Grant Thornton's 2015 Government Contractor Survey

Transcription

1 Grant Thornton's 2015 Government Contractor Survey

2 Contents 1 Introduction 2 Executive Summary 4 Company Profile 10 Workforce Trends 12 Cost Accounting 18 Proposals 22 Project Management and Contract Administration 30 Compliance Programs and Business Systems 34 Dealing with DCAA and Contracting Officers 40 Executive Compensation 43 Mergers and Acquisitions and Other Business Strategies 46 Recent Developments at DCAA 50 Sponsors

3 Introduction Grant Thornton LLP is pleased to provide the 2015 Government Contractor Industry Survey as part of our continued thought leadership within the government contractor community a community we have proudly served for three decades. Our survey provides a comprehensive look at the industry as a whole. It also includes detailed information on the day-today business of a government contractor including a wealth of information on updates to government regulations and changes in the policies, priorities, and approaches of government auditors and contracting officers. Finally, the survey addresses mergers and acquisitions and other business strategies that could benefit the owners of companies involved in government contracting. The survey is designed to cover sensitive areas that can directly affect the revenue and profitability of a government contractor and to help companies remain competitive in the marketplace. We also offer suggestions on how to deal with contractual and financial issues that may arise during performance of government contracts. Whether you are an established government contractor or a business considering entering this market, we hope you will find the information in this survey to be useful in managing your business now and planning for its future. We pride ourselves on being a firm of thought leaders who provide personalized attention and the highest quality of service. Our goal is to ensure this survey continues to evolve and to provide those interested in government contracting with the most precise and useful information possible. We welcome any suggestions for specific topics to cover in next year s survey. Please contact me directly at [email protected] with your suggestions. A special thanks goes to my fellow partner, Kerry Hall, for his leadership in driving this survey process as well as the production of the survey in many of the year s past. We are fortunate to be supported by several generous sponsors who share our passion for this industry: BB&T Capital Markets Cresa Holland & Knight LLP Professional Services Council (PSC) Pleasant Valley Business Solutions (PVBS) Stout Risius Ross, Inc. SunTrust Banks, Inc. Richard P. LaFleur Partner in Charge, Markets, Industries and Clients Government Contracts Practice Leader Atlantic Coast Market Territory 1 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 1

4 Executive Summary Grant Thornton s periodic survey of government contractors presents a wealth of financial and nonfinancial information provided by companies located across the country. The government contractors that participated are small, medium and large companies and include both privately owned as well as publicly held companies. We also included in our survey new developments in government contracting in order to assist the reader in staying current with the seemingly ever-changing priorities and processes followed by government personnel who interact with government contractors. We sincerely appreciate the participation of the many companies that contributed to our survey. Revenue from government contracts During the past year, revenue from government contracts grew for 42% of survey participants, while 37% reported reduced revenue. The remaining 21% reported no significant change in revenue from their government work. The percentage of companies experiencing reductions is at the high end of the trends that we have noted over the many years we have published this survey. The reductions this year are the inevitable consequence of altered government spending priorities as well as sequestration; this will almost certainly be resolved in the next year or two. Profit rates Profit rates remain dismal in the government contracting industry. In the current survey, 52% of respondents reported either no profit or low profit in the range of 1-5% of revenue. This compares to 60% from the 2013 survey and 37% reported in the 2012 survey. Trend in number of full-time employees The number of full-time employees increased at 59% of the surveyed companies, while 15% report decreases, and the remaining 26% reported no significant change. In the 18th annual survey, 42% reported increases, 32% decreases, and 26% no significant change. Trends in indirect cost rates Indirect rates increased at 26% of the surveyed companies and decreased at 42%, with the remaining 32% reporting no significant change. In the 2013 survey, increases in rates were reported by 42% of respondents, 17% reported decreases, and 41% reported no significant change. Impact of revised maximum executive compensation on indirect cost rates The maximum allowable executive compensation for contracts awarded between December 31, 2011 and June 23, 2014 is $952,308. For all contracts awarded on or after June 24, 2014, the compensation limit is $487,000. These different limitations will require a contractor to compute two sets of indirect rates which will be applied based on the award date of individual contracts. Accounting for uncompensated overtime Seventy-five percent of surveyed companies account for uncompensated overtime by computing a diluted hourly rate (compression method) to allocate labor costs to cost objectives. The remaining 25% apply a standard hourly rate (standard 2 Grant Thornton's 2015 Government Contractor Survey Survey

5 variance method) to the hours reported and record the variance between labor distributed and payroll paid as a credit to overhead. In a cost-reimbursable environment, the use of the compression method can result in free work to the government customer and contribute to lower profits for the contractor. Proposal win rates Surveyed companies reported a 35% win rate on proposals submitted in a competitive environment. The win rate increased significantly to 75% when the company was the incumbent on the previous contract. Funding notices on cost reimbursable and T&M contracts Surveyed companies were asked to rate the effectiveness of their procedures for providing required advanced funding notices in a timely manner. Ninety-two percent of respondents reported their procedures are either very effective or somewhat effective; this is up from 86% reported in our last survey. Identifying claims for out-of-scope work Surveyed companies rated the effectiveness of their internal procedures for identifying out-of-scope work. Seventy-seven percent of respondents rated their procedures to be either very effective or somewhat effective which is consistent with the 82% reported in our last survey. Government requests for out-of-scope work without a contract modification Seventy-eight percent of surveyed companies report that government officials either frequently or occasionally request they perform out-of-scope work without a contract modification. Such requests are not consistent with the government s own procurement regulations and, given their frequency, have significantly corrupted the procurement process. Relationship with DCAA auditor A very large percentage of surveyed companies (43%) have a low opinion of the Defense Contract Audit Agency s (DCAA s) work product and the quality of its conclusions and believe the DCAA audit conclusions are arbitrary and not appropriately referenced to procurement regulations. This compares to 53% in our last survey. Further, 33% find DCAA to be inflexible and not responsive to contractor rebuttals. Relationship with the contracting officer Surveyed companies have an even lower regard for contracting officers than they do for DCAA. Forty-nine percent of surveyed companies report that contracting officer positions are arbitrary and supported with appropriate regulatory reference, and 45% find their contracting officer to be inflexible and not reasonably receptive to contractor rebuttals. M&A activity Fifty-six percent of surveyed companies expect the environment for M&A activity to improve over the next 12 months while 35% expect no change. During the past year, 69% of surveyed companies that considered M&A walked away from a prospective deal because of issues identified during due diligence. DCAA's role in the procurement process DCAA s role in the procurement process has been significantly reduced because of government concerns with DCAA s perceived inability to issue quality audit reports in a timely manner. DCAA s responsibilities have been reduced to such a degree that one can easily foresee the possibility that DCAA may soon officially lose its independent status within the procurement system and be put under the direct management control of contracting officers. Cost effectiveness of compliance regulations We asked surveyed companies whether or not they considered the compliance requirements for business ethics to be reasonable and cost-effective. The majority of respondents (63%) believe they are excessive and not cost-effective which compares to the 59% reported in our last survey. The compliance regulations are about to become more costly and more burdensome to contractors if new regulations proposed by the Department of Labor on May 28, 2015 are incorporated into the FAR. 3 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 3

6 Company Profile Grant Thornton s 2015 Government Contractor Survey is based on information provided by companies that do business with the federal government as a primary customer. We distributed questionnaires and received responses from participating companies between March and June of Financial statistics in the survey typically relate to fiscal year 2014 and were treated in the survey as belonging to the current year. We analyzed all of the data provided by respondents to be certain it was statistically valid and representative of the companies that responded to the survey. Data is presented in the survey as a whole or by company size when appropriate. In many instances, we also provide data from prior surveys in order to identify trends from survey to survey. In addition, we include a narrative for each topic and in several instances, offer suggestions on effective practices for cost accounting and contract administration for government contracts. Size of the business Surveyed companies provided their annual revenue by revenue range, and the results are summarized in Figure 1. Each of the revenue ranges shown are well-populated which demonstrates that the survey data represents an excellent cross-section of the government contractor industry. Revenue by market The revenue by market is shown in Figure 2. The percentage of revenue from contracts with federal agencies remains very high at 74% which illustrates that companies participating in the survey see the government as a primary customer. This year s rate of 74% compares with 84% in the 2013 survey, 93% from the 2012 survey, 94% from the 2011 survey, and 91% from the 2010 survey. Fig 1. Annual revenue >$150 million $ million $11-50 million $0-10 million 15% 33% 36% 16% Fig 2. Revenue by market We also asked whether the surveyed companies were classified as small businesses using the size standards published by the Small Business Administration (SBA). Fifty-two percent of the surveyed companies report they are a small business which is similar to the percentages noted in the past four surveys. Defense Other federal State and local Commercial 40% 34% 8% 18% 4 Grant Thornton's 2015 Government Contractor Survey Survey

7 Revenue trend from federal business The revenue trend from federal business is illustrated in Figure 3 for the current survey along with the results from the prior four surveys which are presented for comparison. In the current survey, 37% reported decreased revenue from federal business while 42% experienced increased revenue from government contracts. Fig 3. Revenue trend from federal business 2015 survey 2013 survey 2012 survey Increased 2011 survey 2010 survey 42% 36% 55% This is the second consecutive survey where the number of companies experiencing decreased revenue from government contracts is very close to the number of companies experiencing increased revenue. This is no surprise and indeed is the predictable consequence of altered spending priorities as well as sequestration caused by the inability of politicians from both parties to efficiently manage the country s financial affairs. While procurement by certain civilian agencies can withstand the uncertainties associated with sequestration, it seems clear that procurements for national defense need a steady path from year to year given the need to maintain a modern and well-equipped military in a dangerous world. The government could save a great deal of money by instituting a streamlined procurement process but there are few signs indicating that the government is prepared to make significant changes in the procurement process. Revenue source We asked surveyed companies to provide the percentage of revenue from services, products, and pass-through transactions. On average, professional services generated 66% of revenue, product sales were the source for 18% of revenue, while the remaining 16% came from pass-through transactions. Decreased No change 37% 38% 29% 22% 20% 21% 26% 21% 23% 30% Revenue trend from the GSA or other multiple-award IDIQ contracts Approximately 20 years ago, the government greatly increased the use of indefinite delivery/indefinite quantity (IDIQ) contracts as part of a major effort to streamline the procurement process. Previously, the only major IDIQ contracts were the Federal Supply Schedule contracts which were directed and managed by the General Services Administration (GSA). IDIQ contracts typically include full terms and conditions, product or service offerings, negotiated unit prices, and a nominal minimum ordering requirement. An IDIQ contract is generally awarded to multiple contractors who are then allowed to compete for task orders or delivery orders issued by the government for goods and services. Some task or delivery orders may be set aside for small business competitors, while others are unrestricted and available to all companies holding the IDIQ contracts. IDIQ contracts usually remain in place for several years and are intended to cover those products and services where the government anticipates recurring requirements. Companies that do not have the IDIQ contract are 5 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 5

8 effectively barred from competing for work as a prime contractor for task orders or delivery orders. We have noted in the past that companies often bid deeply discounted pricing as part of their initial proposal for the IDIQ contract. Since the contract itself is simply an ordering vehicle with additional competition required for actual work, we believe it is normally advisable for companies to bid higher prices in the proposal for the initial IDIQ contract with the knowledge that the company has the option to discount those prices in a competition for highly desirable real work under delivery orders or task orders. In our experience, one size fits all is not a formula for success in government contracting. Fig 4. Revenue trends from GSA contracts or other IDIQ contracts Increasing Decreasing No significant change 45% 14% 41% Fig 5. Revenue by contract type We asked companies to provide information on the overall trend in revenue from IDIQ contracts and the results are shown in Figure 4. This year, 45% of respondents report increases in revenue from such contracts while 14% report decreases. The remaining 41% report no significant change. Revenue by contract type Surveyed companies provided a breakdown of revenue by contract type and the results are shown in Figure 5. We ve also provided information from the past five surveys for comparative purposes. The revenue by contract type has changed somewhat from that reported in recent surveys. Compared to the results from the 2013 Survey, the revenue from firm fixed price (FFP) contracts has increased from 20% to 33%, cost-reimbursable contracts have declined from 40% to 34% and T&M contracts have declined from 40% to 33%. There is a major disconnect between government policy and government practice when it comes to selecting a contract type. Part 16 of the Federal Acquisition Regulation (FAR) expresses a clear preference for FFP contracts and imposes specific requirements that must be met before a cost-reimbursable or Time and materials (T&M) contract can be issued. In spite of the clear regulatory preference for FFP, that contract type still represents barely one-third of the total revenue surveyed companies earn from government contracts survey 2013 survey 2012 survey Cost-reimbursable Time and materials Firm fixed price 2011 survey 2010 survey 2009 survey 34% 40% 45% 40% 46% 45% 33% 40% 35% 40% 34% 35% 33% 20% 20% 20% 20% 20% 6 Grant Thornton's 2015 Government Contractor Survey

9 FAR Part 16 also makes clear that T&M is the least favored contract type and such awards require specific determinations by the contracting officer that no other contract type is suitable. The contracting officer s determination must be reviewed and approved by the head of the contracting activity if the total contract term, including option years, exceeds three years. We believe that in the next Congressional examination of necessary improvements to the procurement system, the regulations on contract type should be re-evaluated mandating a preference for FFP where the deliverable is clearly defined and a preference for T&M for the acquisition of professional services where the requirement is less clearly defined. In our opinion, cost reimbursable contracting should be minimized or eliminated since that is the one unique contracting type used by the government that is rarely used in commercial markets for the acquisition of goods and services. Eliminating cost reimbursable contracting would also save the government many billions of dollars annually currently being spent by contractors, DCAA, and contracting officers related to cost submissions and the costs to audit and billions more funding cost overruns on cost reimbursable contracts. Source of revenue growth over the next 18 months We asked respondents to predict the source of revenue growth over the next 18 months. The results are summarized in Figure 6, along with comparative data from the last four surveys. Fig 6. Sources of anticipated revenue growth 2015 survey 2013 survey 2012 survey Prime contracts for federal business Subcontracts for federal business State and local 69% 49% 55% 26% 69% 57% 34% 56% 61% 20% 19% 15% 12% 23% 2011 survey 2010 survey The findings from the five surveys show the effect of the uncertainties involved in federal contracting that many of the respondents face. Although the situations obviously differ from company to company, the data summarized in Figure 6 shows that for many small to medium sized companies, it is challenging to lack visibility as to where the business the company depends on for its survival will come from year to year. Political impacts from factors such as sequestration and lowered priorities for defense and space exploration also create major business uncertainties. It seems axiomatic that it would be preferable and far more cost-effective if the government could adopt certain national priorities that would survive the ever-changing political whims of elected officials. Commercial 31% 32% 25% 19% 26% 7 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 7

10 Profit rates before interest We asked companies to provide their profit rates before interest and taxes as a percentage of revenue and the results are shown in Figure 7. We have also included the results from the five prior surveys for comparison purposes. Profits continue to plunge when compared to profits reported in earlier surveys. The profit rates in Figure 7 are calculated before interest and taxes and therefore do not reflect the total cost of doing business. For companies that make a profit or finance their working capital, the profit rates are significantly lower than the already low profit rates shown in Figure 7. The very low profit rates realized by contractors combined with the insignificant savings from government audits discussed later in the survey strongly suggest that an overhaul of the procurement system could save many billions of dollars currently being wasted conducting audits of low-risk cost submissions. Even if the government sees a need to maintain an audit agency in support of contracting officers, it should be clear that the risk assessments should be redesigned to focus on situations where the risk of procurement issues is evident from premium profit rates. Fig 7. Profit rates before interest and taxes 2015 survey 2011 survey 2013 survey 2010 survey 2012 survey 2009 survey No profit 7% 4% 6% 10% 14% 5% 1-5% profit rate 45% 56% 31% 40% 31% 32% 6-10% profit rate 39% 31% 37% 35% 40% 39% 11-15% profit rate 7% 5% 18% 9% 12% 10% >15% profit rate 2% 4% 8% 6% 3% 14% 8 Grant Thornton's 2015 Government Contractor Survey

11 Facility costs Surveyed companies provided facilities cost as a percentage of revenue and the results are shown in Figure 8. We are aware that several privately held government contractors lease facilities from other organizations that are at least partially owned by the same executives that own the government contracting entity. The rental cost principle in FAR Part 31 limits the amount of rent that can be charged between organizations under common control to the normal cost of ownership such as depreciation, taxes, insurance, facilities capital cost of money, and maintenance. We have observed several instances where a contractor unnecessarily limited rental costs by misinterpreting what constitutes common control or by not claiming all of the costs properly includable in the accounting records for the real estate entities when computing cost of ownership. Fig 8. Facilities cost as a percentage of revenue 69% 24% 4% 2% 1% 1-5% 6-10% 11-15% 16-20% >20% 9 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 9

