2011, respectively. The increases over the three years are due to the acquisitions of NEK in December 2012 and Abraxas in December 2010.

 

45



Table of Contents

 

Defense Systems Segment

 

Years ended September 30,

 

2013

 

2012

 

2011

 

 

 

 

 

(in millions)

 

 

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Defense Systems Sales

 

 

 

 

 

 

 

Training systems

 

$

306.3

 

$

336.5

 

$

337.9

 

Secure communications

 

56.7

 

52.9

 

52.8

 

 

 

$

363.0

 

$

389.4

 

$

390.7

 

 

 

 

 

 

 

 

 

Defense Systems Operating Income (Loss)

 

 

 

 

 

 

 

Training systems

 

$

30.1

 

$

39.7

 

39.0

 

Secure communications

 

(8.1

)

(4.4

)

(9.2

)

Restructuring costs

 

(7.8

)

 

 

 

 

$

14.2

 

$

35.3

 

$

29.8

 

 

Training Systems

 

Training systems sales decreased 9% in 2013 to $306.3 million compared to $336.5 million in 2012. Sales were lower in 2013 from ground combat training systems in the U.S., U.K., and the Far East as well as for sales of virtual small-arms training systems. In addition, the favorable change in estimate recognized in 2012 on a ground combat training range contract discussed in the operating income section below impacted the change in sales between 2013 and 2012. These decreases in sales were partially offset by increased shipments of MILES (Multiple Integrated Laser Engagement Simulation) equipment to the U.S. government. Higher sales of air combat training systems also partially offset the overall decrease in Training System sales for the year. Revenue from our new LCS courseware contract was $4.4 million in 2013. On July 1, 2013 we acquired certain assets of Advanced Interactive Systems and folded these operations into a new Defense Systems subsidiary, Cubic Range Design Solutions (CRDS). CRDS supplies live fire specialized range facilities, virtual simulation products, engineering design and project management services for counter-terrorism, law enforcement and military forces.  CRDS contributed sales of $2.0 million for 2013. The average exchange rates between the prevailing currencies in our foreign operations and the U.S. dollar resulted in an increase in training systems sales of $1.1 million for 2013 over 2012.

 

Training systems sales decreased less than 1% in 2012 to $336.5 million from $337.9 million in 2011. The delivery of air combat training systems to a U.S. government customer in 2011 had resulted in significantly higher sales than in 2012. In addition, sales from a ground combat training system contract in the Far East were lower in 2012 than in 2011 and shipment of MILES equipment to the U.S. government decreased in 2012 compared to 2011. Partially offsetting these decreases were higher sales of our small arms training systems and higher sales from two ground combat training range contracts in Europe. The average exchange rates between the prevailing currencies in our foreign operations and the U.S. dollar resulted in an increase in training system sales of $1.0 million for 2012 over 2011.

 

Operating income for training systems decreased 24% in 2013 to $30.1 million compared to $39.7 million in 2012. The decrease in operating income resulted primarily from a change in estimate that had occurred during 2012 related to a ground combat training  range contract. Prior to the third quarter of 2012 we had been working for more than a year under an arrangement without a firm contract price or scope of work and had been recognizing sales equal to costs. We reached agreement with the customer on a price and scope of work in the third quarter of 2012, resulting in higher sales and operating income of $12.5 million for 2012 because of this favorable change in estimate. Operating margins also decreased in 2013 on the lower sales of ground combat training systems described above, particularly due to decreases in sales to customers in the Far East. These decreases in operating income in 2013 were partially offset by higher operating income on increased sales of air combat training systems. The average exchange rates between the prevailing currencies in our foreign operations and the U.S. dollar resulted in an increase in training systems operating income of $0.2 million for 2013 over 2012.

 

Operating income for training systems was $39.7 million in 2012 and $39.0 million in 2011. Operating income in 2012 included the impact of the $12.5 million favorable change in estimate described above. Offsetting this increase were lower operating profits on lower sales of air combat training systems, a ground combat training system in the Far East and MILES equipment. In addition, we incurred higher than previously expected costs in developing an instrumented training system for the U.S. Marine Corps in 2012. The average exchange rates between the prevailing currencies in our foreign operations and the U.S. dollar resulted in an increase in training systems operating income of $0.3 million for 2012 compared to 2011.

 

46



Table of Contents

 

Secure communications

 

During 2013, certain CDS product lines that were previously classified in an “Other” category have been reclassified into the “Secure communications” category. Prior year amounts have been reclassified to conform to the current year presentation.

 

Secure communications sales increased 7% in 2013 to $56.7 million compared to $52.9 million in 2012. Sales were higher from personnel locater systems for 2013 but were lower from power amplifier and data link products.

 

Secure communications sales increased slightly to $52.9 million in 2012 from $52.8 million in 2011. Sales of personnel locator systems and power amplifiers decreased in 2012, while sales of data links increased.

 

Operating losses increased to $8.1 million in 2013 from $4.4 million in 2012. In 2013 we incurred charges to cost of sales totaling $2.8 million for inventoried costs in excess of estimated realizable value for our global asset tracking product line. This inventory write-down related to global tracking products that were being manufactured in fiscal 2013 for anticipated contracts with the U.S. government for which the probability of contract award has diminished. The increase in operating losses in 2013 was also caused by cost growth on a development contract for a data link system.

 

Secure communications operating losses decreased to $4.4 million in 2012 from $9.2 million in 2011. In 2010, CDS added two new product lines through acquisitions of Impeva Labs and Safe Harbor Holdings that develop global asset tracking and cross domain products. During 2011, we increased our investment in the development and marketing of these products, resulting in an operating loss for these two product lines. In 2012, we reduced operating and development costs for these product lines, but again incurred an operating loss.

 

Restructuring costs

 

In 2013, our CDS business implemented a restructuring plan to reduce global employee headcount by approximately 230 in order to rebalance our resources with work levels that have declined due to recent delays in contract awards and contract funding. CDS incurred resulting restructuring charges of $7.8 million. The total costs of the restructuring plan are not expected to be significantly greater than the charges incurred to date unless market conditions worsen. The workforce realignment was reflective of the current mix of work and anticipated activity levels going forward. We anticipate that operating margins will improve for CDS in fiscal 2014 with the leaner cost structure.

 

Adjusted EBITDA

 

Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization (Adjusted EBITDA) represents net income attributable to Cubic before interest, taxes, non-operating income, goodwill impairment charges, depreciation and amortization. We believe that the presentation of Adjusted EBITDA included in this report provides useful information to investors with which to analyze our operating trends and performance and ability to service and incur debt. Also, Adjusted EBITDA is a factor we use in measuring our performance and compensating certain of our executives. Further, we believe Adjusted EBITDA facilitates company-to-company operating performance comparisons by backing out potential differences caused by variations in capital structures (affecting net interest expense), taxation, the age and book depreciation of property, plant and equipment (affecting relative depreciation expense), goodwill impairment charges and non-operating expenses which may vary for different companies for reasons unrelated to operating performance. In addition, we believe that Adjusted EBITDA is frequently used by securities analysts, investors and other interested parties in their evaluation of companies, many of which present an Adjusted EBITDA measure when reporting their results. Adjusted EBITDA is not a measurement of financial performance under U.S. generally accepted accounting principles (GAAP) and should not be considered as an alternative to net income as a measure of performance. In addition, other companies may define Adjusted  EBITDA differently and, as a result, our measure of Adjusted EBITDA may not be directly comparable to Adjusted EBITDA of other companies. Furthermore, Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

 

·                  Adjusted EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;

 

·                  Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

 

47



Table of Contents

 

·                  Adjusted EBITDA does not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;

 

·                  Adjusted EBITDA does not reflect our provision for income taxes, which may vary significantly from period to period; and

 

·                  Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements.

