Document




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
 
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to                    
Commission File Number: 333-173746
 
 
DELTA TUCKER HOLDINGS, INC.
(Exact name of registrant as specified in its charter) 
 
  
Delaware
27-2525959
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
1700 Old Meadow Road, McLean, Virginia 22102
(571) 722-0210
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices) 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  o    No  þ
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   þ     No   o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
þ  (Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (§230.405 of this chapter) or Rule 12b-2 of the Exchange Act (§240.12b-2 of this chapter).





 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes   o     No   þ
As of May 14, 2018, the registrant had 100 shares of its Class A common stock outstanding.






Delta Tucker Holdings, Inc.
Table of Contents
 
 
Page
 
 
 
 
 
 
 
 
 
 

2




Disclosure Regarding Forward-Looking Information
This Quarterly Report on Form 10-Q contains various forward-looking statements regarding future events and our future results that are subject to the safe harbors created by the Private Securities Litigation Reform Act of 1995 under the Securities Act of 1933 (the "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act"). Without limiting the foregoing, the words "believes," "thinks," "anticipates," "plans," "expects" and similar expressions are intended to identify forward-looking statements. Forward-looking statements involve risks and uncertainties. Statements regarding the amount of our backlog and estimated total contract values are other examples of forward-looking statements. We caution that these statements are further qualified by important economic, competitive, governmental, international and technological factors that could cause our business, strategy, projections or actual results or events to differ materially, or otherwise, from those in the forward-looking statements. These factors, risks and uncertainties include, among others, the following:
our substantial level of indebtedness, our ability to refinance or amend the terms of that indebtedness, and changes in availability of capital and cost of capital;
the ability to refinance, amend or generate sufficient cash to repay our indebtedness, including any future indebtedness, which may force us to take other actions to satisfy our obligations under our indebtedness, which may not be successful;
the future impact of mergers, acquisitions, divestitures, joint ventures or teaming agreements;
the outcome of any material litigation, government investigation, audit or other regulatory matters;
restatement of our financial statements causing credit ratings to be downgraded or covenant violations under our debt agreements;
policy and/or spending changes implemented by the Trump Administration, any subsequent administration or Congress, including any further changes to the sequestration that the United States ("U.S.") Department of Defense ("DoD") is currently operating under;
termination or modification of key U.S. government or commercial contracts, including subcontracts;
changes in the demand for services that we provide or work awarded under our contracts, including without limitation, the Logistics Civil Augmentation Program IV ("LOGCAP IV") and Afghanistan Life Support Services ("ALiSS") contract;
the outcome of future extensions on awarded contracts and the outcomes of recompetes on existing programs;
changes in the demand for services provided by our joint venture partners;
changes due to pursuit of new commercial business in the U.S. and abroad;
activities of competitors and the outcome of bid protests;
changes in significant operating expenses;
impact of lower than expected win rates for new business;
general political, economic, regulatory and business conditions in the U.S. or in other countries in which we operate;
acts of war or terrorist activities, including cyber security threats;
variations in performance of financial markets;
the inherent difficulties of estimating future contract revenue and changes in anticipated revenue from indefinite delivery, indefinite quantity ("IDIQ") contracts and indefinite quantity contracts ("IQC");
the timing or magnitude of any award, performance or incentive fee granted under our government contracts;
changes in expected percentages of future revenue represented by fixed-price and time-and-materials contracts, including increased competition with respect to task orders subject to such contracts;
decline in the estimated fair value of a reporting unit resulting in a goodwill impairment and a related non-cash impairment charged against earnings;
changes in underlying assumptions, circumstances or estimates that may have a material adverse effect upon the profitability of one or more contracts and our performance;
implementation of the tax reform legislation known colloquially as the Tax Cuts and Jobs Act (the "Tax Act") or other tax reform implemented by the Trump Administration, and any subsequent administration or Congress;
changes in our tax provisions or exposure to additional income tax liabilities that could affect our profitability and cash flows;
uncertainty created by management turnover or other restructuring activities;
termination or modification of key subcontractor performance or delivery;
the ability to receive timely payments from prime contractors where we act as a subcontractor; and
statements covering our business strategy, including those described in "Item 1A. Risk Factors" in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission ("SEC") on March 21, 2018 and other risks detailed from time to time in our reports filed with SEC.
Accordingly, such forward-looking statements do not purport to be predictions of future events or circumstances and therefore, there can be no assurance that any forward-looking statements contained herein will prove to be accurate. We assume no obligation to update the forward-looking statements.

3




Calendar Year
Beginning with the first quarter of calendar year 2018 and for all periods subsequent, we report the results of our operations as of the calendar end of each quarter and year end. Previously we reported quarterly as of the last Friday of a calendar quarter, except the fourth quarter of the fiscal year, which ends on December 31.
Included in this Quarterly Report are our unaudited condensed consolidated statements of operations and comprehensive income (loss) for the three months ended March 31, 2018 and March 31, 2017, the related statements of deficit and cash flows for the three months ended March 31, 2018 and March 31, 2017 and the unaudited condensed consolidated balance sheets as of March 31, 2018 and December 31, 2017.


4




PART I. FINANCIAL INFORMATION.

ITEM 1. FINANCIAL STATEMENTS.

Delta Tucker Holdings, Inc.
Unaudited Condensed Consolidated Statements of Operations
 
Three Months Ended
(Amounts in thousands)
March 31, 2018
 
March 31, 2017
Revenue
$
534,293

 
$
459,872

Cost of services
(465,423
)
 
(399,477
)
Selling, general and administrative expenses
(25,359
)
 
(31,719
)
Depreciation and amortization expense
(6,057
)
 
(8,555
)
Earnings from equity method investees
47

 
43

Operating income
37,501

 
20,164

Interest expense
(16,988
)
 
(18,715
)
Loss on early extinguishment of debt
(239
)
 

Interest income
525

 
5

Other income, net
649

 
1,373

Income before income taxes
21,448

 
2,827

Provision for income taxes
(4,744
)
 
(3,039
)
Net income (loss)
16,704

 
(212
)
Noncontrolling interests
(296
)
 
(275
)
Net income (loss) attributable to Delta Tucker Holdings, Inc.
$
16,408

 
$
(487
)
See notes to unaudited condensed consolidated financial statements

5




Delta Tucker Holdings, Inc.
Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)

 
Three Months Ended
(Amounts in thousands)
March 31, 2018
 
March 31, 2017
Net income (loss)
$
16,704

 
$
(212
)
Other comprehensive income, net of tax:
 
 
 
Foreign currency translation adjustment
1

 
12

Other comprehensive income, before tax
1

 
12

Income tax expense related to items of other comprehensive income

 
(4
)
Other comprehensive income
1

 
8

Comprehensive income (loss)
16,705

 
(204
)
Comprehensive income (loss) attributable to noncontrolling interests
(296
)
 
(275
)
Comprehensive income (loss) attributable to Delta Tucker Holdings, Inc.
$
16,409

 
$
(479
)

See notes to unaudited condensed consolidated financial statements

6




Delta Tucker Holdings, Inc.
Unaudited Condensed Consolidated Balance Sheets
 
As Of
(Amounts in thousands, except share data)
March 31, 2018
 
December 31, 2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
117,523

 
$
168,250

Accounts receivable, net of allowances of $9,417 and $10,142, respectively
119,398

 
352,550

Contract assets
200,940

 

Prepaid expenses and other current assets
43,098

 
52,542

Total current assets
480,959

 
573,342

Property and equipment, net
22,981

 
23,568

Goodwill
42,093

 
42,093

Tradenames, net
28,536

 
28,536

Other intangibles, net
49,301

 
55,302

Long-term deferred taxes
677

 
369

Other assets, net
11,322

 
12,507

Total assets
$
635,869

 
$
735,717

LIABILITIES
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt, net
$

 
$
53,652

Accounts payable
79,441

 
109,396

Accrued payroll and employee costs
91,394

 
105,391

Contract liabilities
12,956

 

Accrued liabilities
65,585

 
98,684

Income taxes payable
18,574

 
18,401

Total current liabilities
267,950

 
385,524

Long-term debt, net
530,575

 
527,039

Other long-term liabilities
12,069

 
13,081

Total liabilities
810,594

 
925,644

DEFICIT
 
 
 
Common stock, $0.01 par value – 1,000 shares authorized and 100 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively

 

Additional paid-in capital
596,573

 
596,393

Accumulated deficit
(776,377
)
 
(791,445
)
Accumulated other comprehensive loss
(403
)
 
(404
)
Total deficit attributable to Delta Tucker Holdings, Inc.
(180,207
)
 
(195,456
)
Noncontrolling interests
5,482

 
5,529

Total deficit
(174,725
)
 
(189,927
)
Total liabilities and deficit
$
635,869

 
$
735,717

See notes to unaudited condensed consolidated financial statements

7




Delta Tucker Holdings, Inc.
Unaudited Condensed Consolidated Statements of Cash Flows
 
Three Months Ended
(Amounts in thousands)
March 31, 2018
 
March 31, 2017
Cash flows from operating activities
 
 
 
Net income (loss)
$
16,704

 
$
(212
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
6,820

 
8,898

Loss on early extinguishment of debt
239

 

Amortization of deferred loan costs and original issue discount
1,336

 
1,341

Allowance for losses on accounts receivable and other noncash gains or losses
(560
)
 

Earnings from equity method investees
(47
)
 
(43
)
Distributions from equity method investees

 
222

Deferred income taxes
(308
)
 
460

Other and paid in kind interest
2,983

 
38

Changes in assets and liabilities:
 
 
 
Accounts receivable and contract assets
31,432

 
(5,747
)
Prepaid expenses and other current assets
9,379

 
(1,843
)
Accounts payable, accrued liabilities and contract liabilities
(60,058
)
 
(20,054
)
Income taxes payable
129

 
1,892

Net cash provided by (used in) operating activities
8,049

 
(15,048
)
Cash flows from investing activities
 
 
 
Purchase of property and equipment
(4,852
)
 
(1,757
)
Proceeds from sale of property and equipment
12

 
370

Purchase of software
(32
)
 
(26
)
Return of capital from equity method investees
1,450

 
1,269

Contributions to equity method investees
(200
)
 
(900
)
Net cash used in investing activities
(3,622
)
 
(1,044
)
Cash flows from financing activities
 
 
 
Payments on new senior credit facility
(54,943
)
 

Equity contribution from affiliates of Cerberus
100

 
100

Payment of dividends to noncontrolling interests
(311
)
 
(179
)
Net cash used in financing activities
(55,154
)
 
(79
)
Net decrease in cash, cash equivalents and restricted cash
(50,727
)
 
(16,171
)
Cash, cash equivalents and restricted cash, beginning of period
168,250

 
125,882

Cash, cash equivalents and restricted cash, end of period
$
117,523

 
$
109,711

 
 
 
 
Income taxes paid, net of receipts
$
4,887

 
$
775

Interest paid
$
23,388

 
$
26,115

See notes to unaudited condensed consolidated financial statements

8




Delta Tucker Holdings, Inc.
Unaudited Condensed Consolidated Statements of Deficit
(Amounts in thousands)
Common
Stock
 
Additional
Paid-in
Capital
 
Accumulated
Deficit
 
Accumulated Other Comprehensive Loss
 
Total Deficit Attributable to Delta Tucker Holdings, Inc.
 
Noncontrolling
Interest
 
Total
Deficit
Balance at December 31, 2016

 
$

 
$
555,163

 
$
(822,045
)
 
$
(510
)
 
$
(267,392
)
 
$
5,455

 
$
(261,937
)
Share based compensation, net

 

 
11

 

 

 
11

 

 
11

Comprehensive loss attributable to Delta Tucker Holdings, Inc.

