Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Forward Looking and Cautionary Statements
You should read the following discussion in conjunction with the Consolidated Financial Statements and the notes to those statements included elsewhere in this Annual Report on Form 10-K for the year ended September 30, 2020. This discussion contains certain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Certain statements contained in this Management’s Discussion and Analysis are forward-looking statements that involve risks and uncertainties. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry and business. Our actual results could differ materially from the results contemplated by these forward-looking statements.
Business Overview:
We are a provider of technology-enabled business process outsourcing and program management solutions, and public health research and analytics; primarily focused to improve and better deploy large-scale federal health and human service initiatives. We derive 98% of our revenue from agencies of the Federal government, providing services to several agencies including the Department of Veteran Affairs ("VA"), Department of Health and Human Services ("HHS"), and the Department of Defense ("DoD").
On September 30, 2020, we acquired Irving Burton Associates, LLC (“IBA”) for the base purchase price of $32.0 million in cash. We funded the purchase price and the costs and expenses of the acquisition through funds received under our amended and restated credit agreement, as described in greater detail below. IBA provides research, systems development, and other technology-enabled solutions to the DHA, the Telemedicine & Advanced Technology Research Center of the US Army’s Medical Research and Development Command, and other agencies within the DoD. IBA maintains a top-secret facility clearance, and its defense contracts provide for a range of health IT services including digital transformation, data analytics, cybersecurity, and artificial intelligence
Our business offerings are aligned to three market focus areas within the federal health services market space.
• Defense and Veteran Health Solutions;
• Human Services and Solutions;
• Public Health and Life Sciences.
Major Customers
Our largest customer is the VA, which comprised approximately $100.2 million and $91.9 million of revenue for the years ended September 30, 2020 and 2019, respectively. Our second largest customer, HHS, comprised approximately $95.0 million and $62.0 million of revenue for the years ended September 30, 2020 and 2019, respectively. We remain dependent upon the continuation of our relationships with the VA and HHS as a significant portion of our revenue is concentrated in a small number of contracts with these customers. As described in greater detail above in "Item 1 - Business - Major Contracts", our contracts with the VA are currently subject to renewal solicitations.
Forward Looking Business Trends:
Our mission is to expand our position as a trusted provider of technology-enabled healthcare and public health services, medical logistics, and readiness enhancement services to active duty personnel, veterans, and civilian populations and communities. Our primary focus within the defense agency markets include military service members' and veterans' requirements for telehealth services, behavioral healthcare, medication therapy management, process management, clinical systems support, and healthcare delivery. Our primary focus within the civilian agency markets includes healthcare and social programs delivery and readiness. These include compliance monitoring on large scale programs, technology-enabled program management, consulting, and digital communications solutions ensuring that education, health, and social standards are being achieved within underserved and at-risk populations. We believe these business development priorities will position the Company to expand within top national priority programs and funded areas.
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Federal budget outlook for fiscal 2021:
The President of the United States' broad agenda calls for increased military and, in certain cases, domestic spending, with reduced spending on foreign programs. Most relevant to the Company’s targeted markets, the President advocates the lifting of sequestration caps in the defense sector; increasing infrastructure spending in the United States; and tightening controls on immigration. We continue to carefully follow federal budget, legislative and contracting trends and activities and evolve our strategies to take these into consideration.
In July 2019, White House and Congressional budget negotiators reached an agreement on a two-year budget deal that would increase current spending caps by $320 billion and suspends the debt ceiling through mid-2021. The budget allocates additional spending to defense and non-defense programs. In late July 2019, Congress passed the Bipartisan Budget Act of 2019, which increased the caps for defense and non-defense spending for fiscal 2020 and 2021, established discretionary spending caps for fiscal 2020 and 2021, and suspended the national debt limit through July 2021. On August 2, 2019, the President signed the measure into law. Subsequently, in December 2019, Congress passed two appropriations bills totaling $1.4 trillion for the 2020 fiscal year; on December 20, 2019, both bills were signed into law.