 

Because of these limitations, Adjusted EBITDA should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our GAAP results and using Adjusted EBITDA only supplementally. You are cautioned not to place undue reliance on Adjusted EBITDA.

 

The following table reconciles Adjusted EBITDA to net income attributable to Cubic, which we consider to be the most directly comparable GAAP financial measure to Adjusted EBITDA:

 

 

 

Year Ended September 30,

 

 

 

2013

 

2012

 

2011

 

 

 

 

 

(in thousands)

 

 

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Reconciliation:

 

 

 

 

 

 

 

Net income attributable to Cubic

 

$

25,086

 

$

97,427

 

$

86,044

 

Add:

 

 

 

 

 

 

 

Provision for income taxes

 

14,502

 

40,332

 

34,119

 

Interest expense (income), net

 

1,851

 

(1,392

)

(1,027

)

Other expense (income), net

 

(887

)

(366

)

(863

)

Noncontrolling interest in income of VIE

 

183

 

204

 

310

 

Depreciation and amortization

 

25,359

 

22,857

 

22,341

 

Impairment of goodwill

 

50,865

 

 

 

ADJUSTED EBITDA

 

$

116,959

 

$

159,062

 

$

140,924

 

 

Liquidity and Capital Resources

 

Operating activities used cash of $13.3 million in 2013, compared to using cash of $54.7 million in 2012 and providing cash of $129.1 million in 2011. In 2013, cash generated by earnings was more than offset by increases in accounts receivable of $19.0 million, long- term capitalized construction costs of $48.6 million, inventories of $19.9 million, and a decrease in accounts payable and other current liabilities of $25.6 million, which contributed to the overall use of cash for the year. Net accounts receivable grew on certain large contracts that we worked on in 2013 including transportation contracts in Australia and the U.S. In 2012, cash generated by net  income was more than offset by increases in accounts receivable of $123.0 million, long-term capitalized construction costs of $26.9 million, and a net decrease in customer advances of $55.8 million. The growth in accounts receivable in 2012 and reduction of customer advances related to several large contracts we worked on in 2012, including transportation systems contracts in Canada and Australia and defense system contracts in the U.S., Far East and Middle East. In 2011, cash generated by earnings, decreases in accounts receivable of $2.0 million and inventories of $4.2 million, and increases in net customer advances of $32.7 million contributed to the positive results.

 

Our contract terms with our customers can have a significant impact on our cash provided by (used in) operations. Contract terms, including payment terms on our long-term development contracts, are customized for each contract based upon negotiations with the respective customer. For certain large long-term development contracts, we had received significant up-front cash payments from customers based upon the negotiated terms of these contracts. The customer advance balances on these contracts decreased in 2012 and 2013 as development work progressed. The customized payment terms on long-term development projects also often include payment milestones based upon such items as the delivery of components of systems, meeting specific contractual requirements in the contracts, or other events. These milestone payments can vary significantly based upon the negotiated terms of the contracts. In 2012 and 2013, the growth in the unbilled accounts receivable was based upon when we are entitled to receive milestone payments.

 

48



Table of Contents

 

In 2013 and 2012, MSS contributed positive operating cash flows, while CDS and CTS both generated negative operating cash flows. In 2011, all three segments contributed to positive operating cash flow, with CTS providing the greatest portion of the positive cash flows.

 

We have classified certain unbilled accounts receivable balances as non-current because we do not expect to receive payment within one year from the balance sheet date. At September 30, 2013, this balance was $19.0 million compared to $21.9 million at September 30, 2012 and $23.6 million at September 30, 2011.

 

Investing activities used cash of $76.8 million in 2013, provided cash of $11.6 million in 2012, and used cash of $77.3 million in 2011. In 2013, investing activities on our Statement of Cash Flows included $40.3 million of cash paid for the acquisition of NEK. In addition, we made payments of $7.8 million related to the acquisition of NEK for contingent consideration, which is classified as a financing activity on our Statement of Cash Flows. In addition, our investing activities include the acquisition of NextBus for $20.2 million and $3.3 million for the acquisition of two small defense systems businesses. We also invested $4.1 million in marketable securities during 2013 and made capital expenditures of $9.1 million.

 

In 2012, net cash provided by investing activities consisted of proceeds of $25.8 million from maturities of short-term investments, partially offset by capital expenditures of $14.2 million.

 

In 2011, cash used in investing activities included $126.0 million for the acquisition of Abraxas, $0.7 million for a small defense systems acquisition made during the year, and an additional payment of $0.2 million for a small defense systems acquisition made in 2010. In addition, in 2011, we received proceeds from the sale or maturities of short-term investments of $58.3 million and made capital expenditures of $8.7 million

 

Financing activities provided cash of $77.0 million in 2013, and used cash of $79.6 million in 2012 and $12.0 million in 2011. In  2013, we sold $100.0 million of senior unsecured notes, bearing interest at a rate of 3.35% and maturing on March 12, 2025. We made payments on long-term borrowings of $8.5 million, $4.5 million and $4.6 million in 2013, 2012 and 2011, respectively. Dividends  paid to shareholders amounted to $6.4 million (24 cents per share) in both 2013 and 2012, and $7.5 million (28 cents per share) in 2011. In 2012, we placed $68.6 million of cash in a restricted bank account as collateral for a letter of credit facility we entered into in the U.K., which is described below.

 

We have a committed five-year revolving credit agreement (Revolving Credit Agreement) with a group of financial institutions in the amount of $200 million, expiring in May 2017. Commitment fees associated with this financing arrangement are 0.20% of the unutilized balance per year. As of September 30, 2013, there were no borrowings under this agreement; however, there were letters of credit outstanding totaling $23.5 million, which reduce the available line of credit to $176.5 million.

 

We also have a secured letter of credit facility agreement (Secured Letter of Credit Facility) with a bank that has no expiration date and is cancellable by us at any time upon the completion of certain conditions to the satisfaction of the bank. At September 30, 2013 there were letters of credit outstanding under this agreement of $54.4 million. Of our total restricted cash of $69.4 million at September 30, 2013, $68.9 million of this amount was held on deposit in the U.K. as collateral in support of this Secured Letter of Credit Facility. We are required to leave the cash in the restricted account so long as the bank continues to maintain associated letters of credit under the facility. The maximum amount of letters of credit currently allowed by the facility is $62.6 million, and any increase above this amount would require bank approval and additional restricted funds to be placed on deposit. We may choose at any time to terminate the facility and move the associated letters of credit to another credit facility. Letters of credit outstanding under this facility do not reduce the available line of credit under the Revolving Credit Agreement described above.

