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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 Annual Report on Form 10-K for the year ended December 31, 2012. 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 United States ("U.S.") military, non-military U.S. government 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 We have six operating and reportable segments which include the Logistics Civil Augmentation Program ("LOGCAP") Group, Aviation ("Aviation") Group, Training and Intelligence Solutions ("TIS") Group, Global Logistics & Development Solutions ("GLDS") Group, Security Services ("Security") Group and the Global Linguist Solutions ("GLS") Group. Our operating segment provides services domestically and in foreign countries under contracts with the U.S. government and foreign customers. 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. A description of each of our reportable segments is discussed further below. LOGCAP - This segment provides U.S. military operations and maintenance support. The LOGCAP segment operates under a single Indefinite Delivery, Indefinite Quantity ("IDIQ") contract. Under LOGCAP, the U.S. Army contracts with us to perform selected services in theater to augment U.S. Army forces and to release military units for other missions or to fill U.S. Army resource shortfalls. Aviation - This segment 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 segment 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 and quick-response field teams to customer locations globally to supplement a customer's workforce. 40-------------------------------------------------------------------------------- Table of Contents Training & Intelligence Solutions - This segment provides international policing and police training, judicial support, immigration support and base operations to a variety of international and national customers. Under this segment 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") and the Civilian Police ("CivPol") programs. This segment 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 segment 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 segment 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 segment 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 segment'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 AECOM Technology Corporation's National Security Programs unit in which we have a 51% ownership interest. GLS provides rapid recruitment, deployment and in-theatre management of interpreters and translators for a wide range of foreign languages in support of the U.S. Army, unified commands attached forces, combined forces and joint elements and other U.S. government agencies. GLS is currently one of six providers under the Defense Language Interpretation Translation Enterprise ("DLITE") contract which has an estimated contract value of $9.7 billion. In January 2013, GLS was selected to manage the U.S. Army Central Command ("CENTCOM") task order under the DLITE contract. The CENTCOM task order has one base year with three one year options and a total potential value of $88.4 million. See Note 10 to the Delta Tucker Holdings, Inc. unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion on GLS. In April 2013, the Company amended its organizational structure to improve efficiencies within existing businesses, capitalize on new opportunities, continue international growth and expand commercial business. The Company's five consolidated operating and reporting segments, LOGCAP, Aviation, TIS, GLDS and Security Services were re-aligned into three reporting and operating segments DynAviation, DynLogistics and DynGlobal. DynAviation and DynLogistics will provide services domestically and in foreign countries under contracts with the U.S. government and foreign customers. DynGlobal will initially be solely focused on the expansion of opportunities within the commercial sector. Our segments will operate principally within a regulatory environment subject to governmental contracting and accounting requirements, including Federal Acquisition Regulations ("FAR"), Cost Accounting Standards ("CAS") and audits by various U.S. federal agencies. The financial results will reflect the new organizational structure beginning with second quarter 2013. 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 included elsewhere in this Quarterly Report on Form 10-Q and with our Annual Report on Form 10-K for the year ended December 31, 2012. 