12 Workforce Trends Approximately 66% of the companies participating in this year s survey provide professional services to their clients. This is often a highly competitive business market that puts a premium on a company s ability to recruit and retain skilled and motivated employees who perform as required by the contract. Trend in number of full-time employees We requested that companies provide information on the trend in the number of full-time employees at the company. The responses are summarized in Figure 9 and show that the number of employees is increasing at 59% of the companies, decreasing at 15% of the companies and no significant change at the remaining 26%. These statistics are an improvement over the findings from the last survey in which only 42% reported the number of employees was increasing. Turnover rates We asked surveyed companies to provide employee turnover rates as a percentage of full-time employees and the results are shown in Figure 10. Turnover rates in the 0-5% range are reported by 30% of the respondents, while 26% report turnover in the 6-10% range. Of the remainder, 27% report turnover rates in the 11-15% range and 17% report turnover greater than 15%. The median turnover rate for all respondents is 9%. These high turnover rates are at least partially the result of the government s changing spending priorities and sequestration which has resulted in government programs being cancelled or delayed. We asked surveyed companies to provide the impact of sequestration on their full-time workforce and 25% reported that the impact was major and resulted in a reduction in staff while the remainder reported that the impact was minor or non-existent with no impact on the number of full-time employees. Fig 9. Trend in number of full-time employees Increasing Decreasing No significant change 59% 15% 26% Fig 10. Turnover rates 30% 26% 27% 17% 0-5% 6-10% 11-15% >15% 10 Grant Thornton's 2015 Government Contractor Survey Survey

13 Wage increases We asked companies to provide the average wage increase percentage for full-time employees during the past year. The responses ranged from no increases to 9%, with the median response of 2%. The median wage increase is slightly lower than those reported in recent surveys. Health insurance benefits Surveyed companies provided their health benefits costs as a percentage of labor costs and the results are shown in Figure 11. Also shown are the results from the prior five surveys, provided for comparative purposes. Companies health insurance costs are a function of several variables including benefits offered, percentage of health insurance costs paid by the company, percentage paid by the employee, and other factors. The information in Figure 11 shows the median health insurance cost as a percentage of labor for this year s survey is in the 7.1-8% range, compared to % reported in the last survey. We also asked companies to describe the impact of the Affordable Care Act (ACA) on health care costs at the company and we received some interesting responses. Approximately 46% of respondents reported that health care costs increased significantly while approximately 54% of the companies reported no significant change in health care costs. Additionally, 33% of the respondents increased the employee share of health plan costs and 10% reduced benefits for the employee s family. 401(k) plans We asked companies whether the company percentage contributions to the 401(k) plan had changed in the past year. Only 15% reported changes to the 401(k) match while the remaining 85% reported no change in the percentage match to the employee s 401(k) plan. Of those that changed the match, 9% reduced the match while 6% reported increases. Paid absences Surveyed companies were asked whether paid absences for an employee s vacation and sick time were accrued separately or as a combined benefit. The majority (70%) responded that paid absences are accrued as a combined benefit. Fig 11. Health insurance as a percentage of labor costs <4% 4.1>5% 5.1-6% 6.1-7% 7.1-8% 17% 6% 14% 16% 10% 9% 12% 5% 10% 8% 9% 7% 4% 11% 8% 15% 12% 13% 7% 13% 9% 11% 14% 16% 13% 9% 13% 9% 17% 10% 8.1-9% % >10% 9% 5% 7% 11% 4% 4% 7% 12% 8% 4% 8% 15% 31% 39% 31% 26% 26% 26% 2015 survey 2013 survey 2012 survey 2011 survey 2010 survey 2009 survey 11 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 11

14 Cost Accounting A company s cost accounting practices are often critical factors in the competitiveness and profitability of the company. Government regulations on cost accounting practices are conceptual and provide a great deal of discretion in selecting specific cost accounting practices that are most effective in the various markets where the company operates. Once a company has implemented its cost accounting practices, they must be consistently applied. In some situations, changes to cost accounting practices must be reviewed and approved by a contracting officer or government auditor before the changes can be implemented. Fringe benefit rates Many government contractors offering professional services to their clients account for fringe benefits in a separate burden pool which is allocated to projects and other indirect cost pools as a rate applied to total labor costs. The fringe benefits pool generally includes costs for payroll taxes, paid time off, health insurance, retirement plans and other employee benefits. Some contractors include employee bonuses in the fringe benefits pool, while others charge benefits to other indirect cost pools or as a direct cost to projects. Bonuses can have a significant impact on indirect cost rates in situations where bonuses are large. We asked companies to provide their fringe benefits rates and to indicate whether the fringe benefit pool includes or excludes bonuses. The responses are shown in Table 1 along with the results from the five prior surveys which are presented for comparison. The median fringe benefits rate without bonuses in the pool is 36% while the median rate including bonuses in the pool is 1% higher at 37%. The median fringe benefits rates in this survey are very close to those reported in prior surveys. As discussed in the Workforce Trends section of this survey, it appears that many contractors are maintaining their fringe benefits rates at historical levels by requiring that employees pay a larger portion of increased health insurance costs. Labor overhead rates Firms that offer professional services to government agencies usually maintain indirect cost pools to accumulate the costs of indirect charges for management and support time, as well as other indirect expenses associated with the direct charging personnel who perform the work described in the contract statement of work. These indirect cost pools are usually referred to as labor overhead and are generally allocated to contracts by a rate applied to direct labor costs. Some government contractors include the fringe benefits associated with the direct labor costs in the allocation base rather than in the labor overhead pool. While moving fringe benefits associated with direct labor from the numerator to the denominator yields a lower calculated overhead rate, the sum total of the costs for direct labor, fringe benefits and labor overhead remains the same under either method. Table 1: Fringe benefits rates as a percentage of total labor Benefit inclusion type 2015 Survey 2013 Survey 2012 Survey 2011 Survey 2010 Survey Fringe benefits including bonuses 37% 36.4% 34% 35.5% 35% 35% 2009 Survey Fringe benefits excluding bonuses 36% 34.5% 32% 33% 33% 33.8% 12 Grant Thornton's 2015 Government Contractor Survey Survey

15 Surveyed companies provided their actual labor overhead rates for their primary pools and the results are shown in Table 2 along with the results from the five prior surveys which are included for comparative purposes. Separate rates are shown for on-site (company site) and off-site (customer site) overhead. On-site rates are generally considerably higher than off-site rates, because the on-site overhead pool includes the facility-related expenses incurred by the company to house the employee, while no such expenses are incurred or allocated to the labor costs of direct charging personnel who work at the customer site. The rates in Table 2 are also separated by allocation base, showing rates for companies that include fringe benefits in the allocation base separate from those companies that include fringe benefits in the labor overhead pool. Surveyed companies also provided information relative to the logic behind separate overhead pools where multiple overhead rates are maintained in the cost structure. The results are shown in Figure 12. Physical location is the primary discriminator between overhead pools for contractors that maintain multiple labor overhead pools. The survey also found that only 24% of respondents established separate overhead pools by customer. This approach generally results in commercial work subsidizing government work since it is beyond dispute that government contracts impose far greater administrative and reporting burdens on companies than do contracts with commercial clients for nongovernment work. It might be advantageous for government contractors to revisit this approach, particularly in situations where the company has a strong competitive advantage in the government market in which it operates. When advising clients on indirect cost rate structures, we recommend that to the maximum extent possible, the company should establish an indirect cost rate structure that results in separate rates that are competitive and profitable in each of the government contracting and commercial markets in which the company pursues work. This approach can be implemented within a single legal entity and does not require separate legal entities by market. A one-size-fits-all approach to indirect cost allocations is generally not the most advantageous approach to allocating costs, particularly in situations where a company is striving to attract new business and grow in markets that are very price sensitive. The regulations in the FAR and cost accounting standards (CAS) are very flexible in regard to allocating indirect costs, with a wide range of acceptable methods. A well-thought-out cost structure is very important for all government contractors including not-for-profit organizations that frequently seek funding from government and non-government sources who have entirely separate rules and regulations relative to budgeting and billing. Figure 12: Logic behind multiple overhead rates Location 53% Function 15% Customer 24% Product vs. services 8% Table 2: Overhead rates by site and allocation base Overhead type 2015 Survey 2013 Survey 2012 Survey 2011 Survey 2010 Survey On-site direct labor 77% 84% 80% 65% 69% 84% On-site direct labor plus fringes 36% 43% 48% 38% 48% 51% Off-site direct labor 49% 38% 48% 42% 47% 45% Off-site direct labor plus fringes 20% 21% 23% 19% 18% 17% 2009 Survey 13 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 13

16 G&A rates The cost structures of most government contractors include a general and administrative (G&A) expense pool. G&A typically includes the cost of headquarters functions such as executive management, accounting, legal, contract administration, human resources, and sales and marketing. G&A also typically includes the company-funded portion of independent research and development (IR&D) and bid and proposal (B&P) costs. The G&A pool is usually allocated to projects at a rate applied to total cost input (TCI) or value added cost input (VACI) although other methods are authorized in CAS 410 where neither TCI nor VACI would yield equitable results. TCI is the sum of total costs excluding G&A expenses, while VACI is total costs excluding G&A, direct materials, and direct subcontracts. Surveyed companies provided their actual G&A rates and allocation bases and the results are shown in Table 3 along with the results from the previous five surveys. The G&A rates from this year s survey are generally consistent with those from prior years. Material handling and subcontract administration rates Many government contractors that allocate G&A on a VACI base also establish a material handling/subcontract administration pool. The objective is to apply an indirect cost rate to the costs for direct materials and direct subcontracts which is lower than the full G&A rate applied to other costs in the VACI base. The material handling/subcontract administration pool typically includes the costs of the company s procurement function, the costs of warehousing the items when the company is procuring inventory and minimal charges for contract administration, legal and program management as appropriate. For the current survey, 29% of respondents report they included material handling/subcontract administration rates in their cost structure and provided their rates which are shown in Table 4. We also included the results from the prior five surveys for comparison purposes. By design, the rates have been consistently low for all years. Further, the rates have not varied significantly from survey to survey. Some companies find it difficult to maintain competitive G&A rates in some of the markets in which they compete for new business which is more price-sensitive than the company s existing business. Government regulations very clearly prescribe that the G&A pool should be minimized and costs should be allocated through other means, such as direct costs or overhead, to the maximum extent possible. The regulations also encourage special allocations where appropriate as discussed later in this section of the survey. Table 3: G&A rates by allocation base Allocation base 2015 Survey 2013 Survey 2012 Survey 2011 Survey 2010 Survey Total cost input 13% 12% 13.5% 13% 13% 11% Value-added cost input 17% 15.4% 15.4% 15.5% 15% 15% 2009 Survey Table 4: Material handling and subcontract administration rates Cost type 2015 Survey 2013 Survey 2012 Survey 2011 Survey 2010 Survey Material handling rate 3% 3% 2.7% 2.2% 3% 3% Subcontract administration rate 3% 3.4% 2.5% 2.2% 4% 4% 2009 Survey 14 Grant Thornton's 2015 Government Contractor Survey

17 Special allocations Special allocations of indirect costs are authorized in FAR Part 31 and CAS when the use of the normal established cost accounting practices would result in an inequitable allocation of indirect costs. Special allocations are often used to burden large and unusual pass-through transactions for items such as equipment, materials, subcontracts, or special facilities. They may also be appropriate in short-term projects in remote areas with few reporting requirements where the term and location of the contract work do not permit the amount of G&A management and administrative oversight that is applied to a contractor s normal business. We asked companies whether they used special allocations to burden unusual transactions and only 9% responded affirmatively. See Figure 13 for the responses for this year and the prior five surveys. Contractors frequently encounter situations where reduced allocations are necessary for both competitive reasons and to assure equitable allocation of costs. In such situations, we almost always advise clients to use special allocations rather than changing the allocation base from TCI to VACI. Changing the indirect cost rate structure in anticipation of a possible future award will distort the cost and revenue flow to existing contracts which should be avoided. Changing the rate structure can also create serious funding issues for contractors with significant revenue from cost-reimbursable contracts. Fig 13. Special allocations 9% 10% 7% 18% 8% 8% 2015 survey 2013 survey 2012 survey 2011 survey 2010 survey 2009 survey The concept of special allocations in FAR Part 31 and CAS is also consistent with a government policy put in place in October 2009 which limits indirect costs on large pass-through transactions where the contractor s value added is limited. The Limitation on Pass-Through Charges clause at FAR specifies that the indirect cost burden on large pass-through transactions is limited to the amount of value added by those indirect cost functions. In our view, that clause is conceptually identical to the special allocation provisions in FAR Part 31 and CAS. However, a word of caution is in order. DCAA has applied what we can only describe as tortured reasoning and have concluded that the excessive pass-through costs not compensable as a result of FAR must still be charged to the contract and absorbed by the contractor. DCAA s position is described in Section of the DCAA Audit Manual. DCAA s position that a cost that does not benefit a contract must nonetheless be charged to that same contract appears to be inequitable, inconsistent with the entire concept of equitable allocation of indirect costs, and is unsustainable. We strongly encourage contractors to include a clear description of a special allocation when one is used in a cost proposal. That will put the issue squarely before the contracting officer when the proposal is being evaluated. Assuming the contract is awarded, the contractor will then have a documented basis to demonstrate that the special allocation was accepted by the contracting officer in the contract award. This type of additional protection may become important in the event that DCAA attempts to apply the ill-conceived guidance from DCAA Audit Manual in future audits. There are other alternatives that serve the same purpose as special allocations, and they should be considered as necessary. These alternatives include contract-specific burden pools or establishing a separate business segment with its own cost structure for any contract with staffing needs, performance requirements or cost patterns that differ from the contractor s existing business. 15 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 15

18 Trends in indirect cost rates Surveyed companies were asked to provide information on the trend of indirect cost rates at their company and the results are summarized in Figure 14. Rates are increasing at 26% of the companies and decreasing at 42%. In the last survey, 42% of respondents reported increasing rates while only 17% reported decreasing rates. We will continue to monitor this closely in future surveys. Impact of revised executive compensation limits on indirect cost rates The government recently changed the statutory cap on executive compensation in such a way that will require contractors to apply different indirect rates to different contracts based on the award date of the contract. For all contracts that were awarded on or after December 31, 2011 but before June 24, 2014, the statutory cap is $952,308. For all contracts awarded on or after June 24, 2014, the statutory cap is reduced to $487,000. These significantly different cost limitations depending on the award date of the contract means that indirect rate submissions for provisional billing rates and final rates will necessitate separate rate computations for each statutory cap with the separate rates applied based on the award dates of each contract. These dual rate submissions will be required as long as contracts awarded on or before June 23, 2014 are still active. Many services contracts extend for a five-year term so it s possible that dual-rate submissions will be necessary through Figure 14: Trends in indirect cost rates Increasing 26% Decreasing 42% No significant change 32% Uncompensated overtime Uncompensated overtime refers to hours worked in excess of the standard work week by exempt personnel who are not paid for the overtime hours. The timekeeping and cost accounting practices applied to uncompensated overtime can have a major impact on revenue, profitability, and competitiveness. Surveyed companies were asked whether exempt personnel who charge time directly to contracts work uncompensated overtime; 63% reported in the affirmative. This is slightly higher than the 60% reported in our last survey. For those companies reporting significant uncompensated overtime, we requested information on their timekeeping practices. Eighty-two percent of the companies that reported uncompensated overtime record total time worked rather than limiting hours reported to the standard work week. We advise professional services firms with significant uncompensated overtime to record total time worked. The failure to record total time worked could have a very negative impact on revenue and profitability and might also create a risk that the government could withhold approval of the cost accounting system. Beyond recording total time worked, the cost accounting practices adopted for uncompensated overtime should also be carefully considered to assure that the practices themselves do not harm revenue or profitability. Government regulations in this regard are very permissive and identify two acceptable accounting no change methods, which can be broadly described as the compression method and the standard variance method. decreasing Under the compression method, the company computes an increasing effective hourly rate by dividing the salary paid by the hours worked, and then charges projects at that effective hourly rate. In a cost reimbursable environment, the only party that benefits is the government that reaps the benefit of free work and the party that suffers is the contractor who works extra hours at no charge to the customer. This is illustrated by the following example: A direct labor employee is paid $1,000 per week, which is an average of $25 per hour for a standard Grant Thornton's 2015 Government Contractor Survey

