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DELTA TUCKER HOLDINGS, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our unaudited condensed consolidated financial condition and results of operations should be read in conjunction with the Delta Tucker Holdings, Inc. unaudited condensed consolidated financial statements, and the notes thereto, and other data contained elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis should also be read in conjunction with our audited consolidated financial statements, and notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our 2011 Annual Report. References to "Delta Tucker Holdings", the "Company", "we", "our" or "us" refer to Delta Tucker Holdings, Inc. and its subsidiaries unless otherwise stated or indicated by context. Company Overview We are a leading provider of specialized mission-critical professional and support services for the U.S. military, non-military U.S. governmental agencies and foreign governments. Our specific global expertise is in law enforcement training and support, security services, base and logistics operations, intelligence training, rule of law development, construction management, platform services and operations and linguist services. We also provide logistics support for all our services. Through our Predecessor entities, we have provided essential services to numerous U.S. government departments and agencies since 1951. Our current customers include the U.S. Department of Defense ("DoD"), the Department of State ("DoS"), foreign governments, commercial customers and certain other U.S. federal, state and local government departments and agencies. Reportable Segments In January of 2012, our organizational structure was amended. As part of these changes, we re-aligned our Business Area Teams ("BATs") into strategic business "Groups" reporting directly to the President of the Company. The prior three operating segments, Global Stabilization and Development Solutions ("GSDS"), Global Platform Support Solutions ("GPSS") and Global Linguist Solutions ("GLS") were re-aligned into six operating segments which include the LOGCAP ("LOGCAP") Group, Aviation ("Aviation") Group, Training and Intelligence Solutions ("TIS") Group, Global Logistics & Development Solutions ("GLDS") Group, Security Services ("Security") Group and the GLS Group. Our Aviation operating segment provides services domestically and in foreign countries under contracts with the U.S. government and some foreign customers; whereas our LOGCAP IV, TIS, GLDS, Security and GLS operating segments primarily provide services in foreign countries with the U.S. government as the primary customer. All six segments operate principally within a regulatory environment subject to governmental contracting and accounting requirements, including Federal Acquisition Regulations, Cost Accounting Standards and audits by various U.S. federal agencies. LOGCAP - This Group provides U.S. military operations and maintenance support. The LOGCAP Group operates under a single Indefinite Delivery, Indefinite Quantity ("IDIQ") contract and is the U.S. Army component of the DoD's initiative to award contracts to U.S. companies with a broad range of logistics capabilities in support of the U.S. and allied forces during combat, peacekeeping, humanitarian and training operations. Under LOGCAP IV, the U.S. Army contracts for us to perform selected services in theater to augment U.S. Army forces and release military units for other missions or to fill U.S. Army resource shortfalls. 46 -------------------------------------------------------------------------------- Table of Contents Aviation - This Group provides worldwide maintenance of aircraft fleet and ground vehicles, which includes logistics support on aircraft and aerial firefighting services, weapons systems, and related support equipment to the DoD and other U.S. government agencies and direct contracts with foreign governments. This Group also provides foreign assistance programs to help foreign governments improve their ability to develop and implement national strategies and programs to prevent the production, trafficking, and abuse of illicit drugs. The International Narcotics and Law Enforcement ("INL") Air Wing program and the Contract Field Teams ("CFT") program are the most significant programs in our Aviation Group. The INL Air Wing program supports governments in multiple Latin American countries and provides support and assistance with interdiction services in Afghanistan. This program also provides intra-theater transportation services for DoS personnel throughout Iraq and Afghanistan. The CFT program deploys highly mobile, quick-response field teams to customer locations globally to supplement a customer's workforce. Training & Intelligence Solutions - This Group provides international policing and police training, judicial support, immigration support and base operations to a variety of international and national customers. Under this Group we also provide senior advisors and mentors to foreign governmental agencies to provide leadership, operations and training, intelligence, logistics and security capabilities. This includes the services we provide under key contracts such as the Afghanistan Ministry of Defense Program ("AMDP"), the Combined Security Transition Command Afghanistan ("CSTC-A") program and the Civilian Police ("CivPol") program. This Group also provides proprietary training courses, management consulting and discrete mission support services to the intelligence community and national security clients. As part of our proprietary training courses, we offer a highly specialized human intelligence ("HUMINT") curriculum taught by cleared intelligence professionals to other intelligence, counterintelligence, special operations and law enforcement personnel. Global Logistics and Development Solutions - This Group supports U.S. foreign policy and international development priorities by assisting in the development of stable and democratic governments, implementing anti-corruption initiatives and aiding the growth of democratic public and civil institutions. This Group also provides base operations support, engineering, supply and logistics, pre-positioned war reserve materials, facilities, marine maintenance services, program management services primarily for ground vehicles and contingency response on a worldwide basis. These services are provided to U.S. government agencies in both domestic and foreign locations, foreign government entities and commercial customers. Security Services - This Group manages and operates complex security services by providing static security and personal protective details for U.S. and foreign diplomats, senior governmental officials and commercial clients in hostile and austere environments. This Group's core competencies include protective security details, static guard services, intelligence support and operating tactical operations centers, medical support, and emergency response capabilities. Global Linguist Solutions - GLS is a joint venture between DynCorp International LLC and McNeil Technologies ("McNeil"), in which we have a 51% ownership interest. GLS historically has had no other operations outside of performance on the Intelligence and Security Command ("INSCOM") contract, which began services in 2008. GLS provides rapid recruitment, deployment and on-site management of interpreters and translators in-theatre for a wide range of foreign languages in support of the U.S. Army, unified commands attached forces, combined forces, and joint elements executing the Operation Iraqi Freedom ("OIF") mission, and other U.S. government agencies supporting the OIF mission. During the year ended December 30, 2011, GLS was selected as one of six providers that will compete for task orders on the $9.7 billion Defense Language Interpretation Translation Enterprise ("DLITE") contract. We have submitted a bid on one of the task orders related to the DLITE contract; however, final decision on this task order has not yet been issued by the customer. Current Operating Environment and Outlook The following discussion is a supplement to and should be read in conjunction with the accompanying unaudited financial statements and related notes and with our Annual Report on Form 10-K for the year ended December 30, 2011. External Factors Since 2001, the overall level of U.S. defense spending has doubled. These historically high defense expenditures were driven in part to support operations in Iraq and Afghanistan and were funded through an account supplemental to the base defense budget called Overseas Contingency Operations ("OCO"). As a result of the U.S. military withdrawal from Iraq in December of 2011, and the drawdown of forces in Afghanistan, there has been a proportional and expected decline in the OCO account. In August 2011, Congress enacted the Budget Control Act of 2011 ("the Act") which brought to a conclusion the 2011 United States debt-ceiling crisis, which had threatened to lead the United States into sovereign default. The Act specified an immediate $917 billion of cuts over ten years, including $487 billion from defense spending. Additionally, the Act established the Joint Select Committee on Deficit Reduction, or the "super committee", to produce additional deficit reduction legislation. The goal of the Act was to produce a deficit reduction of at least $1.5 trillion over the coming 10 years which was to be passed 47 -------------------------------------------------------------------------------- Table of Contents by December 23, 2011. If Congress failed to produce such a bill with at least $1.2 trillion in cuts, then this would trigger across-the-board cuts, through a "sequestration of appropriations" equally