While Congress has not completed the final appropriation bills for the government’s 2021 fiscal year, the Company continues to believe that its key programs benefit from bipartisan support and does not expect a material impact on its current business base from budget negotiations. If the appropriations bills are not timely enacted, government agencies operate under a continuing resolution (CR), which may negatively impact our business due to delays in new program starts, delays in contract award decisions, and other factors. While we view the budget environment as stable under BBA 2019 and believe there is bipartisan support for continued investment in the areas of defense and national security, the government is currently operating under a CR which expires December 11, 2020. When a CR expires, unless appropriations bills have been passed by Congress and signed by the President, or a new CR is passed and signed into law, the government must cease operations, or shutdown, except in certain emergency situations or when the law authorizes continued activity. We continuously review our operations in an attempt to identify programs potentially at risk from CRs so that we can consider appropriate contingency plans.
Our customer's missions have received broad support from the legislative and executive branches of the federal government. We expect that support to continue with the change of administration with amended and new priorities established by the President-Elect. As such, we do not anticipate or expect any significant changes to our operations as a result of the recent elections.
Department of Veterans Affairs (VA) health spending trends:
The Company continues to see critical need for expanded health care solutions within our sector of the Federal health market, largely focused on the needs of veterans and their families. Serving over nine million veterans each year, the VA operates the nation's largest integrated health care system, with more than 1,700 hospitals, clinics, community living centers, readjustment counseling centers, and other facilities.
The VA is requesting a budget increase in fiscal 2021 of 10.2% above the fiscal 2020 budget, an increase of $22.5 billion. The budget increase focuses on several key veteran health issues to include several mental health initiatives. We believe the fiscal 2021 budget request supports our identified growth opportunities.
The VA is requesting a total budget of $243.3 billion, an increase in fiscal 2021 of 10.2% above the fiscal 2020 budget. The budget increase focuses on several key veteran health initiatives to include telehealth and mental health. For these initiatives the VA has requested budgets of $1.3 and $10.3 billion, respectively. These requests represent an approximately 27% and 7% increase from fiscal 2020. We believe our capabilities and service delivery models are aligned with our customers growth initiatives.
Department of Health and Human Services (HHS) spending trends:
HHS is the principal federal department charged with protecting the health of all Americans and providing essential human services. Over the past two government fiscal years, spending on health care initiatives has increased and is increasing in fiscal 2020 to $1.3 trillion. The budget will provide resources for efforts aimed to increase affordability of individual health insurance, decrease the price of prescription drugs, and combat the opioid crisis. The Company has existing contracts with multiple agencies under HHS, and we are actively pursuing growth opportunities within this vital agency.
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Over the past two government fiscal years, spending on health care initiatives has increased and is expected to increase in fiscal 2021 to $1.4 trillion. HHS is the principal federal department charged with protecting the health of all Americans and providing essential human services.
The National Institutes of Health ("NIH"), a part of HHS, is asking for approximately $8.8 billion to fund new COVID-19 projects. These projects will focus not only on vaccines and other treatments, but will also evaluate the societal impacts of the disease. We believe our capabilities and past performance are well aligned with the service sought under this budget increase.
Industry consolidation among federal government contractors:
There has been active consolidation and a strong increase in merger and acquisition activity among federal government contractors over the past few years that we expect to continue, fueled by public companies leveraging strong balance sheets. Companies often look to acquisitions that augment core capabilities, contracts, customers, market differentiators, stability, cost synergies, and higher margin and revenue streams.
Potential Impact of Federal Contractual set-aside Laws and Regulations:
The Federal government has an overall goal of 23% of prime contracts flowing through small businesses. As previously reported, various agencies within the federal government have policies that support small business goals, including the adoption of the “Rule of Two” by the VA, which provides that the agency shall award contracts by restricting competition for the contract to service-disabled or other veteran owned businesses. To restrict competition pursuant to this rule, the contracting officer must reasonably expect that at least two of these businesses, which are capable of delivering the services, will submit offers and that the award can be made at a fair and reasonable price that offers best value to the United States. When two qualifying small businesses cannot be identified, the VA may proceed to award contracts following a full and open bid process.
The Company believes that its past performance in this market and track record of success provide a competitive advantage. However, the effect of set-aside provisions may limit our ability to compete for prime contractor positions on programs that we recompete or that we have targeted for growth. In these cases, the Company may elect to join a team with an eligible contractor as prime in support of such small businesses for specific pursuits that align with our core markets and corporate growth strategy.