19 hour work week. In the first week, the employee works 20 hours on project A and 20 hours on project B. Each project is charged $500 (20 $25). In the next week, the employee works 50 hours for the same $1,000 salary. The effective (compressed) hourly rate is $20 ($1,000/50). The employee works 25 hours on project A and 25 hours on project B. Each project is charged $500 (25 $20). The impact of the compression method is that the employee worked an additional 10 hours for the client in the second week and did not generate any revenue for the company for the extra 10 hours worked. Occasionally, we have encountered situations where the government customer will not pay the company for hours worked by company employees without compensation. Except in very rare circumstances, there is no valid contractual basis for such a position and the government s resistance to payment for services received can be easily overcome. Fig 15. Recording uncompensated overtime The generosity in the compression method is absent in the standard variance method, and the client is billed a full hourly rate for each hour worked. At the beginning of each year, a standard rate is established for each direct-charging employee. Total time is recorded in the timekeeping system throughout the year, and total time reported is charged at the standard rate. The variance between the labor charged to projects and burden pools at standard and the actual salary paid is credited to overhead. In a cost reimbursable environment, the advantages to the standard variance method over the compression method are evident. Under the standard variance method, there is a full labor charge to projects for all hours worked and there are no free hours. Further, the credit to overhead and the increased direct labor base can benefit the company from both a competitiveness perspective and a profitability perspective to the extent that lower overhead equates to increased profitability on fixed price and T&M contracts. The standard variance method can also create the opportunity for discretionary spending in overhead as deemed necessary or desirable by company executives. Surveyed companies provided information on the accounting method being used for uncompensated overtime and the results are shown in Figure 15 along with the results from the prior five surveys. The vast majority of the companies continue to use the compression method. Because that method can be so detrimental to revenue, profitability, and competitiveness, we suggest that those companies with a significant amount of cost reimbursable business re-evaluate their accounting approach to uncompensated overtime survey 2013 survey 2012 survey Compression method Standard variance method 2011 survey 2010 survey 2009 survey 75% 78% 72% 76% 80% 84% 25% 22% 28% 24% 20% 16% 17 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 17

20 Proposals Fig 16. B&P costs as a percentage of revenue <1% 15% 14% Government procurement regulations require that contracting officers promote and provide for full and open competition in soliciting offers and awarding government contracts. There are several very broad exceptions to this requirement including (a) only one responsible source and no other supplies or services will satisfy agency requirements; (b) unusual and compelling urgency; (c) industrial mobilization; (d) engineering, developmental, or research capability; (e) expert services for a current or anticipated litigation or dispute; (f) international agreements; (g) authorized or required by statute; (h) national security; or (i) public interest. 1.1>2% 16% 18% 35% 52% 41% 47% 52% 40% Bid and proposal costs as a percentage of revenue Surveyed companies provided statistics showing B&P costs as a percentage of revenue and the results are shown in Figure 16 along with the results of the previous four surveys. The results from the current survey appear to show a sharp movement to the low end of the scale compared to the results from the previous survey. It s likely that the delays in procurements caused by sequestration are a primary cause in the dip in B&P costs during the past year. On the general topic of B&P costs, CAS 420 makes clear that only personnel who charge directly to externally funded projects should charge directly to B&P projects. Applying that regulation, accounting or business development staff that do not charge directly to externally funded projects should not charge time directly to B&P projects % 3.1-4% 4.1-5% 16% 13% 9% 8% 9% 6% 9% 10% 9% 4% 9% 2% 7% 3% 2015 survey 2013 survey 2012 survey 2011 survey 2010 survey 10% 2% >5% 21% 11% 10% 2% 18 Grant Thornton's 2015 Government Contractor Survey Survey

21 Proposal win rate Surveyed companies provided information about their proposal win rates when pursuing non-sole-sourced government contracts. The results are shown in Figure 17 along with the win rates from the five previous surveys which are provided for comparison. The median win rate this year is 35% which is in line with the win rates reported in prior surveys. We also asked for win rates when the respondent was the incumbent on the previous contract. In this situation, the win rate increases significantly from 35% to 75%. This statistic verifies the reasonable expectation that a proven well-performing incumbent should have a significant competitive advantage over nonincumbents when competing for continuing work. We have encountered situations where the incumbent maintained an excellent performance record and yet received a significantly lower technical rating than non-incumbents. It is difficult to rationalize such incongruity unless one stops to consider that the government expects the presumably less qualified incumbent to hand over all of its key employees to the supposedly more qualified company that won the competition. This practice of simply handing over employees from one company to another after a source selection is one of the oddities that make government contracting practices far different from normal commercial business practices. It is little wonder that bid protests are an integral part of government contracting. Proposal win rate when bidding as a special business unit It is fairly common in the government contracting industry for companies to establish special business units such as joint ventures or limited liability corporations to pursue specific government contracts. Frequently, the motivation to establish such units is based on the belief that the current cost structures in the existing business units are not price competitive to win the new business. Depending on the extent of the price competitiveness concern, the special business unit may be populated with employees from member companies or new hires or not populated and simply receive a reduced management and support (G&A) charge from the member companies. When price competitiveness is the primary motivation, we often advise clients that they can achieve the same result by establishing a new lower-cost operating segment with its own cost structure within the existing legal entity. Government procurement regulations give broad discretion to contractors regarding organizational matters. This approach saves the time and expense associated with the creation of a new legal entity such as a joint venture or limited liability corporation, which may or may not win the contract for which it was created to perform. Surveyed companies provided their proposal win rates when they bid as a special business unit and the results are shown in Figure 18. The win rate is 64% which is significantly higher than the reported in the previous survey. Fig 17. Proposal win rates 35% 30% 30% 36% 30% 30% 2015 survey 2013 survey 2012 survey 2011 survey 2010 survey 2009 survey Fig 18. Proposal win rates when bidding as a special business unit 2015 survey 2013 survey 2012 survey 64% 43% 19 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 19

22 Proposals for GSA multiple award contracts GSA multiple award contracts bring unique compliance risks that must be dealt with very carefully when preparing, submitting and negotiating proposals for GSA contracts. The two most significant risks are disclosures in the initial proposal and adherence to the requirements in the Price Reductions Clause. One key to avoid pricing and monetary risks in GSA contracts is a carefully crafted initial proposal with full awareness of the regulatory requirements and the consequences of noncompliance. The initial pricing risks arise from the disclosure requirements in the solicitations for GSA multiple award contracts. The pricing instructions require disclosure of commercial pricing, as well as standard and special discounts. It has been our experience that companies in a rush to negotiate a contract with GSA often provide data that is readily available without giving appropriate consideration to the risks associated with less than full disclosure. Written discount policies that don t include a comprehensive list of special situations that may warrant special discounts create high risk and are the basis for many allegations of overcharging the government through incomplete disclosure in the initial proposal. Such non-disclosures in the initial proposal can be especially expensive to the contractor since the impact of the disclosure may be applied to all orders under the GSA contract if the non-disclosure is identified in a GSA audit. The Price Reductions Clause in GSA contracts brings with it significant risks that can also be best addressed and minimized in the pre-award proposal. Prior to an award, the GSA and the contractor agree on a customer or class of customer that will be used to administer the Price Reductions Clause. This is called the basis of award customer. Under the Price Reductions Clause, the contractor agrees to monitor all sales to the basis of award customer and to notify GSA of all special discounts given to the basis of award customer. This notification must offer the same special discount to the GSA on the same terms and for the same time period that it was offered to the basis of award customer or provide a special justification in the notification why GSA is not entitled to the special discount. The failure to provide the required notice under the Price Reductions Clause will create significant issues in the event of a GSA audit which will likely include a demand for after-the-fact special discounts on all GSA sales from the date of the special discount to the basis of award customer. We asked surveyed companies that used commercial pricing for GSA contracts for information on the basis of award customer for administering the Price Reductions Clause. The results are shown in Figure 19 along with information from the five previous surveys. In the most recent survey, 51% designated all commercial customers while 26% designated a single named customer for the basis of award. When assisting large commercial clients on GSA contract issues, we strongly recommend that they do not designate all commercial customers for the basis of award. In many cases, the number of customers is very large and it is essentially impossible to monitor all deals and special discounts and to provide the required notice to GSA. Fig 19. Basis of award customers on GSA contracts 2015 survey 2013 survey 2012 survey All commercial Single named Other 51% 53% 57% 55% 45% 51% 26% 33% 26% 28% 30% 26% 23% 14% 17% 17% 25% 23% 2011 survey 2010 survey 2009 survey 20 Grant Thornton's 2015 Government Contractor Survey

23 We have also encountered situations where a mistaken belief exists that the GSA is entitled to most favored customer pricing and that the contractor is not allowed to offer lower pricing to other customers. This belief is completely incorrect. There is nothing in the GSA contract which precludes a company from offering whatever pricing the company chooses to offer to any potential customer. The only GSA contract requirement is that the GSA be notified when special discounts are offered to the basis of award customer. Labor multipliers ("wrap rates") Companies that pursue contracts for professional services frequently refer to a metric known as the labor multiplier or wrap rate. This is a financial metric that compares the fully loaded price for an hour of direct labor with the base salary of the employee doing the work. For example, assume that a direct labor employee is paid $10 per hour in base pay. When pricing new work, the contractor applies indirect cost rates for fringe benefits, labor overhead, and G&A and the $10 per hour in base pay grows to $21 including indirect costs. A fee is then applied to the $21 in total costs, resulting in a fully loaded price per hour of $23. The labor multiplier or wrap rate is 2.3, which is derived by dividing $23 by $10. The surveyed companies provided their fully loaded labor multipliers through fee for both on-site and off-site direct labor. The results are shown in Table 5 along with similar information from the last five surveys. The labor multipliers in this year s survey are very consistent with those reported in the last survey. Caution is required when interpreting data on labor multipliers and indirect cost rates. Indirect cost rates vary from company to company based on many factors unrelated to the level of spending including differences in accounting practices between companies for classifying costs as direct or indirect. Another factor that would tend to impact labor multipliers is the accounting practices used for uncompensated overtime. The standard variance method for uncompensated overtime would likely yield a lower multiplier than a company that uses the compression method because of the overhead credit and increased direct labor base generated in the standard variance method. Bid protests In many instances, government procurement regulations permit disappointed bidders to file a formal bid protest if the company believes that the source selection decision did not follow the strict criteria in the solicitation or if the unselected bidder believes its proposal was not fairly evaluated. Bid protests in government contracts have been a frequent occurrence for many years. We asked companies how many bid protests they filed in the last year and how many were successful. The results are shown in Table 6 along with the results from the prior two surveys. Compared to the 2013 survey, the number of bid protests has declined as has the number of successful protests. Although the numbers are somewhat lower than the prior year, the success rate of 30% is in line with the 2013 survey. The success rate seems high when compared to the government s published statistics on successful bid protests but there is a reasonable explanation for the difference. Many successful bid protests are resolved through corrective action agreed to by the government without the protest proceeding to a formal decision by the authority with jurisdiction over the protest. Table 6: Bid protests Type Number of bid protests filed by surveyed companies Bid protests sustained in whole or in part 2015 Survey 2013 Survey 2012 Survey Protest success % 30% 32% 52% Table 5: Labor multiplier through fee Labor type 2015 Survey 2013 Survey 2012 Survey 2011 Survey 2010 Survey On-site direct labor Off-site direct labor Survey 21 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 21

24 Project Management and Contract Administration For a variety of reasons, the government contracting environment can be very challenging for private companies even in the best of times. The challenges come in many forms including (a) complex regulations which bear little or no resemblance to commercial business practices; (b) a lack of standardization across agencies and within agencies on how the regulations are interpreted and applied; (c) a shortage of highly experienced procurement personnel within government service; (d) inefficiencies in the procurement process caused by unpredictable funding from year to year; and (e) many other factors. In order to survive and thrive in such an unstable business environment, contractors must assure that their project management and contract administration personnel work closely together and present a common message to the government program managers, contracting officers and auditors with whom they interact on behalf of the company. The effectiveness of a contractor s project management and contract administration functions can have a significant impact on a company s profitability. This is always very important but even more so in situations where the competition for a contract is highly price sensitive and bid prices are low. Indeed, it is our experience that the amount of profit on a government contract is more often determined through the approach to contract administration than from efficient contract performance. Funding notices Cost reimbursable and T&M contracts include specific terms and conditions that require contractors to monitor cumulative spending and billings against contract funding and to give advance notice to the government when the contractor determines additional funding is necessary to complete the work. Once the notice is given, the government is obligated to either add funding or terminate contract performance once the funding is exhausted. If funding is not added, the contractor is not obligated to continue working on the project at its own expense. If the contractor chooses to continue performance at its own risk, the government is not required to fund the work after the fact unless the government encouraged the contractor to continue working in anticipation of after-the-fact funding. The monitoring and notification requirements are especially challenging in situations where the government chooses to incrementally fund the contract rather than funding an entire year s performance at one time. In most companies, the monitoring and notification requirements for funding notices require close coordination between the accounting, project management, and contract administration departments. Accounting is responsible for determining actual costs including the anticipated impact of actual indirect cost rates if they differ significantly from provisional rates. Project management is responsible for contract performance including direct communications with government program management on performance matters. Contract administration is generally 22 Grant Thornton's 2015 Government Contractor Survey Survey

25 responsible for communicating directly with government contracting officers on all contractual matters including funding notices on cost reimbursable and T&M contracts. Close coordination between these three functions is always critical but even more so in situations where government personnel administering the contract take arbitrary positions that are unsupported by the terms of the contract. We have encountered situations where a government agency attempted to manage funding and limit payments at the contract line item number (CLIN) level even though the contract included clear language that the funding limitations are cumulative at the total contract level. In that situation, the government refused to pay invoices if the amount billed exceeded the CLIN value for a particular contract year. Fig 20. Effectiveness of providing funding notices 2015 survey 2013 survey 2012 survey Very effective Somewhat effective Not effective 45% 45% 52% 48% 45% 42% 41% 47% 33% 42% 46% 8% 14% 8% 15% 10% 9% 2011 survey 2010 survey 2009 survey Surveyed companies rated the effectiveness of their procedures for providing funding notices in a timely manner consistent with contract requirements. The results are shown in Figure 20 along with the results from the five previous surveys. Ninety-two percent of respondents report their procedures are either very effective or somewhat effective, which is 6% higher than the 86% shown in the previous survey. Identifying out-of-scope work The effectiveness of a company s procedures for identifying out-of-scope work is a major factor in the profitability of a government contractor, particularly those with FFP contracts. Out-of-scope work can arise either from directed changes through formal contract modifications or through constructive changes in which contractors are asked to do additional work without a formal contract modification. The contractor is entitled to an equitable adjustment in the contract price in either situation. Directed changes are easily identified because they arise from formal contract modifications, thereby eliminating any disagreement over whether a compensable event has occurred. The identification and negotiation of constructive changes can be far more challenging because the government, having failed to issue a modification for the change, may deny responsibility or liability for the added work. When a company believes that a constructive change has occurred, the procurement regulations require the contractor to provide prompt notification to the contracting officer so that the parties can either formalize the change in a contract modification or take other appropriate action to mitigate the impact of the constructive change. The failure to provide timely notification of the constructive change may significantly limit the contractor s ability to receive an equitable adjustment for the financial and schedule impacts of the change. Constructive changes often originate from informal requests for additional work by government program managers or by other events beyond the contractor s control. In order to effectively identify out-of-scope work from constructive changes, there must be close coordination between a company s project management and contract administration staff with respect to the minimum requirements to perform the statement of work in the contract, and to identify any and all work performed beyond the minimum requirements. Identifying the minimum requirements shortly 23 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 23

26 after contract award is critical in order to identify a baseline above which constructive changes may be potentially identified. We asked respondents to rate the effectiveness of their procedures for identifying out-of-scope work. The results are shown in Figure 21 along with the results from the five previous surveys. Seventy-seven percent of the surveyed companies consider their procedures to be either very effective or somewhat effective, which is slightly lower than the results from most prior surveys. Surveyed companies were also asked to provide information on the frequency of government requests for out-of-scope work without a formal contract modification. The results are shown in Figure 22, along with the results from the prior four surveys. Whether frequent or occasional, the percentage of surveyed companies faced with informal requests for out-of-scope work is alarmingly high and as such, appears to be yet another example where government officials choose to ignore the government s own procurement regulations. These regulations state that only contracting officers have the authority to change contract requirements and it appears that some government program managers routinely ignore those regulations. It is troubling that 78% of respondents are faced with situations where government officials don t comply with regulations and put the contractor in the difficult position of having to choose between following the contract or following the dictates of the government customer in order to maintain good customer relations. The result of this tendency by the government to work around the contract and the regulations in the pursuit of efficiency is often unsuccessful, particularly when routine matters have to be resolved through the costly dispute process. Fig 21. Effectiveness at identifying out-ofscope work Fig 22. Government requests for out-of-scope work without contract modification 2015 survey 2011 survey 2015 survey 2011 survey 2013 survey 2010 survey 2013 survey 2010 survey 2012 survey 2009 survey 2012 survey Very effective 33% Frequently 10% 30% 21% 35% 24% 31% 15% 44% 16% Somewhat effective 35% 44% 52% 45% 37% Occasionally 68% 64% 57% 52% 62% Not effective 39% 45% 23% 18% 20% 32% Never 22% 15% 19% 33% 22% 17% 20% 24 Grant Thornton's 2015 Government Contractor Survey

