Government Contractor Industry Survey: The Pulse of a Vital Industry.

Transcription

1 Results are in from the 7 th Annual Grant Thornton Government Contractor Industry Survey: The Pulse of a Vital Industry. This survey, unique in its field, provides industry executives... Co-Sponsors:

2 ...and decision-makers with essential information and analysis for remaining competitive in the government contractor marketplace. For those wishing to enter or expand their business in this industry, the Grant Thornton Government Contractor Industry Survey compiles an accurate, timely look at the industry and the directions in which it is heading.

3 Government Contractor Industry Survey: The Pulse of a Vital Industry

4 2 Table of Contents Welcome Letter 4 Executive Summary 5 I. Industry Profile 6 Customers 6 Revenue Trends 7 Markets 8 II. Company Data 9 Ownership 9 Workforce 9 Staffing Indirect Activities 11 Small Business 12 III. Financial Information 13 Backlog 15 IV. Indirect Rates 16 Service Centers 16 Fringe Benefit Rates 18 Overhead Rates 19 General and Administrative (G&A) Rates 20 Subcontract/Material Handling Rates 22 Comparing Actual Provisional Billing Rates 23 V. Contracts 24 Contract Types 24 Fees 25 Revenue Recognition for Unfunded Work 25 Litigation 26 IDIQ Contracts 26

5 3 GSA Schedule Contracts 27 Past Performance 28 GWAC/MAC 30 A VI. Compensation 32 Incentive Compensation & Fringe Benefits 32 Retirement Benefits 33 Stock Option Plans 34 Fringe Benefits other than Retirement Plans 34 General Employee Survey Statistics 35 Job Openings 35 Executive Compensation 36 VII. Dealing with the Government 38 Incurred Cost Submissions 38 Audit Relations 39 Audit Issues 39 Moving to the Electronic Age 42 Business Acquisition Strategies 42 Companies Planning to Be Acquired & Other Exit Strategies 43 Looking Forward 44 Sponsor 46 Co-Sponsors 47

6 4 Dear Government Contractor Industry Survey Participant, Welcome to the results of the 7 th Annual Grant Thornton Government Contractor Industry Survey: The Pulse of a Vital Industry. Time and effort spent by you and the Chief Executive Officers and Chief Financial Officers of more than 100 other professional services firms allow us to collect the data needed to analyze where the industry has been over the last year and to predict trends that will be useful to your company and hundreds of others. We are pleased that participation from government contractors outside the metropolitan Washington area doubled this year, giving the survey results a more national scope. This survey, unique in its field, provides industry executives and decision-makers with essential information and analysis for remaining competitive in the government contractor marketplace. In keeping with the ever-changing nature of government contractor work, we modified our survey to include the latest issues of concern. This year, we added data and corresponding analyses on Governmentwide Acquisition Contracts/Multiple Award Contracts, past performance evaluations and customer relations involving billing for goods and services. We appreciate the trust you have demonstrated by permitting us to gather this detailed financial information from you. While we list the names of your companies on the back of this report as a testimonial to your commitment to the government contracting industry, we realize how sensitive this information is, so we guard the company-specific data with great care. As you can see from the report, all results are reported in terms of industry, function, or segment; not by individual company. As participants in this survey, you are presented with this detailed report free-ofcharge. Interestingly, companies who do not yet participate in the survey also find the information valuable and pay $1,000 for each report. We hope they will recognize the benefits of becoming participants for next year s survey. Thanks again and we look forward to hearing from you for next year s survey, Calvin Hackeman Partner

7 Executive Summary 5 We have compiled and analyzed the information gathered for the 7th Annual Government Contractor Industry Survey. This information was collected from companies who consider the Federal Government to be a significant customer. The survey covers a broad range of topics so that you can understand the trends and issues affecting the industry. We asked our participants to share with us information in areas such as the workforce, financial results, mergers and acquisitions activity, contracting methods, and regulatory compliance. Key survey findings include: Workforce Findings For employees who primarily charge directly to contracts, 55.7% are working at client facilities. This percentage fluctuates significantly from year to year. Nevertheless, with a significant workforce off-site, the challenges to obtain company loyalty and to be able to effectively lead and manage require serious attention. Sixty-three percent of respondents said they had a significant number of job openings, with nearly 12% of positions left unfilled. Thirty-eight percent of the companies said their turnover was greater than last year. Revenue per employee is going up and the indirect labor staff is shrinking as a percentage of the total labor force. However, this has not translated into better profit returns for companies. Pre-tax income and net income have dropped to the lowest level since Although this may be influenced by the steady growth of average company revenue, some of the trend may be explained by the increased competition and the importance of past performance, meaning that companies are not as likely to bill customers for contract costs they might have previously billed. Negotiated contract fees did not appear to be the cause for diminished returns. Although the number of companies in the survey greater than $100M has not changed substantially, these same companies are getting larger; four of them had revenue greater than $1B. This allows for more comparison between smaller and larger companies, giving us a better perspective on the differences between small/mid sized corporations vs. large corporations. GWAC/MAC Governmentwide Acquisition Contracts (GWAC) were established to reduce the time for procurement. Companies must compete to be on a GWAC and then compete again for specific requests for bids. Multiple Award Contracts (MAC) were designed to break large-scale systems into logical components and offer broader flexibility at critical design and delivery stages. We wanted to know how well the reform initiative was doing and found that 69% of respondents thought the customer believed it was moderately or very beneficial to the government. Most of the participants thought that GWAC/MAC contracts benefited all companies, and the program should be left alone. Past Performance The procurement rules require consideration of a contractor s past performance in the proposal evaluation process. Approximately 90% of respondents have participated in solicitations in which past performance was a factor. Nearly 60% thought their performance evaluations were somewhat fair and 28% thought they were very fair. If the company did not like the evaluation, 50% thought the process for challenging the evaluation was difficult and 19% thought it was very difficult. Nearly 70% of the respondents believed the government officials were knowledgeable of the past performance evaluation criteria. Compliance Only 3% of the respondents reported that cost disallowances are a significant issue, continuing a downward trend in their importance to company management. Nearly 20% of companies reported executive compensation as a disallowed cost, followed by bonus at 14%, and employee morale costs by 12% of the respondents. The major Cost Accounting Standards (CAS) issue was accounting changes and the associated cost impact. When it comes to getting paid, we found the average age of invoices was approximately 58 days and our respondents found that the Department of Energy (DOE) and the Environmental Protection Agency (EPA) were the best agencies for paying invoices on time. The Department of Defense (DoD) ranked last of the major government agencies. When it comes to resolving issues, we saw very similar results. DOE and EPA were usually the best at solving problems and DoD was the worst.

8 6 I. Industry Profile One hundred and nine companies participated in the 7 th Annual Grant Thornton Government Contractor Industry Survey. Surveys were sent out and responses received in the second quarter of calendar year Therefore, financial and business statistics presented generally represent information for the companies fiscal years ending in Throughout the survey, we analyzed the data as a whole, by company revenue size and by industry group. We combined several of the revenue categories used in last year s survey, reducing the number of revenue categories from 8 down to 5. Industry group information was obtained from the Standard Industrial Classification (SIC) codes provided by the respondents. Customers As shown in Figure 1 below, more than 80% of the revenue from reporting companies comes from the Federal government, which includes DoD, NASA, and civilian agencies. The Department of Defense remains the predominant customer, which increased from 41.2% in the last survey to 47.7%. This growth may be due, in part, to the proliferation of GSA schedule contract revenue. The percentage of revenue from NASA decreased from 4.2% to 1.5% while revenue from civilian agencies dropped 3% from last year s survey. The amount of commercial work performed by survey respondents decreased 2% from the results of last year s survey. Interestingly, this was the first drop in the percentage of commercial work performed by these companies, a number which had steadily progressed in the previous three surveys. Figure 1: Customer Profiles by Revenue Civilian State/Local # Companies DoD NASA Agency Government Commercial Other All % 1.54% 33.96% 4.49% 10.31% 2.04% $0 10M % 1.42% 28.36% 8.26% 10.14% 0.16% $10 20M % 0.30% 58.25% 3.04% 9.36% 1.44% $20 50M % 3.46% 22.57% 3.94% 8.26% 0.03% $50 100M % 0.50% 22.17% 1.42% 15.71% 4.47% >$100M % 1.66% 28.83% 1.99% 11.91% 10.68%