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 ("BCA"). The BCA specified an immediate $917 billion of cuts over ten years, including $487 billion from defense spending. Additionally, the BCA established the Joint Select Committee on Deficit Reduction, or the "super committee", to produce an additional deficit reduction of at least $1.5 trillion over the coming 10 years that was to be passed 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. This sequestration of appropriations was scheduled to begin in January 2013, but was delayed by two months through the American Taxpayer Relief Act of 2012. Sequestration was ultimately triggered on March 1, 2013. On March 21, 2013, Congress passed a modified Continuing Resolution ("CR") that included a number of the negotiated fiscal year 2013 spending bills, including defense. The modified CR for the fiscal year 2013 defense appropriations bill will fund Operations and 41 -------------------------------------------------------------------------------- Table of Contents Maintenance ("O&M") at nearly the amount budgeted by the President, or approximately $230 billion in the base and OCO accounts, which will allow the military and the contractor and subcontractor community to continue their vital work in a timely manner. In addition, the bill provides the DoD with more flexibility, especially within the O&M accounts, and will assist with a better mandate of cuts. The modified CR allows funding and priorities within the fiscal year 2013 defense appropriations to abate the negative impacts of the forethought $1.5 trillion reduction and the challenges around the budget uncertainty may start to be mitigated over the next few months. Over the longer-term, recent statements by Congress and the Administration have generated some optimism that there is a renewed focus on addressing the underlying structural budget issues that have resulted in sequestration. These negotiations related to the budget are expected later in 2013. Funding for our programs is dependent on annual budget and appropriation decisions, as well as geo-political and macroeconomic conditions, which are beyond our control. While there is uncertainty around these domestic and international factors, the final agreed upon appropriated funding levels for national security programs will remain historically high with plenty of opportunity to continue supporting our customers. In recent memos and guidance related to potential further reductions, Pentagon leadership has stated that it will protect programs and funding for warfighter related activities (i.e. OCO accounts). In addition to guidance protecting OCO activities, 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. We believe the Operations and Maintenance ("O&M") budgets will remain relatively robust; however, the risk remains that O&M funds could be temporarily delayed as a first response by our customers in an effort to absorb sequestration. While this could adversely impact our business on a short term basis, we believe the following longer term industry trends are positive and will result in continued demand in our target markets for the types of services we provide: • Realignment of the 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, U.S. Agency for International Development ("USAID"), the United Nations, and even the DoD, to include development and smaller-scale stabilityoperations; • Increased maintenance, overhaul and upgrade needs to support returning rolling stock and 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 North Atlantic Treaty Organization ("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 advise, assist 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 unprecedented international sanctions against the regime and the bolstering of U.S. 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 U.S. 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 U.S. As the U.S. revitalizes and reinforces its presence in this vital region, we expect to see increased demand 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 Three Months Ended March 29, 2013 • In January 2013, GLS was awarded a task order under the DLITE contract with the U.S. Army Intelligence and Security Command to provide linguists to support CENTCOM operations at several locations in the Middle East. The task order has one base year and three, one-year options and a total potential value of $88.4 million. • In February 2013, we were awarded a contract within our Aviation segment with the U.S. Army Aviation and Missile Life Cycle Management Command to provide aviation field and sustainment level maintenance services under the Army Field Maintenance contract throughout the Regional Aviation Sustainment Maintenance-West Region ("RASM-W). The hybrid firm-fixed-price, cost-plus-incentive-fee contract has one base year and four, one-year options and a total potential contract value of $388.5 million. • In March 2013, we were awarded a contract within our GLDS segment with the U.S. Army to provide training, deprocessing, fielding, general maintenance support and other services to military units in the U.S. and abroad. The fixed-price level of effort contract has one base year and two, one-year options and a total potential contract value of $35.3 million. 