27 We also asked respondents how they normally respond to government requests for out-of-scope work without a contract modification. The results are shown in Figure 23 along with the results from the four previous surveys. Ninety-four percent of surveyed respondents reported they always perform, or sometimes perform the out-of-scope work, which is higher than the results from the prior surveys. This extremely high percentage illustrates the dilemma that companies face when asked to do free work by the customer. While an occasional request for free work is not unusual in business arrangements, the frequency of government requests for such work should be unacceptable to the government, particularly considering the government regulations clearly specify that only contracting officers have the authority to change contracts and that all such changes should be through contract modifications. If the government s internal processes and staffing issues preclude the orderly operation of the procurement process, it may be time for the procurement processes to be changed to accommodate the government s current reality. Fig 23. Responses to government requests for out-of-scope work without contract modification 2015 survey 2013 survey 2012 survey Sometimes perform/ sometimes refuse Always perform 70% 74% 68% 68% 66% 24% 10% 16% 15% 15% 2011 survey 2010 survey Filing claims Government procurement regulations allow contractors to file a request for equitable adjustment (REA) or certified claim if the contractor believes it is due additional compensation or other relief while performing the contract requirements. REAs or claims can cover a wide range of issues, but in most cases, the contractor is requesting compensation for work performed to the benefit of the government customer. Two very common examples are contractors seeking funding for work performed beyond contract funding on cost reimbursable or T&M contracts and contractors performing out-of-scope work without a formal contract modification from the government. The most essential component of a successful REA or claim is the ability to document the government s prior knowledge of the situation, along with the government s acquiescence that the contractor should continue contract performance. When faced with a situation that an REA or certified claim may need to be filed in the near future, it is incumbent that the contractor document the out-of-scope work in every way practical in communications with the government. These communications can be in contract status reports, s, letters or any other form of communications that is appropriate in the circumstances. In formal disputes, these types of notifications are key to a successful outcome. The quality and the frequency of these communications from a contractor are dependent on close coordination between the contractor s project management and contract administration functions. Surveyed companies were asked whether they had filed REAs or claims during the past year and only 7% responded affirmatively. The information in Figure 22 shows that 78% of respondents at least occasionally performed out-of-scope work without a contract modification. If only 7% of respondents filed REAs or claims, it appears that approximately 71% of surveyed companies performed out-of-scope work without compensation. It is evident from this statistic that the amount of lost profits from uncompensated work is significant, which is one clear cause of the low profit rates discussed earlier in this survey report. Refuse to perform 6% 16% 16% 17% 19% 25 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 25

28 Earned value management systems Many government contracts require that the contractor establish an elaborate program management system as a condition of contract award. The program management systems are generally referred to as earned value management systems (EVMS). They typically require that work breakdown structures (WBS) be created, with numerous cost accounts at the lowest level of the WBS to manage discrete parts of the statement of work. Each cost account is given a budget and a schedule so that performance can be measured and issues identified at the lowest level of contract performance. The theory behind EVMS is that as cost or schedule issues are identified at the lowest levels, the systems can measure the ripple effect throughout the entire contract and create an early warning signal for contractor and government program managers and for contracting officers. reports. When the management reporting system is too detailed, the stresses between operations and project management are inevitable and can easily reach a point where the government is spending more and more to get less real control. Much like the GAO report on the security fence discussed above, it should be relatively simple to effectively manage a program without the need to spend vast sums of money to point out the obvious. We asked surveyed companies whether they had contracts subject to EVMS and 19% responded affirmatively. We then asked those respondents whether they considered EVMS to be a cost effective management tool and the results are shown in Figure 24. A large majority of respondents (81%) subject to EVMS do not consider it to be a cost effective method for project management. Like many complex and data intensive management systems, the question should be asked whether EVMS, as currently used in government contracting, is more effective in theory than in practice and whether essential program management information regarding significant performance issues could be generated in a far simpler and far less expensive way. A fairly recent example where the complex management system apparently overwhelmed the obvious was a GAO report on a contract to build a security fence on the southern border of the United States. The GAO report found that the contract work was far behind schedule and the GAO report assigned much of the blame to the failure of the EVMS system to adequately provide a timely account of the issues. We are familiar with several situations where an overly complex EVMS can cause serious discord between project management and the operations departments within a contractor s organization. The project management staff responsible for EVMS is required to identify and document performance issues in EVMS. This requires them to interact directly and frequently with operations staff doing the actual contract work in order for project management to gather information to report on problem areas, the estimated impact of the problems on cost and schedule, and planned corrective actions. In our experience, it is not uncommon to find stresses between the operations staff, who see themselves as doing the actual contract work, and EVMS staff, who are seeking information for detailed program management Fig 24. Cost-effectiveness of EVMS as a management tool 2015 survey 2013 survey 2012 survey Cost-effective Not cost-effective 19% 41% 37% 37% 59% 57% 81% 59% 63% 63% 41% 43% 2011 survey 2010 survey 2009 survey 26 Grant Thornton's 2015 Government Contractor Survey

29 We asked surveyed companies with EVMS requirements whether or not they receive meaningful responses to the information in the EVMS reports from their government customers. The results are shown in Figure 25 along with the results from the previous five surveys. As shown, a very large percentage of contractors subject to EVMS rarely receive meaningful government response from the government personnel receiving the report. In our opinion, it is highly likely that the reason there is no meaningful government response to the EVMS reports is that the reports are overly detailed and that government and contractor program managers have already identified issues using far less formal methods than EVMS reports. We also asked companies whether they would use EVMS as a program management system if the government did not require it. An overwhelming majority of respondents (80%) stated they would not use EVMS if it weren t required by the terms of the contract. Fig 25. Government responses to EVMS reports Billing subcontractor hours on T&M contracts In February 2007, the government revised the payment clause for T&M contracts at FAR with respect to billing hours worked by subcontractors. Prior to that date, the clause stated that the cost of subcontractor labor should be billed at actual cost plus the applicable indirect costs from the prime contractor cost structure. No fee was paid to the prime contractor for subcontractor work on T&M contracts. The February 2007 revision required that subcontractor hours be billed at the fixed labor rates in the prime contract as long as the subcontractor personnel performing the work met the professional qualifications specified in the contract for the labor category against which the hours were billed. Surveyed companies provided information on how they billed subcontractor hours against T&M contracts. The results are shown in Figure 26 along with the results from the prior five surveys. The level of compliance continues to be in the 80-90% range which suggests that there still may remain a number of companies that have not revised their billing practices to comply with the FAR change incorporated more than 8 years ago survey 2013 survey 2012 survey 2011 survey 2010 survey 2009 survey Fig 26. Billing subcontractor hours on time and materials contracts 2015 survey 2011 survey No meaningful responses 82% 66% 73% 75% 45% 2013 survey 2012 survey Fixed labor rates in contract 89% 80% 2010 survey 2009 survey 60% 82% Meaningful responses 18% 34% 27% 25% 55% 40% Actual subcontract costs 86% 81% 76% 11% 20% 18% 14% 19% 24% 27 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 27

30 The focus of government audits of T&M contracts has changed in recent years. Previously, the audit focus was simply verifying the hours billed to the project cost system and timekeeping records. The audit focus has shifted and is now concentrating on verifying that the personnel whose hours are billed on T&M contracts possess the professional credentials defined in the contract for the labor category being billed. This change in audit focus has resulted in major issues at several large and medium sized companies. Eliminating the risk from this audit exposure requires close coordination between a contractor s project management, contract administration and human resources functions. We have observed several instances where the project manager is the person that decides which employee will perform the hours in each labor category and oftentimes this judgment is based on the project manager s personal knowledge of the government program manager s expectations. As a matter of risk avoidance, we recommend that there be close coordination between the contractor s project management, contract administration and human resource functions to assure that employees clearly possess the professional qualifications specified in the contract for the labor category being assigned to the employee. If there is a disconnect between the qualifications of the employee and the government program manager expectations for that employee, it would be prudent to propose an equivalent experience exception to the educational or other requirements specified in the contract in order to lessen the audit risk on billings under the contract. We asked respondents to rate the effectiveness of their procedures for properly assigning employees to labor categories in T&M contracts. Seventy-three percent report they believe their procedures are very effective, while the remaining 27% rate their procedures as somewhat effective or not effective. Contract delays or terminations The procurement regulations provide the government unusual rights that are rarely present in commercial contracts between private parties. These unusual rights include the right to delay or stop the contractor s performance under a contract as well as the right to terminate the contract either partially or completely. These government rights can be exercised for its own convenience even in situations where there are no performance issues by the contractor. The contract clauses that afford the government these unusual rights also provide that the contractor is entitled to an equitable adjustment in contract cost, price, and schedule, as appropriate. If the situation involves a delay in performance, the contractor is entitled to compensation for all costs that were the consequence of the delay including but not limited to (a) the cost of implementing and managing the delay; (b) idle time of employees and subcontractors; (c) idle facilities; (d) the cost of preparing and submitting an REA for the delay; and (e) unabsorbed overhead. Unabsorbed overhead costs are the indirect costs that would have been absorbed by the delayed contract but that had to be absorbed by other contracts because of the delay. A contract can be terminated either for the government s convenience or as a termination for default if there are major performance issues by the contractor. The vast majority of terminations are for the government s convenience and so the comments which follow only apply to convenience terminations. Terminations for convenience can either be complete or partial in instances where the government wants some but not all of the work to continue. Terminations for convenience During our many years assisting government contractors, we have noted that the government s decision to terminate a contract for convenience often has the unintended consequence of costing the government far more than it would have cost had the original contract been allowed to proceed to completion. This is the result of termination settlement regulations which are very favorable to the contractor. These regulations are generally described as the fairness principle and have been interpreted in legal decisions to mean that the terminated contractor has the right to be made whole and not underwrite the government s unilateral decision to simply walk away from the contract for its own convenience. Further, the fairness principle also states that business judgment rather than strict accounting principles should be the basis for the termination settlement and that costs that are normally indirect costs during contract performance can be charged directly in a termination settlement. 28 Grant Thornton's 2015 Government Contractor Survey

31 Termination settlement proposals can include essentially any expense for which a nexus to the termination decision can be established. In practice, termination settlements may include but are not limited to (a) excess inventory; (b) idle time; (c) severance pay; (d) idle facilities; (e) costs incurred preparing to perform the terminated contract; (f) termination of subcontractors; (g) costs incurred to wind down operations of the terminated contract; (h) proposal costs for the terminated contract in certain situations; (i) recoupment of discounts applied in the initial contract pricing; (j) adjustment of indirect cost rate ceilings in the original contract; (k) loss of useful value in fixed assets; (l) costs incurred in preparing, submitting, and negotiating the termination settlement; and (m) any other expense that can be linked to the government s decision to terminate the contract. Surveyed companies were asked whether or not any contracts were terminated for convenience during the past three years and the results are shown in Figure 27. Twenty-three percent experienced terminations for convenience. We then asked whether the companies with terminated contracts filed termination settlement proposals and only 24% of companies with terminations had requested payment for the financial impact of the termination. Given the adverse financial impact of a termination for convenience and the generosity of the fairness principle, we would have expected that most if not all contractors suffering terminations for the government s convenience would seek payment of the amounts to which they are entitled. Fig 27: Terminations for convenience during the past three years Some 23% None 77% Partial terminations for convenience The procurement regulations explicitly allow the renegotiation of the price of continuing work when only a portion of the contract work has been terminated. This is almost always a price increase because indirect costs are allocated over a smaller business base by virtue of the termination of some work. We asked companies that experienced partial terminations for the government s convenience whether they had proposed and negotiated an increase in the price of continuing work. The results are shown in Figure 28. Only a small percentage of respondents (18%) proposed and negotiated an increase in the price of continuing work. This is surprising since the entitlement to the adjustment is explicitly authorized in the procurement regulations. Impact of contract funding on termination settlements As a general matter, the total cost to the government from a termination settlement cannot exceed the total funding in the contract immediately prior to termination. This limitation can reduce the amount of the contractor s recovery particularly in a situation where the termination for convenience occurs near the end of the contract performance period. If faced with this situation, it is incumbent on the terminated contractor to identify and request equitable adjustment in the termination settlement proposal for all changes, delays, and other actions by the government that pre-dated the termination for convenience. The effect of these REAs will be to increase the total available contract funding thereby allowing the contractor to receive payment for all expenses to which it is entitled as a result of the government s decision Some to walk away from the contract for its own convenience. None Fig 28: Continuing work after partial termination Renegotiated price of continuing work 18% Did not renegotiate 82% S N 29 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 29

32 Compliance Programs and Business Systems Over the past several years, the government has imposed new requirements that have had, and will likely continue to have, significant impacts on government contractors. Two of these new requirements involve compliance and ethics programs, and business systems which are discussed in this section. Compliance and ethics programs The government procurement process became an area for increased political and media focus in the recent past particularly with regards to procurements placed to assist with the War on Terror and Hurricane Katrina. Allegations of corruption, poor performance, and illegal and unethical behavior were not unusual and it became conventional wisdom that government contracting needed to significantly increase compliance and ethics program requirements in government contracts. It is unfortunate that there was far less publicity later when many of the allegations proved either baseless or far less serious than originally alleged. The new compliance and ethics requirements became effective in April 2010 and apply to all contracts in excess of $5,000,000 with a performance period of 120 days or more. Contractors are required to establish a written code of business ethics and conduct within 30 days of contract award and to make it available to each employee involved in the performance of the contract. Unless the contract is awarded to a small business or involves the procurement of a commercial item, the regulations also require the contractor to establish business ethics/awareness and compliance programs within 90 days of contract award. The business ethics/awareness program requires contractors to conduct periodic training for its employees, agents and subcontractors involved in the performance of the contract. Contractors are also required to exercise due diligence to prevent and detect criminal conduct, and otherwise promote an organizational culture that encourages ethical conduct and a commitment to comply with the law. If this was all that the compliance regulations required, the risks to contractors would be minimal. Unfortunately, they require far more. The new regulations require a contractor to disclose in writing to the government agency s Office of Inspector General (OIG) and contracting officer whenever the contractor has credible evidence that a principal, an employee, an agent or a subcontractor may have committed a violation of federal criminal law involving fraud, conflict of interest, bribery or gratuity violations, or Civil False Claims Act violations. This is a very heavy burden on government contractors because the penalties for non-disclosure can be severe. We have observed that in many instances contractors make formal disclosures to the government for practically any allegation received from any current or exemployee, no matter how frivolous the allegations may appear to be, or how disgruntled the employee or ex-employee may be. If the intent of the regulations is to eliminate all unethical behavior in government procurements, we find it interesting that contractors are required to disclose violations by principals, employees, agents and subcontractors but are not required to disclose violations committed by government officials with whom they interact on the contract. 30 Grant Thornton's 2015 Government Contractor Survey Survey

33 The regulations also require contractors to maintain internal controls with standards and procedures to facilitate timely discovery of improper conduct in connection with government contracts, which assure that corrective measures are promptly taken to correct the situation. The internal control program must include (a) monitoring and auditing to detect criminal conduct; (b) periodic evaluation of the business ethics/awareness and compliance programs, and the internal control systems; (c) periodic assessment of the risk of criminal conduct, with appropriate steps to design, implement, or modify the business ethics/awareness and compliance programs and the internal control systems as necessary to reduce the risk of criminal conduct; (d) an internal reporting system, such as a hotline, that allows for anonymity or confidentiality by which employees may report suspected instances of improper conduct, and instructions that encourage employees to make such reports; (e) disciplinary action for improper conduct or for failing to take reasonable steps to prevent or detect improper conduct; and (f) timely disclosure of suspected violations to the agency s OIG and contracting officer. Fig 29. Cost-effectiveness of compliance regulations 2015 survey 2013 survey 2012 survey Regulations reasonable and cost-effective Regulations excessive and not cost-effective 37% 41% 40% 52% 52% 63% 59% 60% 48% 48% 2011 survey 2010 survey We asked companies subject to the internal controls requirements whether they are conducting the required periodic monitoring and auditing and only 37% report that such audits are being performed. Given the strict requirements in the regulations and the potentially severe repercussions for non-compliance, we recommend that contractors required to conduct such audits be sure to complete them. We also strongly recommend that the audits be performed by individuals with extensive government contracting experience so that audit findings can be properly interpreted. Finally, we also recommend that the causes of any issues identified in the audit be identified as part of the audit in order to avoid an overreaction to a minor technical violation and to avoid unnecessary disclosures of such minor items to the agency OIG and contracting officer. We also asked companies their opinions as to whether the compliance regulations are reasonable and cost-effective. The results are shown in Figure 29 along with the results from the four previous surveys. As shown, a very large percentage of surveyed companies believe the compliance regulations are neither reasonable nor cost-effective. New compliance regulations proposed by the Department of Labor On May 28, 2015, the government proposed an amendment to the FAR which, if adopted, could have far reaching implications for government contractors. The proposed FAR changes have three basic requirements: (1) Contractors and subcontractors will have to report whether, within the preceding three-year period, they were found to have violated certain labor laws through an administrative merits determination, an arbitration award or decision, or a civil judgment. Based on the information provided, the contracting agency must make a responsibility determination before making future awards. (2) Contractors may be required to provide paychecks to workers in languages other than English. (3) Contractors with contracts exceeding $1 million may not impose pre-dispute arbitration agreements for claims under Title VII of the Civil Rights Act. 31 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 31

