• describe selected key metrics evaluated by management;
• explain our critical accounting policies and estimates;
• describe certain line items in our statements of operations;
• explain the year-over-year trends in our results of operations; and
• describe our liquidity and capital resources.
Readers who are not familiar with our company or the financial statements of federal government information technology, or IT, service providers should closely review the "Description of Critical Accounting Estimates," and the "Description of Statement of Operations Items," sections included herein. These sections provide background information that can help readers, in part, understand and analyze our financial information.
We are a leading provider of technology and strategic consulting services and solutions primarily to U.S. federal government organizations. Founded in 1978, we are dedicated to solving complex mission and efficiency challenges for our customers by providing information technology, or IT, solutions and professional services that enable mission performance, improve efficiency of operations or reduce operating costs. Our IT service offerings include infrastructure services, software development, systems integration, cybersecurity, cloud computing, business intelligence, data analytics and mobile solutions. We also provide mission-specific domain expertise in areas such as intelligence analysis; energy and environmental consulting; enterprise logistics; and bioinformatics. We currently serve more than 200 federal government organizations, across National Security and Health & Civil markets, many of which we have served for over 20 years. Revenue from the federal government market represented 98%, 98% and 97% of our revenue for fiscal 2012, 2013 and 2014, respectively. Our revenue and Adjusted EBITDA (as calculated in accordance with our credit agreement) were approximately
$1.4 billionand $178.8 millionfor fiscal 2014, respectively. For a reconciliation of Adjusted EBITDA to net loss, see the section entitled "Items Affecting the Comparability of our Operating Results." The Transaction On March 31, 2011, we entered into an Agreement and Plan of Merger with affiliates of Providence Equity Partners L.L.C., or Providence, and on July 20, 2011we became an indirect wholly-owned subsidiary of Sterling Holdco Inc., or Sterling Holdco, which is controlled by the PEP Funds, which we refer to as the Transaction. The PEP Funds refer collectively to Providence Equity Partners VI LP, or PEP Fund VI, and Providence Equity Partners VI-A LP, or PEP Fund VI-A, each an affiliate of Providence. Presentation The accompanying consolidated statements of operations and cash flows are presented for the Predecessor and the Successor, which relate to the period from July 1 to July 20, 2011and all periods preceding July 1, 2011(preceding the Transaction) and the period July 21, 2011to June 30, 2012and all periods subsequent to June 30, 2012(succeeding the Transaction), respectively. Non-GAAP Financial Measures We have prepared our discussion of the results of operations by comparing the mathematical combination of the Successor and Predecessor period in the fiscal year ended June 30, 2012to the results of operations for the fiscal year ended June 30, 2013. Although the combination of the Predecessor income statement for the period July 1, 2011to July 20, 2011with the Successor income statement for the period of July 21, 2011to June 30, 2012does not comply with generally accepted accounting principles, or GAAP, we believe that it provides a meaningful method of comparison. We have also prepared our discussion of all operating metrics based on the combination of Successor and Predecessor results in the fiscal year ended June 30, 2012compared to the Successor results in the fiscal year ended June 30, 2013. We believe this combination of results for the Predecessor entity and Successor entity periods facilitates an investor's understanding of our results of operations and changes in our results of operations by making the two periods more comparable. This combination should not be used in isolation or substituted for the separate Predecessor entity and Successor entity results, nor do the combined results reflect our Predecessor results on a comparative or pro forma basis. 27 -------------------------------------------------------------------------------- Adjusted EBITDA presented in this section is a supplemental measure that is not required by, or presented in accordance with GAAP. This non-GAAP measure is not a measurement of our financial performance under GAAP and should not be considered as an alternative to net income, operating income, or any other performance measure derived in accordance with GAAP. In addition, our calculations of this non-GAAP measure may not be comparable to that of other companies. We believe this measure is frequently used by securities analysts, investors, and other interested parties in the evaluation of high-yield issuers, as well as management to assess operating performance. Business Environment and Outlook We generate approximately 97% of our revenue from services provided as a prime contractor or subcontractor on engagements with various agencies of the U.S. federal government. Accordingly, our business performance is affected by the overall level of federal spending. The government continues to face fiscal and economic challenges, which have created pressure to examine and reduce spending across all federal agencies in recent years. From October 1 to October 16, 2013, the government was shut down without funding after Congressfailed to enact fiscal year 2014 appropriations. Government functions deemed non-essential were discontinued, many federal employees were furloughed, and certain contracts received "Stop Work" orders temporarily halting their execution. The shutdown reduced our December 2013quarter revenue by approximately $12 millionand Adjusted EBITDA by approximately $4 million. On December 26, 2013, the President signed the Bipartisan Budget Act of 2013, which revised the limits on discretionary appropriations for government fiscal years 2014 and 2015, allowing for higher levels of funding in those years than were allowed under the prior caps and budget enforcement procedures. On January 17, 2014, the President signed a $1.1 trillionomnibus budget bill that finalized federal funding through September 30, 2014. The government shutdown dynamics in fiscal 2014 added to the combination of sequester spending cuts and overall budget uncertainty that have adversely affected our industry's financial performance for the last few years. In certain market segments, federal procurement officials reduced or delayed contract awards, increasing competition and pricing pressure for new business opportunities. These factors have applied pressure to win rates and gross margins in our industry. The replacement of automatic sequester cuts with improved funding levels in fiscal 2014 should offset a portion of the budget uncertainty, but we anticipate that heightened competition and margin pressure will continue. Despite these macro-level uncertainties, we expect the federal government to make continued investments in areas such as cybersecurity, operating efficiency, C4ISR, and health care system modernization, and to continue supporting homeland security and special-forces capabilities. Since fiscal 2011 we have streamlined our cost structure and focused our investments in these and other high-priority markets and technologies. We have increased our annual investments in business development, capture and proposal