split between security and non-security programs. Thus far, an agreement has not been achieved. Should Congress and the Administration fail to change or delay sequestration, beginning January of 2013, our customers could see their fiscal year 2013 budgets reduced by as much as an additional ten percent. Funding for our programs is dependent upon the annual budget and the appropriation decisions, as well as geo-political and macroeconomic conditions, which are beyond our control. While these dynamics could place pressure on defense spending, the President's fiscal year 2013 defense budget request indicates that the weapon system acquisition and modernization programs will be most negatively impacted by budget reductions. Operations and Maintenance budgets will remain relatively robust. We believe the following industry trends will result in continued demand in our target markets for the types of services we provide: • Realignment in military force structure, leading to increased outsourcing of non-combat functions, including life-cycle asset management functions ranging from organizational to depot-level maintenance; • Continued focus on smart power initiatives by DoS, USAID, the United Nations, and even the DoD, to include development and smaller-scale stability operations; • Increased maintenance, overhaul and upgrade needs to support aging military platforms; • Growth in outsourcing by foreign allies of maintenance, supply support, facilities management, infrastructure upgrades and construction management-related services; and • Further efforts by the U.S. government to move from single award to multiple award IDIQ contracts, which offer an opportunity to increase revenue by competing for task orders with the other contract awardees. As the NATO combat mission in Afghanistan comes to its conclusion in 2014, we anticipate significant opportunities to support not only the enduring U.S. and NATO presence, but also expanded opportunities to support the DoS presence, which is expected to expand and include the U.S. embassy in Kabul and four consulates around the country. Additionally, we anticipate that there will be a continued need to train and help professionalize Afghan National Security Forces for many years, as specified in the U.S. Afghanistan Strategic Partnership Agreement. In the Persian Gulf, Iran's continued nuclear ambitions have resulted in an unprecedented international sanctions regime and the bolstering of United States defense ties and presence throughout the region. We believe that base operations and support and maintenance capacity will be key enablers in this environment, and we are especially well positioned to provide these services to both United States forces and Allied nations. Finally, the re-balance to Asia reflects the increased importance of the Asia-Pacific regions, in both security and economic terms for the United States. As the United States revitalizes and reinforces its presence in this vital region, we expect to see increased requirements for base operations support, logistics support and capacity building, all of which we provide best in class. The investments and acquisitions we have made over the past three years have been focused on aligning our business to address areas that have high growth potential, including intelligence training and rule of law development, as well as parallel and evolving customer requirements. Notable Events for the Nine Months Ended September 28, 2012 • In January 2012, we were awarded a contract within our Aviation segment with the U.S. Air Force to provide support services for the DoD and contractor personnel in Egypt. The contract is fixed price with a one year base and four one-year options with a total potential contract value of $95.0 million. • In January 2012, we became a subcontractor to Alenia to support the Air Force Security Assistance Center ("AFSAC") G222/C27 A program. The time and materials contract has a two year base period with eight one-year options with a total potential contract value of $42.0 million and will operate under our Aviation segment. • In March 2012, we received a contract within our Aviation segment with the U.S. Army to provide a Maintenance Augmentation Team for the Kuwait Air Force AH-64D Apache helicopter maintenance program. The fixed price contract has one year base with four, one-year options and a total potential contract value of $25.4 million if all options are exercised. • In March 2012, we were awarded a contract with the U.S. Navy to provide facility support services for personnel from the Naval Mobile Construction Battalion unit in Dili, Timor-Leste. The fixed price, IDIQ contract has one base year with four one-year options and will operate under our Aviation segment. • In April 2012, we were awarded a contract with National Aeronautics and Space Administration ("NASA") to provide aircraft maintenance and operational support services at various locations. The contract is fixed price - award fee / cost plus award fee with a one year and four months base and two, two year option periods and a total potential value of $176.9 million and will operate under our Aviation segment. 48 -------------------------------------------------------------------------------- Table of Contents • In May 2012, we were awarded a task order within the Aviation segment by the U.S. Air Force under the Contract Field Teams ("CFT") to provide aircraft maintenance support at Robins Air Force Base in Georgia. We were the sole awardee for this IDIQ contract which has one base year and one option year and a total potential contract value of $92.6 million. • In June 2012, we were awarded a contract within the GLDS segment by the Naval Facilities Engineering Command-Pacific to provide operations support services within the Joint Operation Area and Manila, Republic of the Philippines. The cost-plus-award fee contract has a base year and four option years with a total potential contract value of $198 million. • In June 2012, we were awarded a contract with the U.S. Air Force Materiel Command to provide support services for T-6A and T-6B aircraft at several Air Force and Navy locations throughout the U.S. The firm-fixed price contract has one base year and one option year and a total potential contract value of $432 million and will operate under our Aviation segment. • In June 2012, we were awarded a task order with the U.S. Army Special Operations Command ("USASOAC") under the CFT contract to provide aviation support to the 160th Special Operations Aviation Regiment - Airborne at Fort Campbell, Kentucky. The IDIQ contract has an eight month base period and two one-year options and a total potential contract value of $54.5 million and will operate under our Aviation segment. • In July 2012, we were awarded multiple task orders within our GLDS segment with the U.S. Air Force under the Air Force Contract Augmentation Program ("AFCAP") program to provide various services at multiple locations including Colorado, the United Arab Emirates and Afghanistan. Collectively, these task orders have one base year and two, one year options and a total potential contract value of $13.2 million. • On July 6, 2012, we acquired 100% of Heliworks, Inc. ("Heliworks"), an aviation service provider based in Pensacola, Florida for $11.1 million, net of cash acquired. Heliworks services include aircraft maintenance and major repairs, avionics upgrades, component overhauls, charter flights and painting and refurbishment. Heliworks will be integrated within our Aviation segment. • In August 2012, we were awarded multiple task orders within our GLDS segment with the U.S. Air Force under the AFCAP program to provide monitor support for the Expeditionary Civil Engineer Squadrons ("ECES") in multiple locations in Afghanistan and to provide maintenance support services to vehicles and equipment at multiple locations in Afghanistan and Qatar. Collectively, these task orders have one base year and two, one year options and a total potential value of $27.3 million. • In September 2012, we were awarded a contract within the Aviation segment with the U.S. Air Force Air Education and Training Command, to provide jet engine maintenance for J-85 aircraft at Laughlin Air Force Base in Texas in support of the Engine Regional Repair Center. This firm-fixed price contract has an 11-month base period and five one-year options and a total potential contract value of $36 million. Contract Types Our business generally is performed under fixed-price, time-and-materials or cost-reimbursement contracts. Each contract type is described below: • Fixed-Price Type Contracts: In a fixed-price contract, the price is not subject to adjustment based on costs incurred, which can favorably or adversely impact our profitability depending upon our execution in performing the contracted service. Our fixed-price contracts may include firm fixed-price, fixed-price with economic adjustment and fixed-price incentive elements. • Time-and-Materials Type Contracts: Time-and-materials type contracts provide for acquiring supplies or services on the basis of direct labor hours at fixed hourly/daily rates plus materials at cost. • Cost-Reimbursement Type Contracts: Cost-reimbursement type contracts provide for payment of allowable incurred costs, to the extent prescribed in the contract, plus a fixed-fee, award-fee or incentive-fee or a combination. Award-fees or incentive-fees are generally based upon various objective and subjective criteria, such as aircraft mission capability rates and meeting cost targets. Award fees are excluded from estimated total contract revenue until a reasonably determinable estimate of award fees can be made. A single contract may be performed under one or more of the contract