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BAH > SEC Filings for BAH > Form 10-Q on 30-Jan-2013All Recent SEC Filings

Show all filings for BOOZ ALLEN HAMILTON HOLDING CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for BOOZ ALLEN HAMILTON HOLDING CORP


30-Jan-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to help the reader understand our business, financial condition, results of operations, and liquidity and capital resources. You should read this discussion in conjunction with our condensed consolidated financial statements and the related notes contained elsewhere in this Quarterly Report on Form 10-Q, or Quarterly Report. The statements in this discussion regarding industry outlook, our expectations regarding our future performance, liquidity and capital resources, and other non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in our Annual Report on Form 10-K for the fiscal year ended March 31, 2012 filed with the Securities and Exchange Commission on May 30, 2012, or Annual Report, and under Part II, "Item 1A. Risk Factors," and "- Special Note Regarding Forward Looking Statements" of this Quarterly Report. Our actual results may differ materially from those contained in or implied by any forward-looking statements.
Our fiscal year ends March 31 and, unless otherwise noted, references to years or fiscal are for fiscal years ended March 31. See "-Results of Operations." Overview
We are a leading provider of management and technology consulting services to the U.S. government in the defense, intelligence, and civil markets. Additionally, we provide management and technology consulting services to major corporations, institutions, and not for profit organizations. As the needs of our clients have grown more complex, we have developed deep expertise in strategy and organization, analytics, technology, engineering, and operations. Our acquisition of the Defense Systems Engineering and Support, or DSES, division of ARINC Incorporated, effective November 30, 2012, will further enhance our existing engineering capabilities and defense market position. Leveraging our 99-year consulting heritage and a talent base of approximately 24,800 people, we deploy our deep domain knowledge, functional expertise, and experience to help our clients achieve their objectives. We serve substantially all of the cabinet-level departments of the U.S. government. Our major clients include the Department of Defense, all branches of the U.S. military, the U.S. Intelligence Community, and civil agencies such as the Department of Homeland Security, the Department of Energy, the Department of Health and Human Services, the Department of the Treasury, and the Environmental Protection Agency. We support these clients in addressing complex and pressing challenges such as combating global terrorism, improving cyber capabilities, transforming the healthcare system, improving efficiency and managing change within the government, and protecting the environment.
We have a collaborative culture, supported by our operating model, which helps our professionals identify and respond to emerging trends across the markets we serve and deliver enduring results for our clients. Financial and Other Highlights
Revenue decreased 3.5% from the three months ended December 31, 2011 to the three months ended December 31, 2012 and decreased 2.5% from the nine months ended December 31, 2011 to the nine months ended December 31, 2012. We continue to focus on cost reduction efforts and efficiency initiatives which includes effective management of our capacity and efficient management of our costs. Capacity management and other cost reduction activities continued throughout the current period, and may influence future periods, due to the continuing trends of fiscal uncertainty and cost cutting in our principal markets. The outcome of these efforts in the three and nine months ended December 31, 2012 have resulted in a net decline in our headcount, which has led to declines in billable hours and therefore a decline in our direct labor. Each of these factors directly results in revenue declines. In this environment, we have also continued to focus on the effective deployment of our consulting staff to minimize the amount of time our staff spend on non-revenue producing activities. This reduction in unbillable time along with efficient use of our indirect costs, contributes to lower indirect costs, and most importantly a lower ratio of indirect costs to direct labor. Reductions in indirect costs have a direct correlation to a reduction of revenue recognized on our large portfolio of cost-reimbursable contracts. Substantially all of our revenue and backlog continues to be derived from services and solutions provided to client organizations across the U.S. government, primarily by our consulting staff and, to a lesser extent, our subcontractors. The mix of revenue generated by our consulting staff and subcontractors affects our operating margin, as the portion of our operating income derived from fees we earn on services provided by our subcontractors is significantly less than the operating income derived from direct consulting staff labor. The decline in our revenue described above was partially offset by revenue from our acquisition of DSES that closed on November 30, 2012. Operating income grew 18.7% to $116.6 million in the three months ended December 31, 2012 from $98.2 million in the three months ended December 31, 2011, which reflects a 160 basis point increase in operating margin to 8.4% from 6.8% in the comparable periods. Operating income grew 15.0% to $333.4 million in the nine months ended December 31, 2012 from $290.0 million in the nine months ended December 31, 2011, which reflects a 120 basis point increase in operating margin to 7.9% from 6.7% in the comparable period. The improvement in operating margin was due to increased contract profitability