activities, while significantly reducing our overall selling, general and administrative expenses, or SG&A, through reductions in our indirect labor force, consolidation and reconfiguration of underutilized office space, and reduction of fringe benefits. In fiscal 2014, we created additional efficiencies by realigning our business into two groups and exiting several underutilized facilities. We also undertook an initiative to improve the profitability of our contract base in order to optimize business performance. We continue to believe we are well positioned to gain market share and achieve long-term growth, and this belief was validated by our improved win rates and contract award volume in fiscal 2014. With less than two percent market share in federal IT and professional services, we feel unconstrained by new business opportunities and continue to invest in our capacity to address them. Discontinued Operations During fiscal 2011, we made the decision to divest our Era Systems, or Era, and Global Clinical Development, or GCD, businesses. We sold the airport operations solutions, or AOS, component of Era in the second quarter of fiscal 2011 and Era's foreign air traffic management and military and security component in the second quarter of fiscal 2012. We also sold the GCD business in the first quarter of fiscal 2012. In connection with the sale transactions, we agreed to certain customary indemnification obligations. The general indemnification periods have expired; however, fraud and tax indemnifications last longer. The Era and GCD businesses are presented as discontinued operations. All financial data contained herein are from continuing operations unless otherwise specified. Key Metrics We manage and assess the performance of our business by evaluating a variety of metrics. Selected key metrics are discussed below. 28 -------------------------------------------------------------------------------- Contract Backlog We define backlog as our estimate of the remaining future revenues from existing signed contracts. Our backlog includes funded and unfunded orders for services under existing signed contracts, assuming the exercise of all option years relating to those contracts, less the amount of revenue we have previously recognized under those contracts and de-obligations. Backlog includes all contract options that have been priced but not yet funded. Backlog also includes an estimate of the contract value under single award indefinite delivery/indefinite quantity, or ID/IQ, contracts against which we expect future task orders to be issued without competition. Backlog does not take contract ceiling value into consideration under multiple award contracts, nor does it include any estimate of future potential delivery orders that might be awarded under multiple award ID/IQ vehicles, government-wide acquisition contracts, or GWACs, or General Services Administration, or GSA, schedule contracts. We define funded backlog to be the portion of backlog for which funding currently is appropriated and obligated to us under a contract or other authorization for payment signed by an authorized purchasing authority. Our future growth is dependent upon the strength of our target markets, our ability to identify opportunities, and our ability to successfully bid and win new contracts. New contract awards or orders generally represent the amount of revenue expected to be earned in the future from funded and unfunded contract awards received during the period. Ceiling increases are as a result of upward contract adjustments under existing contracts and increases in scope. "De-obligations and removals" refers to the removal from backlog of amounts previously awarded by a customer resulting from either (i) a formal contract modification issued by the customer reducing, or de-obligating, the remaining contract value, or (ii) the expiration of the period of performance without an extension issued by the customer which would be necessary for us to continue working under the contract. In the latter case we remove the remaining contract value from backlog even though the contract value is not formally de-obligated by the customer. Fiscal Year Ended June 30, (in millions) 2013 2014 Beginning backlog $ 3,595.1 $ 3,284.5New contract awards 1,036.9 1,560.8 Ceiling increases 521.5 522.6 Total contract awards 1,558.4 2,083.4 De-obligations and removals (416.8 ) (478.2 ) Net orders 1,141.6 1,605.2 Acquired/Divested backlog 55.5 (24.9 ) Revenue recognized (1,507.7 ) (1,386.4 ) Ending backlog $ 3,284.5 $ 3,478.4Funded 704.1 667.2 Unfunded 2,580.4 2,811.2 Total Backlog $ 3,284.5 $ 3,478.4A key measure of our business growth is the ratio of gross contracts awarded compared to the revenue recorded in the same period, or book-to-bill ratio. Our goal is for the level of business awards to exceed the revenue booked in order to drive future revenue growth. Our book-to-bill ratio, calculated using gross contract orders, was 1.0:1 and 1.5:1 in fiscal 2013 and 2014, respectively. As a result of the increased volume of contract awards in fiscal 2014, our total backlog grew by 6% from $3.3 billionas of June 30, 2013to $3.5 billionas of June 30, 2014. With well over $100 billionof annual spending on federal information technology and professional services, our addressable market continues to support a large pipeline of new business opportunities. The total value of proposals we submitted in fiscal 2014 was $4.4 billion. Submittals include the total value of bids submitted for prime funded opportunities, including both new and re-compete contracts. Submittals do not include values of bids submitted for indefinite delivery/indefinite quantity, or IDIQ, contracts, or bids submitted as a subcontractor. As a result of this activity, we had approximately $1.8 billionof funded proposals awaiting award decision at June 30, 2014. Our total backlog as of June 30, 2014includes orders under contracts that, in some cases, extend for several years, with the latest expiring during calendar year 2021. Congressoften appropriates funds for our customers on a yearly basis, even though the corresponding contract with us may call for performance that is expected to take a number of years. As a result, contracts typically are only partially funded at any point during their term with further funding dependent on Congressmaking subsequent appropriations and the procuring agency allocating funding to the contract. The U.S. government may cancel any contract at any 29 -------------------------------------------------------------------------------- time. Most of our contracts have cancellation terms that would permit us to recover all or a portion of our incurred costs, termination costs, and potentially fees for work performed. As of June 30, 2014, we expect to recognize approximately 28% of our backlog as revenue within the next twelve months. Contract Mix When contracting with our customers, we enter into one of three basic types of contracts: cost-plus-fee, time-and-materials, and fixed-price. • Cost-plus-fee contracts. Cost-plus-fee contracts provide for reimbursement of allowable costs and the payment of a fee, which is our profit. In addition, some cost-plus-fee contracts provide for an award
fee or incentive fee for meeting the requirements of the contract.
• Time-and-materials contracts. Time-and-materials contracts provide for
a fixed hourly rate for each direct labor hour expended plus
reimbursement of allowable material costs and out-of-pocket expenses.
• Fixed-price contracts. Fixed-price contracts provide for a
pre-determined fixed price for specified products and/or services.
