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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis is intended to help the reader understand our business, financial condition, results of operations, and liquidity and capital resources. You should read this discussion in conjunction with our condensed consolidated financial statements and the related notes contained elsewhere in this Quarterly Report on Form 10-Q, or Quarterly Report.
The statements in this discussion regarding industry outlook, our expectations regarding our future performance, liquidity and capital resources, and other non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in our Annual Report on Form 10-K for the fiscal year ended March 31, 2023 filed with the Securities and Exchange Commission on May 26, 2023, or Annual Report, and under Part II, “Item 1A. Risk Factors,” and “— Special Note Regarding Forward Looking Statements” of this Quarterly Report. Our actual results may differ materially from those contained in or implied by any forward-looking statements.
Our fiscal year ends March 31 and, unless otherwise noted, references to years or fiscal are for fiscal years ended March 31. See “—Results of Operations.”
Overview
Trusted to transform missions with the power of tomorrow’s technologies, Booz Allen advances the nation’s most critical civil, defense, and national security priorities. Our ability to deliver value to our clients has always been, and continues to be, a product of the strong character, expertise and tremendous passion of our people. Our approximately 33,100 employees work to solve hard problems by making clients' missions their own, combining decades of consulting and domain expertise with functional expertise in areas such as analytics, digital solutions, engineering, and cyber, all fostered by a culture of innovation that extends to all reaches of the Company.
Through our dedication to our clients' missions, and a commitment to evolving our business to address their needs, we have longstanding relationships with our clients, the longest of which is more than 80 years. We support critical missions for a diverse base of federal government clients, including nearly all of the U.S. government's cabinet-level departments, as well as for commercial clients, both domestically and internationally. We support our federal government clients by helping them tackle their most complex and pressing challenges such as protecting soldiers in combat and supporting their families, advancing cyber capabilities, keeping our national infrastructure secure, enabling and enhancing digital services, transforming the healthcare system, and improving government efficiency to achieve better outcomes. We serve commercial clients across industries including financial services, health and life sciences, energy, and technology.
Financial and Other Highlights
During the second quarter of fiscal 2024, the Company generated year over year revenue growth and increased client staff headcount.
Revenue increased 16.0% in the three months ended September 30, 2023 from the three months ended September 30, 2022 and increased 17.0% in the six months ended September 30, 2023 from the six months ended September 30, 2022. The increase was primarily driven by strong demand for our services and solutions as well as continued headcount growth. The increase in revenue over the year-to-date period also includes approximately $69.9 million of contributions related to the acquisition of EverWatch Corp. (“EverWatch”), as well as an increase of $18.3 million representing the reduction to our provision for claimed indirect costs recorded during the second quarter of fiscal 2024. See Note 15, “Commitments and Contingencies,” to the condensed consolidated financial statements for further information.
Operating income increased 19.2% to $267.0 million in the three months ended September 30, 2023 from $223.9 million in the three months ended September 30, 2022 and operating margin increased from 9.7% in the prior year period to 10.0%. Operating income increased 16.3% to $501.4 million in the six months ended September 30, 2023 from $431.1 million in the six months ended September 30, 2022, which reflects a decrease in operating margin from 9.5% to 9.4%. Year-to-date margins were impacted by a $27.5 million reserve associated with the U.S. Department of Justice's investigation of the company (see Note 15, “Commitments and Contingencies,” to the condensed consolidated financial statements for further information). Margin results reflect strong contract-level performance coupled with ongoing cost management efforts, but also reflect higher billable expenses.
Non-GAAP Measures
We publicly disclose certain non-GAAP financial measurements, including Revenue, Excluding Billable Expenses, Adjusted Operating Income, Adjusted EBITDA, Adjusted EBITDA Margin on Revenue, Adjusted EBITDA Margin on Revenue, Excluding Billable Expenses, Adjusted Net Income, and Adjusted Diluted Earnings Per Share, or Adjusted Diluted EPS, because management uses these measures for business planning purposes, including to manage our business against internal projected results of operations and measure our performance. We view Adjusted Operating Income, Adjusted EBITDA, Adjusted EBITDA Margin on Revenue, Adjusted EBITDA Margin on Revenue, Excluding Billable Expenses, Adjusted Net Income, and Adjusted Diluted EPS as measures of our core operating business, which exclude the impact of the items detailed below, as these items are generally not operational in nature. These non-GAAP measures also provide another basis for comparing period to period results by excluding potential differences caused by non-operational and unusual or non-recurring items. In addition, we use Revenue, Excluding Billable Expenses because it provides management useful information about the Company's operating performance by excluding the impact of costs that are not indicative of the level of productivity of our client staff headcount and our overall direct labor, which management believes provides useful information to our investors about our core operations. We also utilize and discuss Free Cash Flow because management uses this measure for business planning purposes, measuring the cash generating ability of the operating business, and measuring liquidity generally. We present these supplemental measures because we believe that these measures provide investors and securities analysts with important supplemental information with which to evaluate our performance, long-term earnings potential, or liquidity, as applicable, and to enable them to assess our performance on the same basis as management. These supplemental performance measurements may vary from and may not be comparable to similarly titled measures by other companies in our industry. Revenue, Excluding Billable Expenses, Adjusted Operating Income, Adjusted EBITDA, Adjusted EBITDA Margin on Revenue, Adjusted EBITDA Margin on Revenue, Excluding Billable Expenses, Adjusted Net Income, Adjusted Diluted EPS, and Free Cash Flow are not recognized measurements under accounting principles generally accepted in the United States, or GAAP, and when analyzing our performance or liquidity, as applicable, investors should (i) evaluate each adjustment in our reconciliation of revenue to Revenue, Excluding Billable Expenses, operating income to Adjusted Operating Income, net income to Adjusted EBITDA, Adjusted EBITDA Margin on Revenue, Adjusted EBITDA Margin on Revenue, Excluding Billable Expenses, Adjusted Net Income and Adjusted Diluted Earnings Per Share, and net cash provided by operating activities to Free Cash Flow, (ii) use Revenue, Excluding Billable Expenses, Adjusted Operating Income, Adjusted EBITDA, Adjusted EBITDA Margin on Revenue, Adjusted EBITDA Margin on Revenue, Excluding Billable Expenses, Adjusted Net Income, and Adjusted Diluted EPS in addition to, and not as an alternative to, revenue, operating income, net income or diluted EPS, as measures of operating results, each as defined under GAAP and (iii) use Free Cash Flow in addition to, and not as an alternative to, net cash provided by operating activities as a measure of liquidity, each as defined under GAAP. We have defined the aforementioned non-GAAP measures as follows:
•“Revenue, Excluding Billable Expenses” represents revenue less billable expenses. We use Revenue, Excluding Billable Expenses because it provides management useful information about the Company's operating performance by excluding the impact of costs that are not indicative of the level of productivity of our client staff headcount and our overall direct labor, which management believes provides useful information to our investors about our core operations.