types discussed above. Any of these three types of contracts may be executed under an IDIQ contract, which are often awarded to multiple contractors. An IDIQ contract does not 49 -------------------------------------------------------------------------------- Table of Contents represent a firm order for services. As a result, the exact timing and quantity of delivery and pricing mechanism for IDIQ profit centers are not known at the time of contract award and could contain any type of pricing mechanism. Our CivPol, CFT and LOGCAP IV programs are three examples of IDIQ contracts. Our historical contract mix by type, as a percentage of revenue, is indicated in the table below. Three Months Ended Three Months Ended Nine Months Ended Nine Months Ended September 28, 2012 September 30, 2011 September 28, 2012 September 30, 2011 Fixed-Price 18 % 17 % 17 % 17 % Time-and-Materials 12 % 13 % 11 % 15 % Cost-Reimbursement 70 % 70 % 72 % 68 % Total 100 % 100 % 100 % 100 % Cost-reimbursement type contracts typically perform at lower margins than other contract types but carry lower risk of loss. Because the LOGCAP IV contract is predominantly a cost-reimbursement type contract, we anticipate that revenue from cost-reimbursement type contracts will continue to represent a large portion of our business in future years. Under many of our contracts, we may rely on subcontractors to perform all or a portion of the services we are obligated to provide to our customers. We use subcontractors primarily for specialized, technical labor and certain functions such as construction and catering. We often enter into subcontract arrangements in order to meet government requirements that certain categories of services be awarded to small businesses. Backlog We track backlog in order to assess our current business development effectiveness and to assist us in forecasting our future business needs and financial performance. Our backlog consists of funded and unfunded amounts under contracts. Funded backlog is equal to the amounts actually appropriated by a customer for payment of goods and services less actual revenue recognized as of the measurement date under that appropriation. Unfunded backlog is the actual dollar value of unexercised, priced contract options and the unfunded portion of exercised contract options. Most of our U.S. government contracts allow the customer the option to extend the period of performance of a contract for a period of one or more years. These priced options may or may not be exercised at the sole discretion of the customer. Historically, it has been our experience that the customer has typically exercised contract options. Firm funding for our contracts is usually made for one year at a time, with the remainder of the contract period consisting of a series of one-year options. As is the case with the base period of our U.S. government contracts, option periods are subject to the availability of funding for contract performance. The U.S. government is legally prohibited from ordering work under a contract in the absence of funding. Our historical experience has been that the government has typically funded the option periods of our contracts. The following table sets forth our approximate backlog as of the dates indicated: As Of September 28, 2012 December 30, 2011 (Amounts in millions) Funded backlog $ 1,867 $ 1,480 Unfunded backlog 4,199 4,261 Total $ 6,066 $ 5,741 Total backlog as of September 28, 2012 was $6.1 billion, as compared to $5.7 billion as of December 30, 2011. The increase in backlog was primarily due to new contract wins within the GLDS and the Aviation segment and the option year extension on the LOGCAP contract, partially offset by revenue recognized on current programs during the three months ended September 28, 2012. 50-------------------------------------------------------------------------------- Table of Contents Results of Operations Consolidated Three Months Ended September 28, 2012 compared to the Three Months Ended September 30, 2011 The following tables set forth our unaudited consolidated results of operations, both in dollars and as a percentage of revenue: Three Months Ended (Amounts in thousands) September 28, 2012 September 30, 2011 Revenue $ 1,010,314 100.0 % $ 935,393 100.0 % Cost of services (917,138 ) (90.8 )% (845,345 ) (90.4 )% Selling, general and administrative expenses (40,347 ) (4.0 )% (47,644 ) (5.1 )% Depreciation and amortization expense (12,375 ) (1.2 )% (12,255 ) (1.3 )% Earnings from equity method investees 315 0.1 % 3,894 0.4 % Impairment of equity method investment - - (76,647 ) (8.2 )% Impairment of goodwill (30,859 ) (3.1 )% - - Operating income (loss) 9,910 1.0 % (42,604 ) (4.6 )% Interest expense (22,011 ) (2.2 )% (22,836 ) (2.4 )% Loss on early extinguishment of debt (696 ) (0.1 )% - - Interest income 21 - 29 - Other income, net 68 - 685 0.1 % Loss before income taxes (12,708 ) (1.3 )% (64,726 ) (6.9 )% (Provision) benefit for income taxes (1,393 ) (0.1 )% 23,878 2.5 % Net loss (14,101 ) (1.4 )% (40,848 ) (4.4 )% Noncontrolling interests (1,693 ) (0.2 )% (780 ) (0.1 )% Net loss attributable to Delta Tucker Holdings, Inc. $ (15,794 ) (1.6 )% $ (41,628 ) (4.5 )% Revenue - Revenue for the three months ended September 28, 2012 was $1,010.3 million, an increase of $74.9 million, or 8.0%, compared to the three months ended September 30, 2011. The increase was primarily driven by the increase in revenue earned under our LOGCAP segment and Aviation segment, which together comprised approximately 78% of total consolidated revenue. See further discussion of our revenue results in the "Results by Segment" section below. Cost of services - Cost of services are comprised of direct labor, direct material, overhead, subcontractor, travel, supplies and other miscellaneous costs. Cost of services for the three months ended September 28, 2012 was $917.1 million, an increase of $71.8 million, or 8.5%, compared to the three months ended September 30, 2011. The increase in Cost of services was primarily due to the growth in our business. As a percentage of revenue, Cost of services was 90.8% and 90.4% during the three months ended September 28, 2012 and the three months ended September 30, 2011, respectively. The increase in Cost of services as a percentage of revenue was primarily driven the growth of our LOGCAP IV program, a cost-reimbursable contract that operates at lower margins relative to the overall contract mix, which contributed a greater share of our overall consolidated operations during the three months ended September 28, 2012 relative to the comparable period in the prior year. See further discussion of program margins in the "Results by Segment" section below. Selling, general and administrative expenses ("SG&A") - SG&A primarily relates to functions such as management, legal, financial accounting, contracts and administration, human resources, management information systems, purchasing, and business development. SG&A decreased by $7.3 million, or 15.3%, to $40.3 million during the three months ended September 28, 2012 compared to the three months ended September 30, 2011 primarily as a result of non-routine severance costs incurred during the three months ended September 30, 2011, a reduction in bonuses accrued under the Management Incentive Plan during the three months ended September 28, 2012 and a reduction in professional fees associated with business system improvements partially offset by an increase in legal costs associated with ongoing litigation. These changes also drove the reduction in SG&A as a percentage of revenue to 4.0% for the three months ended September 28, 2012 from 5.1% for the three months ended September 30, 2011. Depreciation and amortization - Depreciation and amortization during the three months ended September 28, 2012, was $12.4 million, an increase of $0.1 million, or 1.0%, as compared with depreciation and amortization during the three months ended September 30, 2011. The increase was primarily the result of the addition of fixed assets in conjunction with the acquisition of Heliworks, Inc. partially offset by certain non-compete agreements becoming fully amortized during the second half of the year ended December 30, 2011. Earnings from equity method investees - Earnings from operationally integral unconsolidated affiliates for the three months ended September 28, 2012 was $0.3 million. In September of 2011, we recorded an impairment of our investment in GLS resulting in us no longer recognizing any earnings until cash is received through a dividend distribution. We expect our earnings from equity method investees will remain minimal throughout the remainder of the year unless additional task orders are received. See Note 10 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. 