Fixed-price-level-of-effort contracts are similar to time-and-materials
contracts except they require a specified level of effort over a stated
period of time. To the extent our actual costs vary from the estimates
upon which the price of the fixed-price contract was negotiated, we will generate more or less than the anticipated amount of profit or could incur a loss. Each of these contract types has unique characteristics. From time to time, contracts may be issued that are a combination or hybrid of contract types. Cost-plus-fee contracts generally subject us to lower risk. They also can include award fees or incentive fees under which the customer may make additional payments based on our performance. However, not all costs are reimbursed under these types of contracts, and the government carefully reviews the costs we charge. In addition, negotiated base fees are generally lower than projected profits on fixed-price or time-and-materials contracts, consistent with our lower risk. Under time-and-materials contracts, including our fixed-price-level-of effort contracts, we are also generally subject to lower risk; however, our profit may vary if actual labor hour costs vary significantly from the negotiated rates. Fixed-price contracts typically involve the highest risk and, as a result, typically have higher fee levels. However, fixed-price contracts require that we absorb cost overruns, should they occur. The following table summarizes our historical contract mix, measured as a percentage of total revenue, for the periods indicated. Combined Successor Fiscal Year Fiscal Year Fiscal Year Ended Ended Ended June 30, 2012 June 30, 2013 June 30, 2014 Cost-plus-fee 32 % 30 % 30 % Time-and-materials 36 % 35 % 36 % Fixed-price (a) 32 % 35 % 34 % (a) Includes approximately 4% of revenue earned on fixed-price-level-of-effort contracts for fiscal 2012 and 2013 and 3% of revenue earned on fixed-price-level-of-effort contracts for fiscal 2014. Labor Utilization Because most of our revenue and profit is derived from services delivered by our employees, our ability to hire new employees and retain and deploy them is critical to our success. We define direct labor utilization as the ratio of labor expense recorded on customer engagements to total labor expense. We include every working employee in the computation and exclude leave taken, such as vacation time. As of
June 30, 2014, we had approximately 5,200 employees. Direct labor utilization was 79.3%, 80.1% and 81.5% for fiscal 2012, 2013 and 2014, respectively. In assessing labor utilization, management focuses on maintaining a high utilization rate to maximize profitability while ensuring time and resources are also spent strategically growing and managing the business. Labor incurred in the performance of our contracts is included in cost of services and all other labor costs incurred are included in selling, general and administrative expenses. Days Sales Outstanding 30
-------------------------------------------------------------------------------- Days sales outstanding, or DSO, is a measure of how efficiently we manage the billing and collection of accounts receivable, our most significant working capital requirement. From time to time we may offer discounts to our customers for early payment. We also utilize an accounts receivable factoring facility to accelerate cash flow and lower our DSO. We calculate DSO by dividing accounts receivable at the end of each quarter, net of billings in excess of revenue, by revenue per day for the period. Revenue per day for a quarter is determined by dividing total revenue by 90 days, adjusted for partial periods related to any acquisitions and divestitures. DSO was 54 as of
June 30, 2014and 64 days as of June 30, 2013. Seasonality Certain aspects of our operations are influenced by the federal government's October-to-September fiscal year. The timing of contract awards, the availability of funding from the customer and the incurrence of contract costs are the primary drivers of our revenue recognition and may all be affected by the government's fiscal year. Additionally, our quarterly results are impacted by the number of working days in a given quarter. There are generally fewer working days for our employees to generate revenue in the first and second quarters of our fiscal year because our employees usually take relatively more leave for vacations and holidays, which leads to lower revenue and profitability in those quarters. Additionally, we typically give annual raises to our employees in the first half of our fiscal year, while the billing rates on our time-and-materials contracts typically escalate gradually, causing the profitability on these contracts to increase over the course of our fiscal year. Description of Critical Accounting Policies and Estimates The preparation of our financial statements in accordance with GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, as well as the disclosure of contingent assets and liabilities. These estimates are based on our historical experience and various other factors that are deemed reasonable at the time the estimates are made. We re-evaluate these estimates at least quarterly. Actual results may differ significantly from these estimates under different assumptions or conditions. We believe the critical accounting policies requiring significant estimates and judgments are revenue recognition, accounting for acquisitions, including the identification of intangible assets and the ongoing impairment assessments of goodwill and intangible assets, accounting for stock compensation expense and income taxes. If any of these estimates or judgments proves to be inaccurate, our results could be materially affected in the future. Revenue Recognition Although revenue on most of our contracts is recognized based on objective criteria, revenue on some of our fixed-price contracts is recognized using the percentage-of-completion method of contract accounting which requires significant estimates that may change over time. Fixed price contracts using the percentage-of-completion method were approximately 24% of our revenue in fiscal 2014. The percentage-of-completion method requires estimates of total contract costs, profit and ongoing estimates of progress towards completion. To estimate total contract cost, we must make assumptions related to the outcome of future events for periods which may extend several years. These assumptions include future labor productivity and availability, and the nature and complexity of the work to be performed. We estimate profit as the difference between total contract revenue and total estimated contract cost, and recognize profit over the life of the contract. Unless we determine that there is a more suitable objective measure, we estimate progress towards completion based on costs expended to date in relation to total estimated costs expected upon completion of the contract. For our cost-plus-award-fee contracts, we recognize the expected fee to be awarded by the customer when there is a basis to reasonably estimate the amount. Estimates of award or incentive fees require estimates that may change over time and are based on prior award experience and communication with the customer regarding performance, including any interim performance evaluations rendered by the customer. In certain situations, we recognize revenue associated with work performed prior to the completion and signing of contract documents when persuasive evidence of an arrangement exists. We have a standard internal process that we use to determine whether all required criteria for revenue recognition have been met. This revenue is recognized only when it can be reliably estimated and realization is probable. We typically only perform work prior to the completion and signing of contract documents when a relationship with the customer already exists and we base our estimates on previous experiences with the customer, communications with the customer regarding funding status, and our knowledge of available funding for the contract or program. As of June 30, 2014, we had approximately $5.2 millionof accounts receivable related to revenue recognized on work performed prior to completion or signing of contract documents. We have not historically recognized significant losses related to work performed prior to signing a contract. Accounting for Acquisitions The purchase price that we pay to acquire a business is allocated to the net assets acquired based on the estimated fair value of those net assets. The excess of the purchase price over the estimated fair value of the net tangible and separately identified 31 -------------------------------------------------------------------------------- intangible