due to disciplined cost management of indirect spending, as described above, as well as decreases in incentive compensation costs. Our effective management of other indirect costs and lower ratio of indirect costs to direct labor produces higher margins on our time-and-material contracts and ultimately produces higher margins on our fixed-price contracts. The factors contributing to the increased operating margin were partially offset by increases in depreciation expense due to facility expansion in previous years, causing a higher increase in depreciation for fiscal 2013, and transaction costs incurred in connection with the acquisition of DSES.
Cash provided by operations increased $146.9 million to $398.9 million for the nine months ended December 31, 2012 from $252.0 million for the nine months ended December 31, 2011. The increase in cash provided by operations was a result of overall profitability of our contracts, our ability to invoice and collect from clients in a timely manner, and our effective management of vendor payments.
Non-GAAP Measures
We publicly disclose certain non-GAAP financial measurements, including Adjusted Operating Income, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted Earnings Per Share, or EPS, because management uses these measures for business planning purposes, including to manage our business against internal projected results of operations and measure our performance. We view Adjusted Operating Income, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted EPS as measures of our core operating business, which exclude the impact of the items detailed below, as these items are generally not operational in nature. These non-GAAP measures also provide another basis for comparing period to period results by excluding potential differences caused by non-operational and unusual or non-recurring items. We also utilize and discuss Free Cash Flow, because management uses this measure for business planning purposes, measuring the cash generating ability of the operating business, and measuring liquidity generally. We present these supplemental measures because we believe that these measures provide investors with important supplemental information with which to evaluate our performance, long term earnings potential, or liquidity, as applicable, and to enable them to assess our performance on the same basis as management. These supplemental performance measurements may vary from and may not be comparable to similarly titled measures by other companies in our industry. Adjusted Operating Income, Adjusted EBITDA, Adjusted Net Income, Adjusted Diluted EPS, and Free Cash Flow are not recognized measurements under accounting principles generally accepted in the United States, or GAAP, and when analyzing our performance or liquidity, as applicable, investors should (i) evaluate each adjustment in our reconciliation of operating and net income to Adjusted Operating Income, Adjusted EBITDA and Adjusted Net Income, and net cash provided by operating activities to Free Cash Flows, and the explanatory footnotes regarding those adjustments, each as defined under GAAP, (ii) use Adjusted Operating Income, Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted EPS in addition to, and not as an alternative to, operating income, net income or diluted EPS, as a measure of operating results, and (iii) use Free Cash Flows in addition to, and not as an alternative to, net cash provided by operating activities as a measure of liquidity, each as defined under GAAP. We have defined the aforementioned non-GAAP measures as follows:

            "Adjusted Operating Income" represents operating income before
             (i) certain stock option-based and other equity-based compensation
             expenses, (ii) adjustments related to the amortization of intangible
             assets, and (iii) any extraordinary, unusual, or non-recurring
             items. We prepare Adjusted Operating Income to eliminate the impact
             of items we do not consider indicative of ongoing operating
             performance due to their inherent unusual, extraordinary, or
             non-recurring nature or because they result from an event of a
             similar nature.


            "Adjusted EBITDA" represents net income before income taxes, net
             interest and other expense, and depreciation and amortization and
             before certain other items, including: (i) certain stock
             option-based and other equity-based compensation expenses,
             (ii) transaction costs, fees, losses, and expenses, including fees
             associated with debt prepayments, and (iii) any extraordinary,
             unusual, or non-recurring items. We prepare Adjusted EBITDA to
             eliminate the impact of items we do not consider indicative of
             ongoing operating performance due to their inherent unusual,
             extraordinary, or non-recurring nature or because they result from
             an event of a similar nature.