51-------------------------------------------------------------------------------- Table of Contents Impairment of goodwill - Impairment of goodwill for the three months ended September 28, 2012 was $30.9 million. We recognized an impairment charge on our goodwill associated with one of the reporting units within the TIS reporting segment as a result of our assessment of a triggering event during the quarter. See Note 3 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. Interest expense - Interest expense for the three months ended September 28, 2012 was $22.0 million, a decrease of $0.8 million, or 3.6%, compared to the three months ended September 30, 2011. The decrease was primarily due to the reduction of the principal balance of our Term Loan. We made principal prepayments of $98.7 million and $60.0 million during the fourth quarter of calendar year 2011 and during the nine months ended September 28, 2012, respectively. Other income, net - Other income, net includes our share of earnings from unconsolidated joint ventures that are not operationally integral to our business as well as gains/losses from foreign currency and asset sales. Other income, net during the three months ended September 28, 2012 was $0.1 million, a decrease of $0.6 million, or 90.1%, compared to the three months ended September 30, 2011 primarily driven by a reduction in earnings from our unconsolidated joint venture Babcock. Income taxes - Our effective tax rate consists of federal and state statutory rates and certain permanent differences. The effective tax rate for the three months ended September 28, 2012 was 11.0%, as compared to 36.9% for the three months ended September 30, 2011. The decrease in the tax rates was due primarily to the impact of the goodwill impairment recorded in the third quarter of the year. 52 -------------------------------------------------------------------------------- Table of Contents Consolidated Nine Months Ended September 28, 2012 compared to the Nine Months Ended September 30, 2011 The following tables set forth our unaudited consolidated results of operations, both in dollars and as a percentage of revenue: Nine Months Ended (Amounts in thousands) September 28, 2012 September 30, 2011 Revenue $ 3,018,469 100.0 % $ 2,738,441 100.0 % Cost of services (2,756,839 ) (91.3 )% (2,500,412 ) (91.3 )% Selling, general and administrative expenses (116,822 ) (3.9 )% (117,005 ) (4.3 )% Depreciation and amortization expense (37,594 ) (1.3 )% (38,229 ) (1.4 )% Earnings from equity method investees 538 - 11,830 0.5 % Impairment of equity method investment - - (76,647 ) (2.8 )% Impairment of goodwill (30,859 ) (1.0 )% - - Operating income 76,893 2.5 % 17,978 0.7 % Interest expense (65,438 ) (2.2 )% (69,537 ) (2.5 )% Loss on early extinguishment of debt (1,479 ) - (2,397 ) (0.1 )% Interest income 94 - 168 - Other income, net 4,768 0.2 % 4,792 0.2 % Income (loss) before income taxes 14,838 0.5 % (48,996 ) (1.7 )% (Provision) benefit for income taxes (11,744 ) (0.4 )% 17,787 0.6 % Net income (loss) 3,094 0.1 % (31,209 ) (1.1 )% Noncontrolling interests (4,322 ) (0.1 )% (2,185 ) (0.1 )% Net loss attributable to Delta Tucker Holdings, Inc. $ (1,228 ) - $ (33,394 ) (1.2 )% Revenue - Revenue for the nine months ended September 28, 2012 was $3,018.5 million, an increase of $280.0 million, or 10.2%, compared to the nine months ended September 30, 2011. The increase was primarily driven by the increase in revenue earned under our LOGCAP and Aviation segments, which together comprised approximately 76% of total consolidated revenue. See further discussion of our revenue results in the "Results by Segment" section below. Cost of services - Cost of services are comprised of direct labor, direct material, overhead, subcontractor, travel, supplies and other miscellaneous costs. Cost of services for the nine months ended September 28, 2012 was $2,756.8 million, an increase of $256.4 million, or 10.3%, compared to the nine months ended September 30, 2011. The increase in Cost of services was due to the growth in our business and was consistent with the increase in revenue. As a percentage of revenue, Cost of services remained flat at 91.3% during the nine months ended September 28, 2012 and September 30, 2011. See further discussion of program margins in the "Results by Segment" section below. Selling, general and administrative expenses ("SG&A") - SG&A primarily relates to functions such as management, legal, financial accounting, contracts and administration, human resources, management information systems, purchasing, and business development. SG&A decreased by $0.2 million, or 0.2%, to $116.8 million during the nine months ended September 28, 2012 compared to the nine months ended September 30, 2011 primarily as a result of (i) non-routine severance costs incurred during the nine months ended September 30, 2011 associated with the corporate realignment, (ii) the acceleration of the Phoenix and Casals retention bonuses during the nine months ended September 30, 2011 and (iii) a reduction in bonuses accrued under the Management Incentive Plan during the nine months ended September 28, 2012. These decreases were partially offset by an increase in legal costs associated with ongoing litigation. These changes also drove the reduction in SG&A as a percentage of revenue to 3.9% during the nine months ended September 28, 2012 compared to 4.3% during the nine months ended September 30, 2011. Depreciation and amortization - Depreciation and amortization during the nine months ended September 28, 2012, was $37.6 million, a decrease of $0.6 million, or 1.7%, as compared with depreciation and amortization during the nine months ended September 30, 2011. The decrease was primarily the result of non-compete agreements becoming fully amortized during the second half of the year ended December 30, 2011 partially offset by additional depreciation expense on fixed asset additions, including fixed assets acquired in conjunction with the purchase of Heliworks, Inc., during the nine months ended September 28, 2012. Earnings from equity method investees - Earnings from operationally integral unconsolidated affiliates for the nine months ended September 28, 2012 was $0.5 million. In September of 2011, we recorded an $76.6 million impairment of our 53 -------------------------------------------------------------------------------- Table of Contents investment in GLS resulting in us no longer recognizing any earnings until we receive cash through a dividend distribution. As GLS' task orders come to an end in December 2012, we do not anticipate any further work under the task orders after their completion. We expect our earnings from equity method investees will remain minimal throughout the remainder of the year unless additional task orders are received. See Note 10 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. Impairment of goodwill - Impairment of goodwill for the nine months ended September 28, 2012 was $30.9 million. We recognized an impairment charge on our goodwill associated with one reporting units within the TIS reporting segment as a result of our assessment of a triggering event in the quarter. See Note 3 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. Interest expense - Interest expense for the nine months ended September 28, 2012 was $65.4 million, a decrease of $4.1 million, or 5.9%, compared to the nine months ended September 30, 2011. The decrease was primarily due to the reduction of the principal balance of our Term Loan. We made principal prepayments of $98.7 million and $60.0 million during the fourth quarter of calendar year 2011 and during the nine months ended September 28, 2012, respectively. Other income, net - Other income, net includes our share of earnings from unconsolidated joint ventures that are not operationally integral to our business as well as gains/losses from foreign currency and asset sales. Other income, net remained flat at $4.8 million during the nine months ended September 28, 2012 compared to the nine months ended September 30, 2011, as year over year earnings were consistent during the comparable nine month periods from our Babcock joint venture. Income taxes - Our effective tax rate consists of federal and state statutory rates and certain permanent differences. The effective tax rate for the nine months ended September 28, 2012 was 79.1%, as compared to 36.3% for the nine months ended September 30, 2011. The effective tax rate for the nine months ended September 28, 2012 was driven primarily by the impact of the goodwill impairment recognized during the third quarter. 54-------------------------------------------------------------------------------- Table of Contents Results by Segment - Three Months Ended September 28, 2012 Compared to Three Months Ended September 30, 2011 The following tables set forth the revenue for our operating segments, both in dollars and as a percentage of our consolidated revenue as well as operating income for our operating segments along with segment operating margin, during the three months ended September 28, 2012, as compared to the three months ended September 30, 2011. Three Months Ended Three Months Ended (Amounts in thousands) September 28, 2012 September 30, 2011 Revenue LOGCAP $ 438,255 42.9 % $ 383,289 37.9 % Aviation 348,560 34.1 % 283,310 28.0 % Training & Intelligence Solutions 124,989 12.2 % 156,603 15.5 % Global Logistics & Development Solutions 66,199 6.5 % 81,081 8.0 % Security Services 30,058 2.9 % 18,154 1.8 % GLS 13,672 1.3 % 89,524 8.8 % Total segments 1,021,733 100.0 % 1,011,961 100.0 % GLS deconsolidation(1) (13,672 ) (89,524 ) Headquarters/eliminations(2) 2,253 12,956 Consolidated revenue $ 1,010,314 $ 935,393 Operating income (loss) LOGCAP $ 17,997 4.1 % $ 10,187 2.7 % Aviation 30,027 8.6 % 24,485 8.6 % Training & Intelligence Solutions(3) (26,187 ) (21.0 )% 5,624 3.6 % Global Logistics & Development Solutions 6,078 9.2 % 4,628 5.7 % Security Services 1,659 5.5 % 1,168 6.4 % GLS 813 5.9 % 7,740 8.6 % Total segments 30,387 3.0 % 53,832 5.3 % GLS deconsolidation(1) (813 ) (7,740 ) Headquarters/eliminations(4) (19,664 ) (88,696 ) Consolidated operating income (loss) $ 9,910 $ (42,604 ) (1) The Company deconsolidated GLS effective July 7, 2010. (2) Headquarters revenue primarily represents revenue earned on shared service arrangements for general and administrative services provided to unconsolidated joint ventures at zero profit. (3) During the three months ended September 28, 2012, we recognized an impairment charge on our goodwill associated with one of the reporting units within the TIS reporting segment as a result of our assessment of a triggering event in the quarter. See Note 3 