assets acquired represents goodwill. We typically retain an independent third party valuation firm to assist us in our determination of the fair value of goodwill and the fair values and useful lives of identified intangible assets. The fair value determinations required in a purchase price allocation involve significant estimates and management judgments including estimates of future operating results and cash flows. Different estimates and assumptions could result in materially different values assigned to acquired net assets, including identified intangible assets and goodwill. Accounting for Asset Impairments Trade names are evaluated for impairment annually during the fourth quarter as of April 1. We assess the potential impairment by comparing the carrying value of the trade names with their estimated fair value, utilizing the relief from royalty method. If the carrying value exceeds the fair value, we recognize a loss based on the excess carrying value over fair value. Goodwill represents the excess of the cost of an acquired entity over the net amounts assigned to assets acquired and liabilities assumed. We test goodwill for impairment annually during the fourth quarter as of April 1, and between annual tests if events or changes in circumstances indicate the carrying value may not be recoverable. Such events could include, but are not limited to, loss of a key contract, significant underperformance relative to plan or long-term projections, or similar events. The goodwill impairment assessment is separately performed for each of our two reporting units, National Security and Health & Civil. The impairment model prescribes a two-step method for determining goodwill impairment. The first step compares the reporting unit's estimated fair value to its carrying value. We utilize a discounted cash flow analysis as well as comparative market multiples to determine the fair value of our reporting units. If the carrying value exceeds the estimated fair value, a potential impairment is indicated and we must complete the second step of the impairment test. The second step allocates the fair value of the reporting unit determined in step one to the tangible and intangible assets and liabilities to derive an implied fair value for the reporting unit's goodwill. If the carrying value of goodwill exceeds the implied fair value, an impairment charge is recorded to reduce the carrying value of the goodwill to the implied fair value. Intangible assets with finite lives are only evaluated for impairment when events or circumstances indicate that the carrying amount of long-lived assets and intangible assets may not be fully recoverable. We determine whether the carrying value of the long-lived asset is recoverable by comparing the asset's carrying value to its future undiscounted net cash flows, without interest charges. If impairment is indicated as a result of this review, we recognize an impairment charge for the amount by which the carrying amount exceeds the fair value, which is measured using estimated discounted future cash flows. As of April 1, 2014, we evaluated the goodwill of each of our reporting units for impairment. There was no indication of impairment in the National Security reporting unit or the Health & Civil reporting unit as the fair values were more than 20% higher than the carrying values for each reporting unit. Additionally, the estimated fair value of the trade names exceeded their carrying value. Based on these analyses, we concluded that the goodwill and trade names were not impaired in fiscal 2014. The fair value of the reporting units was higher than the carrying value as a result of higher industry valuation multiples, an increase in backlog and higher profit margins. As of April 1, 2013, we evaluated trade names for impairment. We recognized a trade name impairment charge of $51.9 millionin fiscal 2013 for the amount of book value in excess of fair value. As of April 1, 2013, we also evaluated goodwill assigned to our previous four reporting units, which were later consolidated into two reporting units in fiscal 2014, utilizing a discounted cash flow analysis as well as comparative market multiples to determine the fair value of our reporting units. The carrying values of Civil, Defense and IHL reporting units exceeded their respective fair values, indicating a potential impairment. There was no indication of impairment in the Health reporting unit as its fair value was higher than carrying value. We performed the second step of the goodwill impairment analysis to measure the amount of the impairment charge in our Civil, Defense and IHL reporting units. Based on the results of the step two analysis, we recorded a $293.9 milliongoodwill impairment charge in fiscal 2013. As a result of the goodwill impairment in fiscal 2013, we assessed the value of future undiscounted net cash flows related to the identified intangible assets with finite lives, without interest charges. We concluded that the carrying amount of the assets did not exceed the future undiscounted net cash flows, and therefore the identified intangible assets were not impaired. In fiscal 2014, there was no triggering event to assess whether identified intangible assets were impaired. Given the current industry conditions and the uncertainties regarding the impact on our business, there can be no assurance that the estimates and assumptions used in our goodwill and trade names impairment analyses will prove to be accurate predictions of the future. If our estimates regarding forecasted revenue or profitability are not achieved, or we experience adverse changes in market factors such as discount rates or valuation multiples derived from comparable publicly traded companies, we may be required to recognize additional impairment charges in future periods. 32 -------------------------------------------------------------------------------- These impairment charges and our reporting units are discussed in Note 3 of our June 30, 2014consolidated financial statements included in this annual report on Form 10-K. Accounting for Stock-Based Compensation Compensation costs related to our stock-based compensation plans are recognized based on the grant-date fair value of the options and restricted stock granted. In calculating the compensation expense for options granted, we utilize the Black-Scholes-Merton option-pricing model to value the service options and the Monte Carloor binomial lattice model to value the performance options. Both models are widely accepted methods to calculate the fair value of stock options; however, the results are dependent on the inputs, two of which, expected term and expected volatility, are dependent on management's judgment. For the performance options, the expected term is estimated based on management's expected timing of a liquidity event or sale of the Company. The expected volatility is based upon the combination of the historical volatility of comparable, publicly traded companies' stock prices and the implied volatility of comparable, publicly traded companies' share prices determined from publicly trade call options. Changes in management's judgment of the expected term and the expected volatility could have a material effect on the grant-date fair value calculated and, in turn, on the amount of compensation cost recognized. Additionally, we are required to estimate future stock option and restricted stock award forfeitures when determining the amount of stock-based compensation costs to record. We have concluded that our historical forfeiture experience since the Transaction is the best basis available to estimate future stock option forfeitures. However, actual forfeitures may differ from the estimates used, and could materially affect the compensation expense recognized. Accounting for Income Taxes We utilize the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities less valuation allowances, if required. Enacted statutory tax rates are used to compute the tax consequences of these temporary differences. We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain our position following an audit. Significant judgments and estimates, including projection of future taxable income, are required in determining our income tax expense or benefit. To project future taxable income, we develop assumptions including the amount of future state, federal and foreign pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. We have a process to ensure that uncertain tax positions are identified, analyzed and properly reported in our financial statements in accordance with GAAP. We recognize accrued interest and penalties related to uncertain tax positions in the provision