•“Adjusted Operating Income” represents operating income before the change in provision for claimed indirect costs, acquisition and divestiture costs, financing transaction costs, significant acquisition amortization, and the reserve associated with the U.S. Department of Justice investigation disclosed in Note 15, “Commitments and Contingencies,” to the condensed consolidated financial statements. We prepare Adjusted Operating Income to eliminate the impact of items we do not consider indicative of ongoing operating performance due to their inherent unusual, extraordinary, or non-recurring nature or because they result from an event of a similar nature.
•“Adjusted EBITDA” represents net income attributable to common stockholders before income taxes, net interest and other expense and depreciation and amortization and before certain other items, including the change in provision for claimed indirect costs, acquisition and divestiture costs, financing transaction costs, and the reserve associated with the U.S. Department of Justice investigation disclosed in Note 15, “Commitments and Contingencies,” to the condensed consolidated financial statements. “Adjusted EBITDA Margin on Revenue” is calculated as Adjusted EBITDA divided by revenue. “Adjusted EBITDA Margin on Revenue, Excluding Billable Expenses” is calculated as Adjusted EBITDA divided by Revenue, Excluding Billable Expenses. The Company prepares Adjusted EBITDA, Adjusted EBITDA Margin on Revenue, and Adjusted EBITDA Margin on Revenue, Excluding Billable Expenses to eliminate the impact of items it does not consider indicative of ongoing operating performance due to their inherent unusual, extraordinary or non-recurring nature or because they result from an event of a similar nature.
•“Adjusted Net Income” represents net income attributable to common stockholders before: (i) the change in provision for claimed indirect costs (ii) acquisition and divestiture costs, (iii) financing transaction costs, (iv) significant acquisition amortization, (v) the reserve associated with the U.S. Department of Justice investigation disclosed in Note 15, “Commitments and Contingencies,” to the condensed consolidated financial statements, (vi) gains associated with divestitures or deconsolidation, and (vii) amortization and write-off of debt issuance costs and debt discount, in each case net of the tax effect where appropriate calculated using an assumed effective tax rate. We prepare Adjusted Net Income to eliminate the impact of items, net of tax, we do not consider indicative of ongoing operating performance due to their inherent unusual, extraordinary, or non-recurring nature or because they result from an event of a similar nature. We view Adjusted Net Income as an important indicator of performance consistent with the manner in which management measures and forecasts the Company's performance and the way in which management is incentivized to perform.
•“Adjusted Diluted EPS” represents diluted EPS calculated using Adjusted Net Income as opposed to net income. Additionally, Adjusted Diluted EPS does not contemplate any adjustments to net income as required under the two-class method as disclosed in the footnotes to the condensed consolidated financial statements.
•“Free Cash Flow” represents the net cash generated from operating activities less the impact of purchases of property, equipment, and software.
Below is a reconciliation of Revenue, Excluding Billable Expenses, Adjusted Operating Income, Adjusted EBITDA, Adjusted EBITDA Margin on Revenue, Adjusted EBITDA Margin on Revenue, Excluding Billable Expenses, Adjusted Net Income, Adjusted Diluted EPS, and Free Cash Flow to the most directly comparable financial measure calculated and presented in accordance with GAAP.
| | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
September 30, | | Six Months Ended
September 30, |
| (In thousands, except share and per share data) | 2023 | | 2022 | | 2023 | | 2022 |
| | (Unaudited) | | (Unaudited) |
| Revenue, Excluding Billable Expenses | | | | | | | |
| Revenue | $ | 2,666,282 | | $ | 2,298,976 | | $ | 5,320,768 | | $ | 4,548,576 |
| Less: Billable expenses | 824,788 | | 684,941 | | 1,637,092 | | 1,359,207 |
| Revenue, Excluding Billable Expenses* | $ | 1,841,494 | | $ | 1,614,035 | | $ | 3,683,676 | | $ | 3,189,369 |
| Adjusted Operating Income | | | | | | | |
| Operating income | $ | 266,989 | | $ | 223,921 | | $ | 501,407 | | $ | 431,116 |
| Change in provision for claimed indirect costs (a) | (18,345) | | — | | (18,345) | | — |
| Acquisition and divestiture costs (b) | 260 | | 15,932 | | 3,528 | | 21,025 |
| Financing transaction costs (c) | 820 | | 6,888 | | 820 | | 6,888 |
| Significant acquisition amortization (d) | 13,596 | | 11,087 | | 26,704 | | 22,174 |
| Legal matter reserve (e) | — | | — | | 27,453 | | — |
| Adjusted Operating Income | $ | 263,320 | | $ | 257,828 | | $ | 541,567 | | $ | 481,203 |
| EBITDA, Adjusted EBITDA, Adjusted EBITDA Margin on Revenue & Adjusted EBITDA Margin on Revenue, Excluding Billable Expenses |
| Net income attributable to common stockholders | $ | 170,718 | | $ | 170,932 | | $ | 332,106 | | $ | 309,216 |
| Income tax expense | 55,071 | | 51,258 | | 94,551 | | 92,747 |
| Interest and other, net (f) | 41,200 | | 1,882 | | 74,750 | | 29,495 |
| Depreciation and amortization | 40,907 | | 39,052 | | 82,754 | | 79,154 |
| EBITDA | 307,896 | | 263,124 | | 584,161 | | 510,612 |
| Change in provision for claimed indirect costs (a) | (18,345) | | — | | (18,345) | | — |
| Acquisition and divestiture costs (b) | 260 | | 15,932 | | 3,528 | | 21,025 |
| Financing transaction costs (c) | 820 | | 6,888 | | 820 | | 6,888 |
| Legal matter reserve (e) | — | | — | | 27,453 | | — |
| Adjusted EBITDA | $ | 290,631 | | $ | 285,944 | | $ | 597,617 | | $ | 538,525 |
| Net income margin attributable to common stockholders | 6.4% | | 7.4% | | 6.2% | | 6.8% |