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. (4) The Headquarters portion of operating income primarily relates to amortization of intangible assets and other costs that are not allocated to segments and are not billable to our U.S. government customers, partially offset by equity method investee income. During the three months ended September 30, 2011, we recognized an impairment on our equity method investment in GLS. See Note 10 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. LOGCAP Revenue of $438.3 million increased $55.0 million, or 14.3%, during the three months ended September 28, 2012 compared to the three months ended September 30, 2011 primarily as a result of an increase in the volume of work under the Afghanistan Area of Responsibility ("AOR") partially offset by manning reductions under the Kuwait AOR resulting from the troop drawdown in Iraq as Operation Iraqi Freedom ("OIF") winds down. LOGCAP is comprised of task orders that are primarily cost-reimbursable and provide for payment of allowable incurred costs, to the extent prescribed in the contract, plus a 55-------------------------------------------------------------------------------- Table of Contents fixed base fee and an award fee. As discussed in Note 14 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, our award fee estimate increased by $10.4 million during the three months ended September 28, 2012, as we received an award fee determination letter on our Afghanistan task order that was higher than our previous estimate used during the award fee period. Although we believe our award fees will continue to be strong in the future, we anticipate the volume of work in Afghanistan will begin to decline during calendar year 2013. Operating income of $18.0 million increased $7.8 million, or 76.7%, for the three months ended September 28, 2012 compared to operating income of $10.2 million for the three months ended September 30, 2011 primarily as a result of the changes in volume and award fee discussed above. Operating income as a percentage of revenue increased to 4.1% for the three months ended September 28, 2012 compared to 2.7% for three months ended September 30, 2011 primarily as a result of higher award fee scores. Aviation Revenue of $348.6 million increased $65.3 million, or 23.0%, during the three months ended September 28, 2012 compared to the three months ended September 30, 2011. The change was primarily the result of an increase in demand for intra-theater transportation services in Iraq and Afghanistan, construction services in Iraq under the INL Air Wing program and increased demand for flight hours under the Counter Narcoterrorism Technology Program Officer ("CNTPO") contract. Additionally, operations under new CFT task orders, including the Robins Air Force Base and 160th Special Operations Aviation Regiment - Airborne ("SOAR-A") task orders, and new contracts, including the T6 Contractor Operated and Maintained Base Supply ("COMBS"), NASA Aircraft Maintenance Operational Support ("AMOS") and G222 contracts, also drove the increase in revenue for the three months ended September 28, 2012. Operating income of $30.0 million increased $5.5 million, or 22.6%, during the three months ended September 28, 2012 compared to the three months ended September 30, 2011 as a result of the increased demand discussed above with margin expansion on CNTPO and CFT contributing to the increase. Operating income as a percentage of revenue remained flat at 8.6% for the three months ended September 28, 2012 and September 30, 2011. Training and Intelligence Solutions Revenue of $125.0 million decreased $31.6 million, or 20.2%, during the three months ended September 28, 2012 compared to the three months ended September 30, 2011 primarily as a result of the ramp-down of operations under the CivPol program in Iraq and the loss of revenue from the Multi-National Security Transition Command-Iraq ("MNSTC-I") program, which concluded during calendar year 2011 and did not contribute to operations in the current period. These declines were partially offset by increased volume under CivPol Afghanistan and Palestine as well as under our AMDP program. As a result of the decline in revenue and the forecasted outlook for the training and mentoring reporting unit within this segment, we recorded a goodwill impairment charge during the three months ended September 28, 2012 of $30.9 million. See Note 3 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. An operating loss of $26.2 million was recognized during the three months ended September 28, 2012 as a result of the goodwill impairment recorded for the Training and Mentoring reporting unit. See Note 3 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. Operationally, operating income was impacted by the reduction in revenue discussed above and the overall contract mix containing comparatively more contracts operating at lower margins. Global Logistics & Development Solutions Revenue of $66.2 million decreased $14.9 million, or 18.4%, during the three months ended September 28, 2012 compared to the three months ended September 30, 2011 primarily as a result of the completion of certain task orders under the Air Force Contract Augmentation Program ("AFCAP") contract as well as the completion of the Weapons Removal and Abatement ("WRA") and Sudan development contracts. The decrease in revenue was partially offset by operations under the Egyptian Personnel Support Services ("EPSS") contract, which began during calendar year 2012, and the revenue growth under the Oshkosh Defense, War Reserve Materiel ("WRM") and Philippines Operational Support programs. Operating income of $6.1 million increased $1.5 million, or 31.3%, during the three months ended September 28, 2012 compared to the three months ended September 30, 2011 primarily as a result of margin improvements on the Oshkosh Defense contract driven by one-time start up costs related to deploying personnel in the prior year that did not occur in the current period and on the Philippines Operational Support program resulting from higher award fee scores during the current period relative to the comparable period in the prior year partially offset by the changes in volume discussed above. These margin changes drove the increase in operating income as a percentage of revenue to 9.2% for the three months ended September 28, 2012 from 5.7% for the three months ended September 30, 2011. 56 -------------------------------------------------------------------------------- Table of Contents Security Services Revenue of $30.1 million increased $11.9 million, or 65.6%, during the three months ended September 28, 2012 compared to the three months ended September 30, 2011 primarily as a result of the replacement of the Worldwide Personal Protection Program ("WPPS") with the higher volume Worldwide Protective Services ("WPS") program during the three months ended September 30, 2011 as well as the addition of the Chemonics and Bondsteel contracts, which became operational during the first quarter of calendar year 2012. As a result of performance challenges, such as fill rates, transition costs and customer process impediments on the WPS and Bondsteel contracts, these contracts were identified as loss contracts during the first quarter of calendar year 2012. However, during the three months ended September 28, 2012, we reached a final resolution with our customer minimizing future losses on the WPS contract and we completed the transition period and do not anticipate material incremental losses on the Bondsteel contract. Additionally, during the three months ended September 28, 2012, the WPS contract was awarded an additional option year which resulted in a positive change in estimate. These changes resulted in the recognition of operating income of $1.7 million during the three months ended September 28, 2012. GLS Revenue of $13.7 million decreased $75.9 million, or 84.7%, during the three months ended September 28, 2012 compared to the three months ended September 30, 2011 primarily as a result of the reduction in deployed linguists under the INSCOM contract in support of U.S. troop levels in Iraq as the war came to an end in December 2011. GLS' task orders under the INSCOM contract end in December 2012. Operating income of $0.8 million decreased $6.9 million, or 89.5%, during the three months ended September 28, 2012 compared to the three months ended September 30, 2011 primarily as a result of the reduction in volume under the INSCOM contract as discussed above. We do not anticipate any further work under the INSCOM contract after the completion of these task orders. Results by Segment - Nine Months Ended September 28, 2012 Compared to Nine Months Ended September 30, 2011 The following tables set forth the revenue for our operating segments, both in dollars and as a percentage of our consolidated revenue as well as operating income for our operating segments along with segment operating margin, during the nine months ended September 28, 2012, as compared to the nine months ended September 30, 2011. 