 

As of September 30, 2013, we had letters of credit and bank guarantees outstanding totaling $89.6 million, including the letters of credit outstanding under the Revolving Credit Agreement and the Secured Letter of Credit Facility, which guarantee either our performance or customer advances under certain contracts. In addition, we had financial letters of credit outstanding totaling $12.4 million as of September 30, 2013, which primarily guarantee our payment of certain self-insured liabilities.

 

We maintain short-term borrowing arrangements in New Zealand and Australia totaling $0.5 million New Zealand dollars (equivalent to approximately $0.4 million) and $3.0 million Australian dollars (equivalent to approximately $2.9 million) to help meet the short- term working capital requirements of our subsidiaries in those countries. At September 30, 2013, no amounts were outstanding under these borrowing arrangements.

 

Our Revolving Credit Agreement and note purchase and private shelf agreement each contain a number of customary covenants, including requirements for Cubic to maintain certain interest coverage and leverage ratios and restrictions on Cubic’s and certain of its subsidiaries’ abilities to, among other things, incur additional debt, create liens, consolidate or merge with any other entity, or transfer or sell substantially all of their assets, in each case subject to certain exceptions and limitations. These agreements also contain customary events of default, including, without limitation: (a) failure by Cubic to pay principal or interest on the Notes when due; (b) failure by Cubic or certain of its subsidiaries to comply with the covenants in the agreements; (c) failure of the representations and warranties made by Cubic or certain of its subsidiaries to be correct in any material respect; (d) cross-defaults with other indebtedness of Cubic or certain of its subsidiaries resulting in the acceleration of the maturity thereof; (e) certain bankruptcy and insolvency events with respect to Cubic or certain of its subsidiaries; (f) failure by Cubic or certain of its subsidiaries to satisfy certain final judgments when due; and (g) a change in control of Cubic, in each case subject to certain exceptions and limitations. The occurrence of any event of default under these agreements may result in all of the indebtedness then outstanding becoming immediately due and payable.

 

49



Table of Contents

 

We intend to obtain financing in the future for the new fare collection system we have built for the Chicago Transit Authority, for which we have incurred capitalized costs totaling $69.0 million prior to receiving payments under the contract. In order to mitigate the risk of changes in interest rates prior to obtaining this financing, we have entered into a forward starting swap to reduce interest rate variability exposure for the projected interest rate cash flows. See Note 12 to the Consolidated Financial Statements in Item 8 of this Form 10-K/A for further information.

 

The accumulated deficit in other comprehensive loss decreased $17.9 million in 2013 primarily due to a decrease in the recorded liability for our pension plans of $13.5 million (after applicable income taxes) and a net unrealized gain from cash flow hedges of $3.8 million (after applicable income taxes). These adjustments resulted in a balance in accumulated other comprehensive loss of $2.8 million at September 30, 2013 compared to $20.7 million at September 30, 2012.

 

The net deferred tax asset balance was $27.7 million and $24.3 million at September 30, 2013 and 2012 respectively. The increase in the net deferred tax asset during 2013 was the result of the reduction in the deferred tax liability related to the book and tax basis difference of intangible assets as a result of recording the goodwill impairment. We expect to generate sufficient taxable income in the future such that the net deferred tax asset will be realized.

 

Our financial condition remains strong with net working capital of $496.7 million and a current ratio of 3.0 to 1 at September 30, 2013. We expect that cash on hand, our revolving credit agreement and our ability to access the debt markets will be adequate to meet our working capital requirements for the foreseeable future. In addition to short-term borrowing arrangements we have in New Zealand and Australia, we have a committed five-year credit facility from a group of financial institutions in the U.S., aggregating $200 million. This agreement will expire in May 2017. As of September 30, 2013, $23.5 million of this capacity was used for letters of credit, leaving an additional $176.5 million available. Our total debt to capital ratio at September 30, 2013 was 15%. In addition, our cash and cash equivalents, including restricted cash, totaled $273.3 million at September 30, 2013 which exceeded our total debt by $170.4 million. Our cash is invested primarily in highly liquid bank deposits and government instruments in the U.S., U.K., New Zealand and Australia.

 

As of September 30, 2013, $177.7 million of the $207.9 million of our cash, cash equivalents and short-term investments was held by our foreign subsidiaries, primarily in the U.K., New Zealand and Australia. We also had $69.4 million of restricted cash in the U.K. at September 30, 2013. If these funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds. However, we have the intent and ability to permanently reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.

 

The following is a schedule of our contractual obligations outstanding as of September 30, 2013:

 

 

 

 

 

Less than 1

 

 

 

 

 

 

 

 

 

Total

 

Year

 

1 - 3 years

 

4 - 5 years

 

After 5 years

 

 

 

(in millions)

 

Long-term debt

 

$

102.9

 

$

0.6

 

$

1.1

 

$

1.1

 

$

100.1

 

Interest payments

 

32.3

 

3.5

 

6.9

 

6.8

 

15.1

 

Operating leases

 

43.0

 

12.4

 

16.8

 

10.7

 

3.1

 

Deferred compensation

 

10.7

 

0.9

 

0.8

 

0.3

 

8.7

 

 

 

$

188.9

 

$

17.4

 

$

25.6

 

$

18.9

 

$

127.0

 

 

Quarterly Results — Quarters ended December 31, 2012 and 2011 (first fiscal quarter)

 

Consolidated Overview

 

Sales for the quarter ended December 31, 2012 were $314.8 million compared to $319.9 million in the quarter ended December 31, 2011 and $282.3 million in the quarter ended December 31, 2010. These amounts represented a quarter-over-quarter decrease of 2% in the first quarter of fiscal 2013 and an increase of 13% in the first quarter of fiscal 2012. CTS sales decreased 6% in 2013 after having increased 45% in 2012. CDS sales decreased 4% and 11% in 2013 and 2012, respectively. MSS sales increased 5% and 9% in 2013 and 2012, respectively. The sales generated by the operations of NEK, which was acquired on December 14, 2012, were not significant for the first quarter of fiscal 2013. See the segment discussions following for further analysis of segment sales.

 

50


 


Table of Contents

 

Operating income was $20.5 million in the first quarter of fiscal 2013 compared to $29.9 million in the first quarter of fiscal 2012 and $25.4 million in the first quarter of fiscal 2011. CTS operating income decreased 24% in 2013 after having increased 43% in 2012. MSS operating income decreased 7% and 12% in 2013 and 2012, respectively. CDS operating income decreased 75% in 2013 and 24% in 2012. NEK’s operating loss for the first quarter of 2013 was $0.5 million, which included transaction costs of $0.4 million. Corporate and other costs for the first quarter of 2013 were $0.4 million compared to $0.6 million in 2012 and $1.6 million in 2011. See the segment discussions following for further analysis of segment operating income.

 

Adjusted EBITDA for the first quarter of fiscal 2013 was $25.2 million, compared to $35.8 million in the first quarter of fiscal 2012 and $29.3 million in the first quarter of fiscal 2011. The decrease in the first quarter of fiscal 2013 was primarily due to lower operating income in all three segments. The increase in the first quarter of fiscal 2012 was primarily due to higher operating income in CTS, partially offset by lower operating income from the other two segments. See below for a reconciliation of this non-GAAP metric to net income and see the explanation above for why we believe it to be an important measure of performance.