COVID-19 Impact
We are exposed to and impacted by macroeconomic factors and U.S. government policies. Current general economic conditions are highly volatile due to the COVID-19 pandemic, resulting in both market size contractions due to economic slowdowns and government restrictions on movement. We have seen continued demand for the services we provide under our current contract portfolio as the services we provide are largely deemed essential. While the pandemic has had minor offsetting impacts during fiscal 2020 due to social distancing and travel restrictions, we do not expect material impacts from COVID-19 in this fiscal year.
The pandemic may cause reduced demand for certain services we provide, particularly if it results in a recessionary economic environment or the spending priorities of the U.S. government shift in ways adverse to our business focus. Our ability to continue to operate without any significant negative impacts will in part depend on our continued ability to protect our employees. We have endeavored to follow recommended actions of government and health authorities to protect our employees
and were able to broadly maintain our operations. Further, we have partnered with our clients to adopt particular measures to protect our employees at distribution centers, and we expect to execute on a remainder of our contracts through remote and teleworking arrangements. We intend to continue to work with government authorities and implement our employee safety measures to ensure that we are able to continue our operations during the pandemic. However, uncertainty resulting from the pandemic could result in an unforeseen disruption to our operations (for example a closure of a key distribution facility) that may not be fully mitigated. To date we have experienced continuity in the majority of our work for our government clients. While there has been postponements of events and challenges around some project work requiring travel, overall, our government clients have continued to require our services. We are unable to predict whether, and to what extent, this trend will continue. It would be reasonable to expect some deterioration of certain client activities due to COVID-19. The longer the duration of the pandemic, the more likely it is that it could have an adverse effect on our business, financial position, results of operations and/or cash flows. However, we also believe that we are likely to see additional demand from federal agencies such as the CDC and the NIH for our services.
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Due to our ability to continue to perform under our contracts and our cash flow generation, we do not presently expect material liquidity constraints related to COVID-19. We are presently in compliance with all covenants in our term loan and have access to a revolving line of credit to meet any short-term cash needs that cannot be funded by operations . As such, mandatory demands on our cash flow remain low. Further, we have not observed any material impairments of our assets or a significant change in the fair value of our assets due to the COVID-19 pandemic. For additional information on risk factors that could impact our results, please refer to “Risk Factors” in Part I, Item 1A of this Form 10-K.
Results of Operations for Fiscal Year 2020 as Compared to Fiscal Year 2019
The following table summarizes, for the years indicated, consolidated statements of operations data expressed in dollars in thousands except for per share amounts, and as a percentage of revenue:
Year Ended Change in
Consolidated Statement of Operations: September 30, 2020 September 30, 2019 $ % of Rev
Revenue $ 209,185 100.0 % $ 160,391 100.0 % $ 48,794 — %
Cost of operations
Contract costs 163,596 78.2 % 124,551 77.6 % 39,045 0.6 %
General and administrative costs 24,195 11.6 % 20,525 12.8 % 3,670 (1.2) %
Acquisition costs 930 0.5 % 1,391 0.9 % (461) (0.4) %
Depreciation and amortization 7,003 3.3 % 3,956 2.5 % 3,047 0.8 %
Total operating costs 195,724 93.6 % 150,423 93.8 % 45,301 (0.2) %
Income from operations 13,461 6.4 % 9,968 6.2 % 3,493 0.2 %
Interest expense, net 3,441 1.6 % 2,473 1.5 % 968 0.1 %
Income before income taxes 10,020 4.8 % 7,495 4.7 % 2,525 0.1 %
Income tax expense 2,906 1.4 % 2,171 1.4 % 735 — %
Net income $ 7,114 3.4 % $ 5,324 3.3 % $ 1,790 0.1 %
Net income per share - basic 0.58 0.44 0.14
Net income per share - diluted 0.54 0.41 0.14
Revenue
For the twelve months ended September 30, 2020 revenue was $209.2 million, an increase of $48.8 million or 30.4% over the prior year period. The increase is primarily due to the inclusion of Social & Scientific Systems, Inc. ("S3"), acquired in June 2019, for the full year in fiscal 2020.