57 -------------------------------------------------------------------------------- Table of Contents Nine Months Ended Nine Months Ended (Amounts in thousands) September 28, 2012 September 30, 2011 Revenue LOGCAP $ 1,333,770 43.6 % $ 1,165,065 38.4 % Aviation 968,206 31.7 % 813,744 26.8 % Training & Intelligence Solutions 413,924 13.5 % 471,420 15.5 % Global Logistics & Development Solutions 216,034 7.1 % 226,470 7.5 % Security Services 81,358 2.7 % 45,494 1.5 % GLS 43,424 1.4 % 314,675 10.3 % Total segments 3,056,716 100.0 % 3,036,868 100.0 % GLS deconsolidation(1) (43,424 ) (314,675 ) Headquarters/eliminations(2) 5,177 16,248 Consolidated revenue $ 3,018,469 $ 2,738,441 Operating income LOGCAP $ 44,939 3.4 % $ 31,581 2.7 % Aviation 80,714 8.3 % 54,515 6.7 % Training & Intelligence Solutions(3) (17,054 ) (4.1 )% 26,326 5.6 % Global Logistics & Development Solutions 18,348 8.5 % 11,033 4.9 % Security Services (6,501 ) (8.0 )% 3,338 7.3 % GLS 2,864 6.6 % 23,208 7.4 % Total segments 123,310 4.0 % 150,001 4.9 % GLS deconsolidation(1) (2,864 ) (23,208 ) Headquarters/eliminations(4) (43,553 ) (108,815 ) Consolidated operating income $ 76,893 $ 17,978 (1) The Company deconsolidated GLS effective July 7, 2010. (2) Headquarters revenue primarily represents revenue earned on shared service arrangements for general and administrative services provided to unconsolidated joint ventures at zero profit. (3) During the nine months ended September 28, 2012, we recognized an impairment charge on our goodwill associated with one of the reporting units within the TIS reporting segment as a result of our assessment of a triggering event in the quarter. See Note 3 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. (4) The Headquarters portion of operating income primarily relates to amortization of intangible assets and other costs that are not allocated to segments and are not billable to our U.S. government customers, partially offset by equity method investee income. During the nine months ended September 30, 2011, we recognized an impairment on our equity method investment in GLS. See Note 10 in the Delta Tucker Holdings, Inc. financial statements for further discussion. LOGCAP Revenue of $1,333.8 million increased $168.7 million, or 14.5%, during the nine months ended September 28, 2012 compared to the nine months ended September 30, 2011 primarily as a result of an increase in the volume of work under the Afghanistan AOR partially offset by manning reductions under the Kuwait AOR resulting from the troop drawdown in Iraq as OIF winds down. Additionally, revenue related to award fees was estimated and accrued at a higher rate during the nine months ended September 28, 2012 than during the comparable period in the prior year, which also contributed to the overall increase in revenue. As discussed in Note 14 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, our award fee estimate increased during the nine months ended September 28, 2012, as we received an award fee determination letter on our Afghanistan task order that was higher than our previous estimate used during the award fee period. Although we believe our award fees will continue to be strong in the future, we anticipate the volume of work in Afghanistan will begin to decline during calendar year 2013. 58 -------------------------------------------------------------------------------- Table of Contents Operating income of $44.9 million increased $13.4 million, or 42.3%, for the nine months ended September 28, 2012 compared to operating income of $31.6 million for the nine months ended September 30, 2011 primarily as a result of the changes in volume and award fee discussed above. As a percentage of revenue, operating income increased 3.4% for the nine months ended September 28, 2012 compared to 2.7% for nine months ended September 30, 2011 as a result of higher award fee scores. Aviation Revenue of $968.2 million increased $154.5 million, or 19.0%, during the nine months ended September 28, 2012 compared to the nine months ended September 30, 2011 primarily as a result of an increase in demand for intra-theater transportation services in Iraq and Afghanistan, construction services in Iraq under the INL Air Wing program and increased demand for flight hours under the CNTPO contract. Operations under new CFT task orders, including the Robins Air Force Base, TASM-E and 160th SOAR-A task orders, and new contracts, including the T6 COMBS, NASA AMOS and G222 contracts, all of which began operations during calendar year 2012, also drove the increase in revenue for the nine months ended September 28, 2012. These increases were partially offset by the loss of the LCCS programs which effectively ended during the first quarter of 2011. Operating income of $80.7 million increased $26.2 million, or 48.1%, during the nine months ended September 28, 2012 compared to the nine months ended September 30, 2011 primarily as a result of the increase in demand for our services discussed above, higher profitability on the CNTPO program and better margins on our new contracts and task orders as compared to our historical contract mix. Additionally, certain non-recurring charges in the prior year related to program specific severance costs and a write-down of inventory on the LCCS program contributed to the increase in operating income. These changes also drove the improvement in operating income as a percentage of revenue to 8.3% for the nine months ended September 28, 2012 compared to 6.7% for the nine months ended September 30, 2011. Training and Intelligence Solutions Revenue of $413.9 million decreased $57.5 million, or 12.2%, during the nine months ended September 28, 2012 compared to the nine months ended September 30, 2011 primarily as a result of the ramp-down of operations under the CivPol program in Iraq and Afghanistan as well as the completion of the MNSTC-I and the Advanced Military Source Operations Course ("AMSOC") contracts. These decreases were partially offset by revenue growth on the AMDP program which became fully operational in the third quarter of 2011. This program substantially replaced the CivPol Afghanistan program from the prior year. As a result of the decline in revenue during the nine months ended September 28, 2012 and the forecasted outlook for the TM reporting unit within this segment, we recorded a goodwill impairment charge during the nine months ended September 28, 2012 of $30.9 million. See Note 3 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. An operating loss of $17.1 million was recognized during the nine months ended September 28, 2012 as a result of the impairment recorded for the Training and Mentoring reporting unit. See Note 3 to our audited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. Operationally, operating income was impacted by the reduction in revenue discussed above and the overall contract mix containing comparatively more contracts operating at lower margins. Global Logistics & Development Solutions Revenue of $216.0 million decreased $10.4 million, or 4.6%, during the nine months ended September 28, 2012 compared to the nine months ended September 30, 2011 primarily as a result of the completion of certain task orders by our subsidiary Casals & Associates, Inc. and under the AFCAP as well as the completion of WRA and Sudan development contracts. These decreases in volume were partially offset by operations under the EPSS contract, which began during calendar year 2012, as well as revenue growth on the Philippines Operations Support and WRM programs and on operations under certain AFRICAP task orders in Djibouti, the Democratic Republic of Congo and Somalia. Operating income of $18.3 million increased $7.3 million, or 66.3%, during the nine months ended September 28, 2012 compared to the nine months ended September 30, 2011 primarily as a result of operations under the EPSS program which began during calendar year 2012 and operates at margins in excess of the overall contract mix in the prior year as well as an increase in award fee revenue recognized on the Philippines Operations Support program. One-time start-up costs associated with deploying personnel on the Oshkosh Defense contract as well as contract losses recognized on the AFCAP program during the nine months ended September 30, 2011 also drove the increase in operating income during the nine months ended September 28, 2012. These increases also drove the increase in operating income as a percentage of revenue to 8.5% for the nine months ended September 28, 2012 from 4.9% for the nine months ended September 30, 2011. 59 -------------------------------------------------------------------------------- Table of Contents Security Services Revenue of $81.4 million increased $35.9 million, or 78.8%, during the nine months ended September 28, 2012 compared to the nine months ended September 30, 2011 primarily as a result of the replacement of WPPS with the higher volume WPS program during calendar year 2011 and the addition of the Chemonics and Bondsteel contracts, which began operations during the first quarter of 2012. An operating loss of $6.5 million was recognized for the nine months ended September 28, 2012 as a result of performance challenges, such as fill rates, transition costs and customer process impediments on the WPS and Bondsteel contracts, which were identified as loss contracts during the first quarter of calendar year 2012. During the third quarter we reached a final resolution with our customer which we believe will minimizes future losses on the WPS contract. During the third quarter we were also awarded an additional option year on WPS which resulted in a positive change in estimate. We also completed the transition period and do not anticipate material incremental losses on the Bondsteel contract. GLS The level of deployed linguists under the INSCOM contract in support of U.S. troop levels in Iraq has decreased due to the war ending in December 2011. As a result, revenue decreased $271.3 million, or 86.2%, to $43.4 million during the nine months ended September 28, 2012 compared to $314.7 million for the nine months ended September 30, 2011 and operating income decreased $20.3 million, or 87.7%, to $2.9 million for the nine months ended September 28, 2012 compared to $23.2 million for the nine months ended September 30, 2011. GLS' task orders under the INSCOM contract end in December 2012. We do not anticipate any further work