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Variable Interest Entities

9 Months Ended

Jun. 30, 2020

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 or similar governance 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, 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 “Original 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 VIEs 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. In June 2020, MBTA and Boston OpCo executed an amended agreement (the “Amended MBTA Contract”), which modified a number of the provisions of the Original MBTA Contract.

Under the Original MBTA Contract, MBTA was scheduled to make fixed payments to Boston OpCo in the aggregate amount of $558.5 million, adjusted for incremental transaction-based fees, inflation and performance penalties over a ten-year operate and maintain phase. All of Boston OpCo’s contractual responsibilities under the Original MBTA Contract regarding the design and development and the operation and maintenance of the fare system were subcontracted to Cubic by Boston OpCo. Under its subcontract with Boston OpCo, Cubic was scheduled to receive fixed payments in the aggregate amount of $427.6 million, adjusted for incremental transaction-based fees inflation, and performance penalties.

The Amended MBTA Contract modified certain aspects of the Original 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 and duration of the operate and maintain phase. In accordance with ASC 606, Revenue from Contracts with Customers (“ASC 606”), the Amended MBTA Contract was treated as a modification to the Original MBTA Contract, and as such Boston OpCo’s contract value was increased by additional fixed payments to be made by MBTA of $278.9 million plus the estimated value of future variable payments to be made by MBTA for incremental transaction-based fees and inflation indexed payments.

The Amended MBTA Contract consists of a design and build phase of approximately four years and an operate and maintain phase of approximately twelve years. The design and build phase is planned to be completed in 2024 and the initial operate and maintain phase is expected to commence in 2021, with full service commencement spanning from 2024 through 2033. Under the Amended MBTA Contract, MBTA will make payments to Boston OpCo consisting of fixed payments of $43.5 million during the design and build phase, fixed payments of $175.8 million upon full service commencement, fixed payments of $618.0 million during the full service period commencement of the operate and maintain phase, variable payments for incremental transaction-based fees and inflation indexed payments during the operate and maintain phase, and payment adjustments for any performance penalties incurred by Boston OpCo during the project.

Boston OpCo subcontracted all of its contractual responsibilities regarding the design and build and the operation and maintenance of the fare system to Cubic. Under its subcontract with Boston OpCo, Cubic will receive fixed payments in the aggregate amount of $596.4 million, adjusted for incremental transaction-based fees, inflation indexed payments, less any performance penalties incurred.

Upon creation of the P3 Venture and upon execution of the Amended MBTA Contract, John Laing made loans to Boston HoldCo of $24.3 million and $1.9 million, respectively, in the form of bridge loans that are 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 corresponding equity contributions to Boston OpCo in the same amounts which are included within equity of noncontrolling interest in the VIE in our consolidated financial statements. Also, we issued a letter of credit for $2.9 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 June 30, 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 included a long-term credit facility of up to $212.4 million and a revolving credit facility. The long-term credit facility bore interest at variable rates of London Interbank Offer Rate (“LIBOR”) plus 1.3%. In connection with the execution of the Amended MBTA Contract in June 2020, Boston OpCo entered into an amended credit agreement with a group of financial institutions (the “Boston OpCo Amended Credit Agreement”), which includes two long-term debt facilities and a revolving credit facility to replace the facilities in the Boston OpCo Credit Agreement. At closing of the Boston OpCo Amended Credit Agreement, Boston OpCo retired and paid the outstanding principal balance of $92.6 million plus accrued interest of $7.4 million due under the Boston OpCo Credit Agreement.

Under the Boston OpCo Amended Credit Agreement, the long-term debt facilities allow for draws up to an aggregate of $421.6 million and such draws may only be made during the design and build phase of the Amended MBTA Contract. The long-term debt facilities, including all interest and fees incurred, is required to be repaid on a fixed monthly schedule starting once the design and build phase is completed in 2024. The long-term debt facilities bear interest at variable rates of LIBOR plus a margin of 1.75% to 2.0% over the design and build phase and LIBOR plus a margin of 2.0% to 2.5% over the operate and maintain phase. Boston OpCo incurred debt issuance and modification costs of $8.6 million in connection with the Boston OpCo Amended Credit Agreement and these fees are being amortized as interest expense using the effective interest method over the term of the long-term debt facilities. At June 30, 2020, the outstanding balance on the long-term debt facilities was $172.8 million, which is presented net of total unamortized deferred financing costs of $17.3 million. The revolving credit facility allows for draws up to a maximum aggregate amount of $15.8 million during the operate and maintain phase of the Amended 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 Amended Credit Agreement contains a number of covenants which require that Boston OpCo and Cubic maintain progress on the delivery of the MBTA Amended Agreement within a specified timeline and budget and provide regular reporting on such progress. The Boston OpCo Amended 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.

In connection with the Boston OpCo Credit Agreement, Boston OpCo 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 facility. Upon execution of the Boston OpCo Amended Credit Agreement, Boston OpCo terminated these interest rate swaps and paid termination costs of $34.4 million to the counterparties. The termination payments are included in cash flows used in operating activities in our Condensed Consolidated Statements of Cash Flows. In connection with the Boston OpCo Amended Credit Agreement, Boston OpCo entered into new pay-fixed/receive-variable interest rate swaps to mitigate the variable interest rate associated with its long-term debt facility. 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 June 30, 2020, the outstanding notional principal amounts on open interest rate swaps were $172.8 million. The fair value of Boston OpCo’s interest rate swaps at June 30, 2020 was $5.6 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 June 30, 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 $6.9 million and $18.4 million for the three and nine months ended June 30, 2020, respectively, and losses of $7.0 million and $16.9 million for the three and nine months ended June 30, 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 Amended MBTA Contract to allow for the delivery of future change orders directed by MBTA.

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


	June 30,		September 30,
	2020		2019

	(in thousands)
Cash	$	743	$	347
Restricted cash		1,669		9,967
Other current assets		99		33
Long-term contracts financing receivable		191,042		115,508
Other noncurrent assets		—		1,419
Total assets	$	193,553	$	127,274

Trade accounts payable	$	175	$	25
Accrued compensation and other current liabilities		150		191
Due to Cubic		11,754		25,143
Other noncurrent liabilities		5,572		21,605
Long-term debt		155,493		61,994
Total liabilities	$	173,144	$	108,958
Total Cubic equity		(583)		(603)
Noncontrolling interests		20,992		18,919
Total liabilities and owners' equity	$	193,553	$	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 Amended MBTA Contract.

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


	Three Months Ended				Nine Months Ended
	June 30,				June 30,
	2020		2019		2020		2019
Revenue	$	17,585	$	3,233	$	20,632	$	7,519
Operating income		17,344		2,823		19,832		6,521
Other income (expense), net		(6,888)		(7,031)		(19,636)		(16,884)
Interest income		1,663		1,075		4,871		2,335
Interest expense		(1,710)		(829)		(4,864)		(1,939)