9 7 Customer profiles by industry group are outlined in Figure 2. Compared to last year, all industry groups reported increased revenue from DoD as a percentage of total revenue. The most notable increases were in the information services (IS) and management consulting (MC) companies. In 1999, IS revenue from DoD increased from 33% to 42% while MC increased from 9% to 25%. Engineering services organizations generated almost 90% of their revenue from the Federal government; nearly 70% from DoD alone. Telecommunications companies generated more than 50% of their revenue from DoD while relying on the commercial sector for 20%. Manufacturing companies relied primarily on the commercial sector with 44% of revenue from this source. Similar to last year s survey, manufacturing and telecommunications companies average the most commercial work. Revenue Trends When asked about revenue trends and customers in the different sectors over the past three years, survey respondents reported virtually the same as last year, with the exception of DoD, as shown in Figure 3. Figure 2: Customer Profiles by Industry Civilian State/Local # Companies DoD NASA Agency Government Commercial Other All % 1.54% 33.96% 4.49% 10.31% 2.04% Engineering Services % 1.76% 16.22% 6.86% 5.81% 0.08% Information Services % 1.51% 41.15% 4.23% 8.36% 2.78% MGT Consulting % 1.61% 55.30% 2.79% 12.83% 2.55% Biomedical Research % 2.00% 21.26% 0.60% 2.14% 0.00% Telecommunications % 0.00% 20.25% 3.75% 20.50% 2.25% Manufacturing % 0.00% 11.00% 3.50% 44.12% 13.17% Figure 3: Customer Revenue Trends State/Local International Private Sector Government DoD Increased Revenue 26.47% 53.57% 36.25% 41.76% Decreased Revenue 17.65% 13.10% 13.75% 20.88% Stable Revenue 55.88% 33.33% 50.00% 37.36%

10 8 42% of the companies reported increased revenue from DoD, up from 37.5% last year and 36% the year before. Over the last three years, fewer companies are reporting increased revenue from the private sector with 59% in 1997, 56% in 1998, and 54% in However, when asked where they plan to increase revenue over the next three years, two-thirds of the companies said from the private sector. See Figure 4. Markets We asked our respondents to identify their primary SIC classification as well as other significant lines of business. As shown in Figure 5, engineering services, management consulting, and information services are the predominant industries in which our respondents classify themselves. Nearly 40% of our respondents are in the Engineering Services line of business. More than 25% of the respondents consider Information Services to be the primary classification of the work they perform but more consider Information Services to be their second or third primary business line. Figure 4: Sector Revenue Growth In the next 3 years, where do you plan to grow your company: International 24.77% Private 67.89% State/Local Government 34.86% Federal Government 33.03% Figure 5: Market Profile Engineering Services MGT Consulting Information Services Biomedical Research Manufacturing Telecommunications Primary Industry for Respondents Other Than Primary Industry for Respondents R&D 0% 10% 20% 30% 40%

11 II. Company Data 9 Ownership The 7 th Annual Grant Thornton survey also asked questions regarding company ownership, business classifications, 8(a) participation and work force staffing. The survey revealed the following: 43% of the companies were 100% owned by company management, down from 49% in the prior survey. 58% of respondents can claim small business status on at least some of their contracts, compared to 57% and 54% in the prior surveys. 34% of the companies in the survey are women- or minority-owned, compared to 30% and 25% in the last two surveys. Companies with primarily commercial sales comprise 1% of the respondents, down from 5% in the previous survey. The percentage of exempt organization respondents that do business with the Federal government is 6%. The typical respondent has been in business for 21 years. Nearly 90% of the respondents lease 100% of their facilities while only 2% own all of their facilities. Workforce For employees who primarily charge directly to contracts, 55.7% work at client facilities compared to 39%, 53%, and 37% in the last 3 surveys. The size of the company did not affect where employees were based. This year s survey indicates that companies are becoming administratively leaner or are finding ways to direct charge certain positions. This leanness has not necessarily translated into increased profits. The number of indirect employees as a percentage of total labor dropped significantly to 8% compared to 16.1% in 1998 and 16.3% in See Figure 6. Figure 6: Percent Indirect Employees to Total Employees 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

12 10 Revenue per employee has grown over the last 3 years, as shown in Figure 7, while the pretax income has been steadily dropping, as illustrated in Figure 8. This may indicate that realized contract fees are shrinking or that management is incurring more costs in non-recoverable areas such as acquisitions or reorganization costs. Increased competition for a shrinking DOD budget may also be playing a role here as companies may be willing to accept lower margin work or not bill for costs which may have been billed in the past. Some of the lower margin work may be performed by subcontractors who may not be generating the same profit margins for the company as employee labor would, although it would contribute to increased revenues. Government contractors (and thereby their customers) face increasing competition in recruiting workers from dot.coms, the telecom industry, and others. We need to work with our government clients to provide a more flexible workplace, allowing for such options as teleworking and flexible work schedules for contractor employees. Ellen D. Glover, President and C.O.O., ATS Figure 7: Average Revenue Per Employee $140M $120M $100M $80M $60M $40M $20M $0M Figure 8: Pretax Income as a Percentage of Revenue 6% 5% 4% 3% 2% 1% 0%

13 11 Staffing Indirect Activities We also asked respondents to provide headcount information for various indirect functions. Figure 9 presents the percentage of indirect headcount by functional category to total direct labor headcount. The Finance department generally out-numbers the other functional groups 2 or 3 to 1 with the exception of Sales. On average, Finance represents about 1/3 of the indirect labor personnel while Sales varies. Pricing and Legal departments are generally the smaller of the indirect groups across all revenue categories, but it is likely their skill sets are shared with contracts and procurement departments. When reviewing the ratios by industry group, there were some interesting observations. See Figure 10 below. Figure 9: Percentage of Indirect Headcount to Direct Labor Headcount by Revenue Category Total Finance HR MIS Contracts Legal Pricing Procurement Sales Indirect $0 10M 5.91% 2.45% 2.27% 2.17% 1.76% 1.13% 2.54% 3.73% 13.87% $10 20M 3.92% 1.64% 1.55% 1.44% 0.72% 0.54% 1.17% 7.74% 11.49% $20 50M 2.50% 1.45% 1.39% 1.05% 0.21% 0.73% 1.00% 4.08% 10.28% $50 100M 3.41% 2.18% 2.62% 2.23% 0.34% 0.58% 1.41% 2.49% 12.21% >$100M 3.95% 1.94% 2.90% 2.04% 0.38% 0.77% 0.99% 2.56% 14.12% All 4.10% 1.91% 1.98% 1.69% 0.58% 0.74% 1.42% 4.41% 12.10% Figure 10: Percentage of Indirect Headcount to Direct Labor Headcount by Industry Category Total Finance HR MIS Contracts Legal Pricing Procurement Sales Indirect Engineering Services 3.94% 1.54% 1.38% 1.67% 1.18% 0.50% 1.06% 2.73% 8.98% Information Services 3.56% 2.08% 1.98% 1.60% 0.35% 1.05% 1.21% 8.49% 15.07% MGT Consulting 4.31% 2.04% 2.44% 1.49% 0.27% 0.97% 1.81% 1.99% 11.37% Biomedical Research 5.23% 2.24% 1.41% 4.05% 1.27% 0.61% 1.30% 2.21% 14.86% Telecommunications 4.25% 1.61% 1.30% 1.18% 0.16% 0.71% 0.96% 2.61% 12.35% Manufacturing 5.75% 2.48% 3.43% 1.43% 0.15% 0.67% 2.40% 9.56% 25.24%

14 12 Manufacturing companies reported that nearly 25% of their labor force were assigned to the 8 indirect functional areas compared to the next industry group with 15%. Almost 10% of the labor force for manufacturing companies was dedicated to Sales. Similar to manufacturing, information services firms allocated more than 8% of their indirect labor force to Sales. Engineering services organizations allocated their indirect labor consistent with the average for all respondents. The spread of indirect labor across the functional areas was similar between management consulting and engineering although the management consulting industry had a smaller Legal staff. A higher than average of Finance and Contracts staff was reported in the biomedical industry. Small Business Similar to last year s results, about 10% of respondents are participating in the 8(a) Business Development Program with the Small Business Administration (SBA). The source for revenue for these companies was derived as shown in Figure 11. Also similar to last year, 22% of respondents are graduates of the 8(a) program. As shown in Figure 12, although the graduates are generally a little larger than those currently participating, the pretax income as a percent of revenue is significantly higher for those currently in the 8(a) program. As the chart shows, the former 8(a) companies are generating approximately 3.8% pretax income versus 5.3% for current 8(a) companies. Figure 12: Average Revenue and Pretax Income of 8(a) Companies Revenue Figure 11: 8(a) Revenue Commercial Government Competitive 8(a) Set-asides 6.39% 5.00% 43.26% 47.00% 48.69% 48.00% 0% 20% 40% 60% % of Revenue (Current Survey) % of Revenue (Prior Survey) $30M $25M $20M $15M $10M $5M $0M $24,903,358 $938,312 Former 8(a) s Pretax Income $16,173,995 $856,357 Current 8(a) s