under the INSCOM contract after the completion of these task orders. Liquidity and Capital Resources Cash generated by operations and borrowings available under our senior secured credit facility ("Senior Credit Facility") are our primary sources of short-term liquidity (refer to Note 7 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for more detail). We believe our cash flow from operations and our available borrowings will be adequate to meet our liquidity needs for the next twelve months. However, access to our Revolver is dependent upon our meeting financial and non-financial covenants, summarized below, and our cash flow from operations is heavily dependent upon billing and collection of our accounts receivable. Significant changes or limitations in collections or loss of our ability to access our revolver could materially negatively impact liquidity and our ability to fund our working capital needs. Our primary use of short-term liquidity includes debt service and working capital needs sufficient to pay for materials, labor, services or subcontractors prior to receiving payments from our customers. There can be no assurance that sufficient capital will continue to be available in the future or that it will be available at terms acceptable to us. Failure to meet covenant obligations could result in elimination of access to our Senior Credit Facility, which would materially affect our future expansion strategies and our ability to meet our operational obligations. Although we operate internationally, virtually all of our cash is held by either U.S. entities or by foreign entities which are structured as pass through entities. As a result, we do not have significant risk associated with our ability to repatriate cash. Management believes Days Sales Outstanding ("DSO") is an appropriate way to measure our billing and collections effectiveness. DSO measures the efficiency in collecting our receivables as of the period end date and is calculated based on average daily revenue for the most recent quarter and accounts receivable, net of customer advances, as of the balance sheet date. DSO as of September 28, 2012 was 67 days as compared to 69 days as of December 30, 2011. We expect our cash position for the remainder of calendar year 2012 to remain strong as we continue to focus on working capital management and growth in our business. We expect cash to continue to be impacted by interest payments on the Senior Credit Facility and the senior unsecured notes ("Senior Unsecured Notes"). Interest payments are expected to be lower during calendar year 2012 as a result of the $151.3 million principal payments made during the year ended December 30, 2011 and principal payments of $60.0 million made during the nine months ended September 28, 2012. We do not expect to make any federal income tax payments for calendar year 2012 as we continue to utilize our net operating losses ("NOLs") and foreign tax credit carryovers. However, we anticipate our NOLs and foreign tax credits will be exhausted during calendar year 2013. 60-------------------------------------------------------------------------------- Table of Contents Cash Flow Analysis Nine Months Ended (Amounts in thousands) September 28, 2012 September 30, 2011 Net cash provided by operating activities $ 65,248 $ 64,364 Net cash (used in) provided by investing activities (9,983 ) 5,004 Net cash used in financing activities (38,079 ) (36,447 ) Cash Flows Cash provided by operating activities during the nine months ended September 28, 2012 was $65.2 million as compared to cash provided by operating activities of $64.4 million during the nine months ended September 30, 2011. Cash provided by operations for the nine months ended September 28, 2012 was primarily the result of the improvement in working capital coupled with the release of restricted cash in the prior year. Cash provided by operating activities during the nine months ended September 30, 2011 was primarily due to $48.0 million in income tax refunds received in the first quarter of calendar year 2011, primarily related to the approved Change in Accounting Methodology ("CIAM") with the Internal Revenue Service ("IRS"). Cash used in investing activities during the nine months ended September 28, 2012 was $10.0 million as compared to cash provided by investing activities during the nine months ended September 30, 2011 of $5.0 million. Cash used in investing activities during the nine months ended September 28, 2012 was primarily the result of the acquisition of Heliworks, Inc. and investments in fixed assets partially offset by the return of capital from our Partnership for Temporary Housing ("PaTH") joint venture. Cash provided by investing activities during the nine months ended September 30, 2011 was primarily due to a $7.7 million and a $1.5 million return of capital from the GLS and CRS joint ventures, respectively, partially offset by fixed asset and software purchases. Cash used in financing activities during the nine months ended September 28, 2012 was $38.1 million compared to $36.4 million of cash used in financing activities during the nine months ended September 30, 2011. Cash used in financing activities during the nine months ended September 28, 2012 was primarily the result of $60.0 million in prepayments on our Term Loan partially offset by borrowings related to financed insurance. Cash used in financing activities during the nine months ended September 30, 2011 was primarily comprised of a $48.6 million prepayment on our Term Loan in addition to our quarterly principal payment partially offset by borrowings related to financed insurance. Financing As of September 28, 2012, our debt was comprised of (i) $357.3 million of a Term Loan principal associated with our Senior Credit Facility, (ii) $455.0 million of Senior Unsecured Notes and (iii) $0.6 million of senior subordinated notes. We also had Revolver borrowings during the nine months ended September 28, 2012 with the maximum amount borrowed of $90.0 million. These borrowings were for working capital requirements resulting primarily from the timing of customer collections, vendor disbursements and to provide short term liquidity as we continued work on closing the financial statements for 2011 and completed the filing of our 2011 Annual Report. As of September 28, 2012, we had no outstanding revolver borrowings. As of September 28, 2012 and December 30, 2011, the additional available borrowing capacity under the Senior Credit Facility was approximately $111.2 million and $109.6 million, respectively, which gives effect to $38.8 million and $40.4 million, respectively, in letters of credit. The Senior Credit Facility includes a $570 million Term Loan facility ("Term Loan") running from July 7, 2010 through July 7, 2016 with a $150 million revolving credit facility ("Revolver") running from July 7, 2010 through July 7, 2014. In October of 2011, we made a principal prepayment of $48.7 million under the Senior Credit Facility that eliminated all future quarterly amortization payments until maturity. We incur quarterly interest payments on both the Term Loan and the Revolver comprised of (i) Revolver borrowings, (ii) letter of credit commitments and (iii) unused commitment fees. See Note 7 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional information related to the Senior Credit Facility. The Senior Unsecured Notes carry $455 million of principal with a 10.375% interest rate. This Indenture runs from July 7, 2010 through July 1, 2017 with the entire principal balance due on July 1, 2017. The interest payments are payable semi-annually on January 1st and July 1st. The first interest payment was made in January 2011. We or our affiliates may, from time to time, purchase our Senior Unsecured Notes. Any such future purchases may be made through open market or privately negotiated transactions with third parties or pursuant to one or more tender or exchange offers or otherwise, upon such terms and at such prices as we or any such affiliates may determine. 61-------------------------------------------------------------------------------- Table of Contents In addition to the Senior Credit Facility and Senior Unsecured Notes, $0.6 million of our pre-merger 9.5% senior subordinated notes remain outstanding as of September 28, 2012 and are due on February 15, 2013. The weighted-average interest rate as of September 28, 2012 for our debt was 8.6%, excluding the impact of deferred financing fees. There were no interest rate hedges in place during the three months ended September 28, 2012. Debt Covenants and Other Matters The Senior Credit Facility contains financial, as well as non-financial, affirmative and negative covenants that we believe are usual and customary. The negative covenants in the Senior Credit Facility include, among other things, limits on our ability to: • declare dividends and make other distributions; • redeem or repurchase our capital stock; • prepay, redeem or repurchase certain of our indebtedness; • grant liens; • make loans or investments (including acquisitions); • incur additional indebtedness; • modify the terms of certain debt; • restrict dividends from our subsidiaries; • change our business or business of our subsidiaries; • merge or enter into acquisitions; • sell our assets; • enter into transactions with our affiliates; and • make capital expenditures. In addition, the Senior Credit Facility stipulates a maximum total leverage ratio, as defined in the Senior Credit Facility, and minimum interest coverage ratio, as defined in the Senior Credit Facility, that we must maintain. As of September 28, 2012, we were in compliance with our financial covenants. The total leverage ratio is the Consolidated Total Debt, as defined in