Cost of Operations
Contract costs primarily include the costs associated with providing services to our customers. These costs are generally comprised of direct labor and associated fringe benefit costs, subcontract cost, other direct costs, and the related management and infrastructure costs. For the twelve months ended September 30, 2020, contract costs increased by approximately $39.0 million principally due to the growth in revenues.
General and administrative costs are for those employees not directly providing services to our customers, to include but not limited to executive management, bid & proposal, accounting, and human resources. These costs increased as compared to the prior fiscal year by $3.7 million to approximately $24.2 million primarily from the growth in revenues. Acquisition costs in 2020 were due to the IBA acquisition and include due diligence costs, such as legal and accounting fees.
For the year ended September 30, 2020, depreciation and amortization costs were approximately $2.2 million and $4.8 million, respectively, as compared to approximately $1.2 million and $2.7 million for the prior fiscal year, an aggregate increase of $3.0 million. The increase was principally due to the amortization of the acquired definite-lived intangible assets of S3.
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Interest Expense, net
Interest expense, net, includes items such as, interest expense and amortization of deferred financing costs on debt obligations. For the year ended September 30, 2020, interest expense, net, was $3.4 million compared to interest expense, net of $2.5 million in the prior year, an increase of approximately $1.0 million over the prior year period. The increase in interest expense was due to the new credit facility used to finance the acquisition of S3.
Income Tax Expense
Income tax expense for fiscal year ended September 30, 2020 was $2.9 million, an increase of approximately $0.7 million from the prior fiscal year. The effective tax rate for the fiscal years ending September 30, 2020 and 2019 was approximately 29%.
Non-GAAP Financial Measures for Fiscal 2020 and 2019
The Company uses EBITDA as a supplemental non-GAAP measures of our performance. The Company defines EBITDA as net income excluding (i) interest expense, (ii) provision for or benefit from income taxes, if any, and (iii) depreciation and amortization.
On a non-GAAP basis, Earnings Before Interest Taxes Depreciation and Amortization (“EBITDA”) for the year ended September 30, 2020 was approximately $20.5 million, an increase of approximately $6.5 million, or 47.0%, over the prior fiscal year. This increase was principally due to the contribution of S3 and effective management of general and administrative expenses.
For fiscal 2020 and fiscal 2019, our net income was impacted by transaction costs incurred as a result of the IBA and S3 acquisitions, respectively. In fiscal 2020, we incurred $1.0 million of acquisition-related expenses and in fiscal 2019, we incurred $1.4 million of acquisition-related expenses. We are excluding acquisition-related expenses from this measure because they were incurred as a result of specific events, do not reflect the costs of our operations, and can affect the period-over-period assessment of operating results. We are reporting this non-GAAP metric to demonstrate the impact of these events.
These non-GAAP measures of our performance are used by management to conduct and evaluate its business during its regular review of operating results for the periods presented. Management and our Board utilize these non-GAAP measures to make decisions about the use of our resources, analyze performance between periods, develop internal projections and measure management's performance. We believe that these non-GAAP measures are useful to investors in evaluating our ongoing operating and financial results and understanding how such results compare with our historical performance. By providing this non-GAAP measure as a supplement to GAAP information, we believe this enhances investors understanding of our business and results of operations .
Reconciliation of GAAP net income to EBITDA, a non-GAAP measure:
(in thousands)
Year Ended
September 30,
2020 2019 Change
Net income $ 7,114 $ 5,324 $ 1,790
(i) Interest expense, net: 3,441 2,473 968
(ii) Provision for taxes 2,906 2,171 735
(iii) Depreciation and amortization 7,003 3,956 3,047
EBITDA $ 20,464 $ 13,924 $ 6,540
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Reconciliation of GAAP net income to net income adjusted for the effect of the acquisition costs, a non-GAAP measure:
(in thousands)
Year Ended
September 30,
2020 2019 Change
Net income $ 7,114 $ 5,324 $ 1,790
Acquisition costs 930 1,391 (461)
Tax effect of excluding acquisition costs (270) (403) 133
Net income adjusted for acquisition costs $ 7,774 $ 6,312 $ 1,462
Net income per diluted share $ 0.54 $ 0.41 $ 0.13
Impact of acquisition costs, net 0.05 $ 0.08 (0.03)
Net income per diluted share adjusted for acquisition costs $ 0.59 $ 0.49 $ 0.10
Liquidity and capital management
For the year ended September 30, 2020, the Company generated operating income of approximately $13.5 million and net income of approximately $7.1 million. Cash flows from operations totaled approximately $19.5 million and $18.0 million for the years ended September 30, 2020 and 2019, respectively. The increase in cash from operations was principally due to higher profitability.