15 III. Financial Information 13 Figure 13: Summary Financial Data Most Recent Year 2nd Most Recent Year Average Revenue $76,884,000 $79,358,000 Median Revenue $17,500,000 $15,308,000 Current Ratio Pretax Income as a % of Revenue 3.53% 2.23% Net Income as a % of Revenue 2.53% 1.61% Funded Backlog as a % of Revenue 56% 46% Unfunded Backlog as a % of Revenue 140% 141% The financial data for all survey participants is provided in Figure 13. In the survey, we asked the respondents to provide their financial data for the most recently completed fiscal year and the 2nd most recently completed. The results showed the average revenue declined, although the median revenue increased. Alarmingly, 1 in 5 companies reported losing revenue in the most recently completed year compared to the prior year. To discover long-range trends, we analyzed the firmwide data provided to us over the last six annual survey years. We identified some interesting trends and observed some notable items as can be seen in Figure 14 below. Figure 14: Company Data Over the Last Six Surveys Average Median Annual Current Revenue Revenue Pretax Net Survey Ratio ($000,000) ($000,000) Income % Income % 2nd 1.42 $17.0 $ % 3.0 % 3rd 1.85 $12.7 $ % 3.0 % 4th 1.63 $21.9 $ % 3.0 % 5th 1.59 $37.5 $ % 3.0 % 6th 1.35 $59.1 $ % 2.8 % 7th Current 1.91 $76.9 $ % 2.5 %

16 14 Figure 15: Current Year Financial Measures Current Ratio Percent of Pretax Income Percent of Net Income $0 10M $10 20M $20 50M $50 100M >$100M The current ratio reported this year is the highest reported to date ([current assets such as cash and accounts receivable] [current liabilities such as accounts payable and accrued payroll]) improving significantly to 1.9 this year. This generally means that companies are more solvent and healthy, an encouragement for companies to invest in other companies or to become targets for acquisition. Average and median revenue for our participants has been steadily growing since Pretax income, as a percentage of total income, dropped below 4.0% for the first time. We also saw net income dip a bit, continuing a downward trend from the last survey. This may be due, in part, to the increase in the size of the participants as well as other competitive measures. When we examine the companies by revenue category, the smallest and largest businesses had the highest current ratios. However, not surprisingly, the large corporations had much lower pretax and net income results. See Figure 15. Viewing the survey financial data by industry, we discovered that management consulting firms reported a current ratio of 2.2 the highest by far. Other industry categories typically ranged between Most survey industries reported pretax income between 4% to 6% and net income percentage between 2.5% 4.5%. Over the next 3 5 years, all industries expect at least 15% growth with the exception of biomedical, which expects approximately 8% growth. For comparative purposes, we gathered some industry financial ratios from companies in the Fortune 500. See Figure 16.

17 15 Figure 16: Financial Ratios for Fortune 500 Companies Current Ratio Pretax Income Net Income Telecommunication % 10.1% IT Services % 3.1% Management Consulting %.7% Grant Thornton 7th Annual Survey % 2.5% Backlog With the proliferation of General Services Administration (GSA) Indefinite Delivery, Indefinite Quantity (IDIQ) type of contracts, there has been an interesting trend unfolding regarding backlog of work. With service and engineering companies entering into more task-order type of contracts, the customer is not committing funding until the task order is awarded. This puts the contractors more at long-term risk for various reasons. Figure 17 illustrates backlog as a percentage of revenue. Since there is no longterm funding obligation on the part of the government it is logical to assume unfunded backlog would decrease. Larger companies reported barely 4.5 months (39%) worth of funded backlog and 10 months (86%) of unfunded backlog. This puts them at greater risk and would appear to emphasize their need to focus more on business development and customer relations. Firms in the $0 10M category reported nearly 14 months of funded backlog and more than 3.5 years of unfunded backlog. Figure 17: Funded and Unfunded Backlog 350% 300% 250% 200% 150% 100% 50% 0% Funded Unfunded 4th 5th 6th 7th

18 16 IV. Indirect Rates Figure 18: Percentage of Companies Utilizing Each Rate Structure Technique Contract Specific Overhead Multiple G&A Pools 7th Annual Survey 6th Annual Survey 5th Annual Survey Multiple Fringe Pools Sub/Material Handling On-Site Overhead Off-Site Overhead Multiple Overhead Pools Service Centers 0% 10% 20% 30% 40% 50% 60% 70% 80% This section, which addresses the various cost accounting structures and resultant indirect rates, is perhaps one of the more eagerly awaited and frequently read sections in the survey. In the survey, we asked our respondents 15 questions involving indirect cost pools, fringe benefit structures, service centers and provisional vs. actual rates. The results of the survey are discussed below. Readers must be cautioned from performing exact comparisons with their own structure because the activities included in cost pools and bases are not always discernible, but the information should nonetheless be useful when taken as a whole. With the exception of material and subcontract rates, there is a leveling of the number of indirect cost pools companies are using. The use of contract-specific overhead rates has been on the decline for the past four years. This suggests that they are ineffective in controlling costs or that the administrative burden of maintaining such narrow-based pools outweighs the cost benefits. Figure 18 presents the rate structures companies are using compared to prior survey results. Service Centers Service centers are generally a simple and logical way of accumulating certain types of costs/activities that distribute

19 17 these costs/activities directly to contracts or other indirect cost pools. Nearly 3 in 5 companies, and virtually all large corporations, use them. Figure 19 shows the types of service centers used by the respondents. According to the survey results, as a company grows, it becomes more likely to use service centers to distribute costs. Service centers can be more effective than overhead pools because they use a distribution base that is more directly related to an activity, such as allocating facility rent based on square footage or allocating reproduction costs based on the number of pages reproduced. This allows companies to directly charge these costs to a contract based on the actual resources consumed, such as square footage occupied or number of pages reproduced for a particular contract. Figure 20 shows the percentage of companies that charge the service center costs directly. Figure 19: Most Commonly Used Service Centers Last Survey This Survey Computer 31% 31% Facilities 30% 31% Reproduction 26% 24% Personnel 16% 17% Contract Administration 16% 17% Finance & Accounting 15% 18% Payroll 15% 12% Graphics 13% 8% Security 13% 8% Subcontract Management 13% 12% Purchasing 12% 13% Marketing 11% 4% Line Management 9% 7% Word Processing 7% 7% Laboratories 5% 8% Test Equipment 5% 5% Figure 20: Percentage of Companies that Charge Service Center Costs as Direct Costs Reproduction Graphics Test Equipment Line Management Computer Fringe Benefit Word Processing Laboratories Subcontract Mgt. Security 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

20 18 Fringe Benefit Rates We asked the participants to provide information regarding their standard (full benefit) fringe benefits as well as secondary or reduced benefit rate structures, if offered. The average standard fringe benefit rate for all companies surveyed has not been changing. This year the average was 34.48%, compared to 33.88%, and 34.07% in the prior two surveys as shown in Figure 21. The largest companies had the highest fringe benefit rate, but the difference by size of company is insignificant. When viewing the fringe benefit rate by industry, the biomedical research industry offered the highest rate, as shown in Figure 22. Figure 21: Fringe Benefit Rates by Company Size $0 10M $10 20M $20 50M $50 100M >$100M Figure 22: Fringe Benefit Rates by Industry Engineering Services Information Services Management Consulting Biomedical Research Telecommunications Manufacturing 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Twenty percent of the respondents also used a reduced fringe benefit pool for employees with reduced benefits. For all companies that segregate these costs into a separate fringe pool, the average rate is 17.2%. However, we found that these reduced fringe pools varied as to what benefits were actually included. The vast majority of fringe benefit costs can be classified into 4 types of costs: Statutory fringe benefits, primarily employer taxes Paid leave (vacation, sick, etc.) Health benefits Retirement benefits. Statutory fringe costs must be paid for all employees. However, when developing a reduced fringe benefit rate, paid leave, health benefits, and retirement benefits can be offered in any combination. Our survey showed that a fringe rate that included statutory benefits only (i.e., no leave, health, or retirement benefits) was the most popular form of a reduced fringe benefit rate. Other combinations are shown in Figure 23. Keep in mind that variations in these average fringe benefit rates are due not just to the type of costs included, but also by the level of benefits offered. 0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