for income tax expense or benefit. We believe we have adequately provided for any reasonably foreseeable outcome related to our income tax matters, however, our future results may include favorable or unfavorable adjustments to our estimated tax position. To the extent that the expected tax outcome changes, such changes in estimate will impact the income tax provision or benefit in the period in which such determination is made. Description of Statement of Operations Items The following is a description of certain line items of our statements of operations. Revenue Most of our revenue is generated based on services provided either by our employees or subcontractors. The revenue we earn also includes third-party hardware and software that we purchase and integrate when requested by the customer as a part of the solutions that we provide. To a lesser degree, we have developed, licensed and sold software and hardware products to customers. Software licensing and related activity revenue was less than 1% of our annual revenue for each of the last three fiscal years. Cost of Services Cost of services includes the direct costs to provide our services and business solutions to customers. The most significant of these costs are the salaries and wages plus associated fringe benefits and facility-related costs of our employees directly serving customers. Cost of services also includes the costs of subcontractors and outside consultants, third-party materials such as hardware 33 -------------------------------------------------------------------------------- or software that we purchase and provide to the customer as part of an integrated solution, and any other direct costs such as travel expenses incurred to support contract efforts. Selling, General and Administrative Expenses Selling, general and administrative expenses, or SG&A, include the salaries and wages plus associated fringe benefits, stock-based compensation and facility-related costs of our employees not performing work directly for customers. Among the functions covered by these costs are business development, information technology services, finance and accounting, growth, contracts, legal, executive management, facilities, human resources and recruiting. Underutilized labor is also included in selling, general and administrative expenses. Depreciation and Amortization of Property and Equipment Depreciation and amortization of property and equipment includes depreciation of computers, other equipment and furniture, the amortization of software we use internally and the amortization of leasehold improvements. Amortization of Intangible Assets Amortization of intangible assets includes amortization of definite-lived intangible assets, including customer relationships, order backlog, developed technology and software development costs. Transaction Costs Transaction costs include legal, accounting and other expenses, including accelerated stock compensation expense in fiscal 2012, incurred in connection with our acquisition by the PEP Funds. Impairment of Goodwill and Other Assets Impairment of goodwill and other assets includes the impairment charges recorded in fiscal 2013 to reduce the carrying value of goodwill and trade names to fair value. Gain on the sale of a portion of the Health & Civil business Gain on the sale of a portion of the Health & Civil business includes the gain recognized on the sale of six contracts from the Health & Civil group during fiscal 2014. 34
Summary of Financial Results
Predecessor Successor Combined Successor July 1, 2011 July 21, 2011 Fiscal Year Fiscal Year Fiscal Year through through Ended Ended Ended July 20, 2011 June 30, 2012 June 30, 2012 June 30, 2013 June 30, 2014 Revenue
$ 99,308 $ 1,575,872 $ 1,675,180 $ 1,507,722 $ 1,386,363Operating costs and expenses: Cost of services 78,550 1,191,256 1,269,806 1,140,014 1,060,407 Selling, general and administrative 13,721 215,369 229,090 198,338 181,937 Depreciation and amortization of property and equipment 837 14,186 15,023 12,199 9,194 Amortization of intangible assets 442 91,551 91,993 88,147 72,711 Transaction costs 68,069 699 68,768 - - Impairment of goodwill and other assets - - - 345,753 - Gain on the sale of a portion of the Health & Civil business - - - - (1,564 ) Total operating costs and expenses 161,619 1,513,061 1,674,680 1,784,451 1,322,685 Operating (loss) income (62,311 ) 62,811 500 (276,729 ) 63,678 Interest expense (19 ) (101,715 ) (101,734 ) (100,777 ) (104,191 ) Interest income 13 85 98 43 65 Loss from continuing operations before income taxes (62,317 ) (38,819 ) (101,136 ) (377,463 ) (40,448 ) Benefit from income taxes (18,462 ) (14,768 ) (33,230 ) (60,169 ) (16,286 ) Loss from continuing operations (43,855 ) (24,051 ) (67,906 ) (317,294 ) (24,162 ) Loss from discontinued operations, net of tax (1,126 ) (4,893 ) (6,019 ) - - Net loss $ (44,981 ) $ (28,944 ) $ (73,925 ) $ (317,294 ) $ (24,162 )Predecessor Successor Combined Successor July 1, 2011 July 21, 2011 Fiscal Year Fiscal Year Fiscal Year through through Ended Ended Ended July 20, 2011 June 30, 2012 June 30, 2012 June 30, 2013 June 30, 2014 Net cash provided by operating activities (1) $ 43,136 $ 54,215 $ 97,351 $ 66,825 $ 145,653Net cash used in investing activities (1) (1,876 ) (1,736,302 ) (1,738,178 ) (45,422 ) (1,863 ) Net cash provided by (used in) financing activities (1) 505 1,472,380 1,472,885 (20,000 ) (40,000 ) Effect of exchange rate changes on cash and cash equivalents (1) 22 (191 ) (169 ) - - Net increase (decrease) in cash and cash equivalents $ 41,787 $ (209,898 ) $ (168,111 ) $ 1,403 $ 103,790(1) Includes results of discontinued operations in fiscal 2011 and 2012. Items Affecting the Comparability of Our Operating Results We define Adjusted EBITDA as GAAP net loss plus (i) provision for (benefit from) income taxes, (ii) net interest (income) expense, (iii) depreciation and amortization of property and equipment, and (iv) amortization of intangible assets, or EBITDA, adjusted to exclude certain items that do not relate directly to our ongoing operations or which are non-cash in nature. Adjusted EBITDA, or Consolidated EBITDA as is defined in the credit agreement, as presented in the table below is used to determine our compliance with certain covenants contained in our credit agreement. We also use Adjusted EBITDA as a supplemental measure 35 -------------------------------------------------------------------------------- in the evaluation of our business because it provides a meaningful measure of operational performance by eliminating the effects of period-to-period changes in taxes and interest expense, among other things. Adjusted EBITDA decreased in fiscal 2014 and 2013 compared to fiscal 2013 and 2012, respectively, due primarily to a decline in direct labor services caused by the federal budget pressures and increasingly competitive market environment. Adjusted EBTIDA margin for fiscal 2012, 2013 and 2014, excluding the impact of any acquisitions, was 12.1%, 12.6% and 12.9%, respectively. Additionally, Adjusted EBTIDA for fiscal 2014 was negatively impacted by the shutdown in October 2013by approximately $4 million. Combined Successor Fiscal Year Fiscal Year Fiscal Year Ended Ended Ended June 30, 2012 June 30, 2013 June 30, 2014 Loss from continuing operations $ (67,906 ) $ (317,294 ) $ (24,162 )Benefit from income taxes (33,230 ) (60,169 ) (16,286 ) Interest expense, net 101,636 100,734 104,126 Depreciation and amortization of property and equipment 16,809 13,484 10,725 Amortization of intangible assets 91,993 88,147 72,711 Stock compensation 2,402 2,836 3,346 Severance 4,859 1,723 1,479 Facility exit charge 4,417 3,811 12,810 Other, net 10,986 6,353 4,007 Transaction costs 68,768 - - Impairment of goodwill and other assets - 345,753 - Gain on the sale of a portion of the Health & Civil business - - (1,564 ) Subtotal - Adjusted EBITDA before certain items 200,734 185,378 167,192 EBITDA impact of acquisitions - 4,139 - EBITDA impact of cost savings 2,459 4,334 11,607 Adjusted EBITDA $ 203,193 $ 193,851 $ 178,799The following items affect the comparability of our net loss period-over-period, and therefore, have been adjusted in arriving at Adjusted EBITDA: • Stock compensation expense related to the stock incentive plans . The charges are included in SG&A expenses in the consolidated statement of operations. • Severance charges incurred to primarily reduce our indirect labor force. The gross charges are included in SG&A expenses in the consolidated statement of operations. • Facility exit charges related to the exit of underutilized space in certain of our leased facilities. The charges are included in SG&A expenses in the consolidated statement of operations.