| Adjusted EBITDA Margin on Revenue | 10.9% | | 12.4% | | 11.2% | | 11.8% |
| Adjusted EBITDA Margin on Revenue, Excluding Billable Expenses | 15.8% | | 17.7% | | 16.2% | | 16.9% |
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | Six Months Ended
September 30, |
| (In thousands, except share and per share data) | 2023 | | 2022 | | 2023 | | 2022 |
| (Unaudited) | | (Unaudited) |
| Adjusted Net Income | | | | | | | |
| Net income attributable to common stockholders | $ | 170,718 | | $ | 170,932 | | $ | 332,106 | | $ | 309,216 |
| Change in provision for claimed indirect costs (a) | (18,345) | | — | | (18,345) | | — |
| Acquisition and divestiture costs (b) | 260 | | 15,932 | | 3,528 | | 21,025 |
| Financing transaction costs (b) | 820 | | 6,888 | | 820 | | 6,888 |
| Significant acquisition amortization (d) | 13,596 | | 11,087 | | 26,704 | | 22,174 |
| Legal matter reserve (e) | — | | — | | 27,453 | | — |
| | | | | | | |
| Gains associated with divestitures or deconsolidation (g) | — | | (31,160) | | — | | (31,160) |
| Amortization and write-off of debt issuance costs and debt discount | 1,106 | | 4,177 | | 1,888 | | 5,000 |
| Adjustments for tax effect (h) | 988 | | (77) | | (11,954) | | (4,498) |
| Adjusted Net Income | $ | 169,143 | | $ | 177,779 | | $ | 362,200 | | $ | 328,645 |
| Adjusted Diluted Earnings Per Share | | | | | | | |
| Weighted-average number of diluted shares outstanding | 131,133,145 | | 132,729,245 | | 131,337,913 | | 132,869,141 |
| Diluted earnings per share | $ | 1.29 | | $ | 1.28 | | $ | 2.51 | | $ | 2.31 |
| Adjusted Net Income Per Diluted Share (i) | $ | 1.29 | | $ | 1.34 | | $ | 2.76 | | $ | 2.47 |
| Free Cash Flow | | | | | | | |
| Net cash provided by (used in) operating activities | $ | (47,385) | | $ | 272,726 | | $ | (118,917) | | $ | 227,092 |
| Less: Purchases of property, equipment and software | (16,948) | | (16,000) | | (27,436) | | (29,734) |
| Free cash flow | $ | (64,333) | | $ | 256,726 | | $ | (146,353) | | $ | 197,358 |
| Operating cash flow conversion | (28)% | | 160% | | (36)% | | 73% |
| Free cash flow conversion | (38)% | | 144% | | (40)% | | 60% |
* Revenue, Excluding Billable Expenses includes $18.3 million of revenue resulting from the reduction to our provision for claimed indirect costs as noted below.
(a)Represents the reduction to our provision for claimed indirect costs recorded during the second quarter of fiscal 2024, which resulted in a corresponding increase to revenue, as a result of the Defense Contract Audit Agency’s findings related to its audit of our claimed indirect costs for fiscal 2022. See Note 15, “ Commitments and Contingencies,” to the condensed consolidated financial statements for further information.
(b)Represents costs associated with the acquisition efforts of the Company related to transactions for which the Company has entered into a letter of intent to acquire a controlling financial interest in the target entity, as well as the divestiture costs incurred in divesting a portion of our business. Acquisition and divestiture costs primarily include costs associated with (i) buy-side and sell-side due diligence activities, (ii) compensation expenses associated with employee retention, and (iii) legal and advisory fees, primarily associated with the acquisitions of Liberty IT Solutions, LLC (“Liberty”) and Tracepoint Holdings, LLC (“Tracepoint”) in fiscal 2022, and the acquisition of EverWatch Corp. (“EverWatch”) and the divestitures of our management consulting business serving the Middle East and North Africa (“MENA”) and our Managed Threat Services business (“MTS”) in fiscal 2023.See Note 5, “Acquisition, Goodwill and Intangible Assets,” to the condensed consolidated financial statements for further information.
(c)Reflects expenses associated with debt financing activities incurred during the second quarters of fiscal 2024 and 2023.
(d)Amortization expense associated with acquired intangibles from significant acquisitions. Significant acquisitions include acquisitions which the Company considers to be beyond the scope of our normal operations. Significant acquisition amortization includes amortization expense associated with the acquisition of Liberty in the second quarter of fiscal 2022 and EverWatch in the third quarter of fiscal 2023.
(e)Reserve associated with the U.S. Department of Justice's investigation of the Company. See Note 15, “Commitments and Contingencies,” to the condensed consolidated financial statements for further information.
(f)Reflects the combination of Interest expense and Other income (expense), net from the condensed consolidated statement of operations.
(g)Represents the gain recognized on the MENA divestiture.
(h)Reflects the tax effect of adjustments at an assumed effective tax rate of 26%, which approximates the blended federal and state tax rates, and consistently excludes the impact of other tax credits and incentive benefits realized. The tax effect of certain discrete items is calculated specifically and may vary from the general 26% rate. The tax effect also includes the indirect effects of uncertainty around the application of Section 174 of the Tax Cuts and Jobs Act of 2017.
(i)Excludes adjustments of approximately $1.4 million and $2.7 million of net earnings for the three and six months ended September 30, 2023, respectively, and approximately $1.4 million and $2.3 million of net earnings for the three and six months ended September 30, 2022, respectively, associated with the application of the two-class method for computing diluted earnings per share.
Factors and Trends Affecting Our Results of Operations
Our results of operations have been, and we expect them to continue to be, affected by the following factors, which may cause our future results of operations to differ from our historical results of operations discussed under “- Results of Operations.”