the Senior Credit Facility, less unrestricted cash and cash equivalents (up to $50 million) to Consolidated Earnings Before Interest Taxes Depreciation and Amortization ("Consolidated EBITDA"), as defined in the Senior Credit Facility, for the applicable period. Our total leverage ratio could not be greater than 5.5 to 1.0 for the period of April 3, 2011 to June 29, 2012. After June 29, 2012, the maximum total leverage ratio diminishes either quarterly or semi-annually. The maximum leverage ratio for the third quarter 2012 was 5.25 to 1.0 and decreases to 5.0 to 1.0 beginning the fourth quarter of 2012 and will remain at this level through June 28, 2013. The interest coverage ratio is the ratio of Consolidated EBITDA to Consolidated Interest Expense, as defined in the Senior Credit Facility. The interest coverage ratio must not be less than 1.7 to 1.0 for the period of April 3, 2011 to June 29, 2012. The minimum interest ratio increases either quarterly or semi-annually beginning June 29, 2012. The minimum interest coverage ratio for the third quarter 2012 was 1.85 to 1.0 and will remain at this level through December 28, 2012. In the event we fail to comply with the covenants specified in the Senior Credit Facility and the Indenture governing our Senior Unsecured Notes, we may be in default. As of September 28, 2012 and December 30, 2011, the Company was in compliance with all of its debt agreements. As of March 30, 2012, we were in default under our Senior Credit Facility in connection with the failure to deliver to the Administrative Agent the financial statements, reports and other documents as required with respect to the fiscal year ended December 30, 2011. The default was cured with the filing of the 2011 Annual Report to the SEC on April 9, 2012 and did not impact any other debt. 62 -------------------------------------------------------------------------------- Table of Contents Non-GAAP Measures We define EBITDA as GAAP net income attributable to Delta Tucker Holdings, Inc. adjusted for interest expense, taxes and depreciation and amortization. Adjusted EBITDA is calculated by adjusting EBITDA for the items described in the table below. We use EBITDA and Adjusted EBITDA as supplemental measures in the evaluation of our business and believe that EBITDA and Adjusted EBITDA provide a meaningful measure of operational performance on a consolidated basis because it eliminates the effects of period to period changes in taxes, costs associated with capital investments and interest expense and is consistent with one of the measures we use to evaluate management's performance for incentive compensation. In addition, Adjusted EBITDA as presented in the table below corresponds to the definition of Consolidated EBITDA used in the Senior Secured Credit Facilities and the definition of EBITDA used in the Indenture governing the Senior Unsecured Notes to test the permissibility of certain types of transactions, including debt incurrence. Neither EBITDA nor Adjusted EBITDA is a financial measure calculated in accordance with GAAP. Accordingly, they should not be considered in isolation or as substitutes for net income attributable to Delta Tucker Holdings, Inc. or other financial measures prepared in accordance with GAAP. Management believes these non-GAAP financial measures are useful in evaluating operating performance and are regularly used by security analysts, institutional investors and other interested parties in reviewing the Company. Non-GAAP financial measures are not intended to be a substitute for any GAAP financial measure and, as calculated, may not be comparable to other similarly titled measures of the performance of other companies. When evaluating EBITDA and Adjusted EBITDA, investors should consider, among other factors, (i) increasing or decreasing trends in EBITDA and Adjusted EBITDA, (ii) whether EBITDA and Adjusted EBITDA have remained at positive levels historically, and (iii) how EBITDA and Adjusted EBITDA compare to our debt outstanding. The non-GAAP measures of EBITDA and Adjusted EBITDA do have certain limitations. They do not include interest expense, which is a necessary and ongoing part of our cost structure resulting from the incurrence of debt. EBITDA and Adjusted EBITDA also exclude tax, depreciation and amortization expenses. Because these are material and recurring items, any measure, including EBITDA and Adjusted EBITDA, which excludes them has a material limitation. To mitigate these limitations, we have policies and procedures in place to identify expenses that qualify as interest, taxes, loss on debt extinguishments and depreciation and amortization and to approve and segregate these expenses from other expenses to ensure that EBITDA and Adjusted EBITDA are consistently reflected from period to period. Our calculation of EBITDA and Adjusted EBITDA may vary from that of other companies. Therefore, our EBITDA and Adjusted EBITDA presented may not be comparable to similarly titled measures of other companies. EBITDA and Adjusted EBITDA do not give effect to the cash we must use to service our debt or pay income taxes and thus does not reflect the funds generated from operations or actually available for capital investments. 63 -------------------------------------------------------------------------------- Table of Contents The following table provides a reconciliation of net income attributable to Delta Tucker Holdings, Inc. and EBITDA and Adjusted EBITDA for the periods included below: Delta Tucker Holdings, Inc. Unaudited Adjusted EBITDA Delta Tucker Holdings, Inc. Three Months Ended Nine Months Ended September 28, 2012 September 30, 2011 September 28, 2012 September 30, 2011 (Amounts in thousands) (unaudited) Net loss attributable to Delta Tucker Holdings, Inc. $ (15,794 ) $ (41,628 ) $ (1,228 ) $ (33,394 ) Provision (benefit) for income taxes 1,393 (23,878 ) 11,744 (17,787 ) Interest expense, net of interest income 21,990 22,807 65,344 69,369 Depreciation and amortization(1) 12,745 12,689 38,785 39,486 EBITDA $ 20,334 $ (30,010 ) $ 114,645 $ 57,674 Non-recurring or unusual gains or losses or income or expenses and non-cash impairments (2) 31,920 79,955 33,681 85,092 Changes due to fluctuation in foreign exchange rates 22 (165 ) (77 ) (15 ) Earnings from affiliates not received in cash 138 32 (969 ) 288 Employee non-cash compensation, severance, and retention expense 165 646 1,475 8,705 Management fees (3) 419 227 864 1,398 Acquisition accounting and Merger-related items (4) (1,262 ) (881 ) (4,571 ) (3,893 ) Other 9 2,038 (83 ) 2,031 Adjusted EBITDA (5) $ 51,745 $ 51,842 $ 144,965 $ 151,280 (1) Amount includes certain depreciation and amortization amounts which are classified as Cost of services in our Unaudited Condensed Consolidated Statements of Operations. (2) Includes the impairment of goodwill of the TM reporting unit and the impairment of our investment in the GLS joint venture, as well as certain unusual income and expense items, as defined in the Indenture and Senior Credit Facility. (3) Amount includes management fees paid to Cerberus Operations and Advisory Company. (4) Includes the amortization of intangibles arising pursuant to ASC 805 - Business Combination. (5) Under our debt agreement, we are permitted to include in Adjusted EBITDA the amount of cost savings, operating expense reductions and synergies projected as a result of specified actions taken or with respect to which substantial steps have been taken during the period. Since the period in the debt agreements refers to the last twelve months, we have elected for presentation purposes in the Quarterly Report not to include the amount of this specific adjustment in the calculation of Adjusted EBITDA for the periods presented. 64 -------------------------------------------------------------------------------- Table of Contents Off Balance Sheet Arrangements As of September 28, 2012, we did not have any material off-balance sheet arrangements as defined under SEC rules. Critical Accounting Policies and Estimates The process of preparing financial statements in conformity with GAAP requires the use of estimates and assumptions to determine reported amounts of certain assets, liabilities, revenue and expenses and the disclosure of related contingent assets and liabilities. These estimates and assumptions are based upon information available at the time of the estimates or assumptions, including our historical experience, where relevant. These significant estimates and assumptions are reviewed quarterly by management. This evaluation process includes a thorough review of key estimates and assumptions used in preparing our financial statements. Because of the uncertainty of factors surrounding the estimates, assumptions and judgments used in the preparation of our financial statements, actual results may differ from the estimates, and the difference may be material. Our critical accounting policies and estimates are those policies and estimates that are both most important to our financial condition and results of operations and require the most difficult, subjective or complex judgments on the part of management in their application, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. For a discussion of our critical accounting policies and estimates, please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes to Consolidated Financial Statements included in the Company's 2011 Annual Report. Our accounting policies and any new accounting pronouncements are further discussed in Note 1 to the unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Accounting Developments We have presented the information about accounting pronouncements not yet implemented in Note 1 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. |