Variable Interest Entities

3 Months Ended

Dec. 31, 2020

Variable Interest Entities

Variable Interest Entities

Note 3 – Variable Interest Entities

In accordance with Accounting Standards Codification (“ASC”) 810, Consolidation (“ASC 810”), we assess our partnerships and joint ventures at inception, and when there are changes in relevant factors, to determine if they are a variable interest entity (a “VIE”). We consider a partnership or joint venture to be a VIE if it has any of the following characteristics: (a) the total equity investment is not sufficient to permit the entity to finance its activities without additional subordinated financial support, (b) characteristics of a controlling financial interest are missing, or (c) the voting rights of the equity holders are not proportional to their obligations to absorb the expected losses of the entity.

We continually assess each VIE to determine if we are its primary beneficiary. We conclude that we are the primary beneficiary and consolidate the VIE if we have both (a) the power to direct the activities that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. We consider the VIE design, ownership and voting structure, contractual relationships, distribution of profits and losses, risks, responsibilities, and indebtedness in determining if we are the primary beneficiary.

In March 2018, Cubic and John Laing, an unaffiliated company that specializes in contracting under public-private partnerships, jointly formed Boston AFC 2.0 HoldCo. LLC (“Boston HoldCo”). Also in March 2018, Boston HoldCo’s created a wholly owned subsidiary, Boston AFC 2.0 OpCo. LLC (“Boston OpCo”), entered into a contract with the Massachusetts Bay Transit Authority (“MBTA”) for the financing, development and operation of a next-generation fare payment system in Boston, Massachusetts (the “Original MBTA Contract”). Boston HoldCo is 90% owned by John Laing and 10% owned by Cubic. Collectively, Boston HoldCo and Boston OpCo are referred to as the “P3 Venture”. Based on our assessment under ASC 810, we concluded that Boston OpCo and Boston HoldCo are VIEs and that we are the primary beneficiary of Boston OpCo. Consequently, we have consolidated the financial statements of Boston OpCo. We have concluded that we are not the primary beneficiary of Boston HoldCo, and thus we have not consolidated the financial statements of Boston HoldCo. In June 2020, MBTA and Boston OpCo executed an amended agreement (the “Amended MBTA Contract”), which modified certain provisions of the Original MBTA Contract

The Amended MBTA Contract consists of a design and build phase of approximately four years and an operate and maintain phase of approximately twelve years. The design and build phase is planned to be completed in 2024 and the initial operate and maintain phase is expected to commence in December 2021, with full service commencement spanning from 2024 through 2033. Under the Amended MBTA Contract, MBTA will make payments to Boston OpCo consisting of fixed payments of $43.5 million during the design and build phase, fixed payments of $175.8 million at the

full service commencement date, fixed payments of $618.0 million during the full service operate and maintain phase, variable payments for incremental transaction-based fees and inflation indexed payments during the operate and maintain phase, and payment adjustments for any performance penalties incurred by Boston OpCo during the project.

Boston OpCo subcontracted all of its contractual responsibilities regarding the design and build and the operation and maintenance of the fare system under the Amended MBTA Contract to Cubic. Under its subcontract with Boston OpCo, Cubic will receive fixed payments in the aggregate amount of $596.4 million, adjusted for incremental transaction-based fees, inflation indexed payments, less any performance penalties incurred.

Upon creation of the P3 Venture and upon execution of the Amended MBTA Contract, John Laing made loans to Boston HoldCo totaling $26.2 million in the form of bridge loans that are intended to be converted to equity in the future in accordance with its equity funding responsibilities under the terms of the P3 Venture. Concurrently, Boston HoldCo made corresponding equity contributions to Boston OpCo in the same amounts which are included within equity of noncontrolling interest in the VIE in our consolidated financial statements. Also, we issued a letter of credit for $2.9 million to Boston HoldCo in accordance with our equity funding responsibilities. Boston HoldCo is able to draw on this letter of credit in certain liquidity instances, but no amounts have been drawn through December 31, 2020.