Business Environment and Key Trends in Our Markets
We believe that the following trends and developments in the U.S. government services industry and our markets may influence our future results of operations:
•uncertainty around the timing, extent, nature and effect of Congressional and other U.S. government actions to approve funding of the U.S. government, address budgetary constraints, including caps on the discretionary budget for defense and non-defense departments and agencies, as established by the Bipartisan Budget Control Act of 2011 (“BCA”) and subsequently adjusted by the American Taxpayer Relief Act of 2012, the Bipartisan Budget Act of 2013, the Bipartisan Budget Act of 2015, the Bipartisan Budget Act of 2018, and the Bipartisan Budget Act of 2019, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), and the Consolidated Appropriations Act of 2021, and address the ability of Congress to determine how to allocate the available budget authority and pass appropriations bills to fund both U.S. government departments and agencies that are, and those that are not, subject to the caps;
•budget deficits and the growing U.S. national debt increasing pressure on the U.S. government to reduce federal spending across all federal agencies together with associated uncertainty about the size and timing of those reductions;
•cost-cutting and efficiency initiatives, current and future budget restrictions, continued implementation of Congressionally mandated automatic spending cuts, and other efforts to reduce U.S. government spending could cause clients to reduce or delay funding for orders for services or invest appropriated funds on a less consistent or rapid basis or not at all, particularly when considering long-term initiatives and in light of current uncertainty around Congressional efforts to craft a long-term agreement on the U.S. government's ability to incur indebtedness in excess of its current limits, and generally in the current political environment, there is a risk that clients will not issue task orders in sufficient volume to reach current contract ceilings, alter historical patterns of contract awards, including the typical increase in the award of task orders or completion of other contract actions by the U.S. government in the period before the end of the U.S. government's fiscal year on September 30, delay requests for new proposals and contract awards, rely on short-term extensions and funding of current contracts, or reduce staffing levels and hours of operation;
•delays in the completion of future U.S. government’s budget processes, which have in the past and could in the future delay procurement of the products, services, and solutions we provide;
•changes in the relative mix of overall U.S. government spending and areas of spending growth, with lower spending on homeland security, intelligence, defense-related programs as certain overseas operations end, and continued increased spending on cybersecurity, Command, Control, Communications, Computers, Intelligence, Surveillance, and Reconnaissance (C4ISR), advanced analytics, technology integration, and healthcare, including as a result of the presidential and administration transition;
•the extent, nature and effect of disease outbreaks, pandemics and widespread health epidemics, such as COVID-19, including the impact on federal budgets, current and pending procurements, supply chains, demand for services, deployment and productivity of our employees and the economic and societal impact of a pandemic, and the expected continued volatility in billable expenses;
•increased inflationary pressure that could impact the cost of doing business and/or reduce customer buying power;
•risks related to a possible recession and volatility or instability of the global financial system, including bank failures and the resulting impact on counterparties and business conditions generally;
•legislative and regulatory changes to limitations on the amount of allowable executive compensation permitted under flexibly priced contracts following implementation of interim rules adopted by federal agencies pursuant to the Bipartisan Budget Act of 2013, which substantially further reduce the amount of allowable executive compensation under these contracts and extend these limitations to a larger segment of our executives and our entire contract base;
•efforts by the U.S. government to address organizational conflicts of interest and related issues and the impact of those efforts on us and our competitors;
•increased audit, review, investigation, and general scrutiny by U.S. government agencies of government contractors' performance under U.S. government contracts and compliance with the terms of those contracts and applicable laws;
•the federal focus on refining the definition of “inherently governmental” work, including proposals to limit contractor access to sensitive or classified information and work assignments, which will continue to drive pockets of insourcing in various agencies, particularly in the intelligence market;
•negative publicity and increased scrutiny of government contractors in general, including us, relating to U.S. government expenditures for contractor services and incidents involving the mishandling of sensitive or classified information;
•U.S. government agencies awarding contracts on a technically acceptable/lowest cost basis, which could have a negative impact on our ability to win certain contracts;
•increased competition from other government contractors and market entrants seeking to take advantage of certain of the trends identified above, and an industry trend towards consolidation, which may result in the emergence of companies that are better able to compete against us;
•cost cutting and efficiency and effectiveness efforts by U.S. civilian agencies with a focus on increased use of performance measurement, “program integrity” efforts to reduce waste, fraud and abuse in entitlement programs, and renewed focus on improving procurement practices for and interagency use of IT services, including through the use of cloud based options and data center consolidation;
•restrictions by the U.S. government on the ability of federal agencies to use lead system integrators, in response to cost, schedule, and performance problems with large defense acquisition programs where contractors were performing the lead system integrator role;
•increasingly complex requirements and enforcement and reporting landscapes of the Department of Defense and the U.S. intelligence community, including cybersecurity, managing federal health care cost growth, competition, and focus on reforming existing government regulation of various sectors of the economy, such as financial regulation and healthcare; and
•increasing small business regulations across the Department of Defense and civilian agency clients continue to gain traction, agencies are required to meet high small business set aside targets, and large business prime contractors are required to subcontract in accordance with considerable small business participation goals necessary for contract award.
Sources of Revenue
Substantially all of our revenue is derived from services provided under contracts and task orders with the U.S. government, primarily by our client staff and, to a lesser extent, our subcontractors. Funding for our contracts and task orders is generally linked to trends in budgets and spending across various U.S. government agencies and departments. We provide services under a large portfolio of contracts and contract vehicles to a broad client base, and we believe that our diversified contract and client base lessens potential volatility in our business; however, a reduction in the amount of services that we are contracted to provide to the U.S. government or any of our significant U.S. government clients could have a material adverse effect on our business and results of operations. In particular, the Department of Defense is one of our significant clients, and the BCA originally required nine automatic spending cuts (referred to as “sequestration”) of $109 billion annually from 2013 to 2021, half of which was intended to come from defense programs, though less than $1 billion has been cut for defense programs per year under the BCA. Mandatory sequestrations under the BCA were subsequently extended by the Bipartisan Budget Acts of 2013, 2015, 2018 and 2019, the Military Retired Pay Restoration Act, the CARES Act and the Infrastructure Investment and Jobs Act. The extension of the mandatory sequestration applies an 8.3% reduction in defense spending in each year from 2021 to 2031. This could result in a commensurate reduction in the amount of services that we are contracted to provide to the Department of Defense and could have a material adverse effect on our business and results of operations, and given the uncertainty of when and how these automatic reductions required by the BCA may return and/or be applied, we are unable to predict the nature or magnitude of the potential adverse effect.
Contract Types
We generate revenue under the following three basic types of contracts:
•Cost-Reimbursable Contracts. Cost-reimbursable contracts provide for the payment of allowable costs incurred during performance of the contract, up to a ceiling based on the amount that has been funded, plus a fixed fee or award fee. As we increase or decrease our spending on allowable costs, our revenue generated on cost-reimbursable contracts will increase, up to the ceiling and funded amounts, or decrease, respectively. We generate revenue under two general types of cost-reimbursable contracts: cost-plus-fixed-fee and cost-plus-award-fee, both of which reimburse allowable costs and provide for a fee. The fee under each type of cost-reimbursable contract is generally payable upon completion of services in accordance with the terms of the contract. Cost-plus-fixed-fee contracts offer no opportunity for payment beyond the fixed fee. Cost-plus-award-fee contracts also provide for an award fee that varies within specified limits based upon the client’s assessment of our performance against a predetermined set of criteria, such as targets for factors like cost, quality, schedule, and performance.