 

Net income attributable to Cubic for the first quarter of fiscal 2013 was $14.2 million, or 53 cents per share, compared to $22.3 million, or 83 cents per share in 2012 and $18.0 million, or 67 cents per share in 2011. Net income decreased in 2013 from 2012 due primarily to a decrease in operating income, a decrease in other income and an increase in interest expense. These decreases were partially offset by lower income tax expense due to the decrease in income before income taxes, although the effective tax rate in the first quarter of fiscal 2013 was slightly higher, as described below. Included in other income was a net foreign currency exchange gain of $0.1 million in the first quarter of fiscal 2013 compared to a gain of $1.2 million in the first quarter of fiscal 2012. In the first quarter of fiscal 2013, we recorded $0.6 million of interest expense related to a judgment against us, which required us to pay such amount of interest to the court on behalf of a party that had filed claims against us. Net income in the first quarter of fiscal 2012 increased over 2011 primarily due to higher operating income and also due to higher interest and dividend income and higher other income. These increases were partially offset by higher income tax expense due to the increase in income before taxes.

 

Our gross margin percentages on products and services did not change significantly between the first quarter of 2012 and 2013. However, product sales decreased $19.5 million, or 13%, while services sales increased by $14.4 million, or 9% between the first quarter of 2012 and 2013. Product sales increased $22.0 million, or 17%, while services sales increased by $15.6 million, or 10% between first quarter of 2011 and 2012. The lower gross margin percentage on services sales contributed to gross profits that were $1.1 million lower in the first quarter of fiscal 2013 compared to the first quarter of fiscal 2012. The decrease in our gross margin percentage on product sales in the first quarter of 2012 over 2011 was primarily due to cost growth on two CTS design and build contracts, one in North America and one in Europe, totaling $2.2 million and a lower gross margin from CDS contacts in the Far East and Europe.

 

SG&A expenses increased in the first quarter of 2013 to $40.9 million compared to $35.2 million in 2012 and $38.1 million in 2011. As a percentage of sales, SG&A expenses were 13% for the first quarter of 2013 compared to 11% in 2012 and 14% in 2011. SG&A expenses in the first quarter of fiscal 2013 increased in all business segments over 2012 primarily due to higher selling and marketing costs, and increased information technology costs. In addition, during the first quarter of 2013 we incurred $1.1 million of professional services costs in connection with the restatement of our consolidated financial statements for the year ended September 30, 2012 and previous periods. Also, in the first quarter of 2013 SG&A expenses were reduced by $1.4 million related to proceeds from an  insurance claim for losses that we incurred over the period from fiscal 2010 to fiscal 2012. In addition, SG&A expenses for NEK were $0.5 million for the first quarter of 2013. SG&A expenses in the first quarter of 2011 included $0.7 million of costs related to the Abraxas acquisition.

 

Company funded R&D expenditures, which mainly relate to new defense technologies we are developing, increased to $5.8 million for the first quarter of 2013 compared to $4.9 million in 2012 and $6.3 million in 2011. Amortization of purchased intangibles decreased in the first quarter of 2013 to $3.6 million compared to $4.0 million in the first quarter of 2012 and $2.0 million in the first quarter of 2011. These fluctuations primarily reflect changes in the amortization expense for certain intangible assets related to our acquisition of Abraxas in December 2010 that are being amortized using accelerated amortization methods. The decrease in amortization expense in the first quarter of fiscal 2013 was partially offset by the amortization of intangible assets recorded in connection with our acquisition of NEK in December 2012, which totaled $0.2 million in the first quarter of fiscal 2013.

 

Based on the tax law that was in effect at the end of the first quarter of fiscal 2013, we estimated our annual effective tax rate would be approximately 30%, which is reflected in the tax provision for the first quarter of 2013.

 

The American Taxpayer Relief Act of 2012, which reinstated the U.S. R&D tax credit retroactively from January 1, 2012 through December 31, 2013, was not enacted into law until the second quarter of fiscal 2013. Therefore, the expected tax benefit resulting from such reinstatement for fiscal 2013 will not be reflected in our estimated annual effective tax rate for fiscal 2013 until the second fiscal quarter. Additionally, we expect to record a discrete tax benefit of approximately $1.7 million in the second quarter of fiscal 2013 related to the reinstatement of the U.S. R&D tax credit for fiscal 2012. After consideration of both of these items, we estimated our annual effective income tax rate for fiscal 2013 would be approximately 26%. The effective rate for fiscal 2013 could be affected by, among other factors, the mix of business between the U.S. and foreign jurisdictions, our ability to take advantage of available tax credits and audits of our records by taxing authorities.

 

51



Table of Contents

 

Transportation Systems Segment (CTS)

 

 

 

Three Months Ended
December 31,

 

 

 

2012

 

2011

 

2010

 

 

 

(in millions)

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Transportation Systems Segment Sales

 

$

121.2

 

$

128.5

 

$

88.6

 

 

 

 

 

 

 

 

 

Transportation Systems Segment Operating Income

 

$

15.2

 

$

20.0

 

$

14.0

 

 

CTS sales decreased 6% in the first quarter of 2013 to $121.2 million compared to $128.5 million in 2012, which represented a 45% increase over 2011 first quarter sales of $88.6 million. The primary reason for the decrease in sales was due to reduced work on a contract to design and build a system in Vancouver. In the first quarter of fiscal 2012, revenues were higher on the project as we were producing a significant amount of the hardware for the system, while in the first quarter of fiscal 2013 we were in the latter stages of the system delivery. This decrease was partially offset by higher sales in the first quarter of fiscal 2013 from a contract to design and build a system in Sydney. In addition to Vancouver, sales were higher in the first quarter of fiscal 2012 compared to 2011 due to work on the contract in Sydney, and our contracts in the U.K. Partially offsetting these increases in 2012 were lower sales from design and build projects in the U.S. compared to the first quarter of 2011. The average exchange rates between the prevailing currency in our foreign operations and the U.S. dollar resulted in an increase in sales of $2.7 million when comparing exchange rates in the first quarter of 2013 to the first quarter of 2012. Such exchange rates resulted in an increase in sales of $0.7 million in the first quarter of 2012 compared to the first quarter of 2011.

 

Operating income from CTS decreased 24% in the first quarter of fiscal 2013 to $15.2 million, compared to $20.0 million in 2012, which represented a 43% increase over 2011 first quarter operating income of $14.0 million. In the first quarter of fiscal 2013 we incurred costs related to our contract in Sydney to transition portions of the system into full operations, for which revenues were not sufficient to cover our costs of servicing the system. This situation should improve as the systems complete the transition phase and move into full operations. In addition, we realized lower margins on certain projects in the U.K. during the first quarter of 2013 than we had earned on similar projects in the first quarter of 2012. These decreases in operating income were partially offset by sales of certain higher margin fare system products in North America. Higher sales from Vancouver and U.K. contracts, in addition to improved margins from a service contract in North America contributed to the increase in 2012 operating income. Partially offsetting these increases was cost growth of $2.2 million related to contracts in the U.S. and Europe. In addition, profit margins were lower in 2012 than in 2011 because the growth in sales came largely from new contracts that are at an early stage of development, realizing lower margins than our other, more mature, contracts. The average exchange rates between the prevailing currency in our foreign operations and the U.S. dollar resulted in an increase in operating income of $0.3 million when comparing exchange rates in the first quarter of 2013 to the first quarter of 2012. Such exchange rates did not have a material impact on operating income when comparing exchange rates in the first quarter of 2012 to the first quarter of 2011.