 

 

 
(487
)
 
8

 
(479
)
 
275

 
(204
)
Capital contribution

 

 
100

 

 

 
100

 

 
100

DIFZ financing, net of tax

 

 
(72
)
 

 

 
(72
)
 

 
(72
)
Dividends declared to noncontrolling interests

 

 

 

 

 

 
(270
)
 
(270
)
Balance at March 31, 2017

 
$

 
$
555,202

 
$
(822,532
)
 
$
(502
)
 
$
(267,832
)
 
$
5,460

 
$
(262,372
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Amounts in thousands)
Common
Stock
 
Additional
Paid-in
Capital
 
Accumulated
Deficit
 
Accumulated Other Comprehensive Loss
 
Total Deficit Attributable to Delta Tucker Holdings, Inc.
 
Noncontrolling
Interest
 
Total
Deficit
Balance at December 31, 2017

 
$

 
$
596,393

 
$
(791,445
)
 
$
(404
)
 
$
(195,456
)
 
$
5,529

 
$
(189,927
)
Adjustment due to adoption of ASC 606

 

 

 
(1,340
)
 

 
(1,340
)
 

 
(1,340
)
Share based compensation, net

 

 
56

 

 

 
56

 

 
56

Comprehensive income attributable to Delta Tucker Holdings, Inc.

 

 

 
16,408

 
1

 
16,409

 
296

 
16,705

Capital contribution

 

 
100

 

 

 
100

 

 
100

DIFZ financing, net of tax

 

 
24

 

 

 
24

 

 
24

Dividends declared to noncontrolling interests

 

 

 

 

 

 
(343
)
 
(343
)
Balance at March 31, 2018

 
$

 
$
596,573

 
$
(776,377
)
 
$
(403
)
 
$
(180,207
)
 
$
5,482

 
$
(174,725
)
See notes to unaudited condensed consolidated financial statements

9




Delta Tucker Holdings, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements



Note 1 — Basis of Presentation and Accounting Policies
Basis of Presentation
Delta Tucker Holdings, Inc. ("Holdings"), the parent of DynCorp International Inc. ("DynCorp International"), through its subsidiaries (together, "the Company"), provides defense and technical services and government outsourced solutions primarily to U.S. government agencies domestically and internationally. The Company was incorporated in the state of Delaware on April 1, 2010. Our customers include the DoD, the U.S. Department of State ("DoS"), the U.S. Agency for International Development ("USAID"), foreign governments, commercial customers and certain other U.S. federal, state and local government departments and agencies. Unless the context otherwise indicates, references herein to "we," "our," "us," or "the Company" refer to Delta Tucker Holdings, Inc. and our consolidated subsidiaries.
The unaudited condensed consolidated financial statements include the accounts of the Company and our domestic and foreign subsidiaries. These unaudited condensed consolidated financial statements have been prepared pursuant to accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, we believe that all disclosures are adequate and do not make the information presented misleading. These unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.
In the opinion of management, normal recurring adjustments necessary to fairly present our financial position as of March 31, 2018 and December 31, 2017, the results of operations, statements of comprehensive income (loss), statements of deficit and cash flows for the three months ended March 31, 2018 and March 31, 2017 have been included. The results of operations, statements of comprehensive income (loss), statements of deficit and cash flows for the three months ended March 31, 2018 and March 31, 2017 are not necessarily indicative of the results to be expected for the full calendar year or for any future periods. We use estimates and assumptions required for preparation of the financial statements. The estimates are primarily based on historical experience and business knowledge and are revised as circumstances change. Our actual results may differ from these estimates. The unaudited condensed consolidated financial statements include the accounts of both our domestic and foreign subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates
Revenue Recognition and Cost Estimation on Long-Term Contracts
General - We are predominantly a services provider and only include products or systems when necessary for the execution of the service arrangement. As such, systems, equipment or materials are not generally separable from the services we provide. Revenue is recognized for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance, and collectability is probable. Our contracts are primarily with U.S. government customers and are generally structured under the following contract types: (i) fixed-price; (ii) time-and-materials; and (iii) cost-reimbursement contracts. In a fixed-price contract, the price is generally not subject to adjustment based on costs incurred and may include firm fixed-price, fixed-price with economic adjustment, and fixed-price incentive elements. Time-and-materials 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 contracts provide for payment for allowable incurred costs, to the extent prescribed in the contract, plus a fixed-fee, award-fee, incentive-fee or a combination thereof. We apply the appropriate guidance consistently to all contracts.
Our contracts contain promises to provide distinct goods or services to the customer which represent performance obligations and is the unit of account under ASU 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASC 606"). To determine the proper revenue recognition method, consideration is given as to whether a single contract should be accounted for as more than one performance obligation or whether two or more contracts should be combined and accounted for as one single contract. For most of our contracts, the customer contracts with us to provide a significant service of integrating a complex set of tasks and deliverables into a single service solution. Hence, the entire contract is accounted for as one performance obligation. Less commonly, however, we may promise to provide distinct goods or services within a contract in which case we separate the contract into more

10




than one performance obligation. If a contract has multiple performance obligations, the contract’s transaction price is allocated based on the estimated relative standalone selling prices of the promised goods or services underlying each performance. The primary method used to estimate standalone selling price is the expected cost plus a margin approach. In instances where a performance obligation does not have an observable standalone selling price, we select an estimation method that maximizes the use of observable inputs.
Major factors we consider in determining total estimated revenue and cost include the base contract price, contract options, change orders (modifications of the original contract), back charges and claims, and contract provisions for penalties, award fees and performance incentives. All of these factors and other less significant contract provisions are evaluated throughout the life of our contracts when estimating transaction price. We inherently have risks related to our estimates with long-term contracts. Actual amounts could materially differ from these estimates. We believe the following are the risks associated with our estimation process: (i) assumptions are uncertain and inherently judgmental at the time of the estimate; (ii) use of reasonably different assumptions could have changed our estimates, particularly with respect to estimates of contract revenues, costs and recoverability of assets; and (iii) changes in estimates could have material effects on our financial condition or results of operations. The impact of any one of these factors could contribute to a material cumulative adjustment.
Our revenues are primarily derived from long-term contracts and programs with a base period and multiple option periods for services provided to the U.S. federal government. We recognize revenue over time and our contracts typically have one year base periods and multiple one year option periods. The option periods are considered separate purchase obligations from the base period. Generally, the terms and conditions of the contracts result in a continuous transfer of control over the relevant goods and services. As a result of control transferring over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. We generally use a cost-to-cost measure of progress for our contracts because it best depicts the transfer of assets to the customer which occurs as we incur costs on our contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenues, including estimated fees or profits, are recorded proportionally as costs are incurred. Costs to fulfill include labor, materials and subcontractors’ costs, other direct costs and an allocation of indirect costs. In certain instances, we may recognize revenue at the point in time at which control is transferred to the customer using an output method based on units produced or delivered.
We consider the unfunded portions of a contract and award and incentive fees to be variable consideration. Some of our long-term contracts with the U.S. government are only partially funded at inception as a result of the U.S. government’s annual budget and appropriations process. The unfunded portion of a contract is included in the estimated transaction price to the extent it is probable that the unfunded portion of the contract will become funded. We consider the following factors in determining the likelihood that the unfunded portion of the contract would not result in a significant revenue reversal: (i) period of time before contract funding is expected; (ii) history of receiving funding in similar situations; and (iii) communication from the customer that funding will be obtained. Award and incentive fees are generally awarded upon achievement of specified performance objectives, milestones, or cost targets and are considered variable consideration. We do not consider the mere existence of potential award or incentive fees as presumptive evidence that award or incentive fees are to be included in determining total transaction price. We include award or incentive fees in the estimated transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. These estimates are based largely on an assessment of our anticipated performance, historical award experience, and information that is reasonably available to us.
Pre-contract costs are costs incurred to fulfill a contract in anticipation of a contract award. Pre-contract costs such as those specifically chargeable to a customer and probable of recovery under a specific anticipated contract would be capitalized. All other pre-contract costs, including start-up costs, would be expensed as incurred.
Management regularly reviews project profitability and underlying estimates, including total cost to complete a project. For each project, estimates for total project costs are based on such factors as a project's contractual requirements and management's assessment of current and future pricing, economic conditions, political conditions and site conditions. Estimates can be impacted by such factors as additional requirements from our customers, a change in labor markets impacting the availability or cost of a skilled workforce, regulatory changes both domestically and internationally, political unrest or security issues at project locations. Revisions to estimates are reflected in our consolidated results of operations as changes in accounting estimates in the periods in which the facts that give rise to the revisions become known by management. We believe long-term contracts, contracts in a loss position, contracts with material award fees, and contract modifications drive the significant changes in estimates in our contracts.
The preparation of the financial statements requires us to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates. Our estimates and assumptions are reviewed periodically, and the effects of changes, if any, are reflected in the consolidated statements of operations in the period that they are determined. The majority of our contracts are accounted for under series guidance, as the performance obligation represents a series of distinct goods and services where each day of the promised service is a distinct obligation, and the effects of changes

11




in contract estimates related to certain types of contracts accounted for using an input method measure of progress, such as cost-to-cost, are recognized prospectively. Changes in these estimates can occur over the life of a contract for a variety of reasons, including changes in scope, estimated incentive or award fees, cost estimates, level of effort and/or other assumptions impacting revenue or cost to perform a contract. Changes in contract estimates related to past performance are recognized in the period in which such changes are made for the inception to date effect of the changes.
The gross favorable and unfavorable adjustments to income before income taxes below reflect changes in contract estimates during each reporting period, excluding new or completed contracts where no comparative estimates exist between reporting periods. Amounts during the three months ended March 31, 2017 and March 31, 2018 are presented under ASC 605, due to the adoption of ASC 606 on January 1, 2018 using the modified retrospective method.
 