•Time-and-Materials Contracts. Under contracts in this category, we are paid a fixed hourly rate for each direct labor hour expended, and we are reimbursed for billable material costs and billable out-of-pocket expenses inclusive of allocable indirect costs. We assume the financial risk on time-and-materials contracts because our costs of performance may exceed negotiated hourly rates. To the extent our actual direct labor, including allocated indirect costs, and associated billable expenses decrease or increase in relation to the fixed hourly billing rates provided in the contract, we will generate more or less profit, respectively, or could incur a loss.
•Fixed-Price Contracts. Under a fixed-price contract, we agree to perform the specified work for a predetermined price. To the extent our actual direct and allocated indirect costs decrease or increase from the estimates upon which the price was negotiated, we will generate more or less profit, respectively, or could incur a loss. Some fixed-price contracts have a performance-based component, pursuant to which we can earn incentive payments or incur financial penalties based on our performance. Fixed-price level of effort contracts require us to provide a specified level of effort (i.e., labor hours), over a stated period of time, for a fixed price.
The amount of risk and potential reward varies under each type of contract. Under cost-reimbursable contracts, there is limited financial risk, because we are reimbursed for all allowable costs up to a ceiling. However, profit margins on this type of contract tend to be lower than on time-and-materials and fixed-price contracts. Under time-and-materials contracts, we are reimbursed for the hours worked using the predetermined hourly rates for each labor category. In addition, we are typically reimbursed for other contract direct costs and expenses at cost. We assume financial risk on time-and-materials contracts because our labor costs may exceed the negotiated billing rates. Profit margins on well-managed time-and-materials contracts tend to be higher than profit margins on cost-reimbursable contracts as long as we are able to staff those contracts with people who have an appropriate skill set. Under fixed-price contracts, we are required to deliver the objectives under the contract for a predetermined price. Compared to time-and-materials and cost-reimbursable contracts, fixed-price contracts generally offer higher profit margin opportunities because we receive the full benefit of any cost savings but generally involve greater financial risk because we bear the impact of any cost overruns. In the aggregate, the contract type mix in our revenue for any given period will affect that period's profitability. Changes in contract type as a result of re-competes and new business could influence the percentage/mix in unanticipated ways.
The table below presents the percentage of total revenue for each type of contract:
| | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
September 30, | | Six Months Ended
September 30, |
| | 2023 | | 2022 | | 2023 | | 2022 |
| Cost-reimbursable | 55% | | 52% | | 55% | | 53% |
| Time-and-materials | 24% | | 25% | | 24% | | 24% |
| Fixed-price | 21% | | 23% | | 21% | | 23% |
Contract Diversity and Revenue Mix
We provide services to our clients through a large number of single award contracts, contract vehicles, and multiple award contract vehicles. Most of our revenue is generated under indefinite delivery/indefinite quantity, or IDIQ, contract vehicles, which include multiple award government wide acquisition contract vehicles, or GWACs, and General Services Administration Multiple Award Schedule Contracts, or GSA schedules, and certain single award contracts. GWACs and GSA schedules are available to all U.S. government agencies. Any number of contractors typically competes under multiple award IDIQ contract vehicles for task orders to provide particular services, and we earn revenue under these contract vehicles only to the extent that we are successful in the bidding process for task orders.
We generate revenue under our contracts and task orders through our provision of services as both a prime contractor and subcontractor, as well as from the provision of services by subcontractors under contracts and task orders for which we act as the prime contractor. The mix of these types of revenue affects our operating margin. Substantially all of our operating margin is derived from direct client staff labor, as the portion of our operating margin derived from fees we earn on services provided by our subcontractors is not significant. We view growth in direct client staff labor as the primary driver of earnings growth. Direct client staff labor growth is driven by client staff headcount growth, after attrition, and total backlog growth.
Our People
Revenue from our contracts is derived from services delivered by client staff and, to a lesser extent, from our subcontractors. Our ability to hire, retain, and deploy talent with skills appropriately aligned with client needs is critical to our ability to grow our revenue. We continuously evaluate whether our talent base is properly sized and appropriately compensated, and contains an optimal mix of skills to be cost competitive and meet the rapidly evolving needs of our clients. We seek to achieve that result through recruitment and management of capacity and compensation. As of September 30, 2023 and 2022, we employed approximately 33,100 and 30,000 people, respectively, of which approximately 30,200 and 27,200, respectively, were client staff.
Contract Backlog
We define backlog to include the following three components:
•Funded Backlog. Funded backlog represents the revenue value of orders for services under existing contracts for which funding is appropriated or otherwise authorized less revenue previously recognized on these contracts.
•Unfunded Backlog. Unfunded backlog represents the revenue value of orders (including optional orders) for services under existing contracts for which funding has not been appropriated or otherwise authorized.
•Priced Options. Priced contract options represent 100% of the revenue value of all future contract option periods under existing contracts that may be exercised at our clients’ option and for which funding has not been appropriated or otherwise authorized.
Our backlog does not include contracts that have been awarded but are currently under protest and also does not include any task orders under IDIQ contracts, except to the extent that task orders have been awarded to us under those contracts.
The following table summarizes the value of our contract backlog at the respective dates presented:
| | | | | | | | | | | |
| |
| September 30,
2023 | | September 30,
2022 |
| | (In millions) |
| Backlog: | | | |
| Funded | $ | 6,282 | | | $ | 5,475 | |
| Unfunded | 10,128 | | | 10,380 | |
| Priced options | 18,630 | | | 15,981 | |
| Total backlog | $ | 35,040 | | | $ | 31,836 | |
Our total backlog consists of remaining performance obligations, certain orders under contracts for which the period of performance has expired, and unexercised option period and other unexercised optional orders. As of September 30, 2023 and March 31, 2023, the Company had $9.8 billion and $7.9 billion of remaining performance obligations, respectively. We expect to recognize approximately 75% of the remaining performance obligations at September 30, 2023 as revenue over the next 12 months, and approximately 85% over the next 24 months. The remainder is expected to be recognized thereafter. However, given the uncertainties discussed below, as well as the risks described in “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended March 31, 2023, we can give no assurance that we will be able to convert our backlog into revenue in any particular period, if at all. Our backlog includes orders under contracts that in some cases extend for several years. The U.S. Congress generally appropriates funds for our clients on a yearly basis, even though their contracts with us may call for performance that is expected to take a number of years to complete. As a result, contracts typically are only partially funded at any point during their term and all or some of the work to be performed under the contracts may remain unfunded unless and until the U.S. Congress makes subsequent appropriations and the procuring agency allocates funding to the contract.