• Certain other items including the following:
Combined Successor Fiscal Year Fiscal Year Fiscal Year Ended Ended Ended June 30, 2012 June 30, 2013 June 30, 2014 Signing and retention bonuses of certain executive officers $ 7,695 $ 1,141 $ 100 PEP management fees 1,658 1,751 1,750 Merger and acquisition costs 405 2,214 887 Other 1,228 1,247 1,270 Other, net
$ 10,986$ 6,353 $ 4,007 36
• Transaction costs for accelerated stock compensation expense, accounting, investment banking, legal, severance, and other services related to the Transaction. • Impairment of goodwill and trade names as a result of the annual impairment analysis for fiscal 2013. • Gain on the sale of a portion of our Health & Civil business in the first quarter of fiscal 2014. • The acquisitions of
MorganFranklin Corporation'sNational Security Solutions division, or NSS in December 2012. In calculating Adjusted EBITDA, we add the estimated EBITDA impact of acquisitions as if the businesses had been acquired on the first day of the respective period in which an adjustment is recorded. There was no EBITDA impact for the divestitures of Era and GCD as they were reported in discontinued operations. • As defined in our credit agreement, cost savings represents the EBITDA impact of quantifiable run-rate cost savings for actions taken or expected to be taken within 12 months of the
as if they had been realized on the first day of the relevant period. Specifically, for the periods presented, the cost savings adjustment represents the estimated EBITDA impact of actions taken to exit underutilized space in certain of our leased
run-rate cost savings associated with indirect labor
savings associated with certain fringe benefit changes. The impact of these items on our net loss is shown in the table above. We present Adjusted EBITDA as an additional measure of our core business performance period over period. Adjustments to net loss result in a non-GAAP measure; however, we believe adjustment of the items above is useful as they are considered outside the normal course of our operations and obscure the comparability of performance period-over-period. Results of Operations Revenue Revenue decreased 8.0% to
$1,386.4 millionin fiscal 2014 from $1,507.7 millionin fiscal 2013. The decline in revenue was due, in part, to lower materials and other reimbursable costs, which decreased approximately $22.8 million, with the remainder of the decrease due to a decline in labor services, the ending of the our largest contract with the Federal Deposit Insurance Corporation, or FDIC, and the federal government shutdown. The decline in labor services was primarily due to the competitive market environment and the continued delay of contract awards. The FDICcontract ended during our fiscal 2014 and contributed to the decrease in revenue by $36 million. Revenue for the fiscal 2014 was negatively impacted by the government shutdown in October 2013by approximately $12 million. Revenue decreased 10.0% to $1,507.7 millionin fiscal 2013 from $1,675.2 millionin fiscal 2012. The decline in revenue was due, in part, to lower materials and other reimbursable costs, which decreased approximately $64.2 million, with the remainder of the decrease due to a decline in labor services. The decline in labor services was primarily due to the competitive market environment, funding reductions on some of our existing programs, and the continued delay of contract awards. 37 --------------------------------------------------------------------------------
Operating Costs and Expenses Operating costs and expenses consisted of the following for the periods presented (dollars in thousands):
Combined Successor Fiscal Year Ended Fiscal Year Ended June 30, Fiscal Year Ended June 30, June 30, % 2012 2013 % Change 2014 Change Cost of services
$ 1,269,806 $ 1,140,014(10.2 )% $ 1,060,407(7.0 )% Selling, general and administrative 229,090 198,338 (13.4 )% 181,937 (8.3 )% Depreciation and amortization of property and equipment 15,023 12,199 (18.8 )% 9,194 (24.6 )% Amortization of intangible assets 91,993 88,147 (4.2 )% 72,711 (17.5 )% Transaction costs 68,768 - NMF - NMF Impairment of goodwill and other assets - 345,753 NMF - NMF Gain on the sale of a portion of the Health & Civil business - - NMF (1,564 ) NMF (as a percentage of revenue) Cost of services 75.8 % 75.6 % 76.5 % Selling, general and administrative 13.7 % 13.2 % 13.1 % Depreciation and amortization of property and equipment 0.9 % 0.8 % 0.7 % Amortization of intangible assets 5.5 % 5.8 % 5.2 % Transaction costs 4.1 % - % - % Impairment of goodwill and other assets - % 22.9 % - % Gain on the sale of a portion of the Health & Civil business - % - % (0.1 )% NMF = Not meaningful Cost of services consisted of the following for the periods presented (dollars in thousands): Combined Successor Fiscal Year Ended June 30, Fiscal Year Ended June
30, Fiscal Year Ended
2012 % of total 2013 % of total 2014 % of total Direct labor and related overhead
$ 621,88549.0 % $ 570,99550.1 % $ 530,70550.0 % Subcontractor labor 377,657 29.7 % 362,955 31.8 % 346,402 32.7 % Materials and other reimbursable costs 270,264 21.3 % 206,064 18.1 % 183,300 17.3 % Total cost of services $ 1,269,806 $ 1,140,014 $ 1,060,407Cost of services decreased since fiscal 2012 due to lower business volume resulting from federal budget pressures, contract award delays and the government shutdown. As a percentage of revenue, cost of services increased in fiscal 2014 compared to fiscal 2013 partially attributable to the loss of revenue due to the shutdown of the U.S. federal government in October 2013, which reduced labor services costs and revenue but did not reduce the fixed portions of overhead costs. The increase was also driven by ongoing heightened competition and pricing pressures, both for new business opportunities and re-competes of our existing programs. As a percentage of revenue, cost of services decreased in fiscal 2013 compared to fiscal 2012 due to lower materials and other reimbursable costs. Excluding materials and other reimbursable costs, cost of services as a percentage of revenue in fiscal 2013 increased due to reduced margins on direct and subcontracted labor services. 38 -------------------------------------------------------------------------------- Cost of services as a percentage of revenue varies from period to period depending on the mix of direct labor, subcontractor labor, and materials and other reimbursable costs. In periods where we have more materials and other reimbursable content, our costs of services as a percentage of revenue will be higher. We seek to optimize our labor content in performance of our contracts since we typically generate greater gross margin from our labor services, particularly from services that our employees provide, compared with other reimbursable items. SG&A expenses decreased $16.4 millionin fiscal 2014 compared to fiscal 2013 and $30.8 millionin fiscal 2013 compared to fiscal 2012. Excluding the impact of the facility exit charges, stock compensation expense, severance charges to reduce our indirect labor force, officer compensation and other costs, which are all discussed in greater detail in the section titled "Items Affecting the Comparability of Our Operating Results," SG&A expenses decreased approximately $23 millionin fiscal 2014 compared to fiscal 2013 and approximately $22 millionin fiscal 2013 compared to fiscal 2012. The decrease is primarily a result of actions taken to align our indirect costs with our volume of business and maintain competitive cost position. Additionally, the impact of the federal government shutdown in October 2013reduced SG&A costs during fiscal 2014 by approximately $1 millionand fiscal 2013 SG&A expenses benefited from lower incentive compensation expense and changes to our leave policy. Depreciation and amortization of property and equipment