Three Months Ended
(Amounts in millions)
March 31, 2018
 
March 31, 2017
Gross favorable adjustments
$
6.9

 
$
9.3

Gross unfavorable adjustments
(1.2
)
 
(1.2
)
Net adjustments
$
5.7

 
$
8.1

Contract Assets
Contract assets primarily consist of unbilled receivables which represent rights to consideration for work completed but not billed as of the reporting date. Due to the adoption of ASC 606, amounts previously presented as unbilled receivables in Accounts receivable, net of allowances, for the year ended December 31, 2017 of $191.8 million, have prospectively been presented as Contract assets within the Company’s consolidated balance sheets.
Contract Liabilities
Contract liabilities represent advanced payments, billings in excess of costs and earnings, and deferred revenue amounts. These amounts are recognized as revenue once the performance progress has occurred. Contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period. Advance payments and billings in excess of revenue as current, and deferred revenue as current or noncurrent based on the timing of when revenue is expected to be recognized. Due to the adoption of ASC 606, amounts received from customers in excess of revenue recognized previously presented within customer liabilities in Total accrued liabilities, for the year ended December 31, 2017 of $9.2 million, have prospectively been presented as Contract liabilities within the Company’s consolidated balance sheets.
Accounting Policies
There have been no material changes to our significant accounting policies from those described in our Annual Report on Form 10-K for the year ended December 31, 2017, except as described below.
Recently Adopted Accounting Standards
In November 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. ASU 2016-18 clarifies the guidance on the cash flow classification and presentation of changes in restricted cash or restricted cash equivalents. The Company elected to adopt ASU 2016-18 during the fourth quarter of calendar year 2017 and therefore, amounts generally described as restricted cash or restricted cash equivalents are now included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flow. The Company recasted its statement of cash flows for the three months ended March 31, 2017.
Our statement of cash flows explains the change in the total of cash, cash equivalents, and restricted cash. The following table provides a reconciliation of cash and cash equivalents, and restricted cash reported within the consolidated balance sheets that sum to the total of such amounts in the consolidated statements of cash flows:

12




 
Three Months Ended
(Amounts in thousands)
March 31, 2017
Beginning of period
 
Cash and cash equivalents
$
118,218

Restricted cash
7,664

Total cash, cash equivalents and restricted cash, beginning of period
125,882

 
 
End of period
 
Cash and cash equivalents
107,207

Restricted cash
2,504

Total cash, cash equivalents and restricted cash, end of period
109,711

 
 
Net increase (decrease) in cash, cash equivalents and restricted cash
$
(16,171
)
The following table illustrates changes in the Company's Condensed Consolidated Statements of Cash Flows as reported and as previously reported prior to the adoption of ASU 2016-18 in the fourth quarter of calendar year 2017:
 
Three Months Ended
 
March 31, 2017
 
As Reported
 
As Previously Reported
(Amounts in thousands)
 
Net cash used in operating activities
$
(15,048
)
 
$
(15,048
)
Net cash (used in) provided by investing activities
(1,044
)
 
4,116

Net cash used in financing activities
(79
)
 
(79
)
Net decrease in cash, cash equivalents and restricted cash (1)
(16,171
)
 
(11,011
)
Cash, cash equivalents and restricted cash, beginning of period (1)
125,882

 
118,218

Cash, cash equivalents and restricted cash, end of period (1)
109,711

 
107,207

(1) Amounts in the As Reported column include cash, cash equivalents and restricted cash as required upon the adoption of ASU 2016-18. Amounts in the As Previously Reported column reflects only cash and cash equivalents.
In May 2014, the FASB issued ASC 606, which replaces numerous requirements in U.S. GAAP, including industry-specific requirements, and provides companies with a single revenue recognition model for recognizing revenue from contracts with customers. We adopted ASC 606, Revenue from Contracts with Customers, as of January 1, 2018 using the modified retrospective approach only on contracts not completed at the date of initial application with the cumulative effect of adoption recorded as an adjustment to the opening balance of equity as of that date without restatement of comparative periods. See this Note and Note 2 for the required disclosures related to the impact of adopting this standard and a discussion of the Company's updated policies related to revenue recognition.
Recently Issued Accounting Developments
In February 2016, the FASB issued ASU No. 2016-02, Leases. The guidance in ASU 2016-02 supersedes the lease recognition requirements in ASC Topic 840, Leases. ASU 2016-02 requires an entity to recognize right-of-use assets and lease liabilities arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. Entities are required to adopt ASU 2016-02 using a modified retrospective approach, subject to certain optional practice expedients, and apply the provisions of ASU 2016-02 to leasing arrangements existing at or entered into after the earliest comparative period presented in the financial statements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The new standard will be effective for the Company in the first quarter of calendar year 2019. The Company has established a cross-functional team of key stakeholders for implementing the new standard. As part of the Company’s assessment and implementation plan, the Company is evaluating and implementing changes to its business processes, systems and controls. The Company has not yet determined the impact of the adoption of ASU 2016-02 on its consolidated financial position, results of operations and cash flows. The Company expects that upon adoption the most significant impact will be the recognition of right-of-use assets and lease liabilities on our consolidated balance sheets for our operating leases.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which is intended to provide financial statement users with more decision-useful information

13




about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this update replace the existing incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments are effective for annual reporting periods, and interim periods therein, beginning after December 15, 2019 and applied using a prospective transition approach for debt securities for which an other-than-temporary impairment had been recognized before the effective date. We are currently evaluating the potential effects of the adoption of ASU 2016-13 on our consolidated financial statements.
In February 2018, the FASB issued ASU No. 2018-02, Reporting Comprehensive Income - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income to help businesses and other organizations present some effects from the Tax Act’s reduction in the corporate tax rate in their income statements. ASU 2018-02 gives the option of reclassifying what are called the “stranded” tax effects within accumulated other comprehensive income (loss) to retained earnings (deficit) during each fiscal year or quarter in which the effect of the lower tax rate is recorded. ASU 2018-02 instructs businesses and other organizations to provide a disclosure in their financial statement footnotes that describes the accounting policy they used to release the income tax effects from accumulated other comprehensive income (loss), whether they are reclassifying the stranded income tax effects from the Tax Act, and information about the other effects on taxes from the reclassification. The update is effective for fiscal years beginning after December 15, 2018, and the interim periods in those years, and early adoption is permitted. We are currently evaluating the potential effects of the adoption of ASU 2018-02 on our consolidated financial statements.
Other accounting standards updates effective after March 31, 2018 are not expected to have a material effect on our consolidated financial position or results of operations and cash flows for the period ended March 31, 2018.

14




Note 2 — Revenue Recognition
In May 2014, the FASB issued ASC 606, Revenue from Contracts with Customers, which replaces numerous requirements in U.S. GAAP, including industry-specific requirements, and provides companies with a single revenue recognition model for recognizing revenue from contracts with customers. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. We adopted ASC 606, as of January 1, 2018 using the modified retrospective approach with the cumulative effect of adoption recorded as an adjustment to the opening balance of equity as of that date without restatement of comparative periods.
The impacts related to the adoption of ASC 606 on our portfolio of contracts primarily relate to the units of account and methods used to measure of progress toward satisfaction of a performance obligation. Previously, certain of our contracts that included multiple promises related to the transfer of goods or services to the customer were combined or segmented based on profit center and the requisite revenue was recognized by profit center using the percentage-of-completion method or completed-contract method. We now evaluate all promises in an arrangement to determine if they represent one or more distinct performance obligations. The adoption of ASC 606 will not change the total revenue or operating earnings recognized under these contracts, only the timing of when those amounts are recognized.
Nature of Goods and Services
The Company generally derives revenue from long-term, service-based contracts and programs for commercial, government, and military customers. Our contracts typically fall into the following two categories with the first representing substantially all of our revenue: (i) federal government contracts and (ii) other contracts.
Federal Government Contracts - Contracts with the U.S. federal government, primarily to the Department of Defense (“DoD”) and the Department of State (“DoS”), contemplate the provision of services related to aviation solutions, construction management, base and logistics operations, intelligence training, and operations and linguistics support. Certain contracts are structured using an IDIQ vehicle awarded to multiple contractors. However, many IDIQ vehicles permit the customer to direct work to a particular contractor. When a customer wishes to order services under an IDIQ contract, the customer issues a task order request for proposal to the contract awardees and task orders are awarded under a best-value approach. The task orders awarded may be fixed-priced, time-and-materials, or cost-reimbursement contracts.
The Company generally performs over a base period with multiple option periods. The U.S. government is not obligated to exercise options under a contract after the base period. At the time of completion of the contract term of a U.S. government contract, the contract may be re-competed to the extent the service is still required. Historically, the Company has received additional revenue through increases in program scope beyond that of the original contract and “over and above” requests derived from changes in customer requests. For most of our contracts, we provide a significant service of integrating equipment, materials, and services into a single project which is accounted for as one performance obligation. In certain instances, we also provide a stand-ready service in the case where the Company responds to the customer’s needs on the basis of its demand.
For contracts with multiple performance obligations, the contract’s transaction price is allocated to each performance obligation using the best estimate of the standalone selling price for each distinct good or service. Where a series of distinct services has been identified, the Company generally allocates variable consideration to distinct time increments of service (e.g. hours, days, etc.). Where the variable consideration is not directly tied to the base pricing structure of the contract (e.g. cost incurrence), the Company allocates variable consideration to a subset of services within a period (e.g. evaluation periods for awards/incentives).
Revenues are recognized over time upon contract specifications. The method utilized to measure performance progress reflects the best depiction of control to the customer. If control is transferred over time, revenue is recognized over time using the cost-to-cost-method to measure performance progress.
Typical payment terms for U.S. federal government contracts are in accordance with agreed-upon contractual terms, either at periodic intervals (e.g., biweekly or monthly) or upon achievement of contractual milestones. In most instances, the customer generally pays the Company for actual costs incurred within a short period of time. In certain cases, the Company receives interim payments as work progresses or an advance payment. The Company recognizes a liability for advance payments in excess of revenue recognized which is included in contract liabilities on the balance sheet. The advance payment typically is not considered a significant financing component because it is used to meet working capital demands that can be higher in the early stages of a contract.
Other Contracts - Contracts with non-federal government customers are predominantly service arrangements which may involve various combinations related to the provision of services, delivery of equipment and materials, grant licenses and other rights, or take certain actions. For most of our contracts, we provide a significant service of integrating equipment, materials, or other services into a single project which is accounted for as one performance obligation. In certain instances, we also provide a stand-ready service in the case where the Company responds to the customer’s needs on the basis of its demand.

15




In determining transaction price, the Company considers the unfunded portions of a contract and award and incentive fees to be variable consideration which is estimated using the best estimate of consideration to which the Company expects to be entitled per the terms and conditions of the contract at inception and reassessed quarterly. For contracts with multiple performance obligations, the contract’s transaction price is allocated to each performance obligation using the best estimate of the standalone selling price for each distinct good or service. Where a series of distinct services has been identified, the Company generally allocates variable consideration to distinct time increments of service (e.g. hours, days, etc.). Where the variable consideration is not directly tied to the base pricing structure of the contract (e.g. cost incurrence), the Company allocates variable consideration to a subset of services within a period (e.g. evaluation periods for awards/incentives).
Revenue is recognized over time upon contract specifications. The method utilized to measure performance progress reflects the best depiction of control to the customer. If consideration is considered fixed, revenue is recognized over time using the cost-to-cost-method to measure performance progress. If consideration is considered variable, revenue is recognized as performance occurs. In instances where the contract structure is time-and-materials, the Company may utilize the practical expedient allowing the recognition of revenue in the amount at which the Company invoices as the invoiced amounts correspond directly with the value provided to the customer and to which it is entitled to payment for performance to date. The Company is electing the practical expedient on not disclosing remaining performance obligations as the Company's performance obligations have an original expected duration of one year or less.
Typical payment terms for non-federal government contracts are in accordance with agreed-upon contractual terms, either at periodic intervals (e.g., biweekly or monthly) or upon achievement of contractual milestones. In certain cases, the Company receives interim payments as work progresses or an advance payment. The Company recognizes a liability for advance payments in excess of revenue recognized which is included in contract liabilities on the balance sheet. The advance payment typically is not considered a significant financing component because it is used to meet working capital demands that can be higher in the early stages of a contract.
Disaggregation of Revenue
The following table represents revenues disaggregated by product versus service, customer-type, and pricing structure and includes a reconciliation of the disaggregated revenue with reportable segments:
 
Under ASC 606
 
Three months ended March 31, 2018
(Amounts in thousands)
DynAviation
 
DynLogistics
 
Headquarters / Other
 
Total
Customer
 
 
 
 
 
 
 
DOD
$
241,975

 
$
183,649

 
$

 
$
425,624

DOS
58,495

 
31,914

 

 
90,409

Other
16,762

 
1,961

 
(463
)
 
18,260

Total revenue
$
317,232

 
$
217,524

 
$
(463
)
 
$
534,293

 
 
 
 
 
 
 
 
Contract Type
 
 
 
 
 
 
 
Fixed-Price
$
143,407

 
$
80,766

 
$
(194
)
 
$
223,979

Time-and-Materials
20,487

 
1,157

 
(19
)
 
21,625

Cost-Reimbursement
153,338

 
135,601

 
(250
)
 