34 These changes will likely have a major impact on how government contractors handle employee complaints and will almost certainly cause significant harm to a company who receives a negative responsibility determination from the contracting agency. This change will also be expensive to implement and manage and the government will wind up bearing the costs for these new compliance regulations. If the proposed regulations are adopted and incorporated into the FAR, we recommend that government contractors confer with legal counsel to assure internal procedures are adopted to minimize the harm that may come from the proposed regulations. Contractor business systems In February 2012, the DoD issued a final rule on contractor business systems and amended the Contractor Business Systems clause at Department of Defense FAR Supplement (DFARS) to incorporate the final rule. The amended clause applied to all contracts subject to CAS, regardless of whether the contract is subject to full or modified CAS. The requirements applied to six business systems including (a) cost accounting; (b) EVMS; (c) estimating; (d) material management and accounting; (e) property management; and (f) purchasing. Separate DFARS clauses have been implemented for each of the six business systems setting forth the specific criteria for acceptable systems. In the event the government identifies significant deficiencies during an audit of a business system, the clause allows the government to withhold payments against all CAS-covered contracts including cost reimbursement contracts, incentive type contracts, T&M contracts, labor hour contracts, progress payments, and performance-based contracts. The amount withheld must be 5% for one or more significant deficiencies in a single business system and 10% for significant deficiencies in multiple business systems. Unfortunately, the definition of a significant deficiency in the clause is broad and leaves much to the imagination of the individual auditor. The language in the clause defines a significant deficiency as a shortcoming in the system that materially affects the ability of DoD officials to rely upon information produced by the system and needed for management purposes. Predictably, DCAA often took a very conservative approach to any perceived imperfection which it found during audits and tended to identify any concern as significant. A government report that concludes a business system is inadequate can have far greater consequences to contractors than merely payment withholdings on existing contracts. Indeed, an acceptable cost accounting system is a prerequisite for award of contracts that are either cost reimbursable, T&M, labor hour, or FFP contracts with progress payments based on cost. Not surprisingly, DCAA s reluctance to accept the adequacy of cost accounting systems quickly became an impediment to the award of contracts by procurement officials and DoD acted decisively in 2014 to eliminate that impediment by minimizing DCAA s role in accounting system reviews. On June 26, 2014, DCAA issued a new policy which stated that DCAA s accounting system audits would no longer include an opinion on the adequacy of the accounting system but rather would be closed with a memorandum to the contracting officer identifying any practices that DCAA believes are not in accordance with DoD guidelines. Under the new policy, the adequacy of the system is determined by the contracting officer rather than by DCAA. On July 15, 2014, DoD issued a notice of proposed rulemaking which further minimized DCAA s role in the evaluation of cost accounting systems. The purpose of the proposed rule was to entrust contractors with the capability to demonstrate compliance with DFARS system criteria for contractors accounting systems, estimating systems, and material management and accounting systems (MMAS) based on contractors selfevaluations and audits by Certified Public Accountants (CPAs) of their choosing. Under the proposed rule, DCAA s role would be limited to performing overviews of the results of contractor self-evaluations and CPA audits. 32 Grant Thornton's 2015 Government Contractor Survey

35 We asked surveyed companies whether or not there had been any recent government audits of their business systems and the results are shown in Figure 30. Less than one third of the respondents have had recent business systems audits by the government. We also asked whether or not the cost accounting systems have been reviewed and deemed acceptable for government contracting and only 71% replied in the affirmative. We ve observed that government solicitations for new business frequently request information on the approval status of certain business systems. If no formal government approval of the system exists, we recommend that companies that are faced with the requirement for acceptable business systems as a condition of award utilize the July 15, 2014 DoD rule and obtain audits of business systems by qualified CPA firms of your choosing. Fig 30: Recent government audits of business systems Yes 30% No 70% Some None 33 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 33

36 Dealing with DCAA and Contracting Officers Doing business with the government is completely unlike a normal business relationship between companies conducting a typical commercial business transaction. Government procurement regulations control practically every aspect of the business relationship including (a) source selection; (b) how the procurement is priced; (c) how much profit can be included in the price; (d) cost accounting requirements; (e) costs that are chargeable and not chargeable to the contract; (f) audit requirements; (g) how employees must be recruited, hired, and paid; (h) subcontracting and purchasing; (i) inspection and acceptance of the contract deliverables; and (j) payment. Government procurement regulations also include a rather complex set of cost accounting standards (CAS) that govern the way costs are allocated to contracts and include burdensome regulations that must be followed before any significant changes can be made to the established cost accounting practices. The government employs thousands of DCAA auditors scattered around the world to enforce the accounting and business system requirements in the procurement regulations. The regulations require contractors to grant auditors broad access to any and all information within the contractor s organization that has or could have any bearing on contract costs. The mission of DCAA is to provide advisory audit reports to government contracting officers to assist it as it administers contracts on behalf of the government. Within DoD, DCAA is officially independent from the contracting officers in order to minimize or eliminate any possibility that a procurement office would dictate audit findings to the DCAA audit office with access to the contractor s accounting records. However in a practical sense, the amount of real independence changes from time to time commensurate with the degree of DCAA s responsiveness or non-responsiveness to the needs of the procurement offices in awarding and administering contracts. Although DoD has not seen fit to formally put DCAA under the organizational control of procurement offices, it has effectively done the same thing recently by severely limiting DCAA s roles and responsibilities in the procurement process. This diminishment of DCAA s role was a self-inflicted wound that was the result of counterproductive policies put in place within DCAA in the wake of critical GAO reports issued in 2008 and These DCAA policies greatly reduced the timeliness and usefulness of audit reports to contracting officers and inevitably led to the diminishment of DCAA s role in the procurement process. Please refer to the section titled Recent Developments at DCAA in this survey report for additional information. 34 Grant Thornton's 2015 Government Contractor Survey Survey

37 Relationships with the government auditor and contracting officer Companies surveyed provided information on the quality of their business relationships with the government auditor and primary contracting officer from two perspectives. First, we inquired whether or not government positions that are adverse to the company s business interests were well substantiated with appropriate regulatory citations. Second, we asked whether the auditors and contracting officer were open-minded and receptive to contractor rebuttals to government positions. Fig 32: DCAA receptivity to contractor rebuttals Open-minded and receptive 67% Inflexible and rarely receptive 33% n r It is evident from the responses that the government s manner in conducting business with contractors is deficient. Regarding auditor positions, only 57% of respondents find DCAA s positions to be supported with appropriate regulatory citations (Figure 31) and only 67% report that DCAA is receptive to contractor rebuttals to the DCAA positions (Figure 32). The ratings for contracting officers are even worse than those given to DCAA. Only 51% of surveyed companies report that contracting officer positions are substantiated with appropriate regulatory references (Figure 33) and only 55% believe that contracting officers are receptive to rebuttal information provided by contractors (Figure 34). Fig 33: Contracting officer positions Substantiated with appropriate regulatory references 51% Arbitrary and not appropriately referenced 49% n r Fig 31: DCAA audit opinions Substantiated with appropriate regulatory references 57% Arbitrary and not appropriately referenced 43% Fig 34: Contracting officer receptivity to contractor rebuttals not requested Open-minded and receptive requested 55% Inflexible and rarely receptive 45% n r 35 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 35

38 Government efficiency in resolving contract issues We have observed an increasing trend in recent years which is even more disturbing than the lack of a regulatory basis for issues and a lack of receptivity to contractor rebuttals. Specifically, it has become common for contracting officers in some agencies to simply ignore an issue altogether and take no action to resolve matters that have been set forth in audit reports. This is particularly harmful to contractors when the issue involves a contractor s entitlement to payment as a result of a routine billing, a contract change, or a termination for convenience. We have observed situations where contracting officers simply ignored the matter entirely for months and years, and in some cases, refused to pay even those amounts where DCAA and the contractor concur. It appears that some contractors may tolerate this situation in an attempt to mitigate further difficulties. We asked surveyed companies to assess the government s efficiency in resolving contract issues. The results are shown in Figure 35, along with results from the prior four surveys, presented for comparison. Only 45% of respondents believe that the government resolves issues efficiently. Of the 55% that believe the government is inefficient, 38% put the primary blame on the auditor while 17% find that the contracting officer is primarily responsible for failing to efficiently resolve contract issues. Fig 35. Government efficiency in resolving issues 2015 survey 2013 survey 2012 survey Issues resolved efficiently Auditor delays Contracting officer delays 45% 18% 22% 26% 35% 38% 56% 28% 56% 45% 17% 26% 18% 20% 2011 survey 2010 survey 36 Grant Thornton's 2015 Government Contractor Survey

39 Most frequent cost issues Surveyed companies were asked to identify which costs were most frequently challenged by DCAA during incurred cost audits. The results are shown in Figure 36 along with the results from the previous five surveys which are presented for comparative purposes. The most frequently challenged cost is executive compensation, continuing the trend from the prior five surveys. This audit issue is most common in small to medium sized companies where the executive compensation for the highest paid executives is below the statutory ceiling in the procurement regulations. We frequently assist clients in rebutting DCAA challenges to executive compensation. It has been our long-held belief articulated in many recent annual surveys that DCAA s standard analytical techniques for executive compensation are fundamentally flawed. There have been recent decisions by the Armed Services Board of Contract Appeals (ASBCA) which drew the same conclusion. Executive compensation is covered in more detail in a later section of this survey report. DCAA also tends to challenge consultant and legal expenses from the perspective of the adequacy of the supporting documentation. We have noted situations where DCAA has challenged these expenses if a consultant agreement didn t exist or was out of date or if the description in the consultant s invoice of the work performed was not as specific as DCAA desired it to be. We have had considerable success assisting clients faced with this challenge by providing other evidentiary matter supporting the expense and by strongly rebutting DCAA s all or nothing approach to costs when incomplete documentation is the only issue. In December 2013, DCAA issued guidance to field offices which distinguished consultants from purchased labor and instructed auditors not to apply the same documentation requirements to purchased labor that apply to consultants. That guidance memorandum has been removed from DCAA s website. Labor charging issues are also mentioned by some surveyed companies as an area of DCAA focus. In some cases, these issues arise when DCAA questions labor costs because the costs were incurred in an unallowable activity (e.g., lobbying, mergers and acquisitions, entertainment). We believe that DCAA s approach to this issue is inconsistent with the plain language in the procurement regulations. Those regulations are explicitly clear Fig 36. Most frequent cost issues Executive compensation Consultants Incentive compensation Labor charges Indirect cost allocations 21% 23% 29% 27% 23% 18% 11% 7% 7% 9% 14% 15% 21% 17% 11% 15% 14% 6% 10% 11% 12% 14% 14% 16% 10% 12% 10% 8% 12% 13% Legal Employee morale 2015 survey 2013 survey 2012 survey 2011 survey 2010 survey 3% 9% 8% 14% 6% 5% 8% 5% 7% 2% 5% 6% 2009 survey 37 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 37

40 that a cost associated with an unallowable activity should only be disallowed if the cost would not have been incurred but for the unallowable activity. That is rarely the case with salaries and wages. Most frequent CAS issues We asked surveyed companies whether they were subject to full CAS coverage, modified coverage, or exempt from CAS. Twenty-four percent of companies reported they are subject to full CAS and have filed disclosure statements describing their cost accounting practices. Companies subject to full CAS coverage identified the CAS standards where DCAA had raised compliance issues and the results are shown in Table 7 along with the results from the five prior surveys. It appears that the number of companies facing CAS issues is very minor and shrinking compared to prior years. It s not clear how much of this decline is the result of fewer DCAA audits and how much is the result of a higher degree of compliance by contractors. Costs questioned as a percentage of revenue We asked surveyed companies to provide the amount of DCAA questioned costs as a percentage of revenue. The results are shown in Figure 37. The amount of costs questioned is very minor with the vast majority of respondents reporting costs questioned of less than 1% of revenue. It should also be noted that even this paltry amount is overstated since many of the recommended disallowances may not be sufficiently valid to be sustained during negotiations between the contractor and the contracting officer. Partially as a result of its past tendency to focus audit resources on immaterial matters, DCAA has been very far behind in conducting incurred cost audits which has delayed the close-out of contracts and which has taken audit resources away from more significant potential issues which could be affecting current contract activity. DCAA has been criticized for its failure to complete incurred cost audits in a timely manner and is now using aggressive risk assessment techniques to eliminate audit backlog without conducting any significant audit testing. We have encountered situations where DCAA has raised CAS compliance issues several years after the fact while performing incurred cost audits. Assuming the finding has merit, a cost impact process will follow in which the cost impact of the issue on each CAS-covered contract will be computed and potentially refunded to the government. We have found that many contractors in this situation compute the impact on all CAS-covered contracts including those that are only technically subject to modified CAS. This becomes problematic where the compliance issue is for standards other than CAS 401, 402, 405 and 406. The CAS certification in government solicitations allows for modified coverage (e.g., CAS 401, 402, 405 and 406) in situations where the contractor did not receive a contract subject to full coverage in the period immediately preceding the period in which the proposal was submitted. We have observed that companies with a disclosure statement routinely certify the proposed contract is subject to full CAS even when they have not received a contract subject to full CAS in the immediately preceding period. This approach may create additional and unnecessary financial exposure in the event that CAS compliance issues arise in the future which require cost impact submissions. Fig 37: Costs questioned as a percentage of revenue <1 of revenue 72% 1% of revenue 13% 2% of revenue 7% 3% of revenue 1% 4% of revenue 1% 5% of revenue 1% >5% of revenue 5% > < 38 Grant Thornton's 2015 Government Contractor Survey

41 Satisfaction with the resolution of contract issues We asked companies to provide their level of satisfaction with the resolution of audit issues. The response is shown in Figure 38 along with the results from the prior five surveys. Thirtysix percent of surveyed companies are very satisfied with the resolution of audit issues and another 53% are somewhat satisfied. The level of satisfaction with the resolution of contract issues has improved significantly when compared with earlier surveys. This is likely the result of DCAA writing off a large part of its audit backlog with minimal review based on new risk assessments specifically designed to eliminate backlog. Fig 38. Company satisfaction with resolution of issues 2015 survey 2013 survey 2012 survey Very satisfied 36% 18% 16% 33% 49% 35% 2011 survey 2010 survey 2009 survey Somewhat satisfied 53% 61% 60% 42% 36% 52% Not satisfied 11% 21% 24% 25% 15% 13% Table 7: Most frequent CAS issues CAS issue type 2015 Survey Frequency cited 2013 Survey Frequency cited 2012 Survey Frequency cited 2011 Survey Frequency cited 2010 Survey Frequency cited 2009 Survey Frequency cited CAS 401 consistency 0% 2% 16% 10% 16% 8% CAS 403 home office 1% 3% 4% 7% 13% 7% CAS 405 unallowable costs 3% 9% 4% 7% 16% 11% 39 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 39

42 Executive Compensation As explained in the previous section of this report, the reasonableness of executive compensation is a primary area of DCAA focus during incurred-cost audits at small to medium sized government contractors. In this section of the survey report, we present executive compensation information provided by surveyed companies and discuss DCAA s standard audit approach. We also present information regarding the fundamental flaws in DCAA s approach as well as recent ASBCA decisions which also exposed the flaws. Table 8: Compensation of highest paid executive Revenue 25th Percentile Median 75th Percentile $0-10M $200,000 $280,000 $410,000 $11-50M $280,000 $350,000 $545,000 $51-150M $450,000 $680,000 $875,000 >$150M $725,000 $980,000 $1,250,000 Compensation for senior executives Surveyed companies provided the total of base salary and incentive compensation paid to its four most highly paid executives. The results are summarized in Tables 8 through 11. The information is provided by revenue range and is shown at the 25th, 50th (median) and 75th percentile so that readers of the survey report can evaluate how their executive compensation compares with that of similar sized companies. The executive compensation information presented in this and other surveys should be evaluated with care, since compensation practices can vary significantly in form and amount from company to company. This is especially true in small to medium sized privately held companies where factors such as profitability, tax strategy, the presence or absence of stock incentives and deferred compensation, and the personal financial strategies of the principal owners can materially distort the comparability of compensation data between companies. Further, the duties Table 9: Compensation of second highest paid executive Revenue 25th Percentile Median 75th Percentile $0-10M $140,000 $234,000 $280,000 $11-50M $200,000 $260,000 $337,000 $51-150M $325,000 $450,000 $525,000 >$150M $495,000 $750,000 $945,000 Table 10: Compensation of third highest paid executive Revenue 25th Percentile Median 75th Percentile $0-10M $120,000 $160,000 $240,000 $11-50M $165,000 $210,000 $290,000 $51-150M $275,000 $380,000 $475,000 >$150M $380,000 $590,000 $750,000 Table 11: Compensation of fourth highest paid executive Revenue 25th Percentile Median 75th Percentile $0-10M $100,000 $130,000 $190,000 $11-50M $140,000 $175,000 $250,000 $51-150M $210,000 $325,000 $420,000 >$150M $290,000 $460,000 $580, Grant Thornton's 2015 Government Contractor Survey Survey