21 19 Figure 23: Types of Reduced Benefit Packages Ratio of Respondents Fringe Fringe vs. All Reduced Average Fringe Benefits Benefits Fringe Benefits Fringe Package Included Exclude Respondents Benefit Rate Paid Leave Health Benefits 40% of Reduced 1 Statutory Costs Retirement Costs Fringe Respondents 10.70% Statutory Costs Health Benefits 5% of Reduced 2 Paid Leave Retirement Costs Fringe Respondents 20.00% Statutory Costs Paid Leave 35% of Reduced 3 Retirement Costs Health Benefits Fringe Respondents 17.63% Statutory Costs Paid Leave 5% of Reduced 4 Retirement Costs Paid Leave Fringe Respondents 32.26% Statutory Costs Paid Leave 5% of Reduced 5 Retirement Costs Health Benefits Fringe Respondents 12.09% Statutory Costs Paid Leave 10% of Reduced 6 Health Benefits Retirement Costs Fringe Respondents 26.95% Overhead Rates Overhead pools are developed to allocate certain management and support types of indirect costs. Generally, these costs are incurred to manage direct engineering, programmers, scientists or other direct labor. It is common in the services industry to use direct labor as the basis to distribute these costs to contracts. Sometimes companies will include the fringe benefits associated with the direct labor as part of the base. By including fringe benefits in the base, the indirect rate calculated will be lower although the indirect costs remain the same. This method gives the false impression of a lower overhead cost. We asked the respondents to provide information regarding their predominant overhead rate and the corresponding allocation base. For purposes of the survey, we asked that they define on-site as the company location and off-site as the customer location. Furthermore, we asked if they would identify whether or not associated fringe benefits were included in the overhead base. Although there are possibly other structures companies could be using, we believe this captures predominant methods used in the industry. Nevertheless, when reviewing the indirect overhead rates by company size vs. industry, noticeable differences are evident. See Figures 24 and 25.

22 20 When asked the logic behind setting up overhead pools, 31% of respondents said location continues to be the primary reason for setting up multiple overhead pools, followed by functional requirements, reported by 17%, and type of customers, reported by 12%. Approximately 10% of the respondents said the market was also a reason for setting up multiple overhead pools. General and Administrative (G&A) Rates Similar to overhead, G&A is a common cost pool used to allocate indirect costs typically incurred at the corporate home office and the costs benefit company Figure 24: Average Overhead Rates by Company Size $0 10M $10 20M On-Site Overhead DL Base On-Site Overhead DL Base+Fringe Off-Site Overhead DL Base Off-Site Overhead DL Base+Fringe $20 50M $50 100M >$100M 0% 20% 40% 60% 80% 100% 120% 140% Figure 25: Average Overhead Rates by Industry Engineering Services Information Services On-Site Overhead DL Base On-Site Overhead DL Base+Fringe Off-Site Overhead DL Base Off-Site Overhead DL Base+Fringe MGT Consulting Biomedical Research Telecommunications 0% 20% 40% 60% 80% 100% 120% 140%

23 21 operations in many ways. These costs typically include executive functions, legal and accounting fees, and sales and marketing departments. To distribute the G&A costs, companies generally will use one of three generally accepted bases: Total Cost Input (TCI) Base the allocation base includes all operating costs including direct labor, overhead, materials, and subcontracts. Value Added Cost Input (VACI) Base same as TCI except materials and subcontracts are excluded. Direct Labor Base only includes direct labor, but may include associated fringe benefits. The average reported (G&A) rates are shown by type of base in Figures 26 and 27 by company size. Figure 26: Average G&A Rates by Type of Base $0 10M $10 20M TCI Base Value Added Base DL Base $20 50M $50 100M >$100M 0% 5% 10% 15% 20% 25% 30% 35% Figure 27: Average G&A Rates by Industry Manufacturing Telecommunications TCI Base Value Added Base Biomedical Research MGT Consulting Information Service Engineering Services 0% 5% 10% 15% 20% 25%

24 22 The TCI base is used by 57% of respondents, the VACI base by 38%, and the Direct Labor base by 5%. There is a slight shift toward the VACI base compared to last year, which may be attributed to the higher numbers of larger respondents, which have a tendency to use VACI in the professional services industry. More than 67% of smaller companies (less than $20 million) reported using a TCI base, while 78% of the largest (greater than $100 million) companies use the VACI base. In large part, the preponderance of VACI base in larger companies is due to their higher subcontract and material costs which do not benefit significantly from G&A expenses. In addition, many government contracting officers will not accept a G&A rate billed on top of subcontracts and material costs, thus forcing companies with significant material and subcontract costs to either not allocate G&A to these costs or develop a separate subcontract and/or material handling rate. G&A rates by industry are shown in Figure 27. Subcontract/Material Handling Rates Almost an equal number of companies reported using either material handling, subcontractor administration or a combined material/subcontract handling rate. The rates for all three were relatively close, as can be seen below. Material Handling = 3.9% Subcontract Administration = 4.1% Material/Subcontract Rate = 4.4% Neither company size nor industry was a determinant in the use of these various rates. See Figure 28. Figure 28: Average M&S Rates by Company Size $0 10M $10 20M Material Handling Sub Administration Materials & Subcontracts $20 50M $50 100M >$100M 0% 1% 2% 3% 4% 5% 6% 7%

25 23 Comparing Actual to Provisional Billing Rates We asked the respondents to tell us about their provisional rate variances in the last fiscal year and how they treated them Variances How did actual rates compare to provisional? 50% said actual indirect rates were higher than provisional rates. 37% said actual indirect rates were the same as provisional rates. 13% said actual indirect rates were lower than provisional rates. Cause of Variance What caused the actual to vary from provisional rates? If the actual indirect rate was higher than provisional, the cause was almost always because the base was less than expected. If the actual rate was lower, lower pool costs tended to be the main reason. Billing the Variance How do you handle the rate variance? When asked what portion of the variance is billed, the respondents said they billed: All 23% Most 22% Some 34% None 22% If the company billed less than actual, the reasons were due to: Contract Funding 33% Contract Ceilings 27% Customer Relations 22% Other 18% Forty percent of companies continue to wait for the Incurred Cost Audit to be completed before variances are billed. Interestingly, 25% will bill the variance without approval from DCAA while 22% will request approval to bill immediately after the actual rates are calculated. Smaller companies are more likely to wait for the Incurred Cost Audit. As we have seen, the government has slowly come around to recognize the time value of money to contractors and we encourage all companies to utilize the flexibility permitted by the FAR and revise provisional rates as soon as the actual rates can be calculated. Electronic Timesheets What are you currently doing about electronic timesheets? 22% of respondents are currently using electronic timesheets. 36% plan to use electronic timesheets. 42% said they don t plan to use electronic timesheets. 62% said they don t use it because it provides no significant benefit. 24% said it is too difficult to interface. 14% said reason was due to other circumstances. Sixty-five percent of reporting companies use total time accounting, just slightly higher than last year. The balance use a standard workweek.

26 24 V. Contracts The procurement methods used by the federal government to purchase goods and services has undergone significant change over the last 5-7 years. The government has sought ways to improve its business process for two fundamental reasons. First, it has recognized that there are better ways to buy goods and services which give them flexibility and avoid long protracted solicitation and negotiation processes. These are the benefits of using GWAC s, MAC and GSA Schedule contracts. Second, the government has been forced to improve efficiencies because of a shortage of personnel in the procurement function, due to downsizing the federal government. The changes have provided new or different types of opportunities for government contractors, who themselves have been forced to deal with a smaller customer with a different spending pattern. Contract Types For the next fiscal year, government contractors plan to increase the percentage of their total revenue from time and materials (T&M) and GSA Schedule type of contracts and decrease their cost reimbursable as well as non-gsa T&M contracts. In spite of many initiatives within the Federal government to move away from cost-reimbursable contracting because of its risk to the government, they continue to be the most popular contract type for government contracting throughout most major industries and revenue categories. See Figure 29 for details. Figure 29: Percentage of Contract Type by Company Size 0 $10M $10 $20M $20 $50M $50 $100M >$100M All Federal Government Cost Reimbursable 47% 42% 38% 29% 47% 42% Time & Materials 19% 20% 22% 23% 12% 20% GSA Schedule 8% 12% 17% 2% 10% 11% Firm Fixed Priced 9% 13% 11% 22% 21% 13% Total 84% 88% 89% 76% 90% 86% State/Local Cost Reimbursable 3% 0% 0% 0% 0% 1% Government Time & Materials 1% 2% 3% 0% 0% 1% Firm Fixed Priced 4% 1% 1% 0% 1% 1% Total 7% 2% 4% 0% 1% 4% Commercial Cost Reimbursable 1% 1% 0% 0% 1% 0% Time & Materials 7% 5% 2% 1% 2% 4% Firm Fixed Priced 2% 5% 4% 23% 6% 6% Total 9% 10% 6% 23% 9% 10% All 100% 100% 99% 100% 100% 100%