 

52



Table of Contents

 

Mission Support Services Segment (MSS)

 

 

 

Three Months Ended
December 31,

 

 

 

2012

 

2011

 

2010

 

 

 

(in millions)

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Mission Support Services Segment Sales

 

$

113.4

 

$

107.5

 

$

98.8

 

 

 

 

 

 

 

 

 

Mission Support Services Segment Operating Income

 

$

4.2

 

$

4.5

 

$

5.1

 

 

Sales from MSS increased 5% to $113.4 million in the first quarter of 2013, from $107.5 million in 2012, after increasing 9% in 2012 from $98.8 million in the first quarter of 2011. Sales growth in the first quarter of 2013 was driven by an increase in activity at the Joint Readiness Training Center (JRTC) in Fort Polk, Louisiana and by higher Abraxas sales. These increases were partially offset by lower sales due the loss of a contract in 2012 for flight simulator training work, because of a lower bid by a competitor. The sales generated by the operations of the newly acquired NEK business were not significant for the quarter. The acquisition of Abraxas added $19.2 million to sales for the first quarter of fiscal 2012 compared to only $1.3 million in the first quarter of fiscal 2011, the quarter in which we acquired Abraxas. Sales growth in 2012 was also driven by increased activity in support of instruction and maintenance of flight simulators. Partially offsetting these sales improvements was a decrease in activity during the first quarter of 2012 at the Joint Readiness Training Center (JRTC) in Fort Polk, Louisiana, from a contract at the U.S. Army’s Quartermaster Center and School, and from other training and education contracts.

 

MSS operating income decreased 7% to $4.2 million in the first quarter of fiscal 2013 from $4.5 million in the first quarter of 2012, and decreased 12% in 2012 compared to $5.1 million in 2011. The loss of the training work for flight simulators described above had  a negative impact on operating income for the first quarter of fiscal 2013, and cost growth on a training contract in Europe also contributed to the decrease in margins. In addition, NEK had an operating loss of $0.5 million in the first quarter of fiscal 2013 primarily due to the incurrence of $0.4 million of acquisition-related costs. These decreases in operating profits were partially offset  by increased margins on increased Abraxas sales. Lower sales from certain higher margin training and education contracts contributed to the decrease in operating income for the first three months of fiscal 2012. Abraxas incurred an operating loss of $0.8 million for the first quarter of 2012, which included $2.6 million of amortization of intangible assets. Abraxas incurred an operating loss of $0.8 million in the first quarter of 2011, mainly from acquisition related costs.  The amortization expense for MSS intangible assets was $2.9 million in the first quarter of fiscal 2013, $3.3 million in the first quarter of fiscal 2012 and $1.2 million in the first quarter of fiscal year 2011.

 

Defense Systems Segment (CDS)

 

 

 

Three Months Ended
December 31,

 

 

 

2012

 

2011

 

2010

 

 

 

(in millions)

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Defense Systems Segment Sales

 

 

 

 

 

 

 

Training systems

 

$

64.4

 

$

65.1

 

$

81.3

 

Secure communications

 

15.6

 

18.6

 

13.2

 

 

 

$

80.0

 

$

83.7

 

$

94.5

 

 

 

 

 

 

 

 

 

Defense Systems Segment Operating Income

 

 

 

 

 

 

 

Training systems

 

$

2.8

 

$

4.8

 

$

10.4

 

Secure communications

 

(1.3

)

1.2

 

(2.5

)

 

 

$

1.5

 

$

6.0

 

$

7.9

 

 

53



Table of Contents

 

Training Systems

 

Training systems sales decreased 1% in the first quarter of 2013 to $64.4 million compared to $65.1 million in the first quarter of 2012, after having decreased 20% in 2012 from $81.3 million in the first quarter of 2011. Increased sales of air combat training systems in the first quarter of fiscal 2013 were nearly offset by decreased sales of small arms training systems in the Middle East and to the U.S. government. Ground combat training sales in the U.S. and the Far East were lower for the first quarter of fiscal 2012 compared to 2011. Partially offsetting these decreases in the first quarter of 2012 were higher air combat training sales to a customer in the Far East and higher ground combat training sales on a contract with a customer in Europe. In the first quarter of both 2011 and 2012 we recorded revenues equal to costs on this ground combat training contract because we were working under a contractual arrangement without a firm contract price or scope of work. The average exchange rates between the prevailing currency in our foreign operations and the U.S. dollar resulted in an increase in sales of $0.6 million when comparing exchange rates in the first quarter of 2013 to the first quarter of 2012. Such exchange rates resulted in an increase in sales of $0.1 million for the first quarter of 2012 compared to the first quarter of 2011.

 

Operating income decreased 42% for the first quarter of fiscal 2013 to $2.8 million, compared to $4.8 million in the first quarter of 2012, after having decreased 54% in 2012 from $10.4 million in the first quarter of 2011. The decreases in operating income in the  first quarter of fiscal 2013 were the result of decreased sales of the relatively high margin small arms training systems. Also, although total sales of air combat training systems increased in the first quarter of fiscal 2013, sales of higher margin air combat training  systems to a customer in the Far East decreased, which decreased overall margins from air combat training systems. Lower sales in 2012 of ground combat training systems in the U.S. and Far East primarily caused the decrease in operating income from the first quarter of 2011, in addition to a lower profit margin from contracts in the Far East and Europe. The lower margin was partially caused by the ground combat training system contract where we recorded sales equal to costs, as described above. The average exchange rates between the prevailing currency in our foreign operations and the U.S. dollar did not have a material impact on operating income   when comparing exchange rates in the first quarter of 2013 to the first quarter of 2012 and when comparing exchange rates in the first quarter of 2012 to the first quarter of 2011.

 

Secure Communications

 

Secure communications sales decreased 16% in the first quarter of 2013 to $15.6 million from $18.6 million in the first quarter of 2012, after having increased 41% in 2012 from $13.2 million in the first quarter of 2011. The operating loss was $1.3 million in the first quarter of 2013 compared to an operating profit of $1.2 million in 2012, and an operating loss of $2.5 million in 2011. Decreased profitability on lower data link sales, including the impact of a $1.2 million cost increase on a U.S. government contract, contributed   to the decrease in operating income in the first quarter of fiscal 2013. Sales and operating profits were also lower from power amplifiers and personnel locater systems in 2013. In the first quarter of 2012, higher profit margins on higher sales of personnel  locator systems and data link products contributed to improved operating income. In addition, increased sales of global asset tracking products decreased the operating losses that resulted from our continued investment in the development and marketing of this product line.