We used $32.8 million and $67.5 million of cash in investing activities during fiscal 2020 and fiscal 2019, respectively. The cash utilized in each respective fiscal year was predominantly due to acquisitions, IBA in fiscal 2020 and S3 in fiscal 2019.
Cash provided by financing activities during the fiscal years ended September 30, 2020 and 2019 was approximately $12.9 million and $44.9 million, respectively. The activity in each fiscal year was primarily the sourcing of capital to fund acquisitions and early repayment of principal on our senior term loan. We entered into a $95 million credit facility entered on June 7, 2019 which included a $70.0 million term loan. During the year ended September 30, 2020, we had repayments of approximately $19.0 million under our credit facility. We amended and restated the credit facility on September 30, 2020 to acquire IBA. We expect to continue to use operating cash flow to pay outstanding debt.
A summary of the change in cash and cash equivalents is presented below:
Year Ended
September 30,
2020 2019
Net cash provided by operating activities $ 19,451 $ 18,039
Net cash used in investing activities (32,830) (67,484)
Net cash provided by financing activities 12,946 44,880
Net change in cash and cash equivalents $ (433) $ (4,565)
Sources of cash and cash equivalents
As of September 30, 2020, our immediate sources of liquidity include cash and cash equivalents of approximately $1.4 million, accounts receivable, and access to our secured revolving line of credit facility. This credit facility provides us with access of up to $25.0 million, subject to certain conditions including eligible accounts receivable. As of September 30, 2020, we had unused borrowing capacity of $24.8 million. The Company's present operating liabilities are largely predictable and consist of vendor and payroll related obligations. We believe that our current investment and financing obligations are adequately covered by cash generated from profitable operations and that planned operating cash flow should be sufficient to support our operations for twelve months from the date of issuance of these consolidated financial statements.
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Loan Facility
A summary of our loan facilities and subordinated debt financing as of September 30, 2020 is as follows:
($ in Millions)
As of September 30, 2020
Lender Arrangement Loan Balance Interest * Maturity Date
First National Bank of Pennsylvania Secured term loan (a) $ 70.0 LIBOR* + 3.5% 09/30/25
First National Bank of Pennsylvania Secured revolving line of credit (b) $ — LIBOR* + 3.5% 09/30/25
*LIBOR rate as of September 30, 2020 was 0.16%. As of September 30, 2020, our LIBOR rate is subject to a minimum floor of 0.5%. The floor affects interest payments for the periods after September 30, 2020.
(a) Represents the principal amounts payable on our secured term loan. The $70.0 million secured term loan is secured by liens on substantially all of the assets of the Company. The principal of the term loan is payable in quarterly installments with the remaining balance due on September 30, 2025.
The Credit Agreement requires compliance with a number of financial covenants and contains restrictions on our ability to engage in certain transactions. Among other matters, we must comply with limitations on: granting liens; incurring other indebtedness; maintenance of assets; investments in other entities and extensions of credit; mergers and consolidations; and changes in nature of business. The loan agreement also requires us to comply with certain quarterly financial covenants including: (i) a minimum fixed charge coverage ratio of at least 1.25 to 1.00, and (ii) a Funded Indebtedness to Adjusted EBITDA ratio not exceeding the ratio of 3.75:1.0 to 2.75:1.0 through maturity. Adjusted EBITDA ratio is calculated by dividing the Company's total interest-bearing debt by net income adjusted to exclude (i) interest and other expenses, (ii) provision for or benefit from income taxes, if any, (iii) depreciation and amortization, and (iv) non-recurring charges, losses or expenses to include transaction and non-cash equity expense. The term loan has an interest rate spread range from 2.5% to 4.5% depending on the funded indebtedness to adjusted EBITDA ratio. We are in compliance with all loan covenants and restrictions.