We view growth in total backlog and client staff headcount as the two key measures of our potential business growth. Growing and deploying client staff is the primary means by which we are able to achieve profitable revenue growth. To the extent that we are able to hire additional client staff and deploy them against funded backlog, we generally recognize increased revenue. Total backlog increased by 10.1% from September 30, 2022 to September 30, 2023. Additions to funded backlog during the twelve months ended September 30, 2023 totaled $10.8 billion in comparison to $9.4 billion for the comparable period in fiscal 2023, as a result of the conversion of unfunded backlog to funded backlog, the award of new contracts and task orders under which funding was appropriated, and the exercise and subsequent funding of priced options. We report internally on our backlog on a monthly basis and review backlog upon occurrence of certain events to determine if any adjustments are necessary.
We cannot predict with any certainty the portion of our backlog that we expect to recognize as revenue in any future period and we cannot guarantee that we will recognize any revenue from our backlog. The primary risks that could affect our ability to recognize such revenue on a timely basis or at all are: program schedule changes, contract modifications, and our ability to assimilate and deploy new client staff against funded backlog; cost-cutting initiatives and other efforts to reduce U.S. government spending, which could reduce or delay funding for orders for services; and delayed funding of our contracts due to delays in the completion of the U.S. government's budgeting process and the use of continuing resolutions by the U.S. government to fund its operations. The amount of our funded backlog is also subject to change, due to, among other factors: changes in congressional appropriations that reflect changes in U.S. government policies or priorities resulting from various military, political, economic, or international developments; changes in the use of U.S. government contracting vehicles, and the provisions therein used to procure our services and adjustments to the scope of services, or cancellation of contracts, by the U.S. government at any time. In our recent experience, none of the following additional risks have had a material negative effect on our ability to realize revenue from our funded backlog: the unilateral right of the U.S. government to cancel multi-year contracts and related orders or to terminate existing contracts for convenience or default; in the case of unfunded backlog, the potential that funding will not be made available; and, in the case of priced options, the risk that our clients will not exercise their options.
In addition, contract backlog includes orders under contracts for which the period of performance has expired, and we may not recognize revenue on the funded backlog that includes such orders due to, among other reasons, the tardy submission of invoices by our subcontractors and the expiration of the relevant appropriated funding in accordance with a predetermined expiration date such as the end of the U.S. government's fiscal year. The revenue value of orders included in contract backlog that has not been recognized as revenue due to period of performance expirations has not exceeded approximately 4.8% of total backlog as of September 30, 2023 and any of the four preceding fiscal quarters.
We expect to recognize revenue from a substantial portion of funded backlog as of September 30, 2023 within the next twelve months. However, given the uncertainties discussed above, as well as the risks described in “Part I, Item 1A. Risk Factors,” of our fiscal 2023 Annual Report on Form 10-K, we can give no assurance that we will be able to convert our backlog into revenue in any particular period, if at all.
Government Audit Impact on Operating Income
As noted in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2023, in the ordinary course of business, agencies of the U.S. government for which the Company is engaged as a prime contractor or a subcontractor, including the Defense Contract Audit Agency, audit the Company’s claimed indirect costs and conduct inquiries and investigations of our business practices with respect to government contracts. Such audits may result in, and have historically resulted in, the Company’s inability to retain certain claimed indirect costs, including executive and employee compensation, due to differing views of the allowability and reasonableness of such costs.
Due to the previously disclosed civil and criminal investigation of the Company by the U.S. Department of Justice (“DOJ”), years subsequent to the Company’s fiscal year 2011 remain subject to audit and final resolution. As discussed in Note 15, “Commitments and Contingencies,” to the condensed consolidated financial statements, the Company recognized a reserve for estimated adjustments to historical claimed indirect costs in respect of the years subsequent to fiscal 2011, based primarily on historical audit results for periods prior to 2011. Following the settlement of the civil and criminal investigation of the Company by the DOJ, as reported in the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2023, audits for years subsequent to fiscal 2011 have resumed. As audits of the periods subsequent to 2011 are completed, our estimates of adjustment to claimed indirect costs for these periods could change. Any such change could materially impact our reported revenue, operating income, net income and basic and diluted earnings per common share.
Operating Costs and Expenses
Costs associated with compensation and related expenses for our people are the most significant component of our operating costs and expenses. The principal factors that affect our costs are additional people as we grow our business and are awarded new contracts, task orders, and additional work under our existing contracts, and the hiring of people with specific skill sets and security clearances as required by our additional work.
Our most significant operating costs and expenses are described below.
•Cost of Revenue. Cost of revenue includes direct labor, related employee benefits, and overhead. Overhead consists of indirect costs, including indirect labor relating to infrastructure, management and administration, and other expenses.
•Billable Expenses. Billable expenses include direct subcontractor expenses, travel expenses, and other expenses incurred to perform on contracts.
•General and Administrative Expenses. General and administrative expenses include indirect labor of executive management and corporate administrative functions, marketing and bid and proposal costs, legal costs and other discretionary spending.
•Depreciation and Amortization. Depreciation and amortization includes the depreciation of computers, leasehold improvements, furniture and other equipment, and the amortization of internally developed software, as well as third-party software that we use internally, and of identifiable long-lived intangible assets over their estimated useful lives.
Seasonality
The U.S. government's fiscal year ends on September 30 of each year. While not certain, it is not uncommon for U.S. government agencies to award extra tasks or complete other contract actions in the weeks before the end of its fiscal year in order to avoid the loss of unexpended fiscal year funds. In addition, we also have historically experienced higher bid and proposal costs in the months leading up to the U.S. government's fiscal year end as we pursue new contract opportunities being awarded shortly after the U.S. government fiscal year end as new opportunities are expected to have funding appropriated in the U.S. government's subsequent fiscal year. We may continue to experience this seasonality in future periods, and our future periods may be affected by it. While not certain, changes in the government's funding and spending patterns have altered historical seasonality trends, supporting our approach to managing the business on an annual basis.
Seasonality is just one of a number of factors, many of which are outside of our control, which may affect our results in any period. See “Part I, Item 1A. Risk Factors,” of our fiscal 2023 Annual Report on Form 10-K.
Critical Accounting Estimates and Policies
Our critical accounting estimates and policies are disclosed in the Critical Accounting Estimates and Policies section in Part II, “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended March 31, 2023. Other than the change in estimate resulting in a reduction to our provision for claimed indirect costs, there were no other material changes to our critical accounting policies, estimates or judgments that occurred in the quarterly period covered by this report. See Note 15, “Commitments and Contingencies,” to our condensed consolidated financial statements for additional information related to the aforementioned change in estimate.