In connection with the execution of the Amended MBTA Contract, Boston OpCo entered into an amended credit agreement with a group of financial institutions (the “Boston OpCo Amended Credit Agreement”), which includes two long-term debt facilities and a revolving credit facility. Under the Boston OpCo Amended Credit Agreement, the long-term debt facilities allow for draws up to an aggregate of $421.6 million during the design and build phase of the Amended MBTA Contract. The long-term debt facilities, including all interest and fees incurred, are required to be repaid on a fixed monthly schedule commencing once the design and build phase is completed in 2024. The long-term debt facilities bear interest at variable rates of LIBOR plus a margin of 1.75% to 2.0%. Boston OpCo incurred debt issuance and modification costs of $9.2 million during fiscal 2020 in connection with the Boston OpCo Amended Credit Agreement and these fees are being amortized as interest expense using the effective interest method over the term of the long-term debt facilities. Unamortized deferred financing costs are netted against long-term debt and amounted to $17.0 million and $17.2 million at December 31, 2020 and September 30, 2020, respectively. The revolving credit facility allows for draws up to a maximum aggregate amount of $15.8 million during the operate and maintain phase of the Amended MBTA Contract. Boston OpCo’s debt is nonrecourse with respect to Cubic and our subsidiaries. The fair value of the long-term debt facility approximates its carrying amount.

The Boston OpCo Amended Credit Agreement contains a number of covenants which require that Boston OpCo and Cubic maintain progress on the delivery of the MBTA Amended Agreement within a specified timeline and budget and provide regular reporting on such progress. The Boston OpCo Amended Credit Agreement also contains customary events of default including the delivery of a customized fare collection system to MBTA by a pre-determined date. Failure to meet such delivery date will result in Boston OpCo, and Cubic via our subcontract with Boston OpCo, to incur penalties due to the lenders thereunder.

Upon execution of the Boston OpCo Amended Credit Agreement, Boston OpCo terminated its existing interest rate swaps and paid termination costs of $34.4 million to the counterparties. Additionally, in connection with the Boston OpCo Amended Credit Agreement, Boston OpCo entered into new pay-fixed/receive-variable interest rate swaps to mitigate the variable interest rate associated with its long-term debt facility. The interest rate swaps contain forward starting notional principal amounts which align with Boston OpCo’s expected draws on its long-term debt facility. Boston OpCo’s interest rate swaps were not designated as effective hedges, and as such unrealized gains (losses) are included in other income (expense), net. At December 31, 2020 and September 30, 2020, the outstanding notional principal amounts on open interest rate swaps were $215.0 million and $194.0 million, respectively. The fair value of Boston OpCo’s interest rate swaps were $2.6 million and $5.9 million at December 31, 2020 and September 30, 2020, respectively, and is recorded as a liability in other noncurrent liabilities in our condensed consolidated balance sheets. As a result of changes in the fair value of its interest rate swaps, Boston OpCo recognized gains of $3.3 million, and $4.3 million for the three months ended December 31, 2020 and 2019, respectively. See Note 7 for a description of the measurement of fair value of derivative financial instruments, including Boston OpCo’s interest rate swaps.

Boston OpCo holds a restricted cash balance which is required by the Amended MBTA Contract to allow for the delivery of future change orders directed by MBTA.

The assets and liabilities of Boston OpCo that are included in our condensed consolidated balance sheets are as follows:

	December 31,		September 30,
	2020		2020
	(in thousands)
Cash	$	1,337	$	1,065
Restricted cash		3,822		1,822
Other current assets		34		31
Long-term contracts financing receivable		241,814		221,245
Total assets	$	247,007	$	224,163
Trade accounts payable	$	23	$	49
Accrued compensation and other current liabilities		100		85
Due to Cubic		22,674		27,259
Other noncurrent liabilities		2,638		5,890
Long-term debt		187,688		163,348
Total liabilities	$	213,123	$	196,631
Total Cubic equity		764		129
Noncontrolling interests		33,120		27,403
Total liabilities and owners' equity	$	247,007	$	224,163

The assets of Boston OpCo are restricted for its use only and are not available for our general operations. Boston OpCo’s debt is non-recourse to Cubic. Our maximum exposure to loss as a result of our equity interest in the P3 Venture is limited to the $2.9 million outstanding letter of credit, which will be converted to a cash contribution upon completion of the design and build phase of the Amended MBTA Contract.

Boston OpCo’s results of operations included in our Condensed Consolidated Statements of Operations are as follows (in thousands):

	Three Months Ended
	December 31,
	2020		2019
Revenue	$	4,021	$	1,245
Operating income		3,717		972
Other income (expense), net		3,252		3,071
Interest income		1,373		1,553
Interest expense		(1,989)		(1,159)