 

54



Table of Contents

 

Adjusted EBITDA

 

The following table reconciles Adjusted EBITDA to net income attributable to Cubic, which we consider to be the most directly comparable GAAP financial measure to Adjusted EBITDA:

 

 

 

Three Months Ended 

 

 

 

December 31, 

 

 

 

2012 

 

2011 

 

2010

 

 

 

(in thousands) 

 

 

 

(As Restated) 

 

(As Restated) 

 

(As Restated)

 

Reconciliation:

 

 

 

 

 

 

 

Net income attributable to Cubic

 

$

14,241

 

$

22,264

 

$

18,038

 

Add:

 

 

 

 

 

 

 

Provision for income taxes

 

5,869

 

8,956

 

6,457

 

Interest expense (income), net

 

428

 

(402

)

(437

)

Other expense (income), net

 

(102

)

(923

)

1,208

 

Noncontrolling interest in income of VIE

 

73

 

45

 

121

 

Depreciation and amortization

 

4,718

 

5,832

 

3,868

 

ADJUSTED EBITDA

 

$

25,227

 

$

35,772

 

$

29,255

 

 

Liquidity and Capital Resources

 

Operating activities used cash of $26.1 million for the first quarter of 2013. Operating activities used cash of $38.4 million in the first quarter of 2012 and provided cash of $15.0 million in the first quarter of 2011. Increases in accounts receivable and long-term capitalized contract costs and decreases in accounts payable and other current liabilities contributed to the use of cash in 2013. All three segments contributed to the use of cash from operating activities. Increases in accounts receivable and decreases in accounts payable, other current liabilities and customer advances resulted in the use of cash in 2012, with all three segments contributing to the use of cash. A significant portion of the cash used in 2012 was in the transportation segment for expenditures related to large contracts in Australia and Canada.

 

Investing activities for the first three months of fiscal 2013 included $33.1 million of cash paid related to the acquisition of NEK and capital expenditures of $1.4 million.

 

Financing activities for the first three months of fiscal 2013 included scheduled payments on our long-term debt of $4.1 million. The first half of fiscal 2013 also included $25.0 million of proceeds from short-term borrowings on our revolving line of credit.

 

We have a Revolving Credit Agreement with a group of financial institutions in the amount of $200.0 million that expires in May 2017. The available line of credit on the Revolving Credit Agreement is reduced by any letters of credit issued under the agreement. As of December 31, 2012, there were borrowings of $25.0 million under this agreement, of which $5.0 million was repaid in February 2013. Our borrowings under the Revolving Credit Agreement bear interest at a variable rate (1.6% at December 31, 2012). In addition, there were letters of credit outstanding under the Revolving Credit Agreement totaling $42.4 million, which reduce the available line of credit to $132.6 million.

 

We also have a Secured Letter of Credit Facility with a bank that has no expiration date and is cancellable by us at any time upon the completion of certain conditions to the satisfaction of the bank. At December 31, 2012 there were letters of credit outstanding under this agreement of $63.4 million. In support of the Secured Letter of Credit Facility, we placed $68.8 million of our cash on deposit in the U.K. as collateral in a restricted account with the bank providing the facility. We are required to leave the cash in the restricted account so long as the bank continues to maintain associated letters of credit under the facility. The maximum amount of letters of credit currently allowed by the facility is $66.8 million, and any increase above this amount would require bank approval and additional restricted funds to be placed on deposit. We may choose at any time to terminate the facility and move the associated letters of credit to another credit facility. Letters of credit outstanding under the Secured Letter of Credit Facility do not reduce the available line of credit available under the Revolving Credit Agreement.

 

As of December 31, 2012, $165.1 million of the $174.1 million of our cash, cash equivalents, and short-term investments was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.

 

55



Table of Contents

 

Our financial condition remained strong with working capital of $396.7 million and a current ratio of 2.4 to 1 at December 31, 2012. We expect that cash on hand, cash flows from operations, and our unused lines of credit will be adequate to meet our liquidity requirements for the foreseeable future.

 

Quarterly Results — Three- and six-month periods ended March 31, 2013 and 2012

 

Consolidated Overview

 

Sales for the quarter ended March 31, 2013 increased 7% to $368.6 million from $343.8 million in the quarter ended March 31, 2012. Sales in the second quarter of fiscal year 2012 decreased 2% from 2011 sales of $350.2 million. CDS sales and CTS sales increased 28% and 5%, respectively, in fiscal 2013 compared to the second quarter of 2012, while MSS sales decreased 4%. Sales from CTS also increased in the second quarter of 2012, while MSS and CDS sales decreased. Abraxas added sales of $17.0 million to MSS sales in the second quarter of 2012, compared to $14.2 million in the second quarter of 2011. Abraxas was acquired in the first quarter of fiscal 2011.

 

For the first six months of fiscal year 2013, sales increased to $683.4 million compared to $663.7 million in 2012, an increase of 3%. Sales for the first half of 2012 were 5% higher than sales of $632.5 million in the first half of 2011. CDS sales increased 12% in 2013 compared to the first six months of 2012, while CTS and MSS sales remained relatively consistent for these periods. The sales generated by businesses we acquired during 2013 totaled $10.6 million and $11.1 million for the three- and six-month periods ended March 31, 2013, respectively. Sales from CTS and MSS increased in the first half of 2012, while CDS sales decreased. The  acquisition of Abraxas added $36.2 million to MSS sales for the six-month period of 2012 compared to $15.5 million in 2011. See the segment discussions following for further analysis of segment sales.

 

Operating income was $37.4 million in the second quarter of 2013 compared to $35.9 million in the second quarter of 2012, an  increase of 4%. Operating income for the second quarter of 2012 was 16% lower than operating income of $42.7 million in the second quarter of 2011. CTS operating income increased 32% in the second quarter of 2013, while MSS operating income decreased 22% and CDS operating income decreased 100% compared to the second quarter of 2012. CDS operating income for the second quarter included $6.1 million of restructuring costs related to severance pay and benefits. Businesses we acquired in 2013 generated operating losses of $0.6 million for the quarter, including $0.2 of transaction-related costs. For the second quarter of 2012, operating income decreased in all three segments compared to the second quarter of 2011. Unallocated corporate and other costs for the second quarter of 2013 were $1.5 million compared to $1.6 million in 2012 and $1.9 million in 2011.

 

Operating income for the first six months of 2013 decreased 12% to $57.9 million from $65.9 million in 2012. Operating income for the first half of 2012 was 3% lower than operating income of $68.1 million in the first half of 2011. CDS and MSS operating income decreased 88% and 14%, respectively, in 2013 compared to the first six months of 2012, while CTS operating income increased 8%. CDS operating results for the six-month period included the restructuring charge mentioned above. Businesses we acquired in 2013 generated operating losses of $0.8 million for the six months ended March 31, 2013, including $0.6 million of transaction-related costs. Operating income decreased from CDS and MSS in the first half of 2012, while CTS operating income increased slightly from 2011. Unallocated corporate and other expenses for the first six months of the fiscal year were $1.9 million for 2013, $2.2 million for 2012 and $3.5 million for 2011. See the segment discussions following for further analysis of segment operating income.

