Government Contracting Industry Marketplace Outlook. March 12, 2014

Transcription

1 Government Contracting Industry Marketplace Outlook March 12, 2014 BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.

2 Agenda Legal Update Hilary Cairnie, Partner, BakerHostetler LLP DCAA/Regulatory Update Eric Sobota, Partner, BDO USA, LLP M&A/ Economic Outlook Gregory Nossaman, Managing Director, The McLean Group, LLC Page 2

3 Legal Update Hilary Cairnie, Partner 3

4 Emerging Enforcement Trends: Small Business Affiliation GTSI Corp. Settled with SBA, Oct. 19, 2010 (large business uses small businesses as cover to win set asides; Suspended with conditions) MicroTech Settled with SBA, Jan. 27, 2014 (CEO gives false statements about affiliations with other firms; Suspended with conditions) Protection Strategies, Inc. ( PSI )/Security Assistance Corp. ( SAC ) E.D. Va., guilty plea Mar. 18, 2013 (contractor uses figurehead minority female CEOs to win 8(a) contracts which it then performs using shell corporation) United States v. White Sentenced to prison/fined, S.D.N.Y. Oct. 2, 2012) (contractor falsifying veteran status to receive small business contracts) Agility Defense & Government Services v. U.S. Dept. of Defense 11 th Cir. Dec. 31, 2013 (suspensions of two affiliates of an indicted contractor upheld) 4

5 Debarment Risk Factor Increased scrutiny by agencies and rivals Generally smaller businesses are at higher risk for suspension and debarment than larger businesses But larger companies are still at risk (e.g. Micro Technologies, GTSI Corp, etc.) 5

6 Labor Violations Large and Small Businesses Risk of suspension and debarment for a wide variety of general and contractorspecific labor laws December 2013 Senate report recommended increased suspension and debarment for companies that violate labor law 6

7 Small Business Certifications: SDVOSB Veterans Affairs is aggressive in referring companies for debarment Increased risk for companies that mistakenly represent themselves as veteran-owned 7

8 Related Companies Risks of Affiliation Contractors at risk for suspension or debarment of affiliated companies E.g. Agility Defense & Government Services v. U.S. Dept. of Defense May apply to affiliates regardless of whether they were involved in wrongdoing 8

9 DCAA/Regulatory Updates March 12, 2014 Eric Sobota, Partner Joseph McCaffrey, Senior Manager Page 9

10 Areas of Discussion DCAA Audit Alerts & Recent Guidance Final, Interim, and Proposed FAR & DFARS Regulations GAO Bid Protest Report OMB Circulars Reform Page 10

11 DCAA Memo Overdue Contractor Final Indirect Rate Proposals February 3, memo on overdue final indirect rate proposals, and plans for obtaining timely proposals. Backlog is comprised of fiscal years ending in 2011 or earlier, for which DCAA has not received a final indirect rate proposal. DCAA s understanding is that DCMA plans to either: Obtain an adequate proposal (e.g., within 30 days), or Unilaterally establish contract costs as authorized in FAR (c)(1) and FAR (c)(1). In 2014, DCAA plans to: Provide an update of the delinquent proposals Add to the list of fiscal years for which a contractor has submitted a proposal that lacks quality to audit Annually in January, DCAA will provide DCMA with a list of all fiscal years which a proposal is overdue by more than six months (includes FY which proposals cannot be audited due to quality) Page 11

12 DCAA Audit Guidance Revised Policies & Procedures for Low- Risk Incurred Cost Proposals Less than $250M in ADV October 29, 2013 DCAA memo to revise policies and procedures for sampling low-risk incurred cost proposals previously established in MRD 12- PPD-023(R), dated September 6, Changed prior year questioned cost threshold to: Page 12 **Auditable Dollar Volume (ADV)