We are required to pay quarterly amortization payments commencing in December 2020 through September 2025. The annual amount of principal amortization is based on a percentage of the loan balance at September 30, 2020. The annual amortization amounts are $7.0 million for fiscal years 2021 and 2022 and $8.75 million each for fiscal years 2023 - 2025. The quarterly payments are in equal installments. In addition to quarterly payments of the outstanding indebtedness, the loan agreement also requires annual payments of a percentage of excess cash flow, as defined in the loan agreement. The loan agreement states that an excess cash flow recapture payment must be made equal to (a) 75% of the excess cash flow for the immediately preceding fiscal year in which indebtedness to consolidated EBITDA ratio is greater than or equal to 2.50:1.0; (b) 50% of the excess cash flow for the immediately preceding fiscal year in which the funded indebtedness to consolidated EBITDA Ratio is less than 2.50:1.0 but greater than or equal to 1.5:1.0; or (c) 0% of the excess cash flow for the immediately preceding fiscal year in which the funded indebtedness to consolidated EBITDA Ratio is less than 1.5:1.0. In addition, the Company must make additional mandatory prepayment of amounts outstanding based on proceeds received from asset sales and sales of certain equity securities or other indebtedness. For additional information regarding the schedule of future payment obligations, please refer to Note 11 Commitments and Contingencies .
On September 30, 2019, we executed a floating-to-fixed interest rate swap with First National Bank ("FNB") as counter party. The notional amount in the floating-to-fixed interest rate swap is $36 million; the remaining outstanding balance of our term loan is subject to interest rate fluctuations and the minimum LIBOR floor. On the notional amount, the Company pays a fixed rate of 1.61%, plus applicable credit spread. As a result, for the year ended September 30, 2020, interest expense increased by less than $0.2 million.
(b) The secured revolving line of credit has a ceiling of up to $25.0 million. Borrowing on the line of credit is secured by liens on substantially all of the assets of the Company. The Company accessed funds from the revolving credit facility during the year, but has no outstanding balance at September 30, 2020.
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The Company's total borrowing availability, based on eligible accounts receivables at September 30, 2020, was $24.8 million. As part of the revolving credit facility, the lenders agreed to a sublimit of $5 million for letters of credit for the account of the Company, subject to applicable procedures.
The revolving line of credit has a maturity date of September 30, 2025 and is subject to loan covenants as described above. The Company is fully compliant with those covenants.
Contractual Obligations as of September 30, 2020
Payments Due By Period
Contractual obligations Next 12 2-3 4-5 More than 5
(Amounts in thousands) Total Months Years Years Years
Debt Obligations $ 70,000 $ 7,000 $ 15,750 $ 47,250 $ —
Facility leases 31,002 3,317 6,710 6,291 14,684
Equipment operating leases 309 91 166 52 —
Total Obligations $ 101,311 $ 10,408 $ 22,626 $ 53,593 $ 14,684
Off-Balance Sheet Arrangements
The Company did not have any material off-balance sheet arrangements as of September 30, 2020 or subsequent to, or upon the filing of our consolidated financial statements in our Annual Report as defined under SEC rules.
Effects of Inflation
Inflation and changing prices have not had a material impact on the Company’s net revenues, results of operations, and cash flows as inflation has generally been limited. However, the Company has been able to modify its prices and cost structure to respond to inflation and changing prices as needed and expects to be able to do so in future periods.
Critical Accounting Policies and Estimates
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include valuation of goodwill and intangible assets, interest rate swaps, stock-based compensation, right-of-use assets and lease liabilities, valuation allowances established against deferred tax assets, measurement of loss development on workers' compensation claims. In addition, the Company estimates overhead charges and allocates such charges throughout the year. Actual results could differ from those estimates. In particular, a material reduction in the fair value of goodwill would have a material adverse effect on the Company’s financial position and results of operations. For a detailed discussion on the application of these and other accounting policies, you should review the discussion under the caption Significant Accounting Policies in Note 4 of the notes to our Consolidated Financial Statements contained elsewhere in this Annual Report on Form 10-K.