decreased since fiscal 2012 as certain enterprise software applications became fully amortized at the end of fiscal 2012. Amortization of intangible assets decreased in fiscal 2014 as compared to fiscal 2013 and fiscal 2013 as compared to fiscal 2012 as amortization is recorded on an accelerated basis based on the expected benefits of the assets. For further discussion of the intangible assets, see Note 3 to our consolidated financial statements as of and for the fiscal year ended June 30, 2014included in this annual report on Form 10-K. Transaction costs were $68.8 millionin fiscal 2012 and consisted of accounting, investment banking, legal, acceleration of stock compensation and other costs incurred in connection with our acquisition by the PEP Funds. The Company recorded a goodwill and trade names impairment charge of $345.8 millionin fiscal 2013 as a result of the annual impairment analysis. For a discussion of the analysis, see Note 3 to our consolidated financial statements as of and for the fiscal year ended June 30, 2014included in this annual report on Form 10-K. The Company recorded a gain on the sale of a portion of the Health & Civil business of $1.6 millionrecognized on the sale of six contracts from the Health & Civil group during fiscal 2014. For details, see Note 2 to our consolidated financial statements as of and for the fiscal year ended June 30, 2014included in this annual report on Form 10-K. Interest Combined Successor Fiscal Year Ended Fiscal Year Ended Fiscal Year Ended June 30, 2012 June 30, 2013 June 30, 2014 Interest expense $ (101,734 ) $ (100,777 ) $ (104,191 )Interest income 98 43 65 Interest, net $ (101,636 ) $ (100,734 ) $ (104,126 )Interest expense increased in fiscal 2014 by $3.4 millioncompared to fiscal 2013 due to an increase of the fixed rates on our interest rate swaps. Interest expense decreased in fiscal 2013 by $1.0 millioncompared to fiscal 2012 due to lower outstanding debt as a result of the Term Loan B Facility payments. Interest expense for fiscal 2014 and 2013 includes amortization of original issue discount and debt issuance costs of $7.8 millionand $7.1 million, respectively. We manage our exposure to interest rate movements through the use of interest rate swap agreements. As of June 30, 2014, we had fixed the interest rate on all but $110.0 millionof our outstanding total debt. Income Taxes Our fiscal 2014 effective tax rate was a benefit of 40.3%, which is higher than the statutory income tax rate primarily due to federal tax credits. We expect our effective tax rate for future periods to be approximately 40%. Our fiscal 2013 effective tax rate was a tax benefit of 15.9%, which was impacted by the goodwill and trade names impairment charge recognized in fiscal 2013. Excluding the goodwill and trade names impairment charge, our effective tax rate would have been 43.3%, which is higher than the statutory income tax rate primarily due to retroactive reinstatement of the federal research 39 -------------------------------------------------------------------------------- and development credit to January 1, 2012and revisions to certain estimates of non-deductible costs in our fiscal 2012 income tax return. The effective tax rate for the period from July 1, 2011through July 20, 2011was a tax benefit of 29.6% and was impacted by the non-deductible Transaction costs incurred in the period. The effective tax rate for the period from July 21, 2011through June 30, 2012was a tax benefit of 38.0%. Our fiscal 2012 effective tax rate was adversely impacted by the limits on deductible interest expense for state income tax purposes. Liquidity and Capital Resources Our primary capital needs are to finance the costs of operations, pending the billing and collection of accounts receivable and to make acquisitions. Our working capital (current assets minus current liabilities) as of June 30, 2014was $76.0 millioncompared to $96.8 millionas of June 30, 2013. As of June 30, 2014, our total unrestricted cash was $108.8 millionand our total outstanding debt was $1.1 billion, excluding unamortized discount. Combined Successor Fiscal Year Fiscal Year Fiscal Year Ended Ended Ended June 30, 2012 June 30, 2013 June 30, 2014 Net cash provided by operating activities before changes in working capital (1) $ 19,447 $ 79,411 $ 49,926Net cash provided by (used in) changes in working capital (1) 77,904 (12,586 ) 95,727 Net cash provided by operating activities (1) 97,351 66,825 145,653 Net cash used in investing activities (1) (1,738,178 ) (45,422 ) (1,863 ) Net cash provided by (used in) financing activities (1) 1,472,885 (20,000 ) (40,000 ) Effect of exchange rate changes on cash and cash equivalents (1) (169 ) - - Net (decrease) increase in cash and cash equivalents $ (168,111 )$
(1) Includes results of discontinued operations in fiscal 2012.
Cash FlowAccounts receivable represent our largest working capital requirement. We bill the majority of our customers monthly after services are rendered. Our operating cash flow is primarily affected by the overall profitability of our contracts, our ability to invoice and collect from our customers in a timely manner, and the timing of vendor, interest and tax payments. Net cash provided by operating activities was $97.4 million, $66.8 millionand $145.7 millionin fiscal 2012, 2013 and 2014, respectively. In fiscal 2014, the increase in cash provided by operating activities was due to higher cash from the billing and collections of our accounts receivable in addition to lower payments of accrued payroll and employee benefits and interest. In fiscal 2013, the decrease in cash provided by operating activities was due to timing of vendor payments and lower income tax refunds partially offset by improvements in billing and collections of our accounts receivable. Net cash used in investing activities was $1.7 billion, $45.4 millionand $1.9 millionin fiscal 2012, 2013 and 2014, respectively. Acquisitions of businesses and capital expenditures were the primary uses of cash in investing activities for each of the three years. In fiscal 2014, cash used in investing activities was $7.4 millionfor capital expenditures partially offset by proceeds from the sale of a portion of the Health & Civil business of $5.5 million. In fiscal 2013, cash used in investing activities to acquire the assets of NSS was $33.6 millionand $11.8 millionfor capital expenditures. In fiscal 2012, net cash used in investing activities in connection with the Transaction was $1.7 billion, partially offset by proceeds from the sale of Era. Net cash provided by financing activities was $1.5 billionin fiscal 2012. Net cash used in financing activities was $20.0 millionand $40.0 millionin fiscal 2013 and 2014, respectively, which relates to repayments on our Term Loan B Facility. The net cash provided by financing activities in fiscal 2012 relates to the Transaction including $1.3 billionof debt incurred and $394.0 millionof equity contributions by the PEP Funds. Indebtedness In connection with the Transaction, we entered into senior secured credit facilities consisting of an $875 millionterm loan B facility, or Term Loan B Facility, due July 2018, and a $100 millionsenior secured revolving credit facility, or the Revolver, 40 -------------------------------------------------------------------------------- due July 2016, and together with the Term Loan B Facility, the Senior Secured Credit Facilities. Additionally, we issued $400 millionaggregate principal amount of senior notes, or Notes, due October 1, 2019. Our Term Loan B Facility requires annual payments of up to 75% of excess cash flow, or ECF (as defined in the credit agreement), with a reduction to 50% based upon achievement of a net senior secured leverage ratio, or NSSLR, of less than 3.5x, 25% if less than 2.75x and zero if less than 2.0x. Any required ECF payments are due on October 