13 DCAA Audit Guidance Revised Policies & Procedures for Low- Risk Incurred Cost Proposals Less than $250M in ADV (cont.) Proposals with less than $5M or $5M to $250M in ADV and no significant costs questioned in last ICS audit should be considered low-risk; unless Significant relevant risk material to the incurred cost proposal exists Unacceptable opinion from a pre-award accounting review or reported business system deficiencies relevant to the incurred cost proposal ($5 to $250M only), No previous experience (e.g., voucher processing, forward pricing effort, pre-award accounting systems, etc.) (<$5M only), or Specific relevant risk with the contractor that has material impact to the incurred cost proposal (identified by the contracting officer or auditor). There will be no sampling for low-risk proposals with ADV <$1M. Page 13

14 DCAA Audit Alert on Professional Consultant Services Costs (FAR ) and Purchased Labor Consultant Service Costs: December 19, 2013, DCAA issued an audit alert to emphasize audit guidance on the evidence necessary to satisfy the FAR (f) documentation requirements for professional and consultant services. FAR (f) contains three documentation requirements to ensure that professional and consultant service costs can be determined allowable: An agreement that explains what the consultant will be doing for the contractor; A copy of the bill/invoice for the actual services rendered, including sufficient evidence for time and nature of the services; Consultant work product, related documents, or an explanation of what the consultant accomplished for the fees paid o This could be information on the invoice, a drawing, a power point presentation, or some other evidence of the service provided. Page 14

15 DCAA Audit Alert on Professional Consultant Services Costs (FAR ) and Purchased Labor (cont.) Purchased Labor: An agreement that explains what the consultant will be doing for the contractor will suffice. Contractor should have adequate documentation to: Support the reasonableness of amounts paid, Demonstrate the person who provided the service, Represented allowable activities. Auditors will likely question the costs, if: Payment was not reasonable for the services performed (FAR ) Contractor made payment without adequate support that the person provided the service (FAR d). Page 15

16 Regulatory Updates New FAR Rules FAR Case Title Synopsis Rule Type Service Contracts Reporting Requirements This rule amends the FAR by requiring service contractors for executive agencies, except where DoD has fully funded the contract or order, to submit information annually in support of agency-level inventories for service contracts. FAR establishes service contractor reporting requirements based on type of contract and dollar. Reporting required on all cost reimbursable, T&M, and labor-hour contracts and orders above the simplified acquisition threshold (SAT). Phased thresholds for FFP contracts, starting at $2.5M in 2014 to $500,000 in 2016 Required to report: Contract number, dollar amount invoiced & direct labor hours expended. Data also required for first tier subcontractors. Final Page 16 Effective Date: January 30, 2014

17 Regulatory Updates New FAR Rules FAR Case Title Synopsis Rule Type Accelerated Payments to Small Business Subcontractors Requires the prime contractor, upon receipt of accelerated payment from the Government, to make accelerated payments to small business subcontractors subsequent to the receipt of a suitable invoice and associated sufficient supporting documentation from the subcontractor. This rule will be inserted into all new solicitations issued after the effective date of this rule and resultant contracts. Final Page 17 Effective Date: December 26, 2013

18 Regulatory Updates New DFARS Rules FAR Case Title Synopsis Rule Type 2012-D038 Unallowable Fringe Benefits Costs This rule adds paragraph (m)(1) to explicitly state that fringe benefit costs that are contrary to law, employer-employee agreement, or an established policy of the contractor are unallowable. These existing policies make fringe benefit costs expressly unallowable when such costs are unreasonable or conflict with law, employeremployee agreements, or an established policy of the contractor. Final Penalties may be assessed if unallowable dependent healthcare costs are contained in a final indirect cost rate proposal, a final statement of costs incurred, or estimated to be incurred under a fixed-priced incentive contract. Effective Date: December 6, 2013 Page 18

19 Regulatory Updates New DFARS Rules FAR Case Title Synopsis Rule Type 2011-D039 Safeguarding Unclassified Controlled Technical Information DoD issued a final rule amending the DFARS to include a new subpart and associated contract clause addressing the requirements for safeguarding unclassified controlled technical information. Controlled technical information is defined as technical data, computer software, and other technical information covered by DoD Directive , Distribution Statements on Technical Documents. The goal is to prohibit unauthorized access and disclosure, and to prescribe reporting to DoD with regard to certain cyber intrusion events that compromise DoD information resident on or transiting through the contractor s unclassified information systems. Final Page 19 Effective Date: November 18, 2013

