Booz Allen Hamilton Holding Corp quarterly report, Q3 FY2013

Booz Allen Hamilton Holding Corporation — Q3 FY2013 Form 10-Q

Reporting period: Three and nine months ended December 31, 2012; fiscal year ends March 31. The company provides management and technology consulting, primarily to U.S. government clients. Approximately 99% of revenue came from U.S. government agencies or contractors. The filing is unaudited.

Financial performance

Metric	Three months ended Dec. 31, 2012	Year-over-year	Nine months ended Dec. 31, 2012	Year-over-year
Revenue	$1,392.7 million	Down 3.5%	$4,212.8 million	Down 2.5%
Operating income	$116.6 million	Up 18.7%	$333.4 million	Up 15.0%
Operating margin	8.4%	Up from 6.8%	7.9%	Up from 6.7%
Net income	$56.2 million	Down 10.6%	$164.2 million	Down 13.2%
Diluted EPS	$0.38	Down from $0.44	$1.08	Down from $1.34

Operating income improved despite lower revenue, mainly due to lower indirect and corporate spending and reduced incentive compensation. Higher subcontractor expenses partly offset savings. Net income declined as interest expense rose following the July refinancing and the effective tax rate increased; the prior-year tax rate benefited from releases of uncertain tax reserves. Nine-month effective tax rate was 40.2%, versus 26.4%.

For the nine-month period, management-reported non-GAAP adjusted EBITDA was $395.3 million, versus $357.5 million; adjusted net income was $181.4 million, versus $165.0 million; and adjusted diluted EPS was $1.26, versus $1.17. These company-defined measures exclude specified items and should be considered alongside GAAP results.

Cash flow, liquidity and capital structure

• Nine-month operating cash flow was $398.9 million, up from $252.0 million. Management attributed the increase largely to stronger and earlier customer collections, including temporary faster-payment requirements for Department of Defense prime contractors.
• Capital expenditures were $20.7 million, compared with $65.6 million; management-defined free cash flow was $378.3 million, compared with $186.5 million.
• Cash was $317.6 million at December 31, 2012, down from $484.4 million at March 31, 2012. Net investing cash outflow was $178.0 million, including the DSES acquisition; financing cash outflow was $387.7 million, principally reflecting dividends and debt repayment.
• Total debt was $1.726 billion, up from $965.4 million at March 31, 2012. The company had no revolving-facility borrowings; its new facility includes a $500 million revolver. December 31 rates were 2.96% on Tranche A and 4.50% on Tranche B. The company reported compliance with debt covenants.
• Current assets were $1.397 billion and current liabilities $976.3 million. Net accounts receivable was $980.3 million, down from $1.077 billion at March 31; days sales outstanding was 63, versus 65.
• Management expected operating cash flow, cash on hand and revolver capacity to cover anticipated needs for the next 12 months, including operations, working capital, debt service, capital spending and taxes.

Material changes and notable items

• On November 30, the company acquired ARINC’s Defense Systems Engineering and Support division for approximately $155.1 million cash (preliminary purchase-price accounting assumed $152.2 million after an estimated working-capital recovery). DSES added about 900 employees and $1.53 billion of backlog, including $247.3 million funded backlog. Preliminary purchase accounting included $86.2 million goodwill and $26.5 million identifiable intangible assets. The results were consolidated from closing; pro forma results were not presented because the acquisitions were not material to consolidated results.
• Backlog at December 31 was $12.922 billion, up 5.8% from $12.215 billion a year earlier. Funded backlog was $3.152 billion, up 6.1%. The company cautioned that backlog may not convert to revenue on schedule or at all.
• Contract mix shifted toward cost-reimbursable work: 58% of Q3 revenue versus 54% a year earlier; time-and-materials fell to 27% from 31%; fixed-price remained 15%. Management noted that contract mix affects profitability.
• Headcount was approximately 24,800, including DSES employees, versus 25,800 a year earlier. Management linked lower staffing and billable hours to revenue declines and ongoing capacity management.
• The July recapitalization refinanced the prior credit agreement and supported special dividends. Nine-month declared dividends totaled $8.27 per share: $8.00 special and $0.27 regular. Cash dividends paid were $1.110 billion, with $49.8 million of dividend equivalents also paid. Stockholders’ equity fell to $184.5 million from $1.185 billion, primarily due to the special dividends.
• On January 29, 2013, the board declared a regular $0.09-per-share dividend, payable February 28 to holders of record February 11.

Outlook, risks and contingencies

No quantified revenue or earnings guidance is provided. Management described challenging and uncertain government-market conditions, including federal cost-cutting, delayed procurement and funding, lower backlog conversion, and possible insourcing. The filing highlighted possible automatic defense spending reductions beginning March 2, 2013 under sequestration; it cited potential defense cuts of $500–$600 billion over 2013–2021 if implemented, while stating that the company could not predict the impact on its business.

• Government contracting carries regulatory, audit, repayment, penalty, suspension and debarment risks. The company had pending audits or investigations, including matters involving labor time reporting, procurement integrity and classified-information access. It recorded a $149.9 million liability for estimated potential customer refunds related to audits or reviews of post-fiscal-2006 contract costs.
• Seven remaining former-officer and stockholder lawsuits related to the 2008 acquisition alleged approximately $348.7 million in damages, including $291.5 million sought to be trebled under RICO, plus punitive damages, costs and fees. Management did not expect the matters to have a material adverse effect, but outcomes are uncertain.
• The company remained contingently liable on certain leases assigned to Booz & Co.; maximum undiscounted future payments were $27.6 million. No liability was recorded because management assessed payment as unlikely.
• Other stated risks include dependence on federal budgets and contract awards, competition, backlog conversion, staffing and security clearances, fixed-price contract execution, cybersecurity, acquisition integration, and debt covenants. Management reported no material changes to previously disclosed risk factors and no off-balance-sheet arrangements.

Important facts for investors to verify

• Whether federal budget actions, sequestration or continuing resolutions affect contract funding, awards and backlog conversion.
• Whether revenue and headcount stabilize, and whether cost savings can sustain higher operating margins amid the changing contract mix.
• Whether cash collection gains persist; distinguish recurring operating cash generation from unusually favorable collection timing.
• Whether acquisition integration, final DSES purchase accounting and the higher debt burden affect earnings, cash flow and covenant headroom.
• Whether government audits, investigations and former-stockholder litigation lead to repayments, penalties, restrictions or costs beyond recorded reserves.
• How the large special-dividend outflow and reduced equity affect the company’s financial flexibility and future capital allocation.