288,689

Total revenue
$
317,232

 
$
217,524

 
$
(463
)
 
$
534,293



16




Financial Statement Impact of Adopting ASC 606
The Company adopted ASC 606 using the modified retrospective method and we recorded a net increase to opening accumulated deficit of $1.3 million as of January 1, 2018 due to the cumulative impact of adopting ASC 606. Additionally, amounts previously presented as unbilled receivables in Accounts receivable, net of allowances, for the year ended December 31, 2017, have prospectively been presented as Contract assets and amounts received from customers in excess of revenue recognized previously presented within customer liabilities in Total accrued liabilities for the year ended December 31, 2017, have prospectively been presented as Contract liabilities within the Company's consolidated balance sheets. As a result of applying the modified retrospective method to adopt the new revenue guidance, the following adjustments were made to accounts on the condensed consolidated balance sheet as of January 1, 2018:

17




 
As reported
 
Adjustments
 
Adjusted
(Amounts in thousands)
December 31, 2017
 
Contract Assets
 
Contract Liabilities
 
Accumulated Deficit
 
January 1, 2018
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
168,250

 
$

 
$

 
$

 
$
168,250

Accounts receivable, net of allowance of $10,142
352,550

 
(191,780
)
 

 

 
160,770

Contract assets

 
191,780

 

 
(1,340
)
 
190,440

Prepaid expenses and other current assets
52,542

 

 

 

 
52,542

Total current assets
573,342

 

 

 
(1,340
)
 
572,002

Property and equipment, net
23,568

 

 

 

 
23,568

Goodwill
42,093

 

 

 

 
42,093

Tradenames, net
28,536

 

 

 

 
28,536

Other intangibles, net
55,302

 

 

 

 
55,302

Long-term deferred taxes
369

 

 

 

 
369

Other assets, net
12,507

 

 

 

 
12,507

Total assets
$
735,717

 
$

 
$

 
$
(1,340
)
 
$
734,377

 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Current portion of long-term debt, net
$
53,652

 
$

 
$

 
$

 
$
53,652

Accounts payable
109,396

 

 

 

 
109,396

Accrued payroll and employee costs
105,391

 

 

 

 
105,391

Contract liabilities

 

 
9,164

 

 
9,164

Accrued liabilities
98,684

 

 
(9,164
)
 

 
89,520

Income taxes payable
18,401

 

 

 

 
18,401

Total current liabilities
385,524

 

 

 

 
385,524

Long-term debt, net
527,039

 

 

 

 
527,039

Other long-term liabilities
13,081

 

 

 

 
13,081

Total liabilities
925,644

 

 

 

 
925,644

 
 
 
 
 
 
 
 
 
 
Common stock, $0.01 par value – 1,000 shares authorized and 100 shares issued and outstanding at December 31, 2017

 

 

 

 

Additional paid-in capital
596,393

 

 

 

 
596,393

Accumulated deficit
(791,445
)
 

 

 
(1,340
)
 
(792,785
)
Accumulated other comprehensive loss
(404
)
 

 

 

 
(404
)
Total deficit attributable to Delta Tucker Holdings, Inc.
(195,456
)
 

 

 
(1,340
)
 
(196,796
)
Noncontrolling interests
5,529

 

 

 

 
5,529

Total deficit
(189,927
)
 

 

 
(1,340
)
 
(191,267
)
Total liabilities and deficit
$
735,717

 
$

 
$

 
$
(1,340
)
 
$
734,377



18




Impact of New Revenue Guidance on Financial Statement Line Items
The following tables compare the reported condensed consolidated statement of operations, comprehensive income and cash flows for the three months ended March 31, 2018 and the condensed consolidated balance sheet as of March 31, 2018, to the pro-forma amounts had the previous guidance been in effect.
Consolidated Statements of Operations
 
Three months ended March 31, 2018
(Amounts in thousands)
As reported
 
Pro forma as if the previous accounting guidance was in effect
Revenue
$
534,293

 
$
535,374

Cost of services
(465,423
)
 
(465,418
)
Selling, general and administrative expenses
(25,359
)
 
(25,359
)
Depreciation and amortization expense
(6,057
)
 
(6,057
)
Earnings from equity method investees
47

 
47

Operating income
37,501

 
38,587

Interest expense
(16,988
)
 
(16,988
)
Loss on early extinguishment of debt
(239
)
 
(239
)
Interest income
525

 
525

Other income, net
649

 
649

Income before income taxes
21,448

 
22,534

Provision for income taxes
(4,744
)
 
(5,007
)
Net income
16,704

 
17,527

Noncontrolling interests
(296
)
 
(296
)
Net income attributable to Delta Tucker Holdings, Inc.
$
16,408

 
$
17,231

The following summarizes the significant changes on the Company's condensed consolidated statement of operations for the three months ended March 31, 2018 as a result of the adoption of ASC 606 on January 1, 2018 compared to if the Company had continued to recognize revenues under ASC 605. The effect of the change was primarily driven by the change in period of performance of our contracts under ASC 605 as compared to ASC 606 and the impact of timing of recognition on variable consideration on certain contracts. The remaining impacts were not material.

19




Consolidated Statements of Comprehensive Income
 
Three months ended March 31, 2018
(Amounts in thousands)
As reported
 
Pro forma as if the previous accounting guidance was in effect
Net income
$
16,704

 
$
17,527

Other comprehensive income, net of tax:
 
 
 
Foreign currency translation adjustment
1

 
1

Other comprehensive income
1

 
1

Comprehensive income
16,705

 
17,528

Comprehensive income attributable to noncontrolling interests
(296
)
 
(296
)
Comprehensive income attributable to Delta Tucker Holdings, Inc.
$
16,409

 
$
17,232

The Company's statements of comprehensive income were only impacted by the change in net income due to the adoption of ASC 606.

20




Consolidated Balance Sheets
 
As of March 31, 2018
(Amounts in thousands)
As reported
 
Pro forma as if the previous accounting guidance was in effect
Current assets:
 
 
 
Cash and cash equivalents
$
117,523

 
$
117,523

Accounts receivable, net of allowances of $9,417
119,398

 
318,464

Contract assets
200,940

 

Prepaid expenses and other current assets
43,098

 
43,098

Total current assets
480,959

 
479,085

Property and equipment, net
22,981

 
22,981

Goodwill
42,093

 
42,093

Tradenames, net
28,536

 
28,536

Other intangibles, net
49,301

 
49,301

Long-term deferred taxes
677

 
677

Other assets, net
11,322

 
11,322

Total assets
$
635,869

 
$
633,995

 
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
79,441

 
$
79,441

Accrued payroll and employee costs
91,394

 
91,394

Contract liabilities
12,956

 

Accrued liabilities
65,585

 
74,240

Income taxes payable
18,574

 
18,837

Total current liabilities
267,950

 
263,912

Long-term debt, net
530,575

 
530,575

Other long-term liabilities
12,069

 
12,069

Total liabilities
810,594

 
806,556

 
 
 
 
Common stock, $0.01 par value – 1,000 shares authorized and 100 shares issued and outstanding at March 31, 2018

 

Additional paid-in capital
596,573

 
596,573

Accumulated deficit
(776,377
)
 
(774,213
)
Accumulated other comprehensive loss
(403
)
 
(403
)
Total deficit attributable to Delta Tucker Holdings, Inc.
(180,207
)
 
(178,043
)
Noncontrolling interests
5,482

 
5,482

Total deficit
(174,725
)
 
(172,561
)
Total liabilities and deficit
$
635,869

 
$
633,995


Total reported assets were $1.9 million greater than pro-forma balance sheet, which assumes the previous guidance remained in effect as of March 31, 2018. This was largely due to the change in period of performance of our contracts under ASC 605 as compared to ASC 606 and the impact of timing of recognition on variable consideration on certain contracts.
Total reported liabilities were $4.0 million greater than the pro-forma balance sheet, which assumes the previous guidance remained in effect as of March 31, 2018. This was primarily due to the change in amounts received from customers in excess of revenue recognized. The remaining impacts were not material.


21




Consolidated Statements of Cash Flows
 
Three months ended March 31, 2018
(Amounts in thousands)
As reported
 
Pro forma as if the previous accounting guidance was in effect
Cash flows from operating activities
 
 
 
Net income
$
16,704

 
$
17,527

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
6,820

 
6,820

Loss on early extinguishment of debt
239

 
239

Amortization of deferred loan costs and original issue discount
1,336

 
1,336

Allowance for losses on accounts receivable and other noncash gains or losses
(560
)
 
(560
)
Earnings from equity method investees
(47
)
 
(47
)
Deferred income taxes
(308
)
 
(308
)
Other and paid in kind interest
2,983

 
2,983

Changes in assets and liabilities:
 
 
 
Accounts receivable and contract assets
31,432

 
34,646

Prepaid expenses and other current assets
9,379

 
9,379

Accounts payable, accrued liabilities and contract liabilities
(60,058
)
 
(64,358
)
Income taxes payable
129

 
392

Net cash provided by operating activities
8,049

 
8,049

Cash flows from investing activities
 
 
 
Purchase of property and equipment
(4,852
)
 
(4,852
)
Proceeds from sale of property and equipment
12

 
12

Purchase of software
(32
)
 
(32
)
Return of capital from equity method investees
1,450

 
1,450

Contributions to equity method investees
(200
)
 
(200
)
Net cash used in investing activities
(3,622
)
 
(3,622
)
Cash flows from financing activities
 
 
 
Payments on senior secured credit facility
(54,943
)
 
(54,943
)
Equity contribution from affiliates of Cerberus
100

 
100

Payment of dividends to noncontrolling interests
(311
)
 
(311
)
Net cash used in financing activities
(55,154
)
 
(55,154
)
Net decrease in cash, cash equivalents and restricted cash
(50,727
)
 
(50,727
)
Cash, cash equivalents and restricted cash, beginning of period
168,250

 
168,250

Cash, cash equivalents and restricted cash, end of period
$
117,523

 
$
117,523

The adoption of ASC 606 had no impact on the Company's cash flows from operating, investing and financing activities.