27 25 Fees As expected, the range of fees by contract type increases as the level of contractor risk increases, as illustrated in Figure 30. For example, government contractors receive fees ranging from 5.4% to 9.4% for cost-reimbursable contracts. Average negotiated fees ranged from 6.5% to 11.5% for T&M contracts. Indicating the government has more latitude to negotiate fees as risk goes up for the contractor, fixed-price contract fees ranged from 8.1% to 15.7%. The range for average fees negotiated by revenue category are much tighter than in previous surveys. See Figure 31. This indicates the government may be negotiating more evenly across the board regardless of company size. In prior years, smaller companies generally had better fees. This year, the smaller companies did not necessarily demonstrate this advantage. See Figure 32 for fees by industry. Revenue Recognition for Unfunded Work We asked our respondents when and how they would recognize revenue for at-risk/unfunded work: Figure 30: Average Negotiated Fee Ranges by Contract Type and Company Size Cost Reimbursable Time & Materials (T&M) Fixed Price From To Difference From To Difference From To Difference $0 10M 5.60% 8.50% 2.90% 7.00% 10.32% 3.32% 8.13% 12.91% 4.78% $10 20M 5.38% 8.38% 3.00% 7.15% 10.53% 3.38% 9.06% 14.59% 5.53% $20 50M 5.39% 8.64% 3.24% 6.53% 10.93% 4.40% 8.29% 14.60% 6.31% $50 100M 6.40% 9.45% 3.05% 7.65% 11.45% 3.80% 9.68% 15.73% 6.05% >$100M 5.49% 8.84% 3.34% 6.93% 10.95% 4.02% 8.52% 14.30% 5.78% Average 5.65% 8.76% 3.11% 7.05% 10.84% 3.78% 8.74% 14.43% 5.69% Figure 31: Average Fees by Contract Types and Company Size Negotiated Cost Fixed Reimbursable T&M Price $0 10M 7.17% 8.50% 10.69% $10 20M 7.24% 9.45% 11.32% $20 50M 7.00% 8.68% 11.25% $50 100M 6.83% 8.28% 11.64% >$100M 6.97% 8.85% 10.16% Figure 32: Average Fees by Contract Types and Industry Negotiated Cost Fixed Reimbursable T&M Price Engineering Services 6.82% 8.69% 10.68% Information Services 7.53% 9.19% 11.17% MGT Consulting 6.94% 8.41% 11.00% Biomedical Research 6.85% 9.00% 10.00% Telecommunications 8.50% 9.50% 10.00% Manufacturing 7.00% 9.00% 16.33%

28 26 The economics of litigation are changing. Clients are increasingly likely to factor the efficiencies of ADR and settlements into their litigation budgets. As this process continues, we are moving beyond mere acceptance of ADR and into a more advanced stage of its institutionalization into law and practice. Dave Metzger, Partner, Holland & Knight Nearly one third of the companies won t recognize revenue until the contract is awarded. A third of the companies said they would recognize revenue if they had been performing work on an existing funded contract but were awaiting additional funding. Less than 8% said they would recognize revenue if government representatives indicated the award was imminent, but had not been awarded. Larger companies are not as likely to adopt this practice. When we asked how much revenue they would recognize, they said: Nearly 30% will recognize 100% of cost incurred plus full profit. Nearly 50% would only recognize cost. About 10% would recognize cost incurred plus a nominal profit. Nearly10% said they would recognize less than 100% of cost incurred. Litigation If litigation is an indication of business relations with the government, it appears the situation has not changed much. Nearly 72% of respondents said they were just as likely as last year to pursue reimbursement for claims through litigation. When looking at the responses by company size, smaller companies tend to be just as likely today as last year to pursue reimbursement for claims through litigation while larger companies seemed to be either just as likely or even more likely, to pursue litigation. IDIQ Contracts As companies grow, it appears that they do not generate as much revenue from IDIQ contracts, as shown in Figure 33. Information services and engineering services companies derive approximately 50% or more of their revenue from IDIQ contracts. See Figure 34. Figure 33: IDIQ Contracts by Company Size $0 10M $10 20M $20 50M $50 100M Average % of Revenue from IDIQ this Year % of Respondents in Revenue Group with IDIQ Contracts >$100M 0% 10% 20% 30% 40% 50% 60%

29 27 Figure 34: IDIQ Contracts by Industry Manufacturing Telecommunications Biomedical Research Average % of Revenue from IDIQ this Year % of Respondents in Industry Group with IDIQ Contracts MGT Consulting Information Services Engineering Services 0% 10% 20% 30% 40% 50% 60% GSA Schedule Contracts When viewing the GSA Schedule by industry group, as shown in Figure 35, there were no surprises. Interestingly, only 41% (15 companies) of the Engineering Services companies used the Engineering Services Schedule; they actually had a larger participation in the IT Services Schedule. This is because many engineering companies reported information technology SIC s as their secondary or third primary industry. Figure 35: Number of Companies Using GSA Schedule Contracts by Industry Manufacturing Telecommunications Telecommunication Other Engineering Services Mobis IT Services IT Products By far, the GSA Schedule used most frequently by our respondents is the IT Services Schedule. Engineering services and management operations/business improvement services (MOBIS) follow with equal percentages. Substantial numbers of respondents also used the IT Products and Telecommunications Schedules. Biomedical Research MGT Consulting Information Services Engineering Services

30 28 Nearly all of the Information Services companies use the IT Services Schedule. Management Consulting was evenly split between IT Services and MOBIS. Biomedical companies used IT Services and Engineering Services schedules. Not surprisingly, all Telecommunication firms used the Telecommunication Schedule. Two of four Manufacturing companies are on the IT Products Schedule. Nearly 44% of those using the IT Services Schedule were also MOBIS. Conversely, 81% of those using MOBIS were also on the IT Services Schedule. Nearly 86% of companies who use the IT Product Schedule also use IT Services Schedule. However, the reverse is not true. Only 29% of companies who offered IT Services also offered products. As a result of the Federal government transitioning work to the GSA Schedule, 39% have seen their profit margins increase while 37% reported no material impact on their margins. Nearly 14% said their margins had actually decreased. Past Performance Past performance has gained attention in the Government s initiative to award contracts based on best value. Approximately 90% of the respondents have participated in solicitations in which past performance was a factor. As the government has moved towards best value, the past performance of contractors has become a more significant evaluation factor. The methods employed by the government to monitor, evaluate, and report contractor performance, has become somewhat controversial. In February 2000, Grant Thornton held a roundtable discussing these very topics. Figure 36: Government Evaluations as Perceived by Respondents Somewhat Unfair 12% Very Fair 28% Somewhat Fair 60%

31 29 When our respondents were asked if they felt evaluations were fair, most thought it was somewhat fair and nearly 3 in 10 thought it was very fair. When asked about challenging the evaluations, half of the respondents thought it was difficult to challenge the evaluation. Almost 2 in 10 found it very difficult. Another controversial element involves training the government employees on the process of evaluating performance. Nearly 7 in 10 thought the government officials were somewhat knowledgeable while nearly 2 in 10 thought the government officials were somewhat or very unknowledgeable. See Figures 36, 37, and 38. Figure 37: The Process for Challenging a Performance Evaluation Very Difficult 19% Not Difficult 31% Difficult 50% Figure 38: Customer s Knowledge of Past Performance Evaluation Criteria Very Unknowledgeable 3% Somewhat Unknowledgeable 14% Very Knowledgeable 15% Somewhat Knowledgeable 68%

32 30 The overarching need for fundamental fairness and transparency in assessing ones past performance seems somewhat frustrated by inconsistent process. Glenn Baer, Director of Contracts, ARINC Figure 39: Customer s Opinion of GWAC/MAC Very Harmful 2% Moderately Less Beneficial 9% About the Same 20% Moderately Beneficial 41% Very Beneficial 28% GWAC/MAC Nearly 40% of the respondents participated in Governmentwide Acquisition Contracts (GWACs) and 50% participated in Multiple Award Contracts (MACs). When asked what their customers thought about these contract vehicles, many believe the government customer thought they were moderately or very beneficial, as shown in Figure 39. Figure 40: What Size Company Benefits from GMAC/MAC s $0 10M $10 20M Small Companies Only Primarily Large, But Some Small Large Companies Only All Companies and Sizes $20 50M $50 100M >$100M 0% 10% 20% 30% 40% 50%