 

Adjusted EBITDA for the second quarter of fiscal 2013 was $44.3 million, compared to $41.4 million in the second quarter of fiscal 2012 and $48.9 million in the second quarter of fiscal 2011. For the first six months of the fiscal year, Adjusted EBITDA decreased to $69.5 million in 2013 compared to $77.2 million in 2012 and $78.2 million in 2011. The changes in Adjusted EBITDA for the quarter and six-month period ended March 31, 2013 are primarily related to the changes in operating income for the corresponding periods. See below for a reconciliation of this non-GAAP metric to net income and see the explanation above for why we believe it to be an important measure of performance.

 

Net income attributable to Cubic for the second quarter of fiscal 2013 increased to $29.7 million, or $1.11 per share, compared to $25.9 million, or 97 cents per share in 2012 and $30.2 million, or $1.13 per share in 2011. Net income in 2013 increased for the quarter due to an increase in operating income, and a decrease in income tax expense, which was impacted by the decrease in the effective income tax rate, as described below. The impact of these items was partially offset by a decrease in interest and dividend income and an increase in interest expense. Net income decreased for the second quarter of 2012 due to a decrease in operating income, primarily from CDS.

 

For the first six months of 2013, net income attributable to Cubic decreased to $43.9 million, or $1.64 per share, from $48.1 million, or $1.80 per share in 2012 and $48.3 million, or $1.81 per share in 2011. The decrease in net income in 2013 for the six-month period was primarily due to a decrease in operating income, partially offset by a decrease in income tax expense. In the first quarter of fiscal 2013, we recorded $0.6 million of interest expense related to a judgment against us, which required us to pay such amount of interest  to the court on behalf of a party that had filed claims against us. Also, interest and dividend income decreased for the six-month period based upon the decrease in our average cash balances over the first six months of 2013. Included in other income was a net foreign currency exchange loss of $0.2 million in the first six months of 2013 compared to a gain of $1.5 million in 2012 and a loss of $1.6 million in 2011, before applicable income taxes. Net income decreased for the first six months of 2012 due to a decrease in operating income, primarily from CDS. The effective tax rate for the first half of 2012 increased from 2011, also resulting in lower net income   in the first six months of 2012 compared to 2011.

 

56



Table of Contents

 

Our gross margin percentages on product sales decreased to 29% in the second quarter of 2013 from 32% in 2012, which had  increased from 31% in 2011. For the first six months of fiscal year 2013, gross margin percentages on product sales decreased to 28% from 29% in 2012 and 32% in 2011. The decrease in gross margin percentages in 2013 were primarily due to decreases in CDS sales of air and ground combat training systems to customers in the Far East. The decrease in gross margin percentages on product sales in 2012 were primarily due to the growth in sales from new CTS design and build contracts that were in an early stage of development and were realizing lower margins than our other, more mature, CTS contracts and due to cost growth on two CTS design and build contracts, one in North America and one in Europe, totaling $2.8 million for the first half of 2012.

 

Our gross margin percentages on service sales increased to 24% in the second quarter of 2013 from 22% in 2012 and 2011. For the first six months of fiscal year 2013, gross margin percentages on service sales increased to 22% from 21% in 2012 and 20% in 2011. The increase in the gross margin percentages on services sales for the three- and six-month periods ended March 31, 2013 is the result of the increase in CTS service sales as a percentage of our total service sales. CTS service sales have a higher gross margin percentage than service sales from our other segments.

 

SG&A expenses decreased in the second quarter of 2013 to $41.3 million compared to $43.0 million in 2012 and $38.5 million in 2011. For the six-month period of 2013, SG&A increased to $82.3 million compared to 78.3 million in 2012 and $76.7 million in 2011. As a percentage of sales, SG&A expenses were 11% for the second quarter of 2013 compared to 13% in 2012 and 11% in 2011. For the six-month period SG&A expenses were 12% in all three years. The higher SG&A expense in the second quarter of 2012 was primarily due to a $2.9 million provision for a legal claim that was accrued for in that period. Selling and marketing costs in the  second quarter of 2013 were slightly lower than in 2012; however, selling and marketing costs for the six-month period ended March 31, 2013 were higher than in 2012. In the second quarter of 2013 we incurred expenses of $0.7 million in preparation for a secondary offering of currently outstanding shares for certain of our shareholders. During the first quarter of 2013 we incurred $1.1 million of professional services costs in connection with the restatement of our consolidated financial statements for the year ended September 30, 2012 and previous periods. Also, in the first quarter of 2013 SG&A expenses were reduced by $1.4 million related to proceeds from an insurance claim for losses that we incurred over the period from fiscal 2010 to fiscal 2012. SG&A expenses in businesses that we acquired in 2013 were $1.1 million for the second quarter and $1.6 million for the first six months of 2013.

 

Company funded R&D expenditures, which mainly relate to new defense technologies we are developing, were $7.1 million for the second quarter of 2013 compared to $8.1 million in 2012 and $5.3 million in 2011, and were $12.9 million for the six-month period in 2013 compared to $13.0 million in 2012 and $11.5 million in 2011. Amortization of purchased intangibles increased for the second quarter of 2013 to $4.3 million compared to $3.7 million in 2012, which had decreased from $4.3 million in 2011. The increase in 2013 was due to the amortization of intangible assets related to businesses purchased during 2013. Amortization of purchased intangibles for the first six months of 2013 increased to $7.8 million from $7.7 million in 2012 and $6.4 million in 2011.

 

The American Taxpayer Relief Act of 2012, which reinstated the U.S. R&D tax credit retroactively from January 1, 2012 through December 31, 2013, was enacted into law during the second quarter of fiscal 2013. Therefore, the tax benefit resulting from the reinstatement for fiscal 2013 was reflected in our estimated annual effective tax rate for fiscal 2013 in the second fiscal quarter. Additionally, we recorded a discrete tax benefit of approximately $1.9 million in the second quarter of fiscal 2013 related to the reinstatement of the U.S. R&D tax credit for fiscal 2012. After consideration of both of these items, we estimated our annual effective income tax rate for fiscal 2013 would be approximately 25%. The effective rate for fiscal 2013 could be affected by, among other factors, the mix of business between the U.S. and foreign jurisdictions, our ability to take advantage of available tax credits and audits of our records by taxing authorities.

 

57



Table of Contents

 

Transportation Systems Segment (CTS)

 

 

 

Six Months Ended
March 31, 

 

Three Months Ended
March 31, 

 

 

 

2013 

 

2012 

 

2011 

 

2013 

 

2012 

 

2011

 

 

 

(in millions) 

 

(in millions) 

 

 

 

(As Restated) 

 

(As Restated) 

 

(As Restated) 

 

(As Restated) 

 

(As Restated) 

 

(As Restated)

 

Transportation Systems Segment Sales

 

$

263.6

 

$

263.8

 

$

201.2

 

$

142.4

 

$

135.3

 

$

112.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Transportation Systems Segment Operating Income

 

$

50.5

 

$

46.7

 

$

42.7

 

$

35.3

 

$

26.7

 

$

28.7

 

 

