Variable Interest Entities

6 Months Ended

Mar. 31, 2020

Variable Interest Entities

Variable Interest Entities

Note 4 – Variable Interest Entities

In accordance with ASC 810, Consolidation (“ASC 810”), we assess our partnerships and joint ventures at inception, and when there are changes in relevant factors, to determine if any meet the qualifications of a variable interest entity (a “VIE”). We consider a partnership or joint venture to be a VIE if it has any of the following characteristics: (a) the total equity investment is not sufficient to permit the entity to finance its activities without additional subordinated financial support, (b) characteristics of a controlling financial interest are missing (either the ability to make decisions through voting or other rights, the obligation to absorb the expected losses of the entity or the right to receive the expected residual returns of the entity), or (c) the voting rights of the equity holders are not proportional to their obligations to absorb the expected losses of the entity or their rights to receive the expected residual returns of the entity, and substantially all of the entity's activities either involve or are conducted on behalf of an investor that has disproportionately few voting rights.

We perform a qualitative assessment of each VIE to determine if we are its primary beneficiary. We conclude that we are the primary beneficiary and consolidate the VIE if we have both (a) the power to direct the activities that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. We consider the VIE design, the contractual agreements that define the ownership structure, distribution of profits and losses, risks, responsibilities, indebtedness, voting rights and board representation of the respective parties in determining if we are the primary beneficiary. We also consider all parties that have direct or implicit variable interests when determining whether we are the primary beneficiary. As required by ASC 810, our primary beneficiary assessment is continuously performed.

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

The MBTA Contract consists of a design and build phase of approximately three years and an operate and maintain phase of approximately ten years. The design and build phase is planned to be completed in 2021 and the operate and maintain phase is expected to span from 2021 through 2031. MBTA will make fixed payments in the aggregate amount of $558.5 million, adjusted for incremental transaction-based fees, inflation, and performance penalties, to Boston OpCo in connection with the MBTA Contract over the ten-year operate and maintain phase. All of Boston OpCo’s contractual responsibilities regarding the design and development and the operation and maintenance of the fare system have been subcontracted to Cubic by Boston OpCo. Cubic will receive fixed payments in the aggregate amount of $427.6 million, adjusted for incremental transaction-based fees, inflation, and performance penalties, under its subcontract with Boston OpCo in connection with the MBTA Contract.

In December 2019, we entered into a preliminary change order with MBTA and Boston OpCo to modify certain aspects of the MBTA Contract, such as extending the design and build phase to 2024, adding new functionality to the next-generation fare payment system and increasing the scope of the operate and maintain phase. As part of the preliminary change order, MBTA will make payments of up to $30.0 million to Cubic for work performed under the change order while the terms and conditions are finalized. On April 27, 2020 MBTA’s Fiscal and Management Control Board approved the change order, and financial close of the change order is expected during the third quarter of fiscal 2020.

Upon creation of the P3 Venture, John Laing made a loan to Boston HoldCo of $24.3 million in the form of a bridge loan that is intended to be converted to equity in the future in accordance with its equity funding responsibilities under the terms of the P3 Venture. Concurrently, Boston HoldCo made a corresponding equity contribution to Boston OpCo in the same amount which is included within equity of noncontrolling interest in VIE in our consolidated financial statements. Also, upon creation of the P3 Venture, we issued a letter of credit for $2.7 million to Boston HoldCo in accordance with our equity funding responsibilities under the terms of the P3 Venture. Boston HoldCo is able to draw on the letter of credit in certain liquidity instances, but no amounts have been drawn on such letter of credit as of March 31, 2020.

Upon creation of the P3 Venture, Boston OpCo entered into a credit agreement with a group of financial institutions (the “Boston OpCo Credit Agreement”), which includes a long-term debt facility and a revolving credit facility. The long-term debt facility allows for draws up to an aggregate of $212.4 million and such draws may only be made during the design and build phase of the MBTA Contract. The long-term debt facility, including interest and fees incurred during the design and build phase, is required to be repaid on a fixed monthly schedule over the operate and maintain phase of the MBTA Contract. The long-term debt facility bears interest at variable rates of London Interbank Offer Rate (“LIBOR”) plus 1.3% over the design and build phase and LIBOR plus 1.55% over the operate and maintain phases. At March 31, 2020, the outstanding balance on the long-term debt facility was $87.8 million, which is presented net of unamortized deferred financing costs of $8.8 million. The revolving credit facility allows for draws up to a maximum aggregate amount of $13.9 million during the operate and maintain phase of the MBTA Contract. Boston OpCo’s debt is nonrecourse with respect to Cubic and our subsidiaries. The fair value of the long-term debt facility approximates its carrying amount.

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

Boston OpCo has entered into pay-fixed/receive-variable interest rate swaps with a group of financial institutions to mitigate variable interest rate risk associated with its long-term debt. The interest rate swaps contain forward starting notional principal amounts which align with Boston OpCo’s expected draws on its long-term debt facility. At March 31, 2020, the outstanding notional principal amounts on open interest rate swaps were $160.7 million. The fair value of Boston OpCo’s interest rate swaps at March 31, 2020 was $33.1 million and is recorded as a liability in other noncurrent liabilities in our condensed consolidated balance sheets. Boston OpCo’s interest rate swaps were not designated as effective hedges at March 31, 2020 and as such unrealized gains (losses) are included in other income (expense), net. As a result of changes in the fair value of its interest rate swaps, Boston OpCo recognized losses of $15.8 million and $11.5 million for the three- and six- month periods ended March 31, 2020, respectively, and losses of $3.8 million and $9.9 million for the three- and six- month periods ended March 31, 2019, respectively. See Note 8 for a description of the measurement of fair value of derivative financial instruments, including Boston OpCo’s interest rate swaps.

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

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

	March 31,		September 30,
	2020		2019
	(in thousands)
Cash	$	457	$	347
Restricted cash		9,967		9,967
Other current assets		112		33
Long-term contracts financing receivable		137,870		115,508
Other noncurrent assets		—		1,419
Total assets	$	148,406	$	127,274
Trade accounts payable	$	—	$	25
Accrued compensation and other current liabilities		181		191
Due to Cubic		19,220		25,143
Other noncurrent liabilities		33,087		21,605
Long-term debt		87,814		61,994
Total liabilities	$	140,302	$	108,958
Total Cubic equity		(1,627)		(603)
Noncontrolling interests		9,731		18,919
Total liabilities and owners' equity	$	148,406	$	127,274

The assets of Boston OpCo are restricted for its use only and are not available for our general operations. Boston OpCo’s debt is non-recourse to Cubic. Our maximum exposure to loss as a result of our equity interest in the P3 Venture is limited to the $2.7 million outstanding letter of credit, which will be converted to a cash contribution upon completion of the design and build phase of the MBTA Contract.

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

	Three Months Ended				Six Months Ended
	March 31,				March 31,
	2020		2019		2020		2019
Revenue	$	1,802	$	2,325	$	3,047	$	4,286
Operating income		1,516		2,030		2,488		3,698
Other income (expense), net		(15,819)		(3,720)		(12,748)		(9,863)
Interest income		1,655		757		3,208		1,260
Interest expense		(1,995)		(598)		(3,154)		(1,110)