Results of Operations
The following table sets forth items from our condensed consolidated statements of operations for the six months ended September 30, 2023 and September 30, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
September 30, | | | | Six Months Ended
September 30, | | |
| | 2023 | | 2022 | | | | 2023 | | 2022 | | |
| | (Unaudited) | | (Unaudited) | | Percent | | (Unaudited) | | (Unaudited) | | Percent |
| | (In thousands) | | Change | | (In thousands) | | Change |
| Revenue | $ | 2,666,282 | | | $ | 2,298,976 | | | 16.0 | % | | $ | 5,320,768 | | | $ | 4,548,576 | | | 17.0 | % |
| Operating costs and expenses: | | | | | | | | | | | |
| Cost of revenue | 1,232,712 | | | 1,057,450 | | | 16.6 | % | | 2,484,628 | | | 2,132,423 | | | 16.5 | % |
| Billable expenses | 824,788 | | | 684,941 | | | 20.4 | % | | 1,637,092 | | | 1,359,207 | | | 20.4 | % |
| General and administrative expenses | 300,886 | | | 293,612 | | | 2.5 | % | | 614,887 | | | 546,676 | | | 12.5 | % |
| Depreciation and amortization | 40,907 | | | 39,052 | | | 4.8 | % | | 82,754 | | | 79,154 | | | 4.5 | % |
| Total operating costs and expenses | 2,399,293 | | | 2,075,055 | | | 15.6 | % | | 4,819,361 | | | 4,117,460 | | | 17.0 | % |
| Operating income | 266,989 | | | 223,921 | | | 19.2 | % | | 501,407 | | | 431,116 | | | 16.3 | % |
| Interest expense | (44,756) | | | (28,342) | | | 57.9 | % | | (80,230) | | | (52,997) | | | 51.4 | % |
| Other income, net | 3,556 | | | 26,460 | | | (86.6) | % | | 5,480 | | | 23,502 | | | (76.7) | % |
| Income before income taxes | 225,789 | | | 222,039 | | | 1.7 | % | | 426,657 | | | 401,621 | | | 6.2 | % |
| Income tax expense | 55,071 | | | 51,258 | | | 7.4 | % | | 94,551 | | | 92,747 | | | 1.9 | % |
| Net income | 170,718 | | | 170,781 | | | — | % | | 332,106 | | | 308,874 | | | 7.5 | % |
| Net loss attributable to non-controlling interest | — | | | 151 | | | NM | | — | | | 342 | | | NM |
| Net income attributable to common stockholders | $ | 170,718 | | | $ | 170,932 | | | (0.1) | % | | $ | 332,106 | | | $ | 309,216 | | | 7.4 | % |
NM - Not meaningful.
Revenue
Revenue increased 16.0% and 17.0%, respectively, for the three and six months ended September 30, 2023 as compared to the three and six months ended September 30, 2022. The increase was primarily driven by strong demand for our services and solutions as well as continued headcount growth. The increase in revenue over the year-to-date period also includes approximately $70.0 million of contributions related to the Company's acquisition of EverWatch in the third quarter of fiscal 2023, as well as an increase of $18.3 million representing the reduction to our provision for claimed indirect costs recorded during the second quarter of fiscal 2024. See Note 15, “Commitments and Contingencies,” to the condensed consolidated financial statements for further information. Total headcount as of September 30, 2023 increased by approximately 3,100 as compared to September 30, 2022.
Cost of Revenue
Cost of revenue as a percentage of revenue was 46.2% and 46.0% for the three months ended September 30, 2023 and 2022, respectively, and 46.7% and 46.9% for the six months ended September 30, 2023 and 2022, respectively.`Cost of revenue increased 16.6% and 16.5% for the three and six months ended September 30, 2023, respectively, as compared to the three and six months ended September 30, 2022. The increases were primarily due to increases in salaries and salary-related benefits in the three and six months ended September 30, 2023 of $152.7 million and $324.9 million, respectively, driven by increased headcount and salary increases. Other business expenses and professional fees also increased $19.5 million and $28.9 million for the quarter and year-to-date periods.
Billable Expenses
Billable expenses as a percentage of revenue were 30.9% and 29.8% for the three months ended September 30, 2023 and 2022, respectively, and 30.8% and 29.9% for the six months ended September 30, 2023 and 2022, respectively. Billable expenses increased 20.4% for both the three and six months ended September 30, 2023 and 2022, respectively. The increases were primarily attributable to increases in the use of subcontractors driven by client demand and timing of client needs, as well as increases in expenses from contracts requiring the Company to incur other direct expenses and travel on behalf of clients as compared to the prior year period.
General and Administrative Expenses
General and administrative expenses as a percentage of revenue were 11.3% and 12.8% for the three months ended September 30, 2023 and 2022, respectively, and 11.6% and 12.0% for the six months ended September 30, 2023 and 2022, respectively. General and administrative expenses increased 2.5% and 12.5% for the three and six months ended September 30, 2023, respectively, as compared to the three and six months ended September 30, 2022.
For the three and six months ended September 30, 2023, the increases were primarily driven by increases in salary and salary related benefits of $11.8 million and $25.2 million respectively, driven by increased headcount and salary increases. The year-to-date period was also impacted by a $27.5 million reserve associated with the U.S. Department of Justice's investigation of the Company (see Note 15, “Commitments and Contingencies,” to the condensed consolidated financial statements for further information).
Depreciation and Amortization
Depreciation and amortization expense increased 4.8% and 4.5% for the three and six months ended September 30, 2023, respectively, as compared to the three and six months ended September 30, 2022, primarily due to increases in intangible amortization related to the acquisitions in fiscal 2023.
Interest Expense
Interest expense increased 57.9% and 51.4% for the three and six months ended September 30, 2023, respectively, as compared to the three and six months ended September 30, 2022, primarily due to an overall increase in interest rates, as well as an increase of approximately $6.2 million related to the $650.0 million senior notes the Company issued in August of fiscal 2024.
Other Income (Expense), net
Other income (expense), net decreased to $3.6 million net other income for the three months ended September 30, 2023 from $26.5 million for the three months ended September 30, 2022, and decreased to $5.5 million net other income for the six months ended September 30, 2023 from $23.5 million for the six months ended September 30, 2022 . The decreases were primarily driven by a $31.2 million pre-tax gain associated with the divestiture of the Company’s MENA business and $3.4 million in fees related to the Company's debt refinancing, both in the second quarter of fiscal 2023, not present in the current year. This was partially offset by increases in interest income primarily due to an overall increase in interest rates.