            "Adjusted Net Income" represents net income before: (i) certain
             stock option-based and other equity-based compensation expenses,
             (ii) transaction costs, fees, losses, and expenses, including fees
             associated with debt prepayments, (iii) adjustments related to the
             amortization of intangible assets, (iv) amortization or write-off of
             debt issuance costs and write-off of original issue discount, and
             (v) any extraordinary, unusual, or non-recurring items, in each case
             net of the tax effect calculated using an assumed effective tax
             rate. We prepare Adjusted Net Income to eliminate the impact of
             items, net of tax, we do not consider indicative of ongoing
             operating performance due to their inherent unusual, extraordinary,
             or non-recurring nature or because they result from an event of a
             similar nature.


            "Adjusted Diluted EPS" represents diluted EPS calculated using
             Adjusted Net Income as opposed to net income. Additionally, Adjusted
             Diluted EPS does not contemplate any adjustments to net income as
             required under the two-class method as disclosed in the footnotes to
             the financial statements.


            "Free Cash Flow" represents the net cash generated from operating
             activities less the impact of purchases of property and equipment.

Below is a reconciliation of Adjusted Operating Income, Adjusted EBITDA, Adjusted Net Income, Adjusted Diluted EPS, and Free Cash Flow to the most directly comparable financial measure calculated and presented in accordance with GAAP.

                                        Three Months Ended                   Nine Months Ended
                                           December 31,                        December 31,
(Amounts in thousands, except
share and per share data)             2012              2011              2012              2011
                                            (Unaudited)                         (Unaudited)
Adjusted Operating Income
Operating Income                 $     116,596     $      98,188     $     333,361     $     289,975
Certain stock-based compensation
expense (a)                              1,086             2,418             4,944            11,589
Amortization of intangible
assets (b)                               3,125             4,091             9,384            12,273
Transaction expenses (c)                     -                 -             2,725                 -
Adjusted Operating Income        $     120,807     $     104,697     $     350,414     $     313,837
EBITDA & Adjusted EBITDA
Net income                       $      56,184     $      62,860     $     164,245     $     189,328
Income tax expense                      38,815            23,531           110,636            67,971
Interest and other, net                 21,597            11,797            58,480            32,676
Depreciation and amortization           18,127            19,530            54,243            55,924
EBITDA                                 134,723           117,718           387,604           345,899
Certain stock-based compensation
expense (a)                              1,086             2,418             4,944            11,589
Transaction expenses (c)                     -                 -             2,725                 -
Adjusted EBITDA                  $     135,809     $     120,136     $     395,273     $     357,488
Adjusted Net Income
Net income                       $      56,184     $      62,860     $     164,245     $     189,328
Certain stock-based compensation
expense (a)                              1,086             2,418             4,944            11,589
Transaction expenses (c)                     -                 -             2,725                 -
Amortization of intangible
assets (b)                               3,125             4,091             9,384            12,273
Amortization or write-off of
debt issuance costs and
write-off of original issue
discount                                 1,667             1,202            11,493             3,602
Net gain on sale of state and
local transportation business
(d)                                          -                 -                 -            (5,681 )
Release of income tax reserves
(e)                                          -           (11,085 )               -           (35,133 )
Adjustments for tax effect (f)          (2,351 )          (3,084 )         (11,419 )         (10,985 )
Adjusted Net Income              $      59,711     $      56,402     $     181,372     $     164,993
Adjusted Diluted Earnings Per
Share
Weighted-average number of
diluted shares outstanding         145,063,515       141,799,725       144,116,057       140,996,611
Adjusted Net Income Per Diluted
Share (g)                        $        0.41     $        0.40     $        1.26     $        1.17
Free Cash Flow
Net cash provided by operating
activities                       $       9,186     $      74,902     $     398,934     $     252,019
Less: Purchases of property and
equipment                               (6,282 )         (21,918 )         (20,657 )         (65,558 )
Free Cash Flow                   $       2,904     $      52,984     $     378,277     $     186,461


(a) Reflects stock-based compensation expense for options for Class A Common Stock and restricted shares, in each case, issued in connection with the Acquisition of our Company by The Carlyle Group (the Acquisition) under the Officers' Rollover Stock Plan. Also reflects stock-based compensation expense for Equity Incentive Plan Class A Common Stock options issued in connection with the Acquisition under the Equity Incentive Plan.