Revenue Recognition
We recognize revenue over time when there is a continuous transfer of control to our customer. For our U.S. government contracts, this continuous transfer of control to the customer is supported by clauses in the contract that allow the U.S. government to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. When control is transferred over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. For services contracts, we satisfy our performance obligations as services are rendered. We use a cost-based input method to measure progress.
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For time-and-materials contracts, revenue is recognized to the extent of billable rates times hours delivered plus materials and other reimbursable costs incurred. Revenue for cost-reimbursable contracts is recorded as reimbursable costs are incurred, including an estimated share of the applicable contractual fees earned. Contract costs are expensed as incurred. Estimated losses are recognized when identified.
Refer to Note 5 of the accompanying notes to our Consolidated Financial Statements contained elsewhere in this Annual Report on Form 10-K for discussion relative to the Company's revenue recognition in accordance with ASC-606.
Long-Lived Assets
Our long-lived assets include equipment and improvements, right-of-use assets, intangible assets, and goodwill. The Company continues to review its long-lived assets for possible impairment or loss of value at least annually or more frequently upon the occurrence of an event or when circumstances indicate that a reporting unit’s carrying amount is greater than its fair value.
Equipment and improvements are stated at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful asset lives (3 to 7 years) and the shorter of the initial lease term or estimated useful life for leasehold improvements.
Costs incurred to place the asset in service are capitalized and costs incurred after implementation are expensed. Amortization expense is recorded when the software is placed in service on a straight-line basis over the estimated useful life of the software.
Right-of-use assets are measured at the present value of future minimum lease payments, including all probable renewals, plus lease payments made to the lessor before or at lease commencement and indirect costs, less incentives received. Our right-of-use assets include long-term leases for facilities and equipment and are amortized over their respective lease terms.
Intangible assets are originally recorded at fair value and amortized on a straight-line basis over their assessed useful lives. The assessed useful lives of the assets are 10 years.
Goodwill
The Company continues to review its goodwill for possible impairment or loss of value at least annually or more frequently upon the occurrence of an event or when circumstances indicate that a reporting unit’s carrying amount is greater than its fair value. At September 30, 2020, we performed a goodwill impairment evaluation. We performed a qualitative assessment of factors to determine whether it was necessary to perform the goodwill impairment test. Based on the results of the work performed, the Company has concluded that no impairment loss was warranted at September 30, 2020, as no change in business conditions occurred which would have a material adverse effect on the valuation of goodwill. Our assessment incorporated effects of the COVID-19 pandemic, which did not have a meaningful impact on our financial results. Notwithstanding this evaluation, factors including non-renewal of a major contract or other substantial changes in business conditions could have a material adverse effect on the valuation of goodwill in future periods and the resulting charge could be material to future periods’ results of operations.
Income Taxes
The Company accounts for income taxes in accordance with the liability method, whereby deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reflected on the consolidated balance sheet when it is determined that it is more likely than not that the asset will be realized. This guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized. The Company believes it has adequate sources of taxable income to fully utilize its net operating loss carryforwards before their expiration. The Company recorded no valuation allowance as of September 30, 2020 and September 30, 2019, respectively.
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Stock-based Equity Compensation
The Company uses the fair value-based method for stock-based equity compensation. Options issued are designated as either an incentive stock or a non-statutory stock option. No option may be granted with a term of more than 10 years from the date of grant. Option awards may depend on achievement of certain performance measures determined by the Compensation Committee of our Board. Shares issued upon option exercise are newly issued common shares. All awards to employees and non-employees are recorded at fair value on the date of the grant and expensed over the period of vesting. The Company uses a Monte Carlo binomial and Black Scholes option pricing models to estimate the fair value of each stock option at the date of grant. Any consideration paid by the option holders to purchase shares is credited to capital stock.
New Accounting Pronouncements
A discussion of recently issued accounting pronouncements is described in Note 3 of the accompanying notes to our Consolidated Financial Statements contained elsewhere in this Annual Report, and we incorporate such discussion by reference.