43 and responsibilities of principal executives of small to middle sized companies often are substantially different from company to company, making benchmarking by position title especially questionable. Careful benchmarking based on the actual duties performed should be a fundamental prerequisite before using comparative analysis as a technique to evaluate executive compensation. DCAA challenges to executive compensation As previously noted, the reasonableness of executive compensation is a major focus of DCAA s incurred cost audits at small to medium sized government contractors. DCAA s audit approach is simplistic and formulaic and we believe it to be fundamentally flawed. Typically, DCAA extracts data by job title from three or four commercially available surveys but does not attempt to benchmark the job descriptions in the surveys to the actual duties of the executives in the company being audited. The survey data is normally drawn from companies whose revenue size and industry are similar to those of the company under audit. DCAA rarely even considers geographic location in its benchmarking even though geographic location is a factor specifically mentioned in the government regulations. DCAA also frequently fragments the revenue of the company being audited by division, thereby drawing comparison data from companies much smaller than the company being audited. DCAA then averages the median compensation for each executive position and increases the average by an arbitrary 10% range of reasonableness factor. The result is DCAA s recommendation. DCAA then questions the difference between the compensation paid and the amount computed from its analysis. Surveyed companies whose executive compensation was challenged by DCAA provided information on the ultimate resolution of the DCAA s recommended cost disallowance. The company position was sustained 40% of the time, while a reasonable compromise was reached in 45% of the cases. The DCAA position or what was perceived as an unreasonable result was achieved in 15% of the cases. Effective responses to DCAA challenges to executive compensation It is our view that the statistical analysis techniques used by DCAA in their audits of executive compensation are fundamentally flawed and very difficult to defend when effectively challenged. Given the numerous flaws in DCAA s methodology, we have found that a comprehensive response to DCAA s findings to be the most effective rebuttal strategy. Such a response should cite each of the statistical deficiencies in the DCAA analysis. Depending on the circumstances, the rebuttal should include some combination of the following: Questioning DCAA s failure to adequately benchmark the positions in the surveys to the positions in the contractor s organization based on duties performed rather than by job title; Pointing out the disparity in the median compensation from the various surveys being averaged by DCAA; Questioning the validity of DCAA s use of survey data when there is a small number of data points in the survey for the industry and revenue range used by DCAA; Citing DCAA s failure to use data by geographic location despite the express requirement in the procurement regulations to consider geographic location; Questioning the regulatory basis for fragmenting revenue by division for the company being audited and challenging DCAA to prove that the data in the surveys has also been fragmented by division; Relating the current year executive compensation to prior year compensation levels that were audited and accepted by DCAA; Pointing out the poor correlation between revenue and compensation in the survey data in those instances where the company publishing the data has included data on correlation in the survey; Questioning the adequacy of the 10% range of reasonableness adjustment when the correlation in the survey data is very poor; and Questioning the reasonableness of categorizing the company under audit at median when its financial or non-financial achievements merit a higher rating. 41 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 41

44 In many cases, we have found DCAA to be flexible and willing to modify its position when faced with a comprehensive rebuttal. It has been our experience that the flexibility is most often shown in a willingness to rate a company s performance above median to reduce or eliminate the cost disallowance. This type of concession does not require DCAA to compromise its basis analytical approach, no matter how flawed that approach may be. In those cases where DCAA is unwilling to compromise, a successful result is often achievable in negotiations with the contracting officer or by appeal to the Boards of Contract Appeal. Recent Armed Services Board of Contract Appeals decisions During 2012, the ASBCA rendered decisions in two executive compensation cases (J.F. Taylor, Inc. and Metron, Inc.) in which the ASBCA found in favor of the contractor because of the flawed statistical analysis techniques used by DCAA to develop its positions. We are pleased to report that the legal counsels for each company used the same arguments to attack the DCAA positions that we have been advocating for the past several years in our annual surveys. Indeed, Grant Thornton s lead government contractor consultant was associated with legal counsel in the Taylor case and played a major role in the development of the winning arguments against DCAA s flawed statistical analysis used to audit executive compensation. In spite of the demonstrable flaws in its analytical techniques for auditing executive compensation, DCAA continues to use those same discredited techniques even in 2015, three years after they have been repudiated by the ASBCA. Hopefully, DCAA will revisit its approach to this issue and develop audit approaches which consider the specific circumstances of the company under audit. This is particularly important when auditing small to medium sized companies where the circumstances affecting compensation can vary substantially from company to company. 42 Grant Thornton's 2015 Government Contractor Survey

45 Mergers and Acquisitions and Other Business Strategies In this section of the report, we present the results of the survey relative to mergers and acquisitions (M&A) from several different perspectives including the overall M&A environment, the prices paid for acquired businesses, due diligence issues, and the overall success of the acquisition. We also address the contract administration aspect of M&A including the advantages and disadvantages of contract novation after the acquisition has been consummated. Exit strategy In previous surveys, we reported that selling the company is the most favored exit strategy for privately held government contractors. This continues to be the case in this year s survey. We asked respondents which exit strategy was receiving the most consideration at their company. A very significant percentage (74%) of privately owned companies favor sale of the company as an exit strategy. A much smaller percentage (2%) indicated they intended to convey the company to a family member as a gift or through inheritance. For the respondents planning to sell the business, 17% plan to sell in the next 2 years, 52% plan to sell in 3 to 5 years; while the remaining 31% plan to sell within 6 to 10 years. M&A environment There has been a rather robust M&A environment in the government contracting industry going back at least 25 years which was caused by several key factors including (a) consolidations in the wake of the dissolution of the former Soviet Union; (b) the major increase in the Government s use of IDIQ contracts which forced companies to work together in large teams and significantly reduced the number of new business opportunities from non-idiq orders; (c) the very significant impact on products and services caused by the technological advances in the 1990s; and (d) the increased politicization of Government procurements which has either delayed or in some cases entirely terminated contracts for major products and services. We asked surveyed companies whether they were involved in M&A activity during the past year and only 4% answered in the affirmative. This is consistent with the finding from our last survey and the low rate is at least partially the result of budget uncertainties caused by sequestration. We also asked companies about their expectations for the M&A environment over the next 12 months and there is great optimism that the environment will improve. The results are shown in Figure 39. A very significant 56% of respondents expect the environment to improve while only 9% expect it to worsen. The remaining 35% expect no change in the M&A environment over the next 12 months. Fig 39: Expected change in the M&A environment in the next 12 months Improve 56% No change 35% Worsen 9% N P P 43 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 43

46 Divested operations We asked companies whether they had divested any of their operations in the past year and 7% responded in the affirmative. The reasons given included (a) the divested business was not core to the remaining business, and (b) the divested business created potential organizational conflicts of interest which could prevent the company from pursuing other business opportunities. Success of the acquisition We asked surveyed companies involved in an acquisition to rate the success of the acquisition. The results are shown in Figure 41. As shown, 21% rated the acquisition highly successful; 79% rated it successful; and no respondent rated the acquisition unsuccessful. Price paid for acquired business We asked those companies that acquired a business to provide the price paid as a multiple of annual revenue. Fifty percent of the prices were less than of revenue, 33% were between 100 to 125% of revenue, and the remaining 17% were above 125% of annual revenue. Fig 40: Walked away from potential acquisition as a result of due diligence Yes 69% No 31% n r We also asked the companies to provide the price paid as a multiple of EBITDA. The price of one third of the transactions was less than five times EBITDA, another third between five to seven times EBITDA, and the remaining third sold for factors ranging from nine to twelve times EBITDA. Due diligence Government contracts generally carry far greater risks and uncertainties than those found in many commercial businesses and therefore, the due diligence review should be tailored to identify and quantify those unique risks in order not to overpay for the company being acquired. A history of excellent performance does not guarantee future business because of the competitive requirements for follow-on business and because of the unique nature of the government source selection process. Changing government priorities may cause government programs to be abruptly terminated for the Government s convenience even in cases where there are no performance issues on the contracts. Unlike commercial business, government contracts frequently include the requirement that costs and billings be audited by government personnel creating another unique risk factor when acquiring a government contractor. We asked companies involved in an acquisition whether the acquisition price had been reduced as a result of due diligence and 57% responded in the affirmative. Fig 41: Success of the acquisition Highly successful 21% Successful 79% Unsuccessful 0% N P P We also asked companies that considered acquiring another company whether they had walked away from the acquisition as a result of due diligence and the results are presented in Figure 40. As shown, 69% walked away from an acquisition as a result of findings in due diligence which compares to the 63% reported in the previous survey. 44 Grant Thornton's 2015 Government Contractor Survey

47 Contract novation A government contractor cannot assign a contract to another company without government approval. If the company being sold will be dissolved and absorbed into the acquiring company, the buyer and seller may endure an often burdensome contract novation process. This process requires the submission of the purchase agreement to the contracting officer, declarations from both companies boards of directors, audited financial statements, opinions of legal counsel; evidence that security requirements have been met, and other information. Fig 42: Reasons for raising capital Growth and operations 40% Acquisitions 49% Refinancing 4% Returning capital to shareholders 7% In our experience with M&A involving government contractors, many companies forego the novation process and maintain the seller s corporate identity for a period of time after the acquisition is consummated. In such cases, the transaction is usually handled as a stock sale, and the seller maintains its corporate identity as a subsidiary or other form of operating segment within the buyer s organization. A frequently used strategy is to phase out the selling company as its contracts conclude and to compete for follow-on work under the buyer s name. This phased approach seems to work well in terms of integrating the operations of the buyer and the seller. We have also noted that M&A agreements occasionally include earn-out provisions under which the final price is determined in part by the performance of the seller after the acquisition. Delaying contract novation can be helpful in earn-out situations in order to maintain separate accountability for each company during the earn-out period. We asked companies involved in M&A activity whether they had elected to novate the contracts of the selling organization or whether the seller s corporate identity was maintained after the acquisition. Sixty-seven percent of the respondents elected to novate the acquired contracts. Raising capital We asked companies whether they intended to raise capital within the next three years and 48% responded in the affirmative. We also asked the reasons for raising capital and the responses are shown in Figure Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 45

48 Recent Developments at DCAA Beginning with the Grant Thornton Government Contractor Survey published in 2010, we have been following developments at DCAA in the wake of a scathing report issued by the General Accountability Office (GAO) which severely criticized DCAA s priorities and the quality of its work. In several surveys, we expressed our serious concern with actions being taken in the wake of the GAO report and cautioned that the cures may be far more harmful than the disease. Since our last survey was published, there have been several new developments that have further minimalized DCAA s role in the procurement process. In our opinion, it has reached the point where the Government s contract audit function, as currently constituted, contributes less than ever to the procurement processes and it s time that Government officials step back and re-evaluate the changes in DCAA s role that have occurred since the GAO s report was first issued in July On July 22, 2008, the GAO issued a report to Congress after receiving some complaints from certain DCAA employees in three offices in California. GAO reviewed audit files in those offices and concluded that DCAA had failed to comply with Generally Accepted Government Audit Standards (GAGAS). Specifically, GAO concluded that (a) documentation in the work paper files did not support the audit opinion; (b) DCAA supervisors dropped findings and changed audit opinions without adequate evidence for the changes; and (c) sufficient work was not performed to support the audit opinions. GAO also stated that, in their opinion, DCAA was too lenient on contractors and questioned whether or not DCAA had adequate independence from the contractors it was auditing. Unfortunately for the procurement process, GAO also criticized DCAA for having a management and agency culture that focused on a productionoriented mission, which led DCAA management to establish policies and procedures that emphasized performing a large quantity of audits to support contracting decisions. Predictably, this criticism of DCAA s production-oriented mission had a very unfortunate effect. In the wake of the GAO report, DCAA issued a flurry of new policies and procedures which eliminated the production metrics and replaced them with new metrics which emphasized documentation and independence. On December 19, 2008, DCAA issued audit guidance on significant deficiencies/material weaknesses with respect to audit opinions on contractor internal control systems. The new guidance stated that, effective immediately, DCAA no longer would issue reports stating that business systems are inadequate in part. The new policy stated that if any significant deficiency or material weakness was noted, the report would include the opinion that the system is inadequate. Remarkably, the new policy stated that DCAA would no longer include recommendations in the audit report as to steps required to resolve DCAA s concern. The unfortunate result of this new policy was that the resolution of issues took far longer than was previously the case when DCAA reports not only identified an issue but recommended a solution. 46 Grant Thornton's 2015 Government Contractor Survey Survey

49 On March 3, 2009, DCAA issued audit guidance on reporting suspected contractor fraud and other contractor irregularities. Under the new policy, working-level auditors were authorized to make fraud referrals directly to the investigators without prior discussion with the DCAA Branch Manager or Resident Auditor. This new policy effectively encouraged fraud referrals and eliminated the responsibility and authority of DCAA management to examine and properly manage the opinions espoused by its subordinates. On March 13, 2009, DCAA issued guidance on reporting unsatisfactory conditions related to actions of other government officials. The guidance provided examples of unsatisfactory conditions including situations where a contracting officer does not support an audit position and negotiates costs or profit that DCAA considers unreasonable or excessive. The new guidance provided that DCAA could report the situation directly to the Inspector General rather than to higher-level management in the contracting officer s organization. This DCAA policy was effectively an attempt to usurp the contracting officer s authority to negotiate contracting matters with contractors. On July 23, 2009, DCAA issued guidance related to audits of the contractor code of business ethics and conduct. The guidance required auditors to perform procedures to address the requirements of the compliance regulations during audits of a contractor s control environment and accounting system controls. The guidance also required that DCAA obtain and review copies of the contractor s internal/external audit reports performed as part of the control system. On September 23, 2009, GAO issued a report summarizing its examination of several other DCAA offices beyond the three California offices that were the subject of the July 22, 2008 report. GAO reported that major problems existed throughout DCAA and issued a highly critical report. Shortly thereafter, the Director of DCAA was terminated and transferred to another position within DoD. On December 4, 2009, the DoD Director of Procurement and Acquisition Policy issued a policy directive on December 4, 2009 that addressed DCAA reports on proposals of $10 million or higher. The new policy required that the contracting officer must confer with DCAA in any instance in which the contracting officer s pre-negotiation plan was to sustain less than 75% of DCAA s recommended questioned costs. Further, the policy required that all communications be in writing and, if DCAA disagreed with the contracting officer s position, DCAA could refer the matter to higher-level management within the procurement organization and to more senior levels of DoD management outside the procurement organization. The above chronology of events unfortunately show that in a mere 17-month period from the date of GAO s initial report on July 22, 2008 through December 2009, a GAO report that severely criticized the quality of DCAA s work product had resulted in that same DCAA receiving more and more control over the procurement process at the expense of contracting officers. We commented on this in prior surveys and the irony of DCAA receiving more control in the face of failure and noted that DCAA overreach would not be sustainable. The pendulum of authority swung back to contracting officers from DCAA beginning in Indeed, the swing was so extreme that audits and responsibilities that were historically assigned to DCAA were eliminated and the DCAA role in the procurement process has become minimalized. In the Grant Thornton Government Contractor Survey issued in 2012, we reported that DoD had decided that DCAA would no longer initiate audits of purchasing system controls, earned value management systems, and contractor financial capability. DoD also decided that DCAA would only perform evaluations of costs proposals for new work when the proposals exceeded $10 million for firm-fixed-price work and $100 million for cost reimbursable work. These major curtailments of DCAA s role in the procurement process were just the beginning. On June 26, 2014, DCAA issued a new policy which stated that DCAA reports on post-award accounting system audits at non-major contractors would no longer include an opinion on the adequacy of the accounting system. In its place, DCAA will close such assignments with a memorandum to the contracting officer describing the work performed by DCAA and identify any practices that DCAA believes are not in compliance with the DoD guidelines for an adequate accounting system in DoD FAR Supplement On June 26, 2014, DCAA issued another policy statement that DCAA would no longer perform initial adequacy reviews of CAS Disclosure Statements but instead will perform them at a later date in conjunction with Disclosure Statement compliance audits. FAR (b) requires that the contracting officer make a written determination that a Disclosure Statement is adequate before awarding a CAS-covered contract. Removing DCAA 47 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 47