42 -------------------------------------------------------------------------------- Table of Contents Contract Types Our business generally is performed under fixed-price, time-and-materials or cost-reimbursement contracts. Each of these 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 subjectivecriteria, 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 contracts 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 represent a firm order for services. Our CFT and LOGCAP IV programs are two examples of IDIQ contracts. When a customer wishes to order services under an IDIQ contract, the customer issues a task order request for proposal to the contract awardees. The contract awardees then submit proposals to the customer and task orders are typically awarded under a best-value approach. However, many IDIQ contracts permit the customer to direct work to a particular contractor. Our historical contract mix by type, as a percentage of revenue, is indicated in the table below. Three Months Ended March 29, 2013 March 30, 2012 Fixed-Price 21 % 15 % Time-and-Materials 12 % 11 % Cost-Reimbursement 67 % 74 % Total 100 % 100 % Cost-reimbursable 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-reimbursable type contract, we anticipate that our revenue from this contract will continue to represent a large portion of our business for the remainder of 2013. 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 also enter into subcontract arrangements 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. 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. 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. 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 associated with our contracts. 43-------------------------------------------------------------------------------- Table of Contents The following table sets forth our approximate backlog as of the dates indicated: As Of (Amounts in millions) March 29, 2013 December 31, 2012 Funded backlog $ 1,566 $ 1,642 Unfunded backlog 3,373 3,636 Total $ 4,939 $ 5,278 Total backlog as of March 29, 2013 was $4.9 billion, as compared to $5.3 billion as of December 31, 2012. The decrease in backlog was primarily due to revenue outpacing current orders for the three months ended March 29, 2013. Results of Operations Consolidated Three Months Ended March 29, 2013 compared to the Three Months Ended March 30, 2012 The following tables set forth our unaudited consolidated results of operations, both in dollars and as a percentage of revenue, for the three months ended March 29, 2013 and March 30, 2012: Three Months Ended (Amounts in thousands) March 29, 2013 March 30, 2012 Revenue $ 932,108 100.0 % $ 1,047,066 100.0 % Cost of services (845,125 ) (90.7 )% (966,610 ) (92.3 )% Selling, general and administrative expenses (35,544 ) (3.8 )% (38,151 ) (3.6 )% Depreciation and amortization expense (11,848 ) (1.3 )% (12,560 ) (1.2 )% Earnings from equity method investees 2,446 0.3 % 210 - % Operating income 42,037 4.5 % 29,955 2.9 % Interest expense (19,163 ) (2.1 )% (21,690 ) (2.1 )% Interest income 18 - % 38 - % Other income, net 2,098 0.2 % 3,373 0.3 % Income before income taxes 24,990 2.6 % 11,676 1.1 % Provision for income taxes (8,795 ) (0.9 )% (4,797 ) (0.5 )% Net income 16,195 1.7 % 6,879 0.6 % Noncontrolling interests (1,192 ) (0.1 )% (1,304 ) (0.1 )% Net income attributable to Delta Tucker Holdings, Inc. $ 15,003 1.6 % $ 5,575 0.5 % Revenue - Revenue for the three months ended March 29, 2013 was $932.1 million, a decrease of $115.0 million, or 11.0%, compared to the three months ended March 30, 2012. The decrease was primarily driven by the reduction in revenue earned under our LOGCAP group, partially offset by the $61.3 million increase in revenue from the Aviation group resulting from the continued strength of new contract wins from 2012. 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, subcontractors, travel, supplies and other miscellaneous costs. Cost of services for the three months ended March 29, 2013 was $845.1 million, a decrease of $121.5 million, or 12.6%, compared to the three months ended March 30, 2012. The decrease in Cost of services was relatively consistent with the reduction in revenue as well as our consolidated margin improvements resulting from the change in our overall contract mix. The overall change in contract mix drove the reduction in Cost of services as a percentage of revenue to 90.7% for the three months ended March 29, 2013 compared to 92.3% for the three months ended March 30, 2012. See further discussion of the impact 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 $2.6 million, or 6.8%, to $35.5 million during the three months ended March 29, 44-------------------------------------------------------------------------------- Table of Contents 2013 compared to the three months ended March 30, 2012 primarily as a result of a reduction in legal fees associated with ongoing litigation, unallowable general advertising and costs incurred for professional services and other contract labor. SG&A as a percentage of revenue slightly increased to 3.8% for the three months ended March 29, 2013 from 3.6% for the three months ended March 30, 2012 primarily as a result of the reduction in revenue out pacing reductions in general and administrative costs in a manner consistent with the slow down in volume. Depreciation and amortization - Depreciation and amortization during the three months ended March 29, 2013 was $11.8 million, a decrease of $0.7 million, or 5.7%, compared to the three months ended March 30, 2012. The decrease was primarily the result of the impairment of certain intangible assets within the TIS segment during the fourth quarter of the year ended December 31, 2012 partially offset by additional depreciation expense on fixed assets, including those acquired in conjunction with the acquisition of Heliworks, Inc. during the third