(b) Reflects amortization of intangible assets resulting from the Acquisition.

(c) Reflects debt refinancing costs incurred in connection with the Recapitalization Transaction consummated on July 31, 2012.

(d) Nine months ended December 31, 2011 reflects the gain on sale of our state and local transportation business, net of the associated tax benefit of $1.6 million.

(e) Reflects the release of income tax reserves.

(f) Reflects tax effect of adjustments at an assumed marginal tax rate of 40%.

(g) Excludes an adjustment of approximately $475,000 and $9.0 million of net earnings for the three and nine months ended December 31, 2012, respectively, associated with the application of the two-class method for computing diluted earnings per share.

Recent Developments
The following recent developments occurred after December 31, 2012, which may cause our future results of operations to differ from our historical results of operations discussed under "- Results of Operations." On January 29, 2013, our Board of Directors authorized and declared a regular quarterly cash dividend in the amount of $0.09 per share. The quarterly dividend is payable on February 28, 2013 to shareholders of record on February 11, 2013. Factors and Trends Affecting Our Results of Operations Our results of operations have been, and we expect them to continue to be, affected by the following factors, which may cause our future results of operations to differ from our historical results of operations discussed under "- Results of Operations."
Business Environment and Key Trends in Our Markets We believe that the following trends and developments in the U.S. government services industry and our markets may influence our future results of operations:

            budget deficits and the growing U.S. national debt increasing
             pressure on the U.S. government to reduce federal spending across
             all federal agencies together with associated uncertainty about the
             size and timing of those reductions;


            changes in the relative mix of overall U.S. government spending and
             areas of spending growth, with lower spending on homeland security,
             intelligence and defense-related programs as overseas operations
             end, and continued increased spending on cyber-security, advanced
             analytics, technology integration and healthcare;


            cost cutting and efficiency initiatives and other efforts to
             streamline the U.S. defense and intelligence infrastructure,
             including the initiatives implemented by the Secretary of Defense or
             reductions in defense budgets resulting from Congressional action;


            Continued uncertainty around the timing, extent and nature of
             Congressional and other U.S. government action to address budgeting
             constraints and the U.S. government's ability to incur indebtedness
             in excess of its current limit and the U.S. deficit, including, in
             the absence of Congressional action to the contrary, material
             reductions in defense budgets resulting from the commencement on
             March 2, 2013 of automatic sequestration as required under the
             Budget Control Act of 2011 (as amended by the American Taxpayer
             Relief Act of 2012);


            delays in the completion of the U.S. government's budget process,
             which has in the past and could in the future delay procurement of
             the products, services, and solutions we provide;


            existing and proposed fiscal constraints by the U.S. government and
             uncertainty about the size of future budget reductions may cause
             clients to invest appropriated funds on a less consistent or rapid
             basis, or not at all, particularly when considering long-term
             initiatives, not issue task orders in sufficient volume to reach
             current contract ceilings, and delay requests for new proposals and
             contract awards, relying on short-term extensions of current
             contracts instead;


            the federal focus on refining the definition of "inherently
             governmental" work will continue to drive pockets of insourcing in
             various agencies, particularly in the intelligence market;


            cost cutting and efficiency and effectiveness efforts by U.S.
             civilian agencies with a focus on increased use of performance
             measurement, "program integrity" efforts to reduce waste, fraud and
             abuse in entitlement programs, and renewed focus on improving
             procurement practices for and interagency use of IT services,
             including through the use of cloud based options and data center
             consolidation;


            U.S. government agencies awarding contracts on a technically
             acceptable/lowest cost basis, which could have a negative impact on
             our ability to win certain contracts;


            restrictions by the U.S. government on the ability of federal
             agencies to use lead system integrators, in response to cost,
             schedule and performance problems with large defense acquisition
             programs where contractors were performing the lead system
             integrator role;


            increasingly complex requirements of the Department of Defense and
             the U.S. Intelligence Community, including cyber-security, managing
             federal health care cost growth and focus on reforming existing
             government regulation of various sectors of the economy, such as
             financial regulation and healthcare;


            increased competition from other government contractors and market
             entrants seeking to take advantage of the trends identified above;
             and


            efforts by the U.S. government to address organizational conflicts
             of interest and related issues and the impact of those efforts on us
             and our competitors.