22




Note 3 — Composition of Certain Financial Statement Captions
The following tables present financial information of certain consolidated balance sheet captions.
Prepaid expenses and other current assets
 
As Of
(Amounts in thousands)
March 31, 2018
 
December 31, 2017
Prepaid expenses
$
30,794

 
$
38,423

Inventories, net
7,164

 
8,240

Work-in-process inventory
449

 
520

Joint venture receivables
29

 
29

Other current assets
4,662

 
5,330

Total prepaid expenses and other current assets
$
43,098

 
$
52,542

Prepaid expenses include prepaid insurance, prepaid vendor deposits, and prepaid rent, none of which individually exceed 5% of current assets. The reduction in prepaid expenses is primarily due to the timing of insurance payments. Inventory is valued at the lower of cost or net realizable value.
Property and equipment, net
 
As Of
(Amounts in thousands)
March 31, 2018
 
December 31, 2017
Aircraft
$
3,868

 
$
3,868

Computers and related equipment
8,236

 
7,967

Leasehold improvements
17,614

 
17,614

Office furniture and fixtures
4,184

 
4,184

Vehicles
13,451

 
12,659

Gross property and equipment
47,353

 
46,292

Less accumulated depreciation
(24,372
)
 
(22,724
)
Total property and equipment, net
$
22,981

 
$
23,568

As of March 31, 2018 and December 31, 2017, Property and equipment, net, included the accrual for property additions of $2.0 million and $4.4 million, respectively. Depreciation expense, including certain depreciation amounts classified as Cost of services, was $1.7 million and $1.0 million during the three months ended March 31, 2018 and March 31, 2017, respectively.
Other assets, net
 
As Of
(Amounts in thousands)
March 31, 2018
 
December 31, 2017
Investment in affiliates
$
4,543

 
$
5,746

Palm promissory note, long-term portion
1,873

 
1,876

Other
4,906

 
4,885

Total other assets, net
$
11,322

 
$
12,507

Accrued payroll and employee costs
 
As Of
(Amounts in thousands)
March 31, 2018
 
December 31, 2017
Wages, compensation and other benefits
$
74,711

 
$
90,583

Accrued vacation
15,605

 
13,625

Accrued contributions to employee benefit plans
1,078

 
1,183

Total accrued payroll and employee costs
$
91,394

 
$
105,391


23




Accrued liabilities
 
As Of
(Amounts in thousands)
March 31, 2018
 
December 31, 2017
Customer liability
$
14,252

 
$
23,486

Accrued insurance
15,086

 
23,793

Accrued interest
12,085

 
23,194

Contract losses
1,905

 
2,660

Legal reserves
6,569

 
9,233

Other
15,688

 
16,318

Total accrued liabilities
$
65,585

 
$
98,684

We adopted ASC 606, Revenue from Contracts with Customers, as of January 1, 2018 using the modified retrospective approach. Due to the adoption of ASC 606, amounts received from customers in excess of revenue recognized previously presented within customer liabilities in Total accrued liabilities for the year ended December 31, 2017, have prospectively been presented as Contract liabilities within its consolidated balance sheets without restatement to prior periods. See Note 6 for further discussion.
Customer liabilities represent amounts due back to a customer. Contract losses represent our best estimate of forward losses using currently available information and could change in future periods as new facts and circumstances emerge. Changes to the provision for contract losses are presented in Cost of services on our Statement of Operations. Legal matters include reserves related to various lawsuits and claims. See Note 9 for further discussion. Other is comprised primarily of accrued rent and workers' compensation related claims and other balances that are not individually material to the consolidated financial statements.
Other long-term liabilities
As of March 31, 2018 and December 31, 2017, Other long-term liabilities were $12.1 million and $13.1 million, respectively. Other long-term liabilities are primarily due to our long-term incentive bonus plan and nonqualified unfunded deferred compensation plan of $2.4 million and $3.3 million as of March 31, 2018 and December 31, 2017, respectively, and a long-term leasehold obligation related to our Tysons Corner facility in McLean, Virginia, of $2.7 million and $2.8 million as of March 31, 2018 and December 31, 2017, respectively. Other long-term liabilities also include an uncertain tax benefit of $3.5 million as of March 31, 2018 and December 31, 2017. See Note 5 for further discussion.

24




Note 4 — Goodwill and Other Intangible Assets
In January 2018, 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 three operating and reporting segments, Aviation Engineering, Logistics and Sustainment ("AELS"), Aviation Operations and Life Cycle Management ("AOLC") and DynLogistics, were re-aligned into two operating and reporting segments by combining AELS and AOLC into DynAviation with DynLogistics continuing to operate as a separate segment. Our two operating and reporting segments provide services domestically and in foreign countries primarily under contracts with the U.S. government. Each operating and reportable segment is its own reporting unit and only the DynLogistics reporting unit had a goodwill balance as of March 31, 2018, which we assess for potential goodwill impairment. The carrying amount of goodwill for DynLogistics was $42.1 million as of both March 31, 2018 and December 31, 2017.
We assess goodwill and other intangible assets with indefinite lives for impairment annually in October or when an event occurs or circumstances change that would suggest a triggering event. If a triggering event is identified, a goodwill impairment test is performed to identify any possible impairment in the period in which the event is identified.
In connection with our annual assessment of goodwill during the fourth quarter of each year, we update our key assumptions, including our forecasts of revenue and income for each reporting unit. The projections for these reporting units include significant estimates related to new business opportunities. If we are unsuccessful in obtaining these opportunities in 2018, a triggering event could be identified and a goodwill impairment test would be performed to identify any possible goodwill impairment in the period in which the event is identified. There can be no assurance that the estimates and assumptions regarding forecasted earnings and cash flows, the period of strength of the U.S. defense spending, and other inputs used in forecasting the present value of forecasted cash flows will prove to be accurate projections of future performance.
During the three months ended March 31, 2018, we did not have a triggering event in any of our reporting units.
Amortization expense for customer-related intangibles, other intangibles and finite-lived tradenames was $5.1 million and $7.9 million for the three months ended March 31, 2018 and March 31, 2017, respectively. Other intangibles are primarily representative of our capitalized software which had a net carrying value of $2.3 million and $3.2 million as of March 31, 2018 and December 31, 2017, respectively.
Estimated aggregate future amortization expense for finite lived assets subject to amortization are $16.4 million for the nine months ending December 31, 2018, $21.5 million in 2019, $11.3 million in 2020, $0.1 million in 2021, $0.0 million in 2022 and $0.0 million thereafter.


25




Note 5 — Income Taxes
On December 22, 2017, the President of the United States signed into law the Tax Act. The Tax Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and businesses. For businesses, the Tax Act creates limitations on interest expense deductions (if certain conditions apply) and reduces the corporate federal tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. The Company is required to value its deferred tax assets and liabilities applying the rates prescribed by the enacted law for the period in which such deferred tax assets and liabilities are expected to reverse. SEC Staff Accounting Bulletin (“SAB”) 118 allows us to provide a provisional estimate of the impacts of the Tax Act due to the complexities involved in accounting for the enactment of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the enactment of the Tax Act to complete the accounting under ASC 740, Income Taxes. Specific impacts of the Tax Act are discussed below.
The domestic and foreign components of Income before income taxes are as follows:
 
Three Months Ended
(Amounts in thousands)
March 31, 2018
 
March 31, 2017
Domestic
$
21,433

 
$
2,784

Foreign
15

 
43

Income before income taxes
$
21,448

 
$
2,827

Non-current deferred tax assets, net, was $0.7 million and $0.4 million as of March 31, 2018 and December 31, 2017, respectively.
Our effective tax rate ("ETR") was 22.1% and 107.5% for the three months ended March 31, 2018 and March 31, 2017, respectively. For the three months ended March 31, 2018, the ETR was primarily driven by an increase in income before income taxes and a decrease in the corporate federal tax rate effective January 1, 2018.
Management assesses both the available positive and negative evidence to determine whether it is more likely than not that there will be sufficient sources of future taxable income to recognize deferred tax assets. The Company must also assess whether its valuation allowance analyses are affected by the Tax Act. The following items impacted the valuation allowance due to the enacted Tax Act:
A reduction in deductible interest expense for federal income tax purposes which will create an indefinite lived asset;
The prevention of deferring revenue with respect to unbilled receivables; and
The recognition of revenue it had previously deferred as unbilled receivables over a four-year period pursuant to Internal Revenue Code ("IRC") Section 481.
While we anticipate that the Tax Act will result in the Company enhancing its ability to recognize existing deferred tax assets in the future, the Company also anticipates that the Tax Act will create new deferred tax assets that will be subject to future valuation allowance. As such, the Company will remain in a valuation allowance on most domestic deferred tax assets for the period ended March 31, 2018 but will assess the need for valuation allowance each period. As of March 31, 2018 and December 31, 2017, our valuation allowance was $64.7 million and $66.6 million, respectively.
As of March 31, 2018 and December 31, 2017, we had $2.8 million of total unrecognized tax benefits of which $2.7 million would impact our effective tax rate if recognized. We do not expect the unrecognized tax benefit and any related interest or penalties to be settled within the next twelve months.
During the three months ended March 31, 2018, we made no estimated federal income tax payments. All of our income taxes paid or refunds received during the three months ended March 31, 2018 were related to foreign jurisdictions.
During the three months ended March 31, 2018, a tax assessment from the Saudi Arabia Tax Authority ("GAZT") was received, seeking approximately $7.7 million in taxes and penalties specific to an existing audit of a branch location for periods between 2002 to 2013. We intend to file an initial appeal on the assessment with the GAZT and we previously established an accrual for the more likely than not amount of the estimated tax liability. We will continue to monitor and our estimate for the potential tax liability has not changed.




26




Note 6 — Contract Balances
Our contract balances consist of accounts receivable, contract assets and contract liabilities.
We adopted ASC 606, Revenue from Contracts with Customers, as of January 1, 2018 using the modified retrospective approach. Due to the adoption of ASC 606, amounts previously presented as unbilled receivables in Accounts receivable, net of allowances, for the year ended December 31, 2017, have prospectively been presented as Contract assets within its consolidated balance sheets without restatement to prior periods. Contract assets primarily consist of unbilled receivables which represent rights to consideration for work completed but not billed as of the reporting date. The balance of unbilled receivables consists of costs and fees that are: (i) billable immediately; (ii) billable on contract completion; or (iii) billable upon other specified events, such as the resolution of a request for equitable adjustment or formal claim. Contract assets as of March 31, 2018 include $26.9 million related to costs incurred on projects for which we are awaiting final funding, definitization or other contract actions in order for us to bill our customer. As of December 31, 2017, unbilled accounts receivable included $12.0 million related to costs incurred on projects for which we are awaiting final funding, definitization or other contract actions in order for us to bill our customer. As of March 31, 2018 and December 31, 2017, we had one contract claim outstanding totaling $2.7 million, net of reserves. We do not believe we have significant exposure to credit risk as our receivables are primarily with the U.S. government.
Due to the adoption of ASC 606, amounts previously presented as customer liabilities in Total accrued liabilities for the year ended December 31, 2017, have prospectively been presented as Contract liabilities within its consolidated balance sheets without restatement to prior periods. Contract liabilities represent advanced payments, billings in excess of costs and earnings, and deferred revenue amounts. These current and noncurrent contract liabilities are transferred to contract assets once the performance progress has occurred. Contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period.
Our contract balances consisted of the following:
(Amounts in thousands)
March 31, 2018
 
December 31, 2017
 
$ Change
Accounts receivable, net of allowances
$
119,398

 
$
160,770

 
$
(41,372
)
Unbilled accounts receivable

 
191,780

 
(191,780
)
Contract assets
200,940

 

 
200,940

Contract liabilities
12,956

 

 
12,956

During the three months ended March 31, 2018:
we reclassified $191.8 million of Unbilled accounts receivable to Contract assets due to the implementation of ASC 606;
we increased Contract assets by $534.3 million due to the recognition of revenue in the first of quarter of 2018, which included adjustments for changes in estimates arising from a change in the measure of progress, a change in an estimate of the transaction price or a contract modifications;
we reclassified $527.0 million of Contract assets to Accounts receivable when the right to consideration became unconditional;
we recognized revenue of $0.2 million related to our Contract liabilities as of January 1, 2018.
Our allowance for doubtful accounts was $9.4 million as of March 31, 2018 compared to $10.1 million as of December 31, 2017, and is primarily due to outstanding receivables where we operated under a subcontract for a prime contractor on a U.S. government program that ended December 31, 2014. See Note 9 for further discussion.

27




Note 7 — Fair Value of Financial Assets and Liabilities
ASC 820 — Fair Value Measurements and Disclosures establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:
Level 1, defined as observable inputs such as quoted prices in active markets;
Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and
Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
Fair Value of Financial Instruments
Our financial instruments include cash and cash equivalents, accounts receivable, accounts payable, and borrowings. Because of the short-term nature of cash and cash equivalents, accounts receivable, and accounts payable, the fair value of these instruments approximates the carrying value.
Our estimate of the fair value of our 11.875% senior secured second lien notes (the "Second Lien Notes") and New Senior Credit Facility (as defined in Note 8) is based on Level 1 and Level 2 inputs, as defined above. Our estimate of the fair value of our Cerberus 3L Notes (as defined in Note 8) is based on Level 3 inputs, as defined above. We used the following techniques in determining the fair value disclosed for the Cerberus 3L Notes classified as Level 3. The fair value as of March 31, 2018 has been calculated by discounting the expected cash flows using a discount rate of 5.9%. This discount rate is determined using the Moody's credit rating for the Second Lien Notes and reducing the rating one level lower for the Cerberus 3L Notes as they are subordinated to the Second Lien Notes.
 