50 from the initial adequacy determination is another example of procurement offices limiting DCAA s ability to impede and delay contract awards. On July 15, 2014, DCAA issued another policy statement confirming that provisional billing rates must be established near the beginning of the fiscal year and that DCAA should not await a formal submission from contractors to do so. Under the new policy, DCAA will notify contractors that DCAA is beginning the process of establishing provisional billing rates and will ask the contractor whether or not it wishes to provide any information. In the event that the contractor does not choose to provide input, DCAA is required to submit a recommendation to the contracting officer based on information available in DCAA files. Prior to this change, DCAA would often take many months to evaluate contractor provisional submissions and thereby delay the establishment of provisional rates until late in the year. This policy change eliminates DCAA s ability to delay the contracting officer s establishment of provisional billing rates. On July 15, 2014, DoD issued a proposed amendment to the DFARS clauses on review of contractor business systems. DoD stated that the purpose of the proposed rule is to entrust contractors with the capability to demonstrate compliance with DFARS system criteria for contractors accounting systems, estimating systems, and material management and accounting systems (MMAS), based on contractors self-evaluations and audits by independent Certified Public Accountants (CPAs) of their choosing. Ironically, the proposed rule was in response to a GAO report issued on November 3, 2011 which concluded that DCAA s inability to complete audits of contractor business systems was a key external risk to the ability of the Defense Contract Management Agency (DCMA) to effectively carry out its responsibility to determine the adequacy of contractor business systems. The irony, of course, is that the same GAO that criticized DCAA on July 22, 2008 for having a management and agency culture that promoted a production-oriented mission in support of the contracting process later criticizes DCAA for inability to complete audits in a timely manner. In the wake of the above-described major curtailment of DCAA s role in the procurement process, it is instructive to consider how DCAA views its accomplishments and challenges. DCAA is required to issue annual reports to Congress outlining DCAA s performance in the prior fiscal year. The report on FY11 was issued on March 30, 2012; the FY12 report was issued on March 29, 2013; and the FY13 report was issued on March 24, The FY14 report was issued on March 25, These reports do not paint a pretty picture with respect to the number of reports issued and the average time required to perform an audit and issue a report. In terms of number of reports, DCAA issued 7,390 reports in FY11 with a staff of 4,876 employees or an average of 1.5 reports per employee. In FY12, DCAA issued 6,716 reports with a staff of 5,181 or an average of 1.3 reports per employee. In FY13, DCAA issued 6,259 reports with a staff of 4,933 employees or an average of 1.3 reports per employee. In FY14, DCAA issued 5,688 reports with a staff of 5,131 employees or an average of 1.1 reports per employee. While it s understood that a certain small percentage of the workforce are non-auditor support staff, the production of far less than two audit reports per employee per year over a four-year period is a clear indicator that major problems still remain within DCAA. Further, the productivity in FY14 is the lowest productivity reported in the four annual reports to Congress which suggests that DCAA productivity is regressing rather than improving. The low productivity indicated above is explained by the statistics in the DCAA reports to Congress on the length of time that DCAA takes to perform audits. For proposal evaluations, DCAA reports that on average, it took between 95 and 120 days from the date of the audit request to the date the report was issued. For incurred cost audits, the average time lapse ranged from 965 days to 1,184 days. For other audits such as CAS or Truth in Negotiations compliance, the average time to complete an audit ranged from 283 days to 384 days. The time required to issue reports seems particularly high when one considers that it s likely many of the high dollar audits occurred at very large government contractors where DCAA has large staffs in residence at the contractor location. One would think that a large staff dedicated to a single contractor would have enough accumulated knowledge about the contractor s systems and costs that individual audits could be performed in an expedient fashion. In their reports to Congress, DCAA attempts to shift blame to contractors by suggesting that they are being denied access to information necessary to perform their audits. DCAA informs Congress that they are being denied access to records and contractor employees who possess the information pertinent to the area being audited. DCAA s solution is to ask Congress for expanded subpoena authority and changes to other statutes governing these matters. From our experience assisting government contractors with DCAA matters, there is no evidence 48 Grant Thornton's 2015 Government Contractor Survey

51 to support the conclusion that access to records and employees is a frequent issue. The unusually long period it takes DCAA to complete audits is likely the result of DCAA s audit approach rather than delays caused by contractors denying DCAA access to records or employees. To summarize, it seems obvious from the above chronology of events that the cures put in place to address the ills reported by GAO on July 22, 2008 have not helped to improve the situation. Unfortunately, the opposite is true. Given the significant amounts expended by the Government annually in procurement, most would likely agree that an effective and timely audit capability is needed to support contracting officers in their critical role of acquiring at a reasonable price the goods and services needed for the Government to carry out its missions. There are many options as to how best to overhaul the system but, in our opinion, the status quo should not be one of those options. 49 Grant Thornton's 2015 Government Contractor Survey Grant Thornton's 2015 Government Contractor Survey 49

52 Sponsors Grant Thornton has been helping government contractors develop their business for over 30 years. We have a proven track record in helping our clients face the ever increasing challenges of operating in the government contracting industry. At Grant Thornton, we help dynamic organizations unlock their potential for growth. We participate in an ongoing dialog with our clients and bring our best audit, tax and advisory thinking to the table so they can make informed decisions, based on sound financial fundamentals, that consider all the angles. Dynamic companies work with us because we know what succeeds for growth. Give Rich LaFleur, Government Contractor Industry Practice Leader, a call at or contact us at GrantThornton.com. Grant Thornton LLP is the U.S. member firm of Grant Thornton International Ltd. 50 Grant Thornton's 2015 Government Contractor Survey

53 Serving the government contracting industry Transaction Advisory Services assists high-growth, dynamic companies in the government contracting industry navigate complex transactions whether buying or selling with speed and agility. From deal strategy, through due diligence and to the integration of a new business, we help clients solve problems, manage risk and seize opportunities to unlock their potential for growth. T H E T R A N S A C T I O N L I F E C Y C L E Evaluate Opportunities Execute Transaction Enhance Value Formulate transaction strategy Assess market opportunity Initiate enterprisewide diligence Close transaction & plan transition Manage transaction value Improve performance & realize value Transaction Advisory Services SUPPORTED BY TEAMS AT LOCAL, NATIONAL & GLOBAL LEVELS Diligence Sell-side due diligence Buy-side due diligence Quality of earnings Working capital benchmark threshold Market analysis Benchmarks, metrics and analysis Capital Markets IPO preparation Outsourced corporate development Strategic options review Investment Banking Debt and equity Capital efficiency Business modeling Valuation Restructuring advisory Operations Transaction integration Performance improvement Financial management and treasury Information technology Human Capital effectiveness Global Risk (FCPA) Tax Tax diligence Tax structuring Cash-tax optimization Tax merger integration & restructuring services Tax Attribute Analysis Net operating losses Tax credits & incentives Tax accounting methods Tax basis/ E&P Representative transactions Performed sell-side due diligence of $600M contractor providing distribution services to federal government of enterprise hardware and software Provided buy-side due diligence services to a strategic acquirer of a target company providing services to government intelligence agencies Performed due diligence on numerous add-on acquisitions for private equity-owned IT services contractor The people in the independent firms of Grant Thornton International Ltd provide personalized attention and the highest-quality service to public and private clients in more than 100 countries. Grant Thornton LLP is the U.S. member firm of Grant Thornton International Ltd, one of the world s leading organizations of independent audit, tax and advisory firms. Grant Thornton International Ltd and its member firms are not a worldwide partnership, as each member firm is a separate and distinct legal entity. In the United States, visit Grant Thornton LLP at GRANT THORNTON CONTACT Ricky White Director Transaction Advisory Services Phone: [email protected] In the United States, visit Grant Thornton LLP at Grant Thornton LLP. All rights reserved. U.S. member firm of Grant Thornton International Ltd.

54 Valuation services Advisory services Understanding the value of your business or business assets provides you with the means to preserve or grow that value. Grant Thornton s valuation professionals deliver thorough, independent and unbiased valuations so you can capitalize on all of the economic benefits inherent in your business. Valuation services should add value, not just determine it. A valuation should not be performed in a vacuum. Instead, it must be consistent with, and part of, your company s current needs and long-range business plans. Your valuation needs may be driven by tax concerns, ownership issues, transactional needs or other matters. You may need to value assets, on a portion of your business, or the business as a whole. You may need a valuation for financial reporting purposes under the new, and ever changing, accounting rules. Valuation Business Strategy Information Technology ADVISORY SERVICES Restructuring and Turnaround Transaction Support Forensics, Investigations and Litigation Governance, Risk and Compliance Performance Improvement Whether your company is dealing with accounting requirements, transactions, restructuring, or tax or dispute issues, the professionals at Grant Thornton understand the complexities involved and can work quickly to help you understand your options for implementing effective solutions. Financial reporting and transaction support Our highly credentialed valuation professionals perform valuations for a variety of financial reporting, transactional and tax purposes. These specialists draw from extensive experience in a broad range of industries to deliver thoroughly researched, well-documented, supportable results. We understand the specific requirements of the Securities and Exchange Commission (SEC), Internal Revenue Service (IRS) and other government authorities, and our reports conform to the professional standards promulgated by rule-making appraisal organizations. Our proven methodologies enable our personnel to perform valuations quickly and efficiently. Our specialists provide a full range of financial reporting and transactional valuation services, including determinations using fair market value, fair value and investment value, as appropriate: Business combinations (ASC 805 and IFRS 3). Intangible assets and goodwill (ASC 350 and IFRS 38). Impairment or disposal of long-lived assets (ASC 360 and IFRS 36). Stock option compensation (ASC 718 and IFRS 2). Bankruptcy and fresh start valuations (ASC 852). Fair value reporting requirements (ASC 820). Asset retirement obligations (ASC 410) Consolidation of variable-interest entities (ASC 810) Taxation support Corporate tax planning Domestic and international tax planning provides significant opportunities for corporations to manage and increase cash flow through the minimization of tax liabilities. Valuations can be a critical component of achieving effective tax

55 Valuation services Valuation services planning objectives. A comprehensive business valuation across a company s entire capital structure, including common and preferred shares, must be robust and complete to meet regulatory guidelines. Whether your organization is a public or private company, a multinational organization or an emerging business, our professionals can help you navigate the changing regulatory and tax law environment. Because our professionals understand today s complex financial reporting and tax regulations, they are uniquely effective at identifying and addressing areas of concern early in the valuation process. Estate and gift tax Our valuation professionals provide taxrelated valuation services for privately held companies, including control or minority shareholder interests valuations. We have prepared valuations to assist in estate planning and wealth transfers for family limited partnerships and limited liability companies and in connection with conversions from Subchapter C to Subchapter S status. We assist companies in determining the value of intangible assets, such as goodwill, patents, customer lists and other intellectual assets. In addition, we help companies establish the appropriate purchase price allocation for assets bought or sold under specific tax code sections. Private companies are being asked to provide more and more information, including accurate and supportable indications of the value for their various classes of equity. Internal Revenue Code Section 409A (which provides guidance for common stock valuations related to private companies) is the latest addition to a number of requirements that must be addressed by business owners. The analysis and valuation of each element of capital structure, including common shares, must be robust and complete to meet regulatory requirements. We can provide the oversight, coordination and skills necessary to perform this analysis and document our findings to help companies effectively comply with regulatory guidelines. Dispute resolution and litigation support Grant Thornton LLP s professionals provide comprehensive financial consulting, litigation support and expert witness assistance. They support attorneys in the resolution of client business disputes that concern the valuation of a business, business interests, and tangible or intangible assets or liabilities. They are experienced in all phases of the litigation process and can provide valuable assistance with case assessment strategies, loss or damage calculations, settlement negotiations, alternative dispute resolution, and economic evidence and testimony at trial. Bankruptcy and restructuring support Because of the increased complexity of bankruptcy proceedings, the demand for distressed/bankruptcy valuation services is on the rise. VSG professionals provide high-quality, supportable valuation analyses that are relevant for companies facing reorganization, liquidation, bankruptcy or emergence from bankruptcy. Distressed companies going through the restructuring process can benefit from several valuation determinations that are essential to sound decision-making. Tax Professional Standards Statement This document supports Grant Thornton LLP s marketing of professional services, and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the subject of this document we encourage you to contact us or an independent tax advisor to discuss the potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this document may be considered to contain written tax advice, any written advice contained in, forwarded with, or attached to this document is not intended by Grant Thornton to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code. Contact information Contact Information Steve Krug FVS Managing Director - VS [email protected] Tel: Paul Vogt FVS Director - VS [email protected] Tel: Grant Thornton LLP All rights reserved U.S. member firm of Grant Thornton International Ltd

56 AEROSPACE, DEFENSE & GOVERNMENT SERVICES Where Industry Expertise Meets Best Execution Unmanned Underwater Vehicle Assets of has been acquired by has been acquired by has been acquired by has been acquired by $96,000,000 Initial Public Offering Co-Manager IT AND SPECIAL COMMS HIGHLY CLASSIFIED CYBERSECURITY INTELLIGENCE COMMUNITY DEFENSE COMMUNICATIONS SPECIAL FORCES & DOD SPECIALIZED UNMANNED UNDERSEA VEHICLES U.S. NAVY ADVANCED MANUFACTURING 3D PRINTING MERCURY INTELLIGENCE SYSTEMS a wholly owned subsidiary of has been acquired by has been acquired by Pending has been acquired by LinQuest Holdings, Inc., a newly formed entity led by Company Management Fairness Opinion has been acquired by $1,000,000, Senior Notes due 2024 and 1. Senior Notes due 2017 Co-Manager BIG DATA ANALYTICS INTELLIGENCE COMMUNITY AVIATION SERVICES DOD & COMMERCIAL C4ISR & CYBER SYSTEMS NATIONAL SECURITY COMMUNITY SIGNALS INTELLIGENCE INTERNATIONAL COMMUNITY LARGE PRIME DEFENSE BB&T Capital Markets is privileged to be the leading investment bank serving the aerospace, defense and government services communities. With sixteen years of exclusive focus and hundreds of completed transactions under our belts, we are committed to flawless execution and service quality that is second to none. We invite you to experience the difference. BB&T Capital Markets is a division of BB&T Securities, LLC, member FINRA/SIPC. BB&T Securities, LLC, is a wholly owned nonbank subsidiary of BB&T Corporation. Securities or insurance products and annuities sold, offered or recommended are not a deposit, not FDIC insured, not guaranteed by a bank, not guaranteed by any federal government agency and may go down in value. 2015, BRANCH BANKING AND TRUST COMPANY. ALL RIGHTS RESERVED.