33 31 Interestingly, when asked what size company benefits from the use of GWAC/MAC, smaller companies thought it primarily benefited larger companies. Some small companies viewed it as benefiting all companies while none thought it only benefited small companies. See Figure 40. When asked if the GWAC/MAC process should be improved or abolished, many respondents thought it should be improved for the smaller company. Company size did not appear to be a factor in the answer although a small number of companies with less than $50 million in revenue thought they should be abolished. See Figure 41. A-76 We asked the respondents about their thoughts on the subject of A-76 studies and their experience with these unique procurement opportunities in which the government competes to determine if a function or activity should be outsourced. About 17% of our respondents participated in A-76 procurements and said that approximately 7 of 10 times the contract was ultimately awarded to the private sector, either to their company or some other commercial entity. When asked about whether they would participate in the future they said: More Willing 24% Less Willing 26% As Willing as Before 50% Figure 41: The Procurement Process for GWAC/MAC s $0 10M $10 20M Abolished Left Alone Improved for Large Companies Improved for Small Companies $20 50M $50 100M <$100M 0% 10% 20% 30% 40% 50% 60%

34 32 VI. Compensation Incentive Compensation & Fringe Benefits Throughout 1998 and 1999, the shortage of skilled, information technology workers continued to plague companies. As a Figure 42: Percentage of Companies that Offer Incentive Plans to All Employees $0 10M $10 20M $20 50M $50 100M >$100M All result, retaining employees and motivating them to meet the organization s goals for growth and profitability continued to be a top priority. As shown in the figures and narratives below, incentive compensation and welfare benefits have become so prevalent that they are required as part of a minimum compensation package. The strategies to incorporate these elements into a total compensation package that maintains a competitive edge in the market place, varies based on company size, industry, business strategy and compensation philosophy. 0% 20% 40% 60% 80% 100% Figure 43: Standard Fringe Benefits All 0 $10M $10 $20M $20 $50M $50 $100M >$100M Holiday 93.52% 96.88% 92.59% 88.46% 92.31% % Dental 91.67% 96.88% 88.89% 88.46% 84.62% % Life Insurance 90.74% % 85.19% 88.46% 76.92% % Vacation 89.81% 96.88% 88.89% 88.46% 84.62% 81.82% LTD 89.72% 93.55% 88.89% 88.46% 84.62% 90.91% PPO 84.26% 87.50% 81.48% 80.77% 76.92% % Tuition 78.50% 81.25% 77.78% 76.92% 58.33% % STD 77.57% 75.00% 81.48% 65.38% 83.33% % Sick 73.15% 81.25% 70.37% 76.92% 69.23% 54.55% Bonus Plan 61.11% 56.25% 59.26% 61.54% 84.62% 45.45% Other Paid Leave 59.81% 51.61% 55.56% 57.69% 61.54% % HMO 51.85% 37.50% 59.26% 61.54% 53.85% 54.55% Parking 38.32% 51.61% 37.04% 34.62% 15.38% 36.36% Severance 36.79% 29.03% 37.04% 53.85% 8.33% 45.45% Indemnity 25.00% 25.00% 22.22% 26.92% 23.08% 27.27% Health Club 18.87% 19.35% 22.22% 15.38% 25.00% 9.09% Other Benefits 14.15% 6.45% 14.81% 30.77% 0.00% 9.09% Stock Options 10.19% 6.25% 3.70% 15.38% 7.69% 27.27%

35 33 Figure 42 shows the number of companies that offer incentive programs to all employees versus only select employees. The continuing trend in incentive compensation is to pay for performance. In smaller companies, the sole performance measure is often tied to company performance instead of individual performance. As the workforce gets larger, performance measurement gets more challenging. Accordingly, larger companies tend to limit their bonus program to a group of employees who most directly impact company performance. Large companies, however, have more generous salaries and fringe benefits for the employees who are ineligible for the incentive program. Retirement Benefits The 401(k) savings feature is practically a requirement in today s workplace. Survey results show that to be the case, as 90% of respondents provide employees with a 401(k) plan. Retirement benefits are another form of compensation program companies use to retain qualified talent. The types of plans may include: 401(k) Defined Contribution Profit Sharing Defined Contribution Defined Benefit Post Retirement Benefit ESOP s Other Deferred Compensation. To attract and retain employees in this tight labor market, there is an increasing emphasis on flextime and telecommuting as means of attracting personnel. While these new models address employees demand for flexibility, and may even result in lower overhead and operating costs for the employer, they do interject challenges on measuring productivity and how to appropriately reward people. The provision of fringe benefits is directly affected by what can be charged to the contract. Accordingly, the prevalence of basic benefits such as health care coverage, holidays, and vacation days have little variance based on company size. Benefits such as severance and parking are DCAA reimbursable lowers the prevalence of those benefits below the occurrence in business that are not government contractors. The prevalence of deferred compensation is very low due to issues of reimbursement by DCAA. Other than retirement benefits, the standard fringe benefits typically offered by respondents are presented in Figure 43. The plans offered by revenue category were fairly consistent, as can be seen in Figure 44. Figure 44: Retirement Benefits Offered William M. Stanton, Managing Director, Palmer & Cay Consulting Group 401K/ Defined Defined Post Deferred 403B Contributions Benefit Retirement ESOP Compensation $0 10M 96.88% 31.25% 9.38% 6.25% 15.63% 3.13% $10 20M 85.19% 33.33% 3.70% 3.70% 22.22% 0.00% $20 50M 88.46% 34.62% 11.54% 7.69% 19.23% 3.86% $50 100M 84.62% 46.15% 7.69% 7.69% 23.08% 0.00% >$100M % 54.55% 0.00% 0.00% 9.09% 9.09% All 90.74% 37.04% 7.00% 5.56% 18.50% 2.78%

36 34 ESOP s can be extremely useful as an employee incentive tool while at the same time providing an excellent opportunity for shareholders wishing to diversify their investments. Tom Ochsenschlager, Partner, Grant Thornton LLP 401(k) plans were offered by more than 90% of companies. Employer contribution defined contribution plans were offered by 37% of companies. Generally, the larger the company the more likely it would offer the plan. Defined benefit plans were only offered by 7% of companies. Post-retirement benefits were offered by 5% of companies. ESOP s were offered by 18% of the companies. Other deferred compensation was only offered by 3 companies. Stock Option Plans Qualified/Incentive about 19%of the respondents offered qualified plans: An incentive stock option (ISO) is a stock option that provides favorable tax treatment to the employee. At grant of an ISO, there are not income tax consequences to the employee. At exercise there is no ordinary income tax to the employee, but the excess of the fair market value at exercise over the option price paid (spread) is a tax preference for alternative minimum tax purposes. Gain recognized on the sale of the stock will be measured beginning at the date the option was granted and will be taxed as capital gain provided that the stock was held more than two years from the grant and one year from exercise. In order to qualify as an ISO, several requirements that are provided in Code Section 422 must be satisfied. Non-qualified about 20% of the respondents offered non-qualified plans: A non-qualified stock option (NQSO) is an option to purchase employer stock at a stated price. A NQSO is an option that at grant is not intended to be an incentive stock option. If the NQSO does not have readily ascertainable value, the employee does not recognize income when the option is granted. Taxation will occur when the option is exercised on the excess of the fair market value over the option price paid. This spread is taxed as ordinary income. About 75% of the time, stock option plans are awarded at market value. The balance of the companies offered stock options at less than market value. Fringe Benefits other than Retirement Plans Virtually all of the companies with revenues greater than $100M, offer paid time off, medical benefits and disability. Large businesses are more likely to offer more fringe benefits to their employees than small companies, with the exception of parking and health club dues. Other observations were:

37 35 Stock Options Nearly 27% of the large companies offered stock options as a form of compensation while only a range of 0 15% of companies in the other revenue categories offered stock options. In other industry groups there is a trend to offer equity-based compensation even in small companies. Preferred Provider Option All companies larger than $100M offered PPO while the other revenue categories each had a few companies that didn t offer PPO. Short Term Disability All companies with revenue higher than $100M offered STD while generally about 7 of 10 offered it in the other revenue categories. Tuition All of the largest companies offer it, and most of the companies (8 of 10) in the other revenue groups offered help with tuition as well. Parking and Health Club Dues These were benefits the largest companies were less likely to offer. General Employee Survey Statistics Average Health Insurance Cost as % of Salary 16% Holidays Offered per Year 10 days Average Salary Increase 6.5% Accruing for Paid Leave Vacation and Sick Leave Accrued Separately 65% Vacation and Sick Leave Accrued Combined 30% Job Openings About 63% of the survey respondents have a significant number of job openings and are experiencing difficulty finding qualified candidates. This is slightly better than last year, when 75% reported such difficulty. When asked to compare the turnover rate for technical employees to their preceding fiscal year: 38% = Turnover greater than last year 40% = Turnover same as last year 22% = Turnover less than last year As a consequence of turnover, about 12% of the positions are left unfilled, consistent with the results of last year s survey. Consultants or non-employees fill approximately 8% of these positions. Almost 16% of the companies reported that this situation has significantly affected their ability to bid and perform work. About 57% said it has somewhat affected them, while 27% said it has not made a noticeable difference on bidding and performing work. Some of the strategies to retain or recruit employees are shown in Figure % of the companies that offer telecommuting as a retention benefit, and about 6.5% of their employees take advantage of this perk. We asked our respondents if their recruiting budget was growing at a pace similar to the growth in sales and the results are shown in Figure 46. The exercise price at which stock options are awarded is influenced by more than just compensation objectives. The effects on the company s tax returns and financial statements also need careful attention. Tom Ochsenschlager, Partner, Grant Thornton LLP Figure 45: Recruitment and Retention Strategies Increase General Comp 63 Employee Morale Activities 59 Flextime 48 Increase Fringe Benefits 46 Telecommute 45 Part Time Arrangements 44 Expand Pool Eligible for Bonuses 39 Office Aesthetics 32 Out-of-Area Workers 23 Figure 46: Recruiting Budget Increased Significantly 30.48% Increased Somewhat 31.43% About the Same 33.33% Decreased Somewhat 3.81% Decreased Significantly 0.95%

38 36 Executive Compensation When determining compensation levels, not only is external competitiveness critical, but internal equity among positions should be maintained as well. The following information provides compensation data and typical positions of the four highest paid executives. Average total compensation for the 4 most highly compensated employees is shown in Figures In virtually all cases, the President/Chief Executive Officer (CEO) is paid the most. The Chief Operations Officer (COO) and the Executive Vice President (VP)/Senior Vice President are typical descriptions for the number 2 position, while the third position and fourth positions are typically Senior Vice President or CFO. Figure 47: Position 1 Highest Paid $0 10M $10 20M Last Year This Year $20 50M $50 100M >$100M $0 $100K $200K $300K $400K $500K $600K Figure 48: Position 2 Second Highest Paid $0 10M $10 20M Last Year This Year $20 50M $50 100M >$100M $0 $100K $200K $300K $400K $500K $600K

39 37 In recent years, the position of CFO has undergone tremendous change and importance to companies as many financial organizations are now developing and implementing long term transformation plans. The CFO s responsibilities in finance have been expanded to integrate information systems with financial reporting, managing global business risks, effective infrastructure and logistical support, and managing more merger and acquisition activities. CFOs are also the drivers behind their company s responding to the challenges of doing business on the Internet. Larry Glassman, National Director of Recruiting, Grant Thornton LLP Figure 49: Position 3 Third Highest Paid $0 10M Last Year This Year $10 20M $20 50M $50 100M >$100M $0 $50K $100K $150K $200K $250K $300K $350K $400K Figure 50: Position 4 Fourth Highest Paid $0 10M Last Year This Year $10 20M $20 50M $50 100M >$100M $0 $50K $100K $150K $200K $250K $300K $350K $400K

40 38 VII. Dealing with the Government Directly related to the DFAS conversion effort is the necessity to close-out any completed contracts since they will not be converted to the new system. Cross agency and contractor cooperation is going to be particularly critical in getting Incurred Cost Submissions in and audited according to FAR and agency guidelines. Lesley C. Gilbert, Director of Finance, Worldwide Technology Business, Booz Allen & Hamilton Inc It has been recognized that government contracting is more of a selling process than an industry. The products and services sold to the Federal government encompass all industries from selling paper and pens to building ships to integrating new enterprise-wide management information systems. Throughout all this, the customer controls how contractors price, deliver, and ultimately get paid. This process has slowly begun to adopt more traditional commercial practices and the government is recognizing that their institutional bureaucracy is creating more of a roadblock during an era that has seen many government positions eliminated. With the proliferation of GSA Schedule contracts coupled with a reduction in cost reimbursable contracts, the risks of doing business between the public and private sector are gradually shifting. Furthermore, companies have instituted internal controls that mitigate the risks associated with disallowed costs or cost allocation inconsistencies or non-compliance. In the last few years, there have also been government initiatives to improve the process of paying contractors on time. To some extent the 7th Annual Government Contractor Survey shows moderate improvement. Incurred Cost Submissions Eight companies (7%) have been audited through their fiscal year ending in 1999, 26% through FY 98 and another 40% through FY 97. However nearly 25% still have more than 3 open years. Although 90% of the respondents have open years waiting to be audited, only 40% have audits scheduled for next year. 64% of respondents get their incurred cost submission in on time. See Figure 51. Figure 51: Incurred Cost Submissions Submitted % of Respondents >180 Days 64% Days 24% 1 Year 12%

41 39 Audit Relations 7% of our respondents have resident auditors. 60% said they always had a good relationship with DCAA. Another 25% judge the relationship as okay while 12% have seen improvement. Only a small number of our respondents have seen their relations with DCAA deteriorate. 65% have approval to submit public vouchers directly to Defense Finance Accounting Services (DFAS) in order to avoid DCAA audits of individual invoices. Audit Issues Over the last three years, there appears to be a significant improvement in complying with the federal acquisition regulations. Compliance with the Cost Accounting Standards (CAS) is definitely moving in a positive direction. Other than CAS 401, Consistency in Estimating Accumulating and Reporting Costs, and 402, Consistency in Allocating Costs Incurred for the Same Purpose, contentious issues have been decreasing noticeably. CAS 405, Accounting for Unallowable Costs, and CAS 410, Allocation of G&A Expense, are the two standards most frequently challenged. See Figure 52. On the other hand, more companies have been having complications with cost accounting changes and cost impacts. The Cost Accounting Standards Board (CASB) released new rules in the spring of 2000 that provide instructions and clarification on how to administer accounting changes. However, disagreement still remains between industry and DCAA about what constitutes an accounting change. Prior to 1994, nearly 12% of the respondents reported that the costs disallowed by the government were significant. Since then, only 3 or 4%, on average, have reported them as significant. We asked our respondents what cost allowability issues have arisen most frequently over the last two years as well as the allowability issues before that time. See the results in Figure 53. Figure 52: Most Frequent CAS Audit Issues Disclosure Statement Non-Compliance CAS 418 CAS 417 CAS 415 CAS 409 CAS 403 CAS 404 CAS 401 CAS 410 CAS 402 CAS 405 Figure 53: Most Frequent FAR Audit Issues Cost Accounting Change/Cost Impact Within Last Over 2 2 Years Years Ago Executive Compensation 21% 14% Bonus Pools/Incentive Compensation 14% 14% Excessive Employee Morale 12% 11% Capitalized/Expensed Software 9% 2% Value Added vs. TCI G&A Base 8% 11% Indirect Cost Allocations 7% 6% Other 7% 4% Consultant Costs 6% 8% Legal Costs 6% 8% Total Time Accounting 6% 5% 6th Annual Survey 7th Annual Survey 0% 5% 10% 15% 20%

42 40 The average number of days to collect invoices is approximately 58, as shown in Figure 54. Figure 55 shows that when it comes to getting paid, the particular agency with which you are working makes a difference. Figure 54: Average Days Outstanding by Company Size $0 10M $10 20M $20 50M $50 100M >$100M All When asked about which agencies were good at paying on time: Nearly 60% said the Department of Energy (DOE) and the Environmental Protection Agency (EPA) always paid within a reasonable amount of time. Only 27% thought DoD was always reasonable, but 27% also said DOD was getting better. More than 13% said DoD was getting worse at timely payment, the only agency with significant respondents making this claim. 14% of the respondents said the Department of Justice (DOJ) was always poor at paying in a timely manner. Figure 55: Time to Collect Invoices DoD Always Reasonable Getting Better About the Same Getting Worse DOE Always Poor EPA DOT DOJ 0% 10% 20% 30% 40% 50% 60% 70%

43 41 When asked about the quality of the relationships in resolving billing disputes, as illustrated in Figure 56, a strong correlation exists between the quality of the relationship and the amount of time it takes for the business to collect on its invoices. About 60% said DOE and EPA were always reasonable about resolving billing disputes. Only 27% thought DoD was always reasonable. Nearly 10% thought DoD was getting worse and 6% thought they had always been poor. Although DOJ was having trouble paying on time, nearly 50% thought they were reasonable in resolving disputes and another 13% thought they were getting better. Web-enabled systems are emerging within the government and companies, for all types of transactions. The next round of issues we will be responding to will relate to the acceptance of these systems, the auditors reliance on electronic and imaged data, and the audit and control climate, including security features. The public and private sectors will both be questioning the productivity benefits of these systems, as well as whether or not they truly do reduce the cycle times of the government procurement and payment processes. Lesley C. Gilbert, Director of Finance, Worldwide Technology Business, Booz Allen & Hamilton Inc. Figure 56: Quality of Relationship in Resolving Billing Disputes DoD Always Reasonable Getting Better About the Same Getting Worse DOE Always Poor EPA DOT DOJ 0% 10% 20% 30% 40% 50% 60% 70%