20 Regulatory Updates Interim DFARS Rules FAR Case Title Synopsis Rule Type 2013-D016 Limitation on Use of Cost-Reimbursement Line Items; effective January 29, 2014 NDAA Section 811(a) requires DoD to modify the acquisition regulations to prohibit DoD from entering into cost type contracts for the production of major defense acquisition programs for contracts entered into on or after October 1, 2014, with one exception in section 811(b). Under section 811(b), the Under Secretary of Defense for Acquisition, Technology, and Logistics may submit to the congressional defense committees: (1) A written certification that the particular cost-type contract is needed to provide a required capability in a timely, cost effective manner; and (2) An explanation of the steps taken to ensure that the use of cost-type pricing is limited to only those line items or portions of the contact where such pricing is needed to achieve the purpose of the exception. Interim Page 20 Comments should be submitted on or before March 31, 2014

21 Regulatory Updates Proposed DFARS Rules FAR Case Title Synopsis Rule Type 2013-D029 Payment in Local Currency (Afghanistan) DoD proposed to amend DFARS and on the use of a new solicitation provision at XXX, Notification of Payment in Local Currency (Afghanistan), concerning payment for contracts for performance in Afghanistan. This provision provides notification that the payment currency to be used for contracts for performance in Afghanistan shall be dependent on the nationality of the vendor. The solicitation provision, XXX, provides that if the contract is awarded to a host nation vendor (Afghan), the contractor will receive payment in Afghani (local currency) via electronic funds transfer to a local (Afghan) banking institution. Contracts shall not be awarded to host nation vendors (Afghans) who do not bank locally. If awarded to other than a host nation vendor, the contract will be awarded in U.S. dollars. Proposed Page 21 Comments should be submitted on or before March 31, 2014

22 GAO Bid Protest Report Annual Report to Congress for Fiscal Year 2013; Lists federal agencies that did not fully implement a recommendation made in connection with a bid protest decided the prior fiscal year Contains statistics covering overall bid protest filings for the fiscal year. New requirement in 2013 requires GAO to report on the most prevalent grounds for sustaining protests. Report states they were: Failure on the part of federal agencies to follow their stated bid or proposal evaluation criteria; Inadequate documentation of the record; Unequal treatment of offerors; and Unreasonable price or cost evaluation. In 2013, GAO received 2,429 cases, including 2,298 protests, 56 cost claims, and 75 requests for reconsideration; Page 22

23 GAO Bid Protest Report Bid Protest Data Comparison for FY 2009 through 2013 FY 2013 FY 2012 FY 2011 FY 2010 FY 2009 Cases Filed 2,429 2,475 2,353 2,299 1,989 Cases Closed 2,538 2,495 2,292 2,226 1,920 Merit (Sustain and Deny) Decisions Number of Sustains Sustain Rate 17% 18.6% 16% 19% 18% Effectiveness Rate 43% 42% 42% 42% 45% Alternative Dispute Resolution (ADR) ADR Success Rate 86% 80% 82% 80% 93% Hearings 3.36% (31 cases) 6.17% (56 cases) 8% (46 cases) 10% (61 cases) 12% (65 cases) Page 23

24 OMB Reform Guidance Supercircular OMB issued Uniform Administrative Requirements, Cost Principles, and Administrative Requirements for Federal Awards on December 26, 2013 Changes and consolidations include: Provides a single resource for requirements that apply to all recipients Includes new measures designed to ensure merit-based grant awards and identify problems early in the process Introduces more formal requirements for certification of compliance and disclosure of noncompliant or criminal acts Attempts to streamline and standardize the cost principles in many ways, including new options for the recovery of indirect costs Page 24

25 Spring Government Contracting Marketplace Outlook Gregory A. Nossaman, Managing Director March 12, 2014

26 Current Market Dynamics Market Backdrop After a 10-year period of growth and positive market dynamics, the federal contracting environment was significantly impacted in late 2012 through 2013 by rapidly changing market forces The past 18 months have been characterized by budget uncertainty, heighted pressure on margins, longer procurement cycles, and increased competition 2013 Market Challenges Budget uncertainty and shifting federal priorities created a difficult planning environment for middle market companies and large primes Impact and looming threat of government shutdown Delays within program offices for new business and recompetes slowed organic growth Many programs and contracts decreased or cancelled outright Fierce competition and the Government s focus on LPTA procurements squeezed margins and caused large primes to chase smaller contracts that were historically below their size thresholds Resulted in Decreased M&A Interest and Activity as Many Buyers Became Inward Focused 26