As Of
 
March 31, 2018
 
December 31, 2017
(Amounts in thousands)
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
11.875% senior secured second lien notes
$
381,849

 
$
396,665

 
$
379,006

 
$
401,273

Term loan
127,343

 
127,661

 
182,286

 
182,286

Cerberus 3L notes
32,830

 
30,650

 
32,420

 
30,267

Total indebtedness
542,022

 
554,976

 
593,712

 
613,826

Less current portion of long-term debt

 

 
(54,943
)
 
(54,943
)
Total long-term debt
$
542,022

 
$
554,976

 
$
538,769

 
$
558,883




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Note 8 — Debt
Debt consisted of the following:
 
As of March 31, 2018
(Amounts in thousands)
Carrying Amount
 
Original Issue Discount on Term Loan
 
Deferred Financing Costs, Net
 
Carrying Amount less Original Issue Discount on Term Loan and Deferred Financing Costs, Net
11.875% senior secured second lien notes
$
381,849

 
$

 
$
(1,078
)
 
$
380,771

Term loan
127,343

 
(8,116
)
 
(2,184
)
 
117,043

Cerberus 3L notes
32,830

 

 
(69
)
 
32,761

Total indebtedness
542,022

 
(8,116
)
 
(3,331
)
 
530,575

Less current portion of long-term debt, net

 

 

 

Total long-term debt, net
$
542,022

 
$
(8,116
)
 
$
(3,331
)
 
$
530,575

 
As of December 31, 2017
(Amounts in thousands)
Carrying Amount
 
Original Issue Discount on Term Loan
 
Deferred Financing Costs, Net
 
Carrying Amount less Original Issue Discount on Term Loan and Deferred Financing Costs, Net
11.875% senior secured second lien notes
$
379,006

 
$

 
$
(1,177
)
 
$
377,829

Term loan
182,286

 
(8,996
)
 
(2,776
)
 
170,514

Cerberus 3L notes
32,420

 

 
(72
)
 
32,348

Total indebtedness
593,712

 
(8,996
)
 
(4,025
)
 
580,691

Less current portion of long-term debt, net (1)
(54,943
)
 
1,110

 
181

 
(53,652
)
Total long-term debt, net
$
538,769

 
$
(7,886
)
 
$
(3,844
)
 
$
527,039

(1)
The carrying amount of the current portion of long-term debt as of December 31, 2017 includes our Excess Cash Flow Payment of $54.9 million, which was paid on March 21, 2018.
The original issue discount on the Term Loan facility under the New Senior Credit Facility (the "Term Loan") and deferred financing costs are amortized through interest expense. Amortization related to the original issue discount was $0.9 million and $0.9 million during the three months ended March 31, 2018 and March 31, 2017, respectively. Amortization related to deferred financing costs was $0.5 million and $0.5 million during the three months ended March 31, 2018 and March 31, 2017, respectively.
Deferred financing costs for the three months ended March 31, 2018 were reduced by $0.2 million related to the pro rata write-off of deferred financing costs to loss on early extinguishment of debt as a result of the $54.9 million Excess Cash Flow principal payment made on the Term Loan on March 21, 2018, which was the only principal payment made on the Term Loan during the three months ended March 31, 2018. There were no principal payments made on the Term Loan during the three months ended March 31, 2017.
New Senior Credit Facility
On July 7, 2010, we entered into a senior secured credit facility (the "Senior Credit Facility"), with a banking syndicate and Bank of America, N.A. as Administrative Agent (the "Agent"). On April 30, 2016, we entered into Amendment No. 5 ("Amendment No. 5") to the Senior Credit Facility which provided for a new senior secured credit facility (the "New Senior Credit Facility") upon the satisfaction of certain conditions. On June 15, 2016, we satisfied the conditions set forth in Amendment No. 5 and the New Senior Credit Facility became effective. The New Senior Credit Facility is secured by substantially all of our assets and guaranteed by substantially all of our subsidiaries.
As of March 31, 2018, the New Senior Credit Facility provided for the following:
a $127.3 million Term Loan;
a $85.8 million class B revolving facility (the "Revolver"); and
up to $15.0 million in incremental revolving facilities provided by and at the discretion of certain non-debt fund affiliates that are controlled by Cerberus (as defined herein), which shall rank pari passu with, and be on the same terms as, the Revolver.

29




As of March 31, 2018 and December 31, 2017, the available borrowing capacity under the New Senior Credit Facility was approximately $65.5 million and included $20.3 million in issued letters of credit. Amounts borrowed under the Revolver are used to fund operations. As of March 31, 2018 and December 31, 2017 there were no amounts borrowed under the Revolver. The Revolver and the Term Loan mature on July 7, 2019 and July 7, 2020, respectively.
Interest Rates on Term Loan & Revolver
The interest rate per annum applicable to the Term Loan is, at our option, equal to either the Base Rate or the Eurocurrency Rate, in each case, plus (i) 5.00% in the case of Base Rate loans and (ii) 6.00% in the case of Eurocurrency Rate loans. The interest rate per annum applicable to the Revolver is, at our option, equal to either a Base Rate or a Eurocurrency Rate plus (i) a range of 4.50% to 5.00% based on the First Lien Secured Leverage Ratio in the case of Base Rate loans and (ii) a range of 5.50% to 6.00% based on the First Lien Secured Leverage Ratio in the case of Eurocurrency Rate loans. The First Lien Secured Leverage Ratio is the ratio of total first lien secured consolidated debt (net of up to $75 million of unrestricted cash and cash equivalents) to consolidated earnings before interest, taxes, depreciation and amortization ("Consolidated EBITDA"), as defined in the New Senior Credit Facility. The variable Base Rate has a floor of 2.75% and the variable Eurocurrency Rate has a floor of 1.75%. Interest payments on both the Term Loan and Revolver are payable at the end of the interest period as defined in the New Senior Credit Facility, but not less than quarterly.
As of March 31, 2018 and December 31, 2017, the applicable interest rate on the Term Loan was 7.81% and 7.75%, respectively.
Interest Rates on Letter of Credit Subfacility and Unused Commitment Fees
All of our letters of credit under the New Senior Credit Facility are subject to a 0.25% fronting fee. The letter of credit subfacility bears interest at an applicable rate that ranges from 5.50% to 6.00% with respect to the Revolver commitments. The unused commitment fee on our Revolver ranges from 0.50% to 0.75% on the undrawn amount of the facility depending on the First Lien Secured Leverage Ratio. Interest payments on both the letter of credit subfacility and unused commitments are payable quarterly in arrears. We will also pay customary letter of credit and agency fees.
The applicable interest rate for our letter of credit subfacility was 5.50% as of March 31, 2018 and December 31, 2017. The applicable interest rate for our unused commitment fees was 0.50% as of March 31, 2018 and December 31, 2017.
Principal Payments
The credit agreement governing the New Senior Credit Facility contains an annual requirement to submit a portion of our Excess Cash Flow, as defined in the credit agreement, as additional principal payments. Based on our annual financial results for the years ended December 31, 2017 and 2016, we made additional principal payments as required under the Excess Cash Flow provisions of the New Senior Credit Facility of $54.9 million on March 21, 2018 and $25.1 million on April 4, 2017. Certain other transactions can trigger mandatory principal payments such as tax refunds, a disposition of a portion of our business or a significant asset sale. We had no such transactions during the three months ended March 31, 2018 or March 31, 2017.
The New Senior Credit Facility requires us to prepay outstanding term loans, subject to certain exceptions, with:
100% of excess cash flow (as defined in Amendment No. 5) less the amount of certain voluntary prepayments as described in Amendment No. 5; and
100% of the net cash proceeds of all non-ordinary course asset sales and casualty and condemnation events, if we do not reinvest or commit to reinvest those proceeds in assets to be used in our business or to make certain other permitted investments within six months (and, if committed to be so reinvested, actually reinvested within twelve months).
We are permitted to voluntarily repay outstanding loans under the New Senior Credit Facility at any time without premium or penalty, other than customary "breakage" costs with respect to Eurocurrency Rate Loans.
Maturity and Principal Amortization
We are required to make principal amortization payments with respect to the Term Loan of $22.5 million on or prior to June 15, 2017 and $22.5 million on or prior to June 15, 2018, which amounts may be reduced as a result of the application of certain prepayments, including our Excess Cash Flow payment. The June 15, 2018 and June 15, 2017 principal amortization payments were fully satisfied as a result of the additional principal payments of $54.9 million and $25.1 million made on March 21, 2018 and April 4, 2017 respectively under the Excess Cash Flow requirement discussed above. The principal amount of the Term Loan may be reduced as a result of prepayments, with the remaining amount payable on July 7, 2020.
Guarantee and Security
The guarantors of the obligations under the New Senior Credit Facility are identical to those under the Second Lien Notes and the Cerberus 3L Notes. See Note 12. The New Senior Credit Facility is secured on a first lien basis by the same collateral that secures the Second Lien Notes on a second lien basis and the Cerberus 3L Notes on a third lien basis.

30




Covenants and Other Terms
The New Senior Credit Facility contains a number of financial, as well as non-financial, affirmative and negative covenants that we believe are usual and customary. Among other things, the New Senior Credit Facility requires us to maintain a maximum total leverage ratio and a minimum interest coverage ratio. The total leverage ratio is the ratio of Consolidated Total Debt, as defined in Amendment No. 5 (which definition excludes debt under the Cerberus 3L Notes), less unrestricted cash and cash equivalents (up to $75.0 million) to Consolidated EBITDA, as defined in Amendment No. 5, for the applicable period. The maximum total leverage ratio was 5.50 to 1.0 for the period ended March 31, 2018. The interest coverage ratio is the ratio of Consolidated EBITDA to Consolidated Interest Expense, as defined in Amendment No. 5 (which provides that interest expense with respect to the Cerberus 3L Notes is excluded). The minimum interest coverage ratio was 1.60 to 1.0 for the period ended March 31, 2018.
The New Senior Credit Facility requires, solely for the benefit of the lenders under the Revolver, for us to maintain minimum liquidity (based on availability of revolving credit commitments plus unrestricted cash and cash equivalents) as of the end of each fiscal quarter ending after December 31, 2017 of not less than $50 million. The credit agreement governing the New Senior Credit Facility also contains customary representations and warranties and events of default.
As of March 31, 2018 and December 31, 2017, we were in compliance with our financial maintenance covenants under the New Senior Credit Facility. We expect, based on current projections and estimates, to be in compliance with our covenants in the New Senior Credit Facility (including our financial maintenance covenants), and the covenants in the Second Lien Notes and the Cerberus 3L notes, further discussed below, for the next twelve months.
Second Lien Notes
On June 15, 2016, $415.7 million principal amount of the 10.375% Senior Notes due 2017 (the "Senior Unsecured Notes") were exchanged for $45.0 million cash and $370.6 million aggregate principal amount of Second Lien Notes due November 30, 2020, which are governed by the terms of the indenture (the "Indenture"), among DynCorp International, Holdings, as parent guarantor, DynCorp International’s subsidiaries that currently guarantee the New Senior Credit Facility, as subsidiary guarantors (the "Subsidiary Guarantors"), and Wilmington Trust, National Association, as trustee and collateral agent.
Interest on the Second Lien Notes accrues at the rate of 11.875% per annum, comprised of 10.375% per annum in cash and 1.500% per annum payable in kind ("PIK," and such interest "PIK Interest"). The cash portion of the interest on the Second Lien Notes is payable in cash and the PIK Interest on the Second Lien Notes is payable in kind, each semi-annually in arrears on January 1 and July 1. PIK interest converted into the carrying amount of the Second Lien Notes during the three months ended March 31, 2018 and March 31, 2017 was $2.8 million and $2.8 million, respectively. PIK interest accrued on the Second Lien Notes was $1.4 million and $2.8 million as of March 31, 2018 and December 31, 2017, respectively.
Covenants and Events of Default
The Indenture contains a number of non-financial affirmative and negative covenants we believe are usual and customary. These covenants are subject to a number of important exceptions and qualifications as set forth in the Indenture. In addition, the Indenture requires DynCorp International to make an amortization payment of $22.5 million principal amount of the Term Loan under the New Senior Credit Facility no later than June 15, 2018, which amount was fully satisfied as a result of the Company’s $54.9 million excess cash flow payment discussed above.
The Indenture contains customary events of default, including for failure to pay other indebtedness in a total amount exceeding $10.0 million after final maturity of such indebtedness.
Optional Redemption
On and after July 1, 2017, the Second Lien Notes are redeemable at the option of the Company, in whole or in part, at any time and from time to time, upon not less than 30 nor more than 60 days’ prior notice, at the following redemption prices (expressed as a percentage of the principal amount), plus accrued and unpaid cash interest, if any, together with an amount of cash equal to all accrued and unpaid PIK Interest to but excluding the redemption date:
Period
 