CTS sales increased 5% in the second quarter of 2013 to $142.4 million compared to $135.3 million in 2012, which represented a 20% increase over 2011 second quarter sales of $112.6 million. For the six-month period, sales remained relatively consistent at $263.6 million in 2013 compared to $263.8 million in 2012, which had increased 31% over 2011 sales of $201.2 million for such period. During the quarter and six months ended March 31, 2013, CTS generated higher sales from contracts in the U.K., including higher annual system usage incentives on a significant U.K. contract that were recognized in the second quarter, as well as higher sales on a contract for a suburban bus system near Chicago. NextBus, a business we acquired in January 2013 that provides real-time passenger information products and services to transit agencies, contributed sales of $1.5 million for the quarter. For the quarter and six-month period CTS realized lower sales both from a contract to design and build a system in Sydney and due to reduced work on a contract to design and build a system in Vancouver. Sales for the quarter and the six-month period ended March 31, 2012, were higher than in 2011 due to work on the contracts in Sydney and Vancouver, and our contracts in the U.K. Partially offsetting these increases were lower sales from design and build projects in the U.S. compared to the second quarter and six-month period of 2011. The average exchange rates between the prevailing currency in our foreign operations and the U.S. dollar resulted in a decrease in sales of $1.6 million for the second quarter of 2013 and an increase in sales of $1.1 million for the six-month period, compared to the same periods in 2012. In 2012, such exchange rates resulted in an increase in sales of $0.9 million for the second quarter of 2012 and $1.6 million for the six-month period, compared to 2011.

 

CTS operating income increased 32% in the second quarter of 2013 to $35.3 million compared to $26.7 million in 2012, which represented a 7% decrease from 2011 second quarter operating income of $28.7 million. For the six-month period, operating income increased 8% in 2013 to $50.5 million from $46.7 million in 2012, which had increased 9% over 2011 first half operating income of $42.7 million. The increases in operating income for the quarter and six-month period of 2013 were primarily due to higher sales from our contracts the U.K., including higher annual system usage incentives from the U.K. contract described above. In addition, sales increased during the quarter and six-month period on certain higher-margin products and services that we provide in Australia. In recent quarters, including the first quarter of 2013 we were incurring costs related to our contract in Sydney to transition portions of  the systems into operations, for which revenues were not sufficient to cover our costs of servicing the system. This situation began to improve in the second quarter of 2013 as portions of the systems were moving through the transition phase towards operations. The operating loss from NextBus was $0.3 million in the second quarter of 2013, including costs of the acquisition totaling $0.2 million. The improvement in 2012 operating income came from higher profit margins on a service contract in North America and from increased operating income on higher sales from the Vancouver contract. Partially offsetting these improvements was the $2.9 million claim provision mentioned above and cost growth on contracts in the U.S. and Europe that reduced operating income by $2.8 million for the six-month period of 2012.  The average exchange rates between the prevailing currency in our foreign operations and the U.S. dollar resulted in a decrease in operating income of $0.2 million for the second quarter of 2013 and an increase in operating income of $0.1 million for the six-month period, compared to the same periods in 2012. In 2012, such exchange rates resulted in a decrease in operating income of $0.2 million for the second quarter and the six-month period compared to 2011.

 

Mission Support Services Segment (MSS)

 

 

 

Six Months Ended
March 31,

 

Three Months Ended
March 31,

 

 

 

2013

 

2012

 

2011

 

2013

 

2012

 

2011

 

 

 

(in millions)

 

(in millions)

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Mission Support Services Segment Sales

 

$

235.6

 

$

234.4

 

$

231.9

 

$

122.2

 

$

126.9

 

$

133.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mission Support Services Segment Operating Income

 

$

7.8

 

$

9.1

 

$

10.2

 

$

3.6

 

$

4.6

 

$

5.1

 

 

MSS sales decreased 4% in the second quarter of 2013 to $122.2 million compared to $126.9 million in 2012, which had decreased  5% from 2011 sales of $133.1 million. Sales increased 1% for the six-month period to $235.6 million in 2013 from $234.4 million in 2012, after increasing 1% from sales of $231.9 million in 2011. Sales in the quarter and six-month period in 2013 were lower from certain contracts, including at the Joint Readiness Training Center (JRTC) in Fort Polk, Louisiana due to lower activity. The decrease in sales was also caused by the loss of contracts due to lower bids by competitors. These decreases in sales were partially offset for the quarter and were more than offset for the six-month period by increases in sales on certain Abraxas contracts, and by sales generated by NEK, a Special Operation Forces training business acquired in December 2012 that generated sales of $9.1 million and $9.6 million in the three- and six-month periods ended March 31, 2013, respectively. Sales growth for the six-month period of 2012 was driven by the acquisition of Abraxas in December 2010, which added $36.2 million to sales in 2012 compared to $15.5 million in 2011. Abraxas sales for the second quarter of 2012 were $2.8 million higher than in the second quarter of 2011. Sales decreased for the 2012 second quarter and six-month period from training and education contracts due to the migration of certain contracts to small businesses where we are now in a subcontractor role. In addition, earlier in 2012 we lost a contract in a competitive bid situation, for support of simulation trainers that we had performed for several years.

 

58



Table of Contents

 

MSS operating income decreased 22% in the second quarter of 2013 to $3.6 million compared to $4.6 million in 2012, which represented a 10% decrease from 2011 second quarter operating income of $5.1 million. For the six-month period, operating income decreased 14% in 2013 to $7.8 million from $9.1 million in 2012, which had decreased 11% from 2011 first half operating income of $10.2 million. The decreased operating income in 2013 primarily resulted from increased personnel costs on a flight simulator training contract and the loss of contracts described above. In addition, NEK had an operating loss of $0.3 million for the quarter and $0.5 million for the six-month period ended March 31, 2013, including acquisition-related costs of $0.4 million. Lower sales from certain higher margin training and education contracts contributed to the decrease in operating income for the quarter and six-month period in 2012 compared to 2011. The competitive environment in the government services industry is driving profit margins somewhat lower than in recent years, especially on contracts where we must compete for task orders on a regular basis.

 

59



Table of Contents

 

Defense Systems Segment (CDS)

 

 

 

Six Months Ended

 

Three Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2013

 

2012

 

2011

 

2013

 

2012

 

2011

 

 

 

(in millions)

 

(in millions)

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Defense Systems Segment Sales

 

 

 

 

 

 

 

 

 

 

 

 

 

Training systems

 

$

152.7

 

$

136.0

 

$

172.9

 

$

88.3

 

$

70.9

 

$

91.6

 

Secure communications

 

31.2

 

29.0

 

25.7

 

15.6

 

10.4

 

12.5

 

 

 

$

183.9

 

$

165.0

 

$

198.6

 

$

103.9

 

$

81.3

 

$

104.1

 

Defense Systems Segment Operating Income

 

 

 

 

 

 

 

 

 

 

 

 

 

Training systems

 

$

9.5

 

$

12.8

 

$

24.2

 

$

6.7

 

$

7.9

 

$

13.8

 

Secure communications

 

(1.9

)

(0.5

)

(5.5

)

(0.6

)

(1.7

)

(3.0

)

Restructuring costs

 

(6.1

)

 

 

(6.1

)

 

 

 

 

$

1.5

 

$

12.3

 

$

18.7

 

$

 

$

6.2

 

$

10.8

 

 

Training Systems

 

Training systems sales increased 25% in the second quarter of 2013 to $88.3 million compared to $70.9