quarter of the year ended December 31, 2012. Earnings from equity method investees - Earnings from equity method investees include our proportionate share of the income of our equity method investees deemed to be operationally integral to our business, such as Partnership for Temporary Housing LLC ("PaTH"), Contingency Response Services LLC ("CRS"), Global Response Services LLC ("GRS") and GLS. Earnings from operationally integral unconsolidated affiliates for the three months ended March 29, 2013 was $2.4 million, an increase of $2.2 million, or 1,064.8%, compared to the three months ended March 30, 2012 primarily as a result of equity method income recognized upon the receipt of a $2.6 million dividend distribution from GLS. As a result of impairment of our investment in GLS recorded during the year ended December 30, 2011, we no longer recognize any earnings related GLS until we receive cash through dividend distributions. See Note 10 to the Delta Tucker Holdings, Inc. unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion of GLS and our other equity method investees. Interest expense - Interest expense for the three months ended March 29, 2013 was $19.2 million, a decrease of $2.5 million, or 11.7%, compared to the three months ended March 30, 2012. The decrease is the result of the reduction of the principal balance of our Term Loan as a result of principal prepayments of $90.0 million during the year ended December 31, 2012. Other income, net - Other income, net consists primarily of our share of earnings from Babcock DynCorp Limited ("Babcock"), our unconsolidated joint venture that is not operationally integral to our business, as well as gains/losses from foreign currency. Other income, net during the three months ended March 29, 2013 was $2.1 million, a decrease of $1.3 million, or 37.8%, compared to the three months ended March 30, 2012 primarily as a result of a reduction in earnings from 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 March 29, 2013 was 35.2%, as compared to 41.1% for the three months ended March 30, 2012. The decrease in the effective tax rate was primarily the result of the change in our deferred tax assets during the three months ended March 30, 2012 due to a discrete item noted during that period. 45-------------------------------------------------------------------------------- Table of Contents Results by Segment - Three Months Ended March 29, 2013 Compared to Three Months Ended March 30, 2012 The following tables set forth the revenue, both in dollars and as a percentage of our consolidated revenue, operating income and operating margin for our operating segments for the three months ended March 29, 2013 and March 30, 2012. The following amounts agree to our segment disclosures in Note 9 to the Delta Tucker Holdings, Inc. unaudited condensed consolidated financial statements included elsewhere in the Quarterly Report on Form 10-Q. Three Months Ended March 29, 2013 March 30, 2012 % of % of (Amounts in thousands) Revenue Total Revenue Revenue Total Revenue LOGCAP $ 362,723 38.3 % $ 478,046 45.1 % Aviation 367,677 38.8 % 306,415 28.9 % Training & Intelligence Solutions 113,071 11.9 % 156,598 14.8 % Global Logistics & Development Solutions 70,899 7.5 % 79,143 7.5 % Security Services 20,364 2.1 % 23,877 2.3 % GLS 13,411 1.4 % 14,990 1.4 % Total segments 948,145 100.0 % 1,059,069 100.0 % GLS deconsolidation (1) (13,411 ) (14,990 ) Headquarters/eliminations (2) (2,626 ) 2,987 Consolidated revenue $ 932,108 $ 1,047,066 Operating Operating Income (Loss) Profit Margin Income (Loss) Profit Margin LOGCAP $ 10,581 2.9 % $ 16,918 3.5 % Aviation 32,761 8.9 % 22,506 7.3 % Training & Intelligence Solutions 5,682 5.0 % 4,947 3.2 % Global Logistics & Development Solutions 3,968 5.6 % 5,312 6.7 % Security Services (1,702 ) (8.4 )% (6,634 ) (27.8 )% GLS 1,402 10.5 % 757 5.1 % Total segments 52,692 5.6 % 43,806 4.1 % GLS deconsolidation (1) (1,402 ) (757 ) Headquarters/eliminations (3) (9,253 ) (13,094 ) Consolidated operating income $ 42,037 $ 29,955 (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. (3) Headquarters operating expenses primarily relate 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. LOGCAP Revenue of $362.7 million decreased $115.3 million, or 24.1%, for the three months ended March 29, 2013 compared to the three months ended March 30, 2012 primarily as a result of a reduction in manning, material and other direct cost requirements under the Afghanistan Area of Responsibility ("AOR"). This reduction in scope is consistent with our expectation of reduced volume resulting from the continued drawdown of troops in Afghanistan. Given the continual drawdown and uncertainty surrounding the defense and government contracting industry, we expect LOGCAP revenue could continue to decline over the remainder of the year ending December 31, 2013. Operating income of $10.6 million decreased $6.3 million, or 37.5%, for the three months ended March 29, 2013 compared to operating income of $16.9 million for the three months ended March 30, 2012 primarily as a result of the reduction in volume discussed above. Operating income as a percentage of revenue decreased to 2.9% for the three months ended March 29, 2013 compared to 3.5% for three months ended March 30, 2012 primarily as a result of a favorable cumulative catch up adjustment to revenue during the three months ended March 30, 2012 to recognize award fee revenue at a rate higher than previously estimated for all eligible contract costs incurred throughout the respective period of performance. Margins on the LOGCAP IV program have stabilized as a result of the Afghanistan and Kuwait task orders being converted from a cost-plus-award-fee contract vehicle to a cost-plus-fixed-fee arrangement. 