Redemption Price

July 1, 2017 through June 30, 2018
 
106.00
%
July 1, 2018 through June 30, 2019
 
103.00
%
July 1, 2019 and thereafter
 
100.00
%
Cerberus 3L Notes

31




On June 15, 2016, DynCorp Funding LLC, a limited liability company managed by Cerberus Capital Management, L.P. ("Cerberus"), entered into a Third Lien Credit Agreement (the "Third Lien Credit Agreement") with us. Under the Third Lien Credit Agreement, DynCorp Funding LLC has made a $30 million term loan to us (the "Cerberus 3L Notes"). The proceeds of the Cerberus 3L Notes were fully utilized and were restricted to pay fees and expenses (including reimbursement of out-of-pocket expenses) in support of or related to the Company’s Global Advisory Group.
 
Interest Rate and Fees
The interest rate per annum applicable to the Cerberus 3L Notes is 5.00%, payable in kind on a quarterly basis. PIK interest converted into the carrying amount of the Cerberus 3L Notes during the three months ended March 31, 2018 and March 31, 2017 was $0.4 million and $0.4 million, respectively.

Prepayments
The Cerberus 3L Notes do not require any mandatory prepayments, and, subject to the terms of the Intercreditor Agreement (as defined below), we are permitted to voluntarily repay outstanding loans under the Cerberus 3L Notes without premium or penalty. The New Senior Credit Facility and the Indenture governing the Second Lien Notes restrict us from making any principal payments on the Cerberus 3L Notes.

Maturity and Amortization
The Cerberus 3L Notes do not require any mandatory amortization payments prior to maturity and the outstanding principal amounts shall be payable on June 15, 2026.

Covenants and Events of Default
The Cerberus 3L Notes include non-financial affirmative and negative covenants consistent with the covenants set forth in the Second Lien Notes; provided that each "basket" or "cushion" set forth in the covenants is at least 25% less restrictive than the corresponding provision set forth in the Second Lien Notes. The Third Lien Credit Agreement contains customary events of default, including for failure to pay other debt in a total amount exceeding $12.5 million after final maturity or acceleration of such indebtedness.

Intercreditor Agreement

The collateral granted to secure the indebtedness under the New Senior Credit Facility, on a first-priority basis, has also been granted to secure (a) the Second Lien Notes and the guarantees under the Indenture on a second-priority basis and (b) the Cerberus 3L Notes and the guarantees under the Third Lien Credit Agreement on a third-priority basis. The relative priority of the liens afforded to the New Senior Credit Facility, Second Lien Notes and Cerberus 3L Notes and the subordination in right of payment of the Cerberus 3L Notes to the New Senior Credit Facility and the Second Lien Notes are set forth in the Intercreditor Agreement (the "Intercreditor Agreement"), dated as of June 15, 2016, by and among the administrative agent under the New Senior Credit Facility, the collateral agent under the Indenture, and the collateral agent under the Third Lien Credit Agreement.

Note 9 — Commitments and Contingencies
Commitments
We have operating leases for the use of real estate and certain property and equipment which are either non-cancelable, cancelable only by the payment of penalties or cancelable upon one month’s notice. All lease payments are based on the lapse of time but include, in some cases, payments for insurance, maintenance and property taxes. There are no purchase options on operating leases at favorable terms, but most leases have one or more renewal options. Certain real estate leases are subject to annual escalations for increases in base rents, utilities and property taxes. Lease rental expense was $10.6 million and $9.8 million for the three months ended March 31, 2018 and March 31, 2017, respectively. We have no significant long-term purchase agreements with service providers.

32




Contingencies
General Legal Matters
We are involved in various lawsuits and claims that arise in the normal course of business. We have established reserves for matters in which it is believed that losses are probable and can be reasonably estimated. Reserves related to these matters have been recorded in Other accrued liabilities totaling approximately $6.6 million and $9.2 million as of March 31, 2018 and December 31, 2017, respectively. We believe that appropriate accruals have been established for such matters based on information currently available; however, some of the matters may involve compensatory, punitive, or other claims or sanctions that, if granted, could require us to pay damages or make other expenditures in amounts that could not be reasonably estimated at March 31, 2018. These accrued reserves represent the best estimate of amounts believed to be our liability in a range of expected losses. In addition to matters that are considered probable and that can be reasonably estimated, we also have certain matters considered reasonably possible. Other than matters disclosed below, we believe the aggregate range of possible loss related to matters considered reasonably possible was not material as of March 31, 2018. Litigation is inherently unpredictable and unfavorable resolutions could occur. Accordingly, it is possible that an adverse outcome from such proceedings could (i) exceed the amounts accrued for probable matters; or (ii) require a reserve for a matter we did not originally believe to be probable or could be reasonably estimated. Such changes could be material to our financial condition, results of operations and cash flows in any particular reporting period. Our view of the matters not specifically disclosed could possibly change in future periods as events thereto unfold.
Pending Litigation and Claims
In October 2007, we entered into a subcontract with Northrop Grumman Technical Services, Inc. (“Northrop”) to support Northrop’s prime contract with the DoD Counter Narcotics Terrorism Program Office ("CNTPO"). We performed the services requested by Northrop, the government determined that it received “intended quality and skills of personnel,” and Northrop paid our invoices until July 2014. Subsequent to July 2014, Northrop stopped paying our periodic invoices. The contract operations ended on December 31, 2014. In March 2015, Northrop filed a civil action against us to obtain documents regarding our invoices and now asserts approximately $5.0 million in damages. We believe the damages asserted by Northrop represent a loss contingency that is remote. In September 2015, we filed an Answer and Counterclaim seeking approximately $41.0 million for unpaid invoices. We have collected a portion of these funds and we continue to seek payment on the remaining balance.
On February 24, 2012, we were advised by the Department of Justice Civil Litigation Division (the "Civil Division”) that they are conducting an investigation regarding the CivPol and Department of State Advisor Support Mission ("DASM") contracts in Iraq and Corporate Bank, a former subcontractor. The issues include allowable hours worked under a specific task order and invoices to the Department of State for certain hotel leasing, labor rates and overhead within the 2003 to 2008 timeframe. Since 2012, the Company has been in discussions with the Civil Division, and has been cooperating with the Civil Division’s requests for information. On July 19, 2016, the Civil Division filed a civil lawsuit asserting violations of underlying contract terms and also the False Claims Act. If our operations are found to be in violation of any laws or government regulations, we may be subject to penalties, damages or fines, any or all of which could adversely affect our financial results; however, the complaint does not include any specific monetary demand and as such we are unable to estimate a range of loss at this time. We are continuing to evaluate this lawsuit and at this time believe the potential for penalties, damages or fines resulting from this matter do not represent a probable loss contingency.
U.S. Government Investigations
We primarily sell our services to the U.S. government. These contracts are subject to extensive legal and regulatory requirements, and we are occasionally the subject of investigations by various agencies of the U.S. government who investigate whether our operations are being conducted in accordance with these requirements. Such investigations could result in administrative, civil or criminal liabilities, including repayments, fines or penalties being imposed on us, or could lead to suspension or debarment from future U.S. government contracting. U.S. government investigations often take years to complete and may result in adverse action against us. We believe that any adverse actions arising from such matters could have a material effect on our ability to invoice and receive timely payment on our contracts, perform contracts or compete for contracts with the U.S. government and could have a material effect on our operating performance.
U.S. Government Audits
Our contracts are regularly audited by the Defense Contract Audit Agency ("DCAA") and other government agencies. These agencies review our contract performance, cost structure and compliance with applicable laws, regulations and standards. The government also reviews the adequacy of, and our compliance with, our internal control systems and policies, including our purchasing, property, estimating, accounting and material management business systems. Any costs found to be improperly allocated to a specific contract will not be reimbursed. The DCAA will in some cases issue a Form 1 representing the non-conformance of such costs or requirements as it relates to our government contracts. If we are unable to provide sufficient evidence of the costs in question, the costs could be suspended or disallowed which could be material to our financial statements. Government

33




contract payments received by us for direct and indirect costs are subject to adjustment after government audit and repayment to the government if the payments exceed allowable costs as defined in the government regulations.
We have received a series of audit reports from the DCAA related to their examination of certain incurred, invoiced and reimbursed costs on the Logistics Civil Augmentation Program IV ("LOGCAP IV") for contract years 2009 to 2014. For contract years 2009 to 2012, through our negotiation efforts with the Contracting Officer the issues have been resolved, resulting in final settlements of all audited costs of approximately $0.8 million of questioned costs. For contract years 2013 and 2014, we have recently received DCAA’s final audit report, which questions approximately $3.9 million of costs. We are in discussion with the Contracting Officer and we believe that the settlement of these outstanding amounts will not be material to our financial statements. Additionally, the DCAA is currently auditing fiscal years 2015 and 2016 and we believe the risk of loss for those years is remote and eventual settlement amounts should be comparable to the previous outcome for fiscal years 2009 to 2014.
Foreign Contingencies
On January 22, 2014, a tax assessment from the Large Tax Office of the Afghanistan Ministry of Finance ("MOF") was received, seeking approximately $64.2 million in taxes and penalties specific to one of our business licenses in Afghanistan for periods between 2009 to 2012. The majority of this assessment was income tax related; however, $10.2 million of the assessed amount is non-income tax related and represents loss contingencies that we consider reasonably possible. We filed our initial appeal of the assessment with the MOF on February 19, 2014. In May 2014, the MOF ruled in our favor for the income tax related issue which totaled approximately $54.0 million. We are still working with the MOF to remove the assessment on the remaining non-income tax related items. As of March 31, 2018, we are continuing to evaluate this matter and at this time believe it does not represent a probable loss contingency.
Credit Risk
We are subject to concentrations of credit risk primarily by virtue of our accounts receivable. Departments and agencies of the U.S. federal government account for all but minor portions of our customer base, minimizing this credit risk. Furthermore, the significance of any one contract can change as our business expands or contracts. Additionally, as contract modifications, contract extensions or other contract actions occur, the profitability of any one contract can become more or less significant to the Company. As contracts are re-competed, there is the potential for the size, contract type, contract structure or other contract elements to materially change from the original contract resulting in significant changes to the scope, scale, profitability or magnitude of accounts receivable of the new re-competed contract as compared to the original contract. We continuously review all accounts receivable and record provisions for doubtful accounts when necessary.
Risk Management Liabilities and Reserves
We are insured for domestic workers' compensation liabilities and a significant portion of our employee medical costs. However, we bear risk for a portion of claims pursuant to the terms of the applicable insurance contracts. We account for these programs based on actuarial estimates of the amount of loss inherent in that period’s claims, including losses for which claims have not been reported of $7.1 million and $7.7 million as of March 31, 2018 and December 31, 2017, respectively. These loss estimates rely on actuarial observations of ultimate loss experience for similar historical events. We limit our risk by purchasing stop-loss insurance policies for significant claims incurred for both domestic workers' compensation liabilities and medical costs. Our exposure under the stop-loss policies for domestic workers' compensation and medical costs is limited based on fixed dollar amounts. For domestic workers' compensation and employers' liability under state and federal law, the fixed dollar amount of stop-loss coverage is $1.0 million per occurrence on most policies, but is $0.25 million per occurrence on a California-based policy. For medical costs, the fixed dollar amount of stop-loss coverage is $0.4 million for total costs per covered participant per calendar year.