Income Tax Expense
Income tax expense increased to $55.1 million for the three months ended September 30, 2023 from $51.3 million for the three months ended September 30, 2022, an increase of 7.4%, and increased to $94.6 million for the six months ended September 30, 2023 from $92.7 million for the six months ended September 30, 2022, an increase of 1.9%.
The effective tax rate for the three months ended September 30, 2023 increased to 24.4% from 23.1% for the three months ended September 30, 2022 primarily due to an increase in items recognized discretely in the current period relating to interest accrued on prior period uncertain tax positions. The effective tax rate for the six months ended September 30, 2023 decreased to 22.2% from 23.1% for the six months ended September 30, 2022, primarily due to increases in the estimated Foreign Derived Intangible Income benefit and research tax credits, partially offset by an increase in items recognized discretely in the current period relating to interest accrued on prior period uncertain tax positions.
Liquidity and Capital Resources
As of September 30, 2023, our total liquidity was $1.6 billion, consisting of $557.3 million of cash and cash equivalents and $998.7 million available under the Revolving Credit Facility. In the opinion of management, we will be able to meet our liquidity and cash needs through a combination of cash flows from operating activities, available cash balances, and available borrowing under the Revolving Credit Facility. If these resources need to be augmented, additional cash requirements would likely be financed through the issuance of debt or equity securities.
The following table presents selected financial information as of September 30, 2023 and March 31, 2023 and for the first six months of fiscal 2024 and 2023:
| | | | | | | | | | | |
| | September 30,
2023 | | March 31,
2023 |
| | (Unaudited) | | |
| | (In thousands) |
| Cash and cash equivalents | $ | 557,296 | | | $ | 404,862 | |
| Total debt | $ | 3,430,402 | | | $ | 2,812,145 | |
| | | |
| Six Months Ended
September 30, |
| 2023 | | 2022 |
| (Unaudited) | | (Unaudited) |
| (In thousands) |
| Net cash (used in) provided by operating activities | $ | (118,917) | | | $ | 227,092 | |
| Net cash (used in) provided by investing activities | (37,002) | | | 14,329 | |
| Net cash provided by (used in) financing activities | 308,353 | | | (180,811) | |
| Total increase in cash and cash equivalents | $ | 152,434 | | | $ | 60,610 | |
From time to time, we evaluate alternative uses for excess cash resources once our operating cash flow and required debt servicing needs have been met. Some of the possible uses of our remaining excess cash at any point in time may include funding strategic acquisitions, further investment in our business and returning value to shareholders through share repurchases, quarterly dividends, and special dividends. While the timing and financial magnitude of these possible actions are currently indeterminable, the Company expects to be able to manage and adjust its capital structure in the future to meet its liquidity needs.
Historically, we have been able to generate sufficient cash to fund our operations, mandatory debt and interest payments, capital expenditures, and discretionary funding needs. However, due to fluctuations in cash flows, including as a result of the trends and developments described above under “—Factors and Trends Affecting Our Results of Operations” relating to U.S. government shutdowns, U.S. government cost-cutting, reductions or delays in the U.S. government appropriations and spending process and other budgetary matters, it may be necessary from time-to-time in the future to borrow under our Senior Credit Facility to meet cash demands. While the timing and financial magnitude of these possible actions are currently indeterminable, we expect to be able to manage and adjust our capital structure to meet our liquidity needs. Our expected liquidity and capital structure may also be impacted by discretionary investments and acquisitions that we could pursue. We anticipate that cash provided by operating activities, existing cash and cash equivalents, and borrowing capacity under our Revolving Credit Facility will be sufficient to meet our anticipated cash requirements for the next twelve months, which primarily include:
•operating expenses, including salaries;
•working capital requirements to fund both organic and inorganic growth of our business;
•capital expenditures which primarily relate to the purchase of computers, business systems, furniture and leasehold improvements to support our operations;
•the ongoing maintenance around all financial management systems;
•commitments and other discretionary investments;
•debt service requirements for borrowings under our Senior Credit Facility and interest payments for the Senior Notes due 2028, Senior Notes due 2029 and Senior Notes due 2033; and
•cash taxes to be paid.
Our ability to fund our operating needs depends, in part, on our ability to generate positive cash flows from operations or, if necessary, raise cash in the capital markets. In addition, from time to time we evaluate conditions to opportunistically access the financing markets to secure additional debt capital resources and improve the terms of our indebtedness.
On October 14, 2022, the Company acquired EverWatch Corp. (“EverWatch”) for approximately $445.1 million, net of post-closing adjustments, and also incurred transaction costs as part of the acquisition. As a result of the transaction, EverWatch became a wholly owned subsidiary of Booz Allen Hamilton Inc. EverWatch is a leading provider of advanced solutions to the defense and intelligence communities. See Note 5, “Acquisition, Goodwill and Intangible Assets,” to our condensed consolidated financial statements for additional information related to the acquisition of EverWatch.
During the first and second quarters of fiscal 2024, we borrowed $500.0 million on our Revolving Credit Facility for our working capital needs, which was subsequently repaid in the second quarter of fiscal 2024.
On July 21, 2023, the Company entered into a Settlement Agreement (the “Settlement Agreement”) with the United States of America, acting through the U.S. Department of Justice and on behalf of the Department of Defense and Defense Contract Management Agency (collectively the “United States”), and Relator Sarah A. Feinberg, to resolve the civil investigation related to certain elements of the Company’s cost accounting and indirect costs charging practices from April 1, 2011 through March 31, 2021. Under the terms of the Settlement Agreement, the Company agreed to pay to the United States $377.5 million, which the Company paid with cash on hand and by drawing on its revolving credit facility. See Note 15, “Commitments and Contingencies,” to our condensed consolidated financial statements for additional information related to the Settlement Agreement.
Cash Flows
Cash received from clients, either from the payment of invoices for work performed or for advances in excess of costs incurred, is our primary source of cash. We generally do not begin work on contracts until funding is appropriated by the client. Billing timetables and payment terms on our contracts vary based on a number of factors, including whether the contract type is cost-reimbursable, time-and-materials, or fixed-price. We generally bill and collect cash more frequently under cost-reimbursable and time-and-materials contracts, as we are authorized to bill as the costs are incurred or work is performed. In contrast, we may be limited to bill certain fixed-price contracts only when specified milestones, including deliveries, are achieved. In addition, a number of our contracts may provide