46-------------------------------------------------------------------------------- Table of Contents Aviation Revenue of $367.7 million increased $61.3 million, or 20.0%, for the three months ended March 29, 2013 compared to the three months ended March 30, 2012. The change was primarily the result of operations under new programs including the National Aeronautics and Space Administration ("NASA") Aircraft Maintenance Operational Support ("AMOS"), T-6 Contractor Operated and Maintained Base Supply ("T-6 COMBS") and G222 programs as well as operations under new task orders awarded under the Contract Field Teams ("CFT") program, including the Robins Air Force Base, TASM-E and 160th Special Operations Aviation Regiment-Airborne ("SOAR-A") task orders. These increases were partially offset by a slight reduction in demand under the INL program. Operating income of $32.8 million increased $10.3 million, or 45.6%, for the three months ended March 29, 2013 compared to the three months ended March 30, 2012 primarily as a result of the increases in volume discussed above as well as overall margin improvements resulting from operations under certain new programs, including the T-6 COMBS, G222 and Robins Air Force Base, performing at higher margins than the overall contract mix in the prior year. This change in contract mix also drove the increase in operating income as a percentage of revenue to 8.9% for the three months ended March 29, 2013 compared to 7.3% for the three months ended March 30, 2012. Training and Intelligence Solutions Revenue of $113.1 million decreased $43.5 million, or 27.8%, for the three months ended March 29, 2013 compared to the three months ended March 30, 2012 primarily as a result of a decline in scope of AMDP and the continued wind down of the CivPol task order in Iraq directly related to the shift of DoD/DoS priorities and the continued drawdown of troops in this region. These reductions were partially offset by an increase in vehicle deliveries under the Palestinian Security Sector task order under the CivPol contract. Operating income of $5.7 million increased $0.7 million, or 14.9%, for the three months ended March 29, 2013 compared to the three months ended March 30, 2012 as a result of the increase in vehicle deliveries under the CivPol contract as discussed above as well as an increase in headcount under the NMEC 4 program, both of which also improved program margins as the vehicle and labor contract line items earn higher margins than the overall contract. These changes drove the increase in operating income as a percentage of revenue to 5.0% for the three months ended March 29, 2013 compared to 3.2% for three months ended March 30, 2012. Global Logistics & Development Solutions Revenue of $70.9 million decreased $8.2 million, or 10.4%, for the three months ended March 29, 2013 compared to the three months ended March 30, 2012 primarily as a result of a reduction in the level of effort on the Navistar Defense and Oshkosh Defense programs as well as the completion of the Weapons Removal and Abatement ("WRA") contract and certain task orders under the Africa Peacekeeping program in the Republic of Liberia and the Republic of Djibouti. These reductions were partially offset by operations under the Egyptian Personnel Support Services ("EPSS") contract, which began in May 2012, as well as base support services provided under new contracts in the Republic of Honduras and the Democratic Republic of Timor-Leste. Operating income of $4.0 million decreased $1.3 million, or 25.3%, for the three months ended March 29, 2013 compared to the three months ended March 30, 2012 primarily as a result of lower volume on the Oshkosh Defense program partially offset by operations under the new EPSS contract and the collection of the remainder of our Request for Equitable Adjustment ("REA") related to the Africa Peacekeeping Security Sector Transformation ("APK-SST") task order in the Republic of the Sudan. These changes also drove the decrease in operating income as a percentage of revenue to 5.6% for the three months ended March 29, 2013 from 6.7% for the three months ended March 30, 2012. Security Services Revenue of $20.4 million decreased $3.5 million, or 14.7%, for the three months ended March 29, 2013 compared to the three months ended March 30, 2012 primarily as a result of a customer driven reduction in scope on the Worldwide Protective Services ("WPS") program partially offset by growth under the Bondsteel contract as this program was fully operational during the three months ended March 29, 2013 relative to being in ramp up during the three months ended March 30, 2012. An operating loss of $1.7 million was recognized for the three months ended March 29, 2013, an improvement of $4.9 million, or 74.3%, from the operating loss of $6.6 million recognized for the three months ended March 30, 2012, the period in which forward operating losses were recognized on the Bondsteel and WPS contracts. The operating loss recognized for the three months ended March 29, 2013 primarily consists of general and administrative period costs that were unabsorbed by the operations for the three months ended resulting from the de-scoping of work being performed on the largest contract in the segment which is thereby driving lower margins on the contract within this segment. 