57 AEROSPACE, DEFENSE & GOVERNMENT SERVICES Momentum in M&A continues to build in After a slow 2013 and a bit of a rebound in 2014, 2015 is off to a hot start with 100 government services and defense-related transactions in the first five months. These transactions have been fueled by increased federal budget certainty, inexpensive capital, and a need for companies to put excess cash to work. In fact, strategic buyers comprised 65.0% of total M&A transaction volume in Timing continues to be an important element for companies planning to enter the M&A market, as well as successful positioning with potential acquirers who are able to realize both revenue and cost synergies through a transaction. BB&T Capital Markets continues to see strategic companies pursuing acquisitions in the C4ISR, Big Data Analytics, Cloud-related capabilities, and IT modernization market spaces in order to fill capability or technology gaps. This trend is perfectly illustrated in Cubic Corporation s purchase of DTECH LABS in late In that transaction, Cubic desired to find a cornerstone company to serve as a pillar for its communication and C4ISR strategy. BB&T Capital Markets worked with DTECH LABS to navigate the M&A process landscape and successfully executed the transaction to the mutual benefit of both the seller and the buyer. Similarly, Unmanned Aerial Systems (UAS), Unmanned Underwater Vehicles (UUVs), and Unmanned Surface Vehicles (USV) continue to be an area of significant forecasted growth in the federal market. UAS operations are expected to exceed manned aircraft operations for both the military and commercial market by In that same timeframe, the DoD is expected to add nearly 14,000 UAS to its inventory, representing approximately 70% of its aerial vehicle fleet. This estimated forecast from the US Department of Transportation comes on the heels of framework announced in February by the FAA to allow the routine use of certain small UAS in today s aviation system. BB&T Capital Markets has direct experience working with specialized technology providers in the UAS, UUV, and USV space as demonstrated by our recent transaction where we represented the Columbia Group in its sale of its UUV technology division to Huntington Ingalls Industries. We expect strong M&A markets to continue through the remainder of the year, and look forward to continuing to serve our clients in achieving their strategic goals. Carter Leake Senior Vice President Investment Banking [email protected] CORPORATE BANKING INVESTMENT BANKING RISK MANAGEMENT BBTCAPITALMARKETS.COM/ADG BB&T Capital Markets is a division of BB&T Securities, LLC, member FINRA/SIPC. BB&T Securities, LLC, is a wholly owned nonbank subsidiary of BB&T Corporation. Securities or insurance products and annuities sold, offered or recommended are not a deposit, not FDIC insured, not guaranteed by a bank, not guaranteed by any federal government agency and may go down in value. 2015, Branch Banking and Trust Company. All rights reserved

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59 A conflict of whose interest? Conflicts of interest diminish the value of both the organizations that contract with the federal government and the vendors that support the contracting organization, as well as the overall mission. So, what happens when a vendor s best interest does not align with its clients? In the federal contracting arena the verdict is clear: the idea that a company can both consult with the federal government on a purchase and then recommend a product of its own manufacture, are gone. Legislation, such as the 2009 Weapon Systems Acquisition Reform Act (WSARA), forbids conflicts created by the use of federal contractors as both advisors of support services and developers of major defense acquisition programs; and with it, area organizations continue to see unprecedented change. In this era of expansive oversight and excessive protests, these organizations often morph into multiple companies to provide a clear separation of interest. And, corporate America today is as vigilant. With the Sarbanes- Oxley legislation and ensuing business reforms and regulation, senior management is now more sensitive than ever to any perception of conflict. So, while federal contractors and corporate America as a whole continue to be under such scrutiny, why are vendors in the commercial real estate arena who advise these organizations regarding what is typically their second largest line item expense, not required to follow the same rules? Many have long realized the process of acquiring real estate is broken. Business is about capitalizing on opportunities, and real estate companies are about business. With no federal mandate, public and private commercial real estate advisory firms continue to negotiate on behalf of government contractors against the very same organizations they rely on for what is often a vast majority of their income: supporting real estate owners in leasing, management, maintenance and other areas. While many firms representing landlords create a separate division that claims to represent tenants, to date, no national firm has followed the federal contractors example of splitting their organizations for complete transparency. In other words, these real estate advisory firms still answer to the same shareholders. Information is key: California s governor, Jerry Brown, recently signed into law Senate Bill 1171 which took effect January 1, 2015, requiring commercial real estate brokers to disclose prior business relationships with landlords or tenants, to ensure transparency. I believe we need our representatives in the Washington, DC area to take the same proactive approach. Until we get there, the only truly transparent option is a firm that advises commercial tenants exclusively. Without the pressure of maximizing revenues through relationships with landlords and developers, tenant-only firms alone can provide completely objective and conflict-free consultation. With a focus on and all resources dedicated simply to tenant issues, these select firms gain the technology, perspective and expertise to ensure the greatest bottom line impact for their clients. William Tidwell, Senior Vice President, Cresa Washington DC [email protected] Cresa is the largest pure tenant representation firm in America with over 60 domestic offices, numerous international locations and over 1,000 collaborative and entrepreneurial professionals. Cresa was ranked in 2015 as #1 in client advocacy and #2 in key service metrics among all national real estate advisory firms by the Watkins Survey.

60 The law firm of Holland & Knight is proud to co-sponsor the 2015 Government Contractor Industry Survey. Mergers and Acquisitions Partners Government Contracts Partners Adam August Jocelyn Brittin David Cole Samuel Kastner Michael Mannix David Matuszewski William Mutryn Marisa Terrenzi Eric Wechselblatt Jonathan Wolcott David Black Mary Beth Bosco Thomas Brownell John Brownlee Richard Duvall Brandon Elledge Terry Elling Lynne Halbrooks Joseph Hornyak Christopher Myers Ronald Perlman Robert Tompkins Tysons Corner, VA Copyright 2015 Holland & Knight LLP All Rights Reserved

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66 ABOUT VISION NOV , 2015 FAIRVIEW PARK MARRIOTT The Vision Conference, now a product of PSC, is in its 51st year of providing the only non-profit federal market forecast that addresses the defense, civilian, and federal information technology markets. At the Vision Conference, Vision participants, industry leaders, and government agency representatives convene to present and discuss the results of the Vision Federal Market Forecast which includes analyses of 200+ interviews conducted with key government agency executives, congressional staff, industry members, think tank analysts and Wall Street analysts. The purpose is to: Provide a forum for the federal marketplace to obtain a concise, quantifiable assessment of the budgets, programs, priorities, and issues in a rapidly changing environment. Provide government customers the opportunity to express their current and future needs. Enable industry to understand and contribute to technology innovations, requirements, development, upcoming opportunities, improved business practices and better customer relationships. Encourage greater government/industry communication and interchange on issues, technology, programs and other areas of mutual interest. SESSIONS Hear in depth analysis on: Macroeconomic and Defense Topline Forecast Technology Outlook Acquisition Trends Industry Outlook Federal IT Budget Forecast Federal Services Outlook Federal Healthcare Outlook (VA, DHA, HHS) Customize your specific tracks: Department of Defense International Defense DoD IT/Networks Defense Platforms 1. Space 2. Aircraft 3. Shipbuilding 4. Vehicles C4ISR DoD Services and Support Civilian Dept. of Agriculture NASA Dept. of Treasury Dept. of State/USAID Dept. of Homeland Security Dept. of Justice Dept. of Commerce Social Security Administration EPA SPONSORSHIPS Vision is the perfect venue to garner exposure for your brand at an exciting new event packed with top executives and government decision makers. Contact Erin Whittaker at [email protected] for more information.

67 The Professional Services Council is the voice of the government technology and professional services industry, representing the full range and diversity of the sector. PSC is the most respected industry leader on legislative and regulatory issues related to government acquisition, business and technology. PSC helps shape public policy, leads strategic coalitions, and works to build consensus between government and industry. PSC s more than 375 member companies represent small, medium, and large businesses that provide federal agencies with services of all kinds, including information technology, engineering, logistics, facilities management, operations and maintenance, consulting, international development, scientific, social, environmental services, and more. Together, the trade association s members employ hundreds of thousands of Americans in all 50 states. ONE ASSOCIATION SERVING AS THE VOICE OF THE GOVERNMENT TECHNOLOGY AND PROFESSIONAL SERVICES INDUSTRY. Find out about our FIVE COUNCILS at GT contractor survey Ad.indd 2 7/29/2015 2:00:56 PM

68 IS YOUR ACCOUNTING SOFTWARE REALLY TAKING YOU WHERE YOU WANT TO GO? Find out how DCAA Compliant Microsoft Dynamics NAV for Government Contractors helps businesses find their future. Contact us today Microsoft Dynamics NAV for Government Contractors 2015 from PVBS is more than just a comprehensive project accounting & resource management software solution. Built-in analytics and real-time reporting processes position GovCon businesses for growth, profitability and competitiveness. Streamlined workflows, processes: Budgeting and Forecasting: Real Time Information Time Collection approvals through to invoicing Direct and Indirect Rates Management and Reporting Reporting, Analytics and Executive Dashboards: Dozens of out of the box financial and project performance reports Integrated business intelligence designed to be easily used by executives, accounting & finance, project managers and other key stakeholders (role based security) Integrated drill-down to transactional level detail DCAA Compliance: Automated approval processes for time and expense submission Out of the box government standard invoices Automated Incurred Cost Submission Schedules Pleasant Valley Business Solutions Sunrise Valley Drive, #200 Reston, Virginia [email protected]

69 Government Contractors Must Get Leaner By Paul Skurpski PVBS Vice President of Sales and Marketing GovCon Blog Paul Skurpski is widely regarded in government contracting circles as one of the industry s true experts on government contracting financial management solutions. Paul sits on the board of a number of industry associations including the Small and Emerging Contractor Advisory Forum (SECAF) and frequently speaks and conduct webinars on topics of interest for companies that provide services or sell products to the Federal Government. Prior to co-founding PVBS, Paul was corporate process improvement manager and director of enterprise systems for Oberthur Card Systems. He has a process improvement and enterprise systems background with over ten years experience delivering and managing enterprise inventory and financial management solutions. At PVBS, we recently completed a webinar on government contractor profitability, when a major theme emerged about how increasingly automated accounting and finance processes can lead to a richer bottom line. Managed properly, deeper automation will help create a sleek infrastructure that sets your business up for faster, more profitable growth. Government contractors continue to look to do more with less. So really it s about how do you automate manual tasks and streamline existing business processes? Forward-looking companies are looking for best practices to implement. The companies that are just doing things the same old way are the ones that seem to suddenly disappear. Reduce Your Margins or Your Operating Costs In the LPTA environment, you have two options; you can either (a) reduce your margins or (b) you can reduce the operating costs associated with the management and delivery of these contracts. Long term, of course, if your rates aren t competitive, winning new awards without reducing your back-office costs is going to lead to disaster. Am I Lean Enough or Do I Need to Automate More? Many of the government contractors I ve worked with want to understand how well they are doing from a systems perspective, compared to their counterparts. Depending on what type of company it is determines the back office staff that is needed. For example, some companies have project accountants that manage the financial aspects of the project. Some companies put that burden on the PMs, and often they re really not equipped to handle this function. They really don t have the training for some of those elements. Automation Will Help Project Managers Perform Better A great example of additional steps in the approval process is that many project managers are now approving invoices. It s a trend we re seeing because government contractors are now empowering project managers to make midcourse decisions to improve their projects. They want to make sure that there are no issues with the government client so they have added this step. Automating and integrating that approval process as part of invoicing has become a big initiative. Integrating Documentation throughout the Process The other area of automation that people are looking at is the integration of documentation within the business process, for example in managing funding. Managing funding is critical because when you re over the funded value, you re at risk with the government. Integrating documentation gives the right people access to critical information across the entire process. Pleasant Valley Business Solution Washington DC Linkedin.com/PVBS Google.com/+PvbsNet

70 Government Services Experience SRR is among the largest independent financial advisory firms with extensive expertise in valuation and transaction opinions. Our in-depth knowledge of the government contractor sector makes us uniquely qualified to provide financial advisory services to companies in your industry. Our services include: n n Fairness & solvency opinions n n Purchase price allocations n n Goodwill and long-lived asset impairment testing n n Employee stock options n n ESOP & ERISA advisory services n n Succession and shareholder planning valuation services n n Corporate tax planning valuation services n n Expert litigation testimony & valuation opinions n n E-Discovery document management To discuss how our team can help you, please contact us directly: Jeremy L. Krasner, CFA [email protected] Paul R. Mallarkey, CFA [email protected]

71 Are the Winds Finally Changing? A Look at Government Services Transaction Multiples Jeremy L. Krasner, CFA - [email protected] The defense industry gained momentum in 2014 and The Ryan-Murray budget deal in late 2013 provided much needed clarity to investors and rewarded the industry with higher valuations. Sequestration remains a very real issue for many, but there is much more clarity and optimism on where the industry is headed, which appears to be driving an improved transaction market with several large, notable deals recently announced, including Exelis, TASC, and Scitor. Values for these deals all exceeded $700 million and an average EBITDA multiple of almost 11.0x (with Scitor the biggest driver at over 15.0x). Although large deals make a splash, they are not necessarily indicative of overall market sentiment. SRR compiled a database of private company transactions to help assess current market conditions. Figure I Transaction multiples over the past several years have steadily declined. However, consistent with the general optimism within the government sector, recent deal activity and multiples appear to be improving. As Figure I highlights, LTM EBITDA multiples paid for deals since 2011 are materially below those paid for the three years prior. Continuing resolutions during much of fiscal year 2011 and the possibility of a shutdown dampened industry expectations. The mood did not improve following the formation of a bipartisan super-committee which looked at cutting $1.2 trillion from the federal deficit over ten years. Figure II shows the annual change in multiples between 2008 and 2014, and even more clearly illustrates the changes in transaction multiples. After a very robust 2008 market, multiples dropped in 2009 as in-sourcing became a key headwind. As that abated, the market improved slightly but then additional budgetary constraints hit and curbed enthusiasm until the last year or so as more clarity arose regarding spending priorities. Figure II 1

72 Figure III also provides an annual trend between 2008 and today, but compares deals with publicly available information with our private company transaction database. The publicly available deals reported higher implied multiples in all but two of the past seven years; and often by a meaningful amount. Another noticeable difference is the relatively consistent multiples paid for those deals with publicly available information compared to sharp declines experienced in the SRR private company database. Figure III Jeremy L. Krasner, CFA is a Managing Director in the Valuation & Financial Opinions Group. He has extensive experience with government service providers in the areas of transaction opinions, intangible asset valuation, goodwill impairment testing and other tax, corporate and litigation related matters. Mr. Krasner can be reached at or [email protected]. This article is intended for general information purposes only and is not intended to provide, and should not be used in lieu of, professional advice. The publisher assumes no liability for readers use of the information herein and readers are encouraged to seek professional assistance with regard to specific matters. Any conclusions or opinions are based on the specific facts and circumstances of a particular matter and therefore may not apply in all instances. All opinions expressed in these articles are those of the authors and do not necessarily reflect the views of Stout Risius Ross, Inc. or Stout Risius Ross Advisors, LLC. Figure IV One factor driving the difference in multiples is size, but even when deals greater than $100 million are compared, the SRR private company database reported a median multiple of only 8.7x EBITDA (See Figure IV) compared to 11.7x EBITDA for the publicly available transactions. Surprisingly, multiples for the publicly available deals remained consistent, except in This result may be more a result of many deals never happening and only those transactions that met specific strategic needs of buyers closed. Despite differences between the larger, public deals, the evidence shows, in general, the deal market continues to improve regardless of whether private or public

73 Dreams Within Reach. Manage cash flow, fund growth, and make your business dreams come true. SunTrust Bank, Member FDIC SunTrust Banks, Inc. SunTrust and How can we help you shine? are federally registered service marks of SunTrust Banks, Inc. SunTrust Bank s Government Contractor Group provides banking services to a variety of government contract services companies located in the Greater Washington, Maryland, and Virginia region for more than 30 years. We have a team of professionals located in Tysons Corner, VA. To inquire or learn more, please contact Pete Mandanis, Senior Vice President & Team Lead at or [email protected].

74 Contact Information For more information, please contact: Richard P. LaFleur Partner in Charge, Markets, Industries and Clients Government Contracts Practice Leader Atlantic Coast Market Territory Grant Thornton LLP T E [email protected] Offices of Grant Thornton LLP National Office 175 W. Jackson Blvd., 20th Floor Chicago, IL Alaska Anchorage Georgia Atlanta Washington National Tax Office 1250 Connecticut Ave. NW, Suite 400 Washington, DC Nevada Reno Rhode Island Providence Arizona Phoenix California Irvine Los Angeles Sacramento San Diego San Francisco San Jose Colorado Denver Connecticut Hartford Stamford Florida Fort Lauderdale Miami Orlando Tampa Illinois Chicago Oakbrook Terrace Schaumburg Kansas Overland Park Wichita Maryland Baltimore Massachusetts Boston Westborough Michigan Detroit Minnesota Minneapolis Missouri Kansas City St. Louis Nebraska Omaha New Jersey MetroPark New York Albany Long Island Manhattan North Carolina Charlotte Raleigh Ohio Cincinnati Cleveland Oklahoma Oklahoma City Tulsa Oregon Portland Pennsylvania Philadelphia Pittsburgh South Carolina Columbia Texas Austin Dallas Houston San Antonio Utah Salt Lake City Virginia Alexandria McLean Washington Seattle Washington, D.C. Washington, D.C Wisconsin Appleton Madison Milwaukee

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76 Tax professional standards statement This content supports Grant Thornton LLP s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code. About Grant Thornton LLP Founded in Chicago in 1924, Grant Thornton LLP (Grant Thornton) is the U.S. member firm of Grant Thornton International Ltd, one of the world s leading organizations of independent audit, tax and advisory firms. In the United States, Grant Thornton has revenue in excess of $1.3 billion and operates 57 offices with more than 500 partners and 6,000 employees. Grant Thornton works with a broad range of dynamic publicly and privately held companies, government agencies, financial institutions, and civic and religious organizations. This content is not intended to answer specific questions or suggest suitability of action in a particular case. For additional information about the issues discussed, contact a Grant Thornton LLP professional. Connect with us linkd.in/grantthorntonus Grant Thornton refers to Grant Thornton LLP, the U.S. member firm of Grant Thornton International Ltd (GTIL). GTIL and the member firms are not a worldwide partnership. Services are delivered by the member firms. GTIL and its member firms are not agents of, and do not obligate, one another and are not liable for one another s acts or omissions. Please see grantthornton.com for further details Grant Thornton LLP All rights reserved U.S. member firm of Grant Thornton International Ltd