34




Note 10 — Segment Information
In January 2018, the Company amended its organizational structure. The Company's previous three operating and reporting segments, AELS, AOLC and DynLogistics, were re-aligned into two operating and reporting segments by combining AELS and AOLC into DynAviation with DynLogistics continuing to operate as a separate segment. The DynAviation and DynLogistics 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.
The following is a summary of the financial information of the reportable segments reconciled to the amounts reported in the condensed consolidated financial statements:
 
Three Months Ended
(Amounts in thousands)
March 31, 2018
 
March 31, 2017
Revenue
 
 
 
DynAviation
$
317,232

 
$
287,948

DynLogistics
217,524

 
172,358

Headquarters / Other (1)
(463
)
 
(434
)
Total revenue
$
534,293

 
$
459,872

 
 
 
 
Operating income (loss)
 
 
 
DynAviation
$
25,934

 
$
18,946

DynLogistics
19,306

 
17,500

Headquarters / Other (2)
(7,739
)
 
(16,282
)
Total operating income (loss)
$
37,501

 
$
20,164

 
 
 
 
Depreciation and amortization
 
 
 
DynAviation
$
498

 
$
289

DynLogistics
416

 
140

Headquarters / Other
5,906

 
8,469

Total depreciation and amortization (3)
$
6,820

 
$
8,898

(1)
Headquarters revenue primarily represents revenue earned on shared services arrangements for general and administrative services provided to unconsolidated joint ventures and elimination of intercompany items between segments.
(2)
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 and Global Advisory Group costs, partially offset by equity method investee income.
(3)
Includes amounts included in Cost of services of $0.8 million and $0.3 million for the three months ended March 31, 2018 and March 31, 2017, respectively.
The following is a summary of the assets of the reportable segments reconciled to the amounts reported in the consolidated financial statements:
 
As Of
(Amounts in thousands)
March 31, 2018
 
December 31, 2017
Assets
 
 
 
DynAviation
$
244,224

 
$
244,231

DynLogistics
201,232

 
243,281

Headquarters / Other (1)
190,413

 
248,205

Total assets
$
635,869

 
$
735,717

(1)
Assets primarily include cash, investments in unconsolidated subsidiaries, and intangible assets (excluding goodwill).


35




Note 11 — Related Parties, Joint Ventures and Variable Interest Entities
Consulting Fee
We have a Master Consulting and Advisory Services agreement ("COAC Agreement") with Cerberus Operations and Advisory Company, LLC ("COAC") where, pursuant to the terms of the agreement, they make personnel available to us for the purpose of providing reasonably requested business advisory services. The services are priced on a case by case basis depending on the requirements of the project and agreements in pricing. We incurred $0.1 million and $1.3 million of consulting fees on a gross basis before considering the effect of our contract mix which provides for partial recovery in conjunction with the COAC Agreement during the three months ended March 31, 2018 and March 31, 2017, respectively.
The New Senior Credit Facility permits payments under the COAC Agreement or any transaction contemplated thereby not to exceed $6.0 million per fiscal year with respect to executives seconded from COAC and personnel of COAC that provide services to us at cost on a weekly, monthly or pro-rated basis.
Certain members of executive management and board members of the Company and seconded COAC individuals may have agreements and conduct business with Cerberus and its affiliates for which they receive compensation. We recognize such compensation as an administrative expense in the consolidated financial statements.
Joint Ventures and Variable Interest Entities
We account for our investments in variable interest entities ("VIEs") in accordance with ASC 810 - Consolidation. In cases where we have (i) the power to direct the activities of the VIE that most significantly impact its economic performance and (ii) the obligation to absorb losses of the VIE that could potentially be significant or the right to receive benefits from the entity that could potentially be significant to the VIE, we consolidate the entity. We consolidated DynCorp International FZ - LLC ("DIFZ") based on the aforementioned criteria. Alternatively, in cases where all of the aforementioned criteria are not met, the investment is accounted for under the equity method. As of March 31, 2018, we accounted for Partnership for Temporary Housing LLC ("PaTH") and Global Linguist Solutions ("GLS") as equity method investments. We present our share of the PaTH and GLS earnings in Earnings from equity method investees as these joint ventures are considered operationally integral.
Receivables due from our unconsolidated joint ventures totaled $0.1 million as of both March 31, 2018 and December 31, 2017. These receivables are a result of items purchased and services rendered by us on behalf of our unconsolidated joint ventures. We have assessed these receivables as having minimal collection risk based on our historic experience with these joint ventures and our inherent influence through our ownership interest. We did not incur cost or earn revenue from services provided to our unconsolidated joint ventures during the three months ended March 31, 2018. We recognized $0.2 million in cost of services and did not earn revenue from our unconsolidated joint ventures during the three months ended March 31, 2017. Additionally, we earned $0.0 million and $0.1 million in equity method income during the three months ended March 31, 2018 and March 31, 2017, respectively.
GLS’ revenue was $5.4 million and $7.9 million during the three months ended March 31, 2018 and March 31, 2017, respectively. GLS’ operating and net income was $0.2 million and its operating and net loss was $1.1 million during the three months ended March 31, 2018 and March 31, 2017, respectively.
We currently hold one promissory note included in Other assets on our consolidated balance sheet from Palm Trading Investment Corp, which had an aggregate initial value of $9.2 million. The loan balance outstanding was $1.9 million and $2.0 million as of March 31, 2018 and December 31, 2017, respectively, reflecting the initial value plus accrued interest, less non-cash dividend payments against the promissory note. The fair value of the note receivable is not materially different from its carrying value.
As discussed above and in accordance with ASC 810 - Consolidation, we consolidate DIFZ. The following tables present selected financial information for DIFZ as of March 31, 2018 and December 31, 2017 and for the three months ended March 31, 2018 and March 31, 2017:
 
As Of
(Amounts in millions)
March 31, 2018
 
December 31, 2017
Assets
$
4.6

 
$
4.5

Liabilities
1.4

 
0.9

 
Three Months Ended
(Amounts in millions)
March 31, 2018
 
March 31, 2017
Revenue
$
42.2

 
$
41.0


36




The following tables present selected financial information for our equity method investees as of March 31, 2018 and December 31, 2017 and for the three months ended March 31, 2018 and March 31, 2017:
 
As Of
(Amounts in millions)
March 31, 2018
 
December 31, 2017
Current assets
$
23.9

 
$
28.2

Total assets
23.9

 
28.2

Current liabilities
8.5

 
11.6

Total liabilities
8.5

 
11.6

 
Three Months Ended
(Amounts in millions)
March 31, 2018
 
March 31, 2017
Revenue
$
7.3

 
$
8.2

Gross profit (loss)
0.5

 
(1.6
)
Net income (loss)
0.5

 
(1.5
)
Many of our joint ventures and VIEs only perform on a single contract. The modification or termination of a contract under a joint venture or VIE could trigger an impairment in the fair value of our investment in these entities. In the aggregate, our maximum exposure to losses as a result of our investment consists of our (i) $4.5 million investment in unconsolidated joint ventures, (ii) $0.1 million in receivables from our unconsolidated joint ventures, (iii) $1.9 million note receivable from Palm Trading Investment Corp. and (iv) contingent liabilities that were neither probable nor reasonably estimable as of March 31, 2018.

37




Note 12 — Consolidating Financial Statements of Subsidiary Guarantors
The Second Lien Notes issued by DynCorp International Inc. ("Subsidiary Issuer"), the New Senior Credit Facility and the term loan under the Third Lien Credit Agreement are fully and unconditionally guaranteed, jointly and severally, by the Company ("Parent") and the following domestic subsidiaries of Subsidiary Issuer: DynCorp International LLC, DTS Aviation Services LLC, DynCorp Aerospace Operations LLC, DynCorp International Services LLC, DIV Capital Corporation, Dyn Marine Services of Virginia LLC, Services International LLC, Worldwide Management and Consulting Services LLC, Worldwide Recruiting and Staffing Services LLC, Heliworks LLC, Phoenix Consulting Group, LLC, Casals & Associates, Inc., Culpeper National Security Solutions LLC, and Highground Global, Inc. ("Subsidiary Guarantors"). Each of the Subsidiary Issuer and the Subsidiary Guarantors is 100% owned by the Company. Under the Indenture governing the Second Lien Notes, a guarantee of a Subsidiary Guarantor would terminate upon the following customary circumstances: (i) the sale of the capital stock of such Subsidiary Guarantor if such sale complies with the indenture; (ii) the designation of such Subsidiary Guarantor as an unrestricted subsidiary; (iii) if such Subsidiary Guarantor no longer guarantees certain other indebtedness of the Subsidiary Issuer or (iv) the defeasance or discharge of the indenture.
The following condensed consolidating financial statements present (i) unaudited condensed consolidating balance sheets as of March 31, 2018 and December 31, 2017, (ii) unaudited condensed consolidating statements of operations and comprehensive income (loss) for the three months ended March 31, 2018 and March 31, 2017, (iii) unaudited condensed consolidating statements of cash flows for the three months ended March 31, 2018 and March 31, 2017 and (iii) elimination entries necessary to consolidate Parent and its subsidiaries.
The Parent company, the Subsidiary Issuer, the combined Subsidiary Guarantors and the combined subsidiary non-guarantors account for their investments in subsidiaries using the equity method of accounting; therefore, the Parent column reflects the equity income of the subsidiary and its subsidiary guarantors, and subsidiary non-guarantors. Additionally, the Subsidiary Guarantors’ column reflects the equity income of its subsidiary non-guarantors.
DynCorp International Inc. is considered the Subsidiary Issuer as it issued the Second Lien Notes.

38




Delta Tucker Holdings, Inc. and Subsidiaries
Unaudited Condensed Consolidating Statement of Operations Information
For the Three Months Ended March 31, 2018 
(Amounts in thousands)
Parent
 
Subsidiary
Issuer
 
Subsidiary
Guarantors
 
Subsidiary
Non-
Guarantors
 
Eliminations
 
Consolidated
Revenue
$

 
$

 
$
537,551

 
$
46,450

 
$
(49,708
)
 
$
534,293

Cost of services

 

 
(469,319
)
 
(45,795
)
 
49,691

 
(465,423
)