47-------------------------------------------------------------------------------- Table of Contents GLS Revenue of $13.4 million decreased $1.6 million, or 10.5%, for the three months ended March 29, 2013 compared to the three months ended March 30, 2012 primarily as a result of the continued wind down of the INSCOM contract consistent with the decline in U.S. troop levels in Iraq partially offset by operations under CENTCOM task order under the DLITE contract, which was awarded to GLS and was in ramp up during the three months ended March 29, 2013. Operating income of $1.4 million increased $0.6 million, or 85.2%, for the three months ended March 29, 2013 compared to the three months ended March 30, 2012 primarily as a result of the ramp up of operations under the CENTCOM task order of the DLITE contract, which operates at higher margins relative to operations under the INSCOM contract. This change also drove the increase in operating income as a percentage of revenue to 10.5% for the three months ended March 29, 2013 from 5.1% for the three months ended March 30, 2012. 48-------------------------------------------------------------------------------- Table of Contents 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 the Delta Tucker Holdings, Inc. 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 and we have seen an increase in the days to receive customer payments so far in 2013. Significant changes, such as CR or any other 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 was 79 days and 69 days as of March 29, 2013 and December 31, 2012, respectively. The increase in DSO was primarily driven by longer payment cycles by our customer. We expect our cash position to increase throughout the remainder of the year ending December 31, 2013 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 and could continue to be impacted by customer payment cycles. Interest payments throughout the year ending December 31, 2013 are expected to be lower relative to the year ended December 31, 2012 as a result of the $90.0 million in principal payments made during 2012. Cash Flow Analysis Three Months Ended (Amounts in thousands) March 29, 2013 March 30, 2012 Net cash used in operating activities $ (73,491 ) $ (9,952 ) Net cash used in investing activities (1,633 ) (2,595 ) Net cash provided by financing activities 23,978 80,907 Cash Flows Cash used in operating activities during the three months ended March 29, 2013 was $73.5 million as compared to cash used in operating activities of $10.0 million during the three months ended March 30, 2012. Cash used in operations for the three months ended March 29, 2013 was primarily the due to the increase in working capital requirements resulting from the slow down in collections of our accounts receivables as well as cash expended to reduce accounts payable partially offset by the utilization of prepaid expenses. Cash used in operating activities during the three months ended March 30, 2012 was primarily due to an increase in working capital resulting from the growth in revenue out pacing our accounts receivables collections partially offset by the release of restricted cash and the utilization of prepaid expenses. Cash used in investing activities during the three months ended March 29, 2013 was $1.6 million as compared to cash used in investing activities during the three months ended March 30, 2012 of $2.6 million. Cash used in investing activities during the three months ended March 29, 2013 was due to the purchase of fixed assets and software. Cash used in investing activities during the three months ended March 30, 2012 was primarily the result of fixed asset purchases and capital contributions to the PaTH and Mission Readiness joint ventures. Cash provided by financing activities during the three months ended March 29, 2013 was $24.0 million compared to $80.9 million of cash provided by financing activities during the three months ended March 30, 2012. Cash provided by financing activities during the three months ended March 29, 2013 was primarily the result of amounts borrowed under our Revolver partially offset by payments related to financed insurance. Cash provided by financing activities during the three months ended March 30, 2012 was primarily the result of $90.0 million of borrowings under our Revolver to provide additional liquidity as we completed our financial statements. 