27 Current Market Dynamics Graphic Representations Federal Discretionary Spending Authority Market Evolution $1,600.0 B $1,400.0 B $1,200.0 B Golden Era CAGR of 8% 2009 Impacted by Relief Spending Market Headwinds CAGR of -3% $1,000.0 B $800.0 B $600.0 B $400.0 B $200.0 B $0.0 B DoD Civilian Source: OMB 27

28 Current Market Dynamics Uncertainty Paralysis - Budget Chaos in 2012 and 2013 The budget environment for 2013 was characterized by confusion and lack of clarity In FY13 alone agencies had to contend with four different spending levels and plans This tumult resulted in unprecedented contract delays, program disruptions, and even cash shortfalls FY13 Budget Swings BCA Projected Discretionary Spending Limits $1,400.0 B $1,200.0 B $1,224 B $1,157 B $1,301 B $1,300 B $1,200 B $1,000.0 B $1,100 B $800.0 B $1,000 B $600.0 B $400.0 B $200.0 B $0.0 B FY13 CR - ATRA 3/1/13 Sequestration Defense Civilian FY13 CR - HR 933 $900 B $800 B $700 B $600 B 2013 BCA Limit PSC, OMB 28

29 Current Market Dynamics Sequestration & the Bipartisan Budget Agreement Clarity finally restored through the budget agreement reached in December 2013 Reduces the impact of sequestration, increasing 2014 discretionary spending from $967 billion to $1.012 trillion providing $63 billion in sequester relief Provides for 2015 discretionary spending to grow by a nominal level Additionally the budget agreement allows for targeted reductions to spending rather than across the board cuts as well as spending on new projects and initiatives Discretionary Budget - Replacing Sequester $1,150B $1,100B $1,091B $1,050B $1,000B $1,050B $1,043B $988B $968B $1,012B $995B $1,014B $950B $900B $850B $800B FY10 FY11 FY12 FY13 FY14 Sequester FY14 Current FY15 Sequester FY15 Current Discretionary budget authority levels are adjusted for inflation and exclude OCO / War, Disaster, Program Integrity, and Emergency Funding Source: Congressional Research Service, Trends in Discretionary Spending, February18,

30 Current Market Dynamics Impact to Growth The budget uncertainty of 2012 and 2013 drastically impacted the growth profiles of companies in the sector Public government services companies on average saw growth of 12% in 2009 and 7% in 2010 drop to -6% in 2012 and -2% in 2013 Industry analysts estimate that up to 66% of all privately held government services companies experience a decline in revenue in 2013 Industry growth was directly impacted by an 11% reduction in contract spending across the federal government Average Public Company Growth Federal Contract Spending 23% 17% 15% 12% 11% $600 B $550 B $500 B 2013 Annual Decline = 11% 7% 6% $450 B 2% $400 B -2% -2% -6% -6% $350 B $300 B $250 B 10-Year CAGR = 4% Government Services Index Large Diversified Primes Index Government Services Index consists of the following: BAH, CACI, DRCO, EGL, ICFI, MANT, NCIT, SAI, VSEC Large Diversified Primes Index consists of the following: BA, GD, HON, LLL, LMT, NOC, RTN, UTX Source: S&P Capital IQ, USA Spending 30

31 Current Market Dynamics Impact to M&A M&A activity decreased in 2013 as many buyers reassessed strategy Since 2010, activity among public buyers has declined while private equity and privately held strategics have become more active Privately held companies and financial buyers now account for over 70% of total deal activity in the sector, more than twice the level of just three years ago Defense and Gov. Services Transaction Activity M&A Transactions by Buyer Type % 90% % 70% 60% 50% 40% 40 30% 20% 20 10% % Public Company Private Company PEG Source: S&P CapitalIQ, DACIS, Washington Technology, TMG Research 31