15each year. We are required to meet the NSSLR covenant quarterly if any revolving loan, swing-line loan or letter of credit is outstanding on the last day of the quarter. As of June 30, 2014, we had no outstanding letters of credit or borrowings under our Revolver. The ratio is calculated as the consolidated net secured indebtedness as of the last day of the quarter (defined as consolidated net secured debt less any cash and permitted investments) to the preceding four quarters' consolidated EBITDA (as defined in the Credit Agreement). The required ratio decreases over time from less than or equal to 5.0x as of June 30, 2014to less than or equal to 4.5x as of June 30, 2016. As of June 30, 2014, our net senior secured leverage ratio was 3.2x. We were in compliance with all of our covenants as of June 30, 2014. We repaid $140.0 millionof our Term Loan B Facility in fiscal 2012, which satisfied all of the required quarterly principal payments for the term of the loan and satisfied our required ECF principal payments for fiscal 2012. We repaid $20.0 millionof our Term Loan B Facility in fiscal 2013, which satisfied our required ECF principal payments for fiscal 2013. The fiscal 2014 ECF requirement is $62.0 million, of which we repaid $40.0 millionduring fiscal 2014. The remaining $22.0 millionis due October 15, 2014and is included in current liabilities on the consolidated balance sheet. The $400.0 millionof Notes bear interest at a rate of 11% per annum and mature on October 1, 2019. Interest on the Notes is payable semi-annually. The Notes are redeemable in whole or in part, at our option, at varying redemption prices that generally include premiums. In addition, until October 1, 2014, we may, at our option, redeem up to 35% of the then outstanding aggregate principal amount of the Notes with the net cash proceeds from certain equity offerings at a redemption price equal to 111% of the aggregate principal amount thereof. The Senior Secured Credit Facilities and the Notes are guaranteed by all of our wholly-owned subsidiaries. The Senior Secured Credit Facilities are also guaranteed by Sterling Parent. The guarantees are full and unconditional and joint and several. Each of our subsidiary guarantors are 100% owned and have no independent assets or operations. Capital Requirements We believe the capital resources available to us under the Revolver portion of our Senior Secured Credit Facilities and cash from our operations are adequate to fund our normal working capital needs as well as our capital expenditure requirements, which are expected to be less than 0.8% of revenue, for at least the next twelve months. Income Taxes The Transaction accelerated the recognition of expense for stock options and restricted stock, creating a tax deduction of approximately $80.0 millionin fiscal 2012. As a result of this stock compensation deduction, as well as Transaction costs and tax-deductible interest expense, we do not expect to make any material U.S. federal income tax payments until fiscal 2016. Accounts Receivable Factoring During fiscal 2014, we entered into an accounts receivable purchase agreement under which we sell certain accounts receivable to a third party, or the Factor, without recourse to the Company. The Factor initially pays the Company 90% of the receivable and the remaining price is deferred and based on the amount the Factor receives from our customer. The structure of the transaction provides for a true sale, on a revolving basis, of the receivables transferred. Accordingly, upon transfer of the receivable to the Factor, the receivable is removed from our consolidated balance sheet, a loss on the sale is recorded and the deferred price is an account receivable until it is collected. The balance of the sold receivables may not exceed $50 millionat any time. For fiscal 2014, we sold approximately $142.2 millionof receivables and recognized a related loss of $0.4 millionin selling, general and administrative expenses. As of June 30, 2014, the balance of the sold receivables was approximately $25.4 million, and the related deferred price was approximately $2.5 million. The factoring agreement resulted in accelerated cash flow to the Company. 41 -------------------------------------------------------------------------------- Off-Balance Sheet Arrangements As of June 30, 2014, other than operating leases, which are included in the Contractual Obligations table below, we had no material off-balance sheet arrangements, including no retained or contingent interests in assets transferred to unconsolidated entities; no derivative instruments indexed to our stock and classified in stockholder's equity on the consolidated balance sheet; or variable interests in entities that provide us with financing, liquidity, market risk or credit risk support or engage with us in leasing, hedging or research and development services. We no longer utilize forward contracts to offset foreign currency exchange rate risk as our foreign operations, Era and GCD, were sold in fiscal 2012. We utilize interest rate derivatives to add stability to interest expense and to manage our exposure to interest rate movements. For further discussion of our derivative instruments and hedging activities see Item 7A below and Note 9 to our consolidated financial statements as of and for the fiscal year ended June 30, 2014included in this annual report on Form 10-K. Contractual Obligations The following table summarizes our contractual obligations as of June 30, 2014that require us to make future cash payments. For contractual obligations, we included payments that we have an unconditional obligation to make. Payments due by period Less than 1 More than 5 Total year 1 to 3 years 3 to 5 years years (in thousands) Notes $ 400,000$ - $ - $ - $ 400,000Term Loan B Facility (a) 675,000 22,000 50,000 603,000 - Interest on debt 420,925 88,212 170,453 140,260 22,000 Operating lease obligations (b) 224,312 28,944 46,240 32,740 116,388 Total contractual obligations $ 1,720,237 $ 139,156 $ 266,693 $ 776,000 $ 538,388
(a) Includes the required excess cash flow payments that are due under our credit
October 15each year. This does not include voluntary prepayments of borrowings that we may expect to make as such voluntary prepayments are not required under the credit agreement.
(b) Includes approximately
underutilized space that we exited during fiscal 2012, 2013 and 2014.
In the normal course of our business, we enter into agreements with subcontractors and vendors to provide products and services that we consume in our operations or that are delivered to our customers. These products and services are not considered unconditional obligations until the products and services are actually delivered, at which time we record a liability for our obligation. The liability related to unrecognized tax benefits has been excluded from the contractual obligations table because a reasonable estimate of the timing and amount of cash out flows from future tax settlements cannot be determined. See Note 10 of our
June 30, 2014consolidated financial statements included in this annual report on Form 10-K for additional information regarding taxes and related matters. Recent Accounting Pronouncements In July 2013, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, which requires standard presentation of an unrecognized tax benefit when a carryforward related to net operating losses or tax credits exist. This update is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2013, or our fiscal 2015. The adoption of this ASU is not expected to have an impact on our financial position, results of operations or cash flows. 42 -------------------------------------------------------------------------------- In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for our fiscal 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting. 43