Sources of Revenue
Substantially all of our revenue is derived from services provided under contracts and task orders with the U.S. government, primarily by our consulting staff and, to a lesser extent, our subcontractors. Funding for our contracts and task orders is generally linked to trends in budgets and spending across various U.S. government agencies and departments. We provide services under a large portfolio of contracts and contract vehicles to a broad client base, and we believe that our diversified contract and client base lessens potential volatility in our business; however, a reduction in the amount of services that we are contracted to provide to the U.S. government or any of our significant U.S. government clients could have a material adverse effect on our business and results of operations. In particular, the Department of Defense is one of our significant clients, and the Budget Control Act of 2011 (as amended by the American Taxpayer Relief Act of 2012) could impose an estimated $500 billion to $600 billion in automatic federal defense spending cuts between 2013 and 2021 to the extent that automatic sequestration required by the act commences on March 2, 2013. A reduction in the amount of services that we are contracted to provide to the Department of Defense could have a material adverse effect on our business and results of operations, and given the uncertainty of how these automatic reductions may be applied, we are unable to predict the nature or magnitude of the potential adverse effect. Contract Types
We generate revenue under the following three basic types of contracts:
Cost-Reimbursable Contracts. Cost-reimbursable contracts provide for the payment of allowable costs incurred during performance of the contract, up to a ceiling based on the amount that has been funded, plus a fee. We generate revenue under two general types of cost-reimbursable contracts:
cost-plus-fixed-fee and cost-plus-award-fee, both of which reimburse allowable costs and provide for a fee. The fee under each type of cost-reimbursable contract is generally payable upon completion of services in accordance with the terms of the contract. Cost-plus-fixed-fee contracts offer no opportunity for payment beyond the fixed fee.
Cost-plus-award-fee contracts also provide for an award fee that varies within specified limits based upon the client's assessment of our performance against a predetermined set of criteria, such as targets for factors like cost, quality, schedule, and performance.

                  Time-and-Materials Contracts. Under a time-and-materials
                   contract, we are paid a fixed hourly rate for each direct
                   labor hour expended, and we are reimbursed for allowable
                   material costs and allowable out-of-pocket expenses. To the
                   extent our actual direct labor and associated costs vary in
                   relation to the fixed hourly billing rates provided in the
                   contract, we will generate more or less profit, or could incur
                   a loss.


                  Fixed-Price Contracts. Under a fixed-price contract, we agree
                   to perform the specified work for a pre-determined price. To
                   the extent our actual costs vary from the estimates upon which
                   the price was negotiated, we will generate more or less
                   profit, or could incur a loss. Some fixed-price


contracts have a performance-based component, pursuant to which we can earn incentive payments or incur financial penalties based on our performance. Fixed-price level of effort contracts require us to provide a specified level of effort (i.e., labor hours), over a stated period of time, for a fixed price.

The amount of risk and potential reward varies under each type of contract. Under cost-reimbursable contracts, there is limited financial risk, because we are reimbursed for all allowable costs up to a ceiling. However, profit margins on this type of contract tend to be lower than on time-and-materials and fixed-price contracts. Under time-and-materials contracts, we are reimbursed for the hours worked using the predetermined hourly rates for each labor category. In addition, we are typically reimbursed for other contract direct costs and expenses at cost. We assume financial risk on time-and-materials contracts because our labor costs may exceed the negotiated billing rates. Profit margins on well-managed time-and-materials contracts tend to be higher than profit margins on cost-reimbursable contracts as long as we are able to staff those contracts with people who have an appropriate skill set. Under fixed-price contracts, we are required to deliver the objectives under the contract for a . . .

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