44 42 One area that any of us dealing with contracts administered out of DCMA with payment from DFAS will need to be aware of, is the reengineering effort from MOCAS and other related systems to SPS and DPPS. With their long term goal of improving the payment process, the short term impact may be just the opposite. Professional services firms will be the last group converted to the new system, with the implication that we will be the last still operating on the old systems. Lesley C. Gilbert, Director of Finance, Worldwide Technology Business, Booz Allen & Hamilton Inc. Moving to the Electronic Age As shown in Figure 57 below, government contractors are moving into the electronic age, with almost all of the survey respondents having the ability to accept electronic funds transfer. Figure 57: Companies Using E-Commerce Accepting Government Credit Cards Having Capability to Accept EFT Submitting Electronic Invoices Submitting Electronic Invoices Over Internet Submitting Electronic Proposals Submitting Electronic Proposals Over Internet Business Acquisition Strategies Companies were very active in the acquisition arena last year, with nearly 20% of the participants involved in transactions. In the 6th Annual Grant Thornton Survey, 20% of the respondents expected to acquire at least a portion of another company. It looks like that forecast was reliable. We asked the respondents if they acquired contracts or assets from another company in the last 18 months or if they acquired the entire company. By far, the more popular strategy was to acquire contracts, with companies averaging nearly eight transactions per year. As expected, companies did not pay as much of a percentage of revenue for contracts as they would have with transactions involving assets or companies. See Figure 58. Yes 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% No Plan To

45 43 Looking to the next 18 months, it appears that buying other companies will be even more popular, as 29% of our respondents plan to make an acquisition. They expect the price to be comparable to this year s average, as shown in Figure 59. Companies Planning to Be Acquired & Other Exit Strategies Some of the respondents were also approached to sell their companies. Thirty-seven of our respondents have contemplated one of four exit strategies, as listed below in Figure 60. Figure 58: Company Acquisitions Average # of Average Price as Acquisitions Transactions % of Revenue Contracts % Assets % Entire Company % All 20 % of All Respond18.35% Figure 59: Companies Planning Acquisitions Planned Average # of Average Price as Acquisitions Transactions % of Revenue Contracts % Assets % Entire Company % All 32 % of All Respond29.36% Figure 60: Exit Strategies % of all Companies Companies Contemplating Exit IPO % Sale % ESOP % Gift/Inheritance % Total %

46 44 Looking Forward Virtually all government contractors with revenues from $10 million to $200 million are constantly examining their strategic options : financing internal and external growth (acquisitions); the realities of an IPO; establish an ESOP; or sell. The cumulative effort of the proliferation of multiple government wide contracting vehicles, the bundling of contracts, and the movement towards outsourcing has created uncertainty for middle-market contractors. I expect the consolidation activity to continue but with buyers focused more on strategic and cultural fit and less on building critical mass in part due to a tightening of credit and a downturn in the public markets. J. Richard Rick Knop, Chairman & Co-Managing Partner, Windsor Group, LLC. As the industry regulations and needs change and companies mold themselves around these changes, new business risks emerge. It is incumbent upon management to isolate how these new risks expose the company and rebalance their investments in protecting against these risks. Chris Mattingly, Director of Government Contracts Business Services, Grant Thornton LLP While we face a number of future challenges, in my view, none are more profound than our need to work at improving the overall perception and communicating the economic benefits of our industry. The war of public opinion continues to drive the legislators and policy makers. The pressures of budget limitations and defense downsizing continue to fuel outsourcing debates which could fundamentally reshape our marketplace. Glenn Baer, Director of Contracts, ARINC The environment that we have enjoyed in the past decade may be changing and changing fairly significantly. Double-digit healthcare costs are returning co-incidental with a slowing economy. Employers may no longer be able to preserve a strategy of absorbing benefits and Medical cost increases. William M. Stanton, Managing Director, Palmer & Cay Consulting Group

47 ADR is changing the very culture of litigation itself. Litigation, at its essence, is war the method of last resort. ADR is consensus-based. Clients will place a higher value on lawyers who are adept in the arts of both litigation and ADR settlement techniques, than they will for the one-dimensional warrior. Dave Metzger, Partner, Holland & Knight LLP In addition to spending time on strategy and broader issues, CFO s are responding to their company s increased focus on profitability and are studying revenues and profits by customer, product and market. Concurrently, analyses of capital investments and cash-flow generation are being reviewed closely. Larry Glassman, National Director of Recruiting, Grant Thornton LLP 45 A future challenge will be continuing to leverage the government buying power while balancing the interest of social economic programs. We need an effective and equable approach to address the issues of requirement bundling. Glenn Baer, Director of Contracts, ARINC ADR brings a wide variety of benefits compared to litigation, including a greater range of remedies, the ability to attract a specialized expert to hear the matter, faster process and lower costs. There are also obstacles to ADR, including bitterness between parties, lack of familiarity of ADR by litigators and agreement to ground rules. ADR benefits accrue only to those who can move beyond the front-end obstacles. Dave Metzger, Partner, Holland & Knight LLP It will be interesting to see the effects the internet will have on the prices the government pays for products and services. The proliferation of GSA has helped corporate profit margins. However, new government internet tools will provide it with the capability to search for the lowest price quicker and at less cost. Chris Mattingly, Director of Government Contracts Business Services, Grant Thornton LLP It is likely that healthcare costs will more than double as a per capita charge within this decade which will increase cost shifting and employee demand for greater choice and value. We are also likely to experience the continuation of the trend of reducing or eliminating employer sponsored medical coverage for retirees. William M. Stanton, Managing Director, Palmer & Cay Consulting Group

48 46 Sponsor Helping government contractors stay ahead... you are creating the future rather than waiting for it, you might want call Chris Mattingly at (703) Grant Thornton is dedicated to helping your company meet the challenges and complexities of the government contracting industry. Our consultants have broad experience working with some of the largest government contractors in the industry. Our services include: Billing Rate Analysis - Evaluate labor categories to maximize profits and increase revenues through effective pricing. Cash Flow - Improve cash cycle and reduce processing time from cash disbursement to cash collections. Balanced Scorecard - Develop and monitor comprehensive financial and non-financial business plans that are balanced with all corporate functions. Risk Management - Manage and avoid key hazards involved in running a business (GSA Schedule Risks, Negotiated Contract Risks, Internal Audit Outsourcing). Litigation Support - Provide expert assistance with Cost Accounting Standards, Federal Acquisition Regulations and the Truth in Negotiations Act. Mergers and Acquisitions - Due diligence audit program designed for government contracting industry. Backlog analysis, margin analysis, compliance risk assessment, net worth components assessment, results of operations, and cash flow analysis.

49 Co-Sponsor 47 This is your turf. This is our turf. Face it. As a government contractor, you ve got challenges that the big banks don t always address. And the little fish don t always understand. As the Washington metro region s only locally owned and locally managed bank, we ve been there. We cover the full range of modern, commercial banking services. We ve got $12 billion in assets. We ve got over 170 branches. We ve got a Government Contracting and Technology Group that speaks your language. And understands your needs. Let s get together we ve got a lot in common

50 48 Co-Sponsor The resources of a bulge bracket firm. The senior management attention of a boutique. As outsourcing amongst Federal agencies continues to grow and GWAC vehicles proliferate the government contracting sector has never been more competitive. In an effort to access customers and enhance their service or product offerings, many companies are relying on mergers and acquisitions. Located in Northern Virginia, Windsor Group is the premier investment bank for Government contractors. By virtue of our unique understanding of the Federal marketplace and our end-to-end capabilities we provide customized services for contractors who perform IT, telecom, and professional services functions for civilian, defense and intelligence agencies. In the last five years alone, we have closed 25 M&A transactions ranging between $15 million and $1.2 billion. In addition to providing the resources of a bulge bracket firm, Windsor Group devotes senior-level management attention to all transactions. From identifying targets, through due diligence to negotiation, financing and closing our partners and senior associates are intimately engaged in each transaction to ensure that we deliver maximum value to our clients. For more information, please contact: J. Richard Knop, Chairman and Co-managing Partner, Windsor Group, LLC or [email protected]. Formerly Boles Knop & Company, LLC

51

52 Grant Thornton LLP The US member Firm of Grant Thornton International 2001 Grant Thornton LLP