32 Current Market Dynamics Defense Technology and Government Services M&A Activity Buyer activity and confidence has already shown signs of significant improvement in 2014 The first two months of 2014 has seen more closed transaction than the same period in Market Drivers Budget agreement reached, providing clarity in spending and program priorities Pipeline of contract opportunities being released across the government Reduction in the severity of sequestration Buyers emerging from past 12 months with new acquisition strategies Public company valuations have rebounded and stabilized Capital remains readily available Driving Increased M&A Interest and Activity Jan Feb Transactions Transaction activity up over 40% YTD 2014 compared to 2013 Public buyers reemerging over half of YTD transactions consummated by public companies 32

33 Current Market Dynamics Evolving M&A Preferences This environment has altered acquisition strategies for most buyers Capital remains readily available (both cash on hand and leverage multiples) Buyers today are focused on acquiring highly differentiated businesses that provide key contract vehicles, access to new agencies, capabilities, and/or unique technology and IP Evolving M&A Preferences Prior to Today Scale Robust infrastructure Diversification Capabilities Commoditized services Key contracts / IDIQ vehicles Minimal post closing synergies Stand alone growth opportunities Activity driven by access to select markets: Cyber Big Data Healthcare IT Intelligence Community Strategic positioning Focus (on growth areas) Solutions Technology / IP Highly differentiated services / capabilities Prime contracts Depth (franchise positioning) Key contracts / IDIQ vehicles Synergistic growth opportunities 33

34 Current Market Dynamics Summary of Industry Value Drivers Threshold Value Drivers High Neutral Low Contract Award Basis Not a concern 20% or less 20% or more SB exposure DL vs Sub > 90% Direct Labor 75% to 90% <75% Direct Labor Prime vs. Sub >75% Prime 50% to 75% <50% Prime % of OCI No concern 15% or less >15% Growth 20% or higher 5% to 20% <5% Margin 12% or higher 8% to 12% <8% Strength of Infrastructure Best in class Solid, but may need upgrades Needs major upgrades Revenue Visibility Strong backlog and long-term contracts Good backlog; a few near-term recompetes Low backlog; several near-term recompetes Management Depth and Quality Very strong; long tenures Good management team Lacking in leadership Synergistic Value Drivers Mission-Focused >50% 25% to 50% Non-mission focus Strategic Contracts Customers Large opportunity with limited players Predominately IC; well-funded DOD; healthcare Solid, but no strategic contracts Mix with a toehold in attractive accounts None Mix of non-strategic DoD or Civilian Capabilities High-end / in-demand Mix Commoditized Services / IT IP / Technology Employee Credentials Strong suite that provides scalability Highly cleared, well educated, certified Some IP but not a driver Solid but not a differentiator None Not a selling point 34

35 Current Market Dynamics Current Valuation Drivers The decline in growth opportunities in the federal market coupled with the associated pull-back of public buyers, who in the past have been among the most aggressive buyers, has caused average valuation levels to recede from the historic highs of the past several years However, companies with impressive growth prospects and specialized products or capabilities continue to garner attractive valuation multiples Services Companies Highly Specialized Product / IP Oriented Cyber & Intelligence Community Companies Companies with Significant Access to High Growth Market Segments Generalist IT Services, High Percentage of Work from Subcontracts, Some Set Aside Exposure EBITDA Multiple Spectrum 10.0x + 9.0x 8.0x 7.0x 6.0x 5.0x 4.0x Company Characteristics Driving Premium Valuations Strong Financial Performance Attractive, Sustainable Margins Rapid Growth, Scale Significant Revenue Visibility (Strong Backlog) Attractive Contract Base Full and Open, Prime Contracts Hard to Penetrate Customers Key Contract Vehicles Strategic Rationale Specialized Capabilities / Technology Positioning for Large Contract Opporunities Discriminators Highly Cleared Employee Base Management Quality, Depth and Breadth 35

36 Contact Information Hilary Cairnie: Eric Sobota : esobota@bdo.com Gregory Nossaman : gnossaman@mcleanllc.com BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.