49 -------------------------------------------------------------------------------- Table of Contents Financing As of March 29, 2013, our debt was comprised of (i) $455.0 million of a Term Loan principal associated with our Senior Credit Facility and (ii) $327.3 million of Senior Unsecured Notes. We also had Revolver borrowings during the three months ended March 29, 2013 with the maximum amount borrowed of $41.2 million. These borrowings were for working capital requirements resulting primarily from the timing of customer collections, vendor disbursements. As of March 29, 2013 we had $41.2 million outstanding revolver borrowings. As of December 31, 2012, we had no outstanding revolver borrowings. As of March 29, 2013 and December 31, 2012, the additional available borrowing capacity under the Senior Credit Facility was approximately $70.9 million and $111.7 million, respectively, which gives effect to $41.2 million in outstanding revolver borrowing and $37.9 million in letters of credit as of March 29, 2013 and $38.3 million in letters of credit as of December 31, 2012. 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 the Delta Tucker Holdings, Inc. 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. In addition to the Senior Credit Facility and Senior Unsecured Notes, $0.6 million of our pre-merger 9.5% senior subordinated notes remained outstanding as of December 31, 2012. The pre-merger notes matured and were paid in full on February 15, 2013. The weighted-average interest rate as of March 29, 2013 for our debt was 8.5%, excluding the impact of deferred financing fees. There were no interest rate hedges in place during the three months ended March 29, 2013. 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 March 29, 2013, 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 cannot be greater than 5.0 to 1.0 through the period ending June 28, 2013, after which, the maximum total leverage diminishes quarterly or semi-annually. 50-------------------------------------------------------------------------------- Table of Contents 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 2.0 to 1.0 through the period ending June 27, 2014, after which, the minimum total interest coverage ratio increases quarterly or semi-annually thereafter. 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 March 29, 2013 and December 31, 2012, the Company was in compliance with all of its debt agreements. Non-GAAP Measures We define EBITDA as Generally Accepted Accounting Principles ("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. 51 -------------------------------------------------------------------------------- Table of Contents Delta Tucker Holdings, Inc. Unaudited Adjusted EBITDA 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: Three Months Ended (Amounts in thousands) March 29, 2013 March 30, 2012 Net income attributable to Delta Tucker Holdings, Inc. $ 15,003 $ 5,575 Provision for income taxes 8,795 4,797 Interest expense, net of interest income 19,145 21,652 Depreciation and amortization (1) 12,289 12,956 EBITDA 55,232 44,980 Non-recurring or unusual gains or losses or income or expenses and non-cash impairments (2) 551 215 Changes due to fluctuation in foreign exchange rates (138 ) 80 Earnings from affiliates not received in cash (1,944 ) (3,101 ) Employee non-cash compensation, severance, and retention expense 88 924 Management fees (3) 474 177 Acquisition accounting and Merger-related items (4) (869 ) (1,851 ) Other (95 ) (42 ) Adjusted EBITDA $ 53,299 $ 41,382 (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 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. 52 -------------------------------------------------------------------------------- Table of Contents Off Balance Sheet Arrangements The Company did not have any material off-balance sheet arrangements subsequent to the filing of our consolidated financial statements in our Annual Report on Form 10-K 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, revenues and expenses and the disclosure of related contingent assets and liabilities. These estimates and assumptions are based on information available at the time of the estimates or assumptions, including our historical experience, where relevant. Significant estimates and assumptions are reviewed quarterly by management. The 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 materially differ from the estimates. 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 the notes to the Delta Tucker Holdings, Inc. consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. Any material changes to our accounting policies and estimates from those described in our Annual Report on Form 10-K for the year ended December 31, 2012 are further discussed in Note 1 to the Delta Tucker Holdings, Inc. unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Accounting Developments In February 2013, the FASB issued Accounting Standards Update ("ASU") No. 2013-02-Comprehensive Income that requires new disclosure requirements for items reclassified out of accumulated other comprehensive income ("AOCI"). We adopted ASU 2013-02 as of March 29, 2013. The adoption of this ASU did not have a material effect on our consolidated financial position or results of operations. See Note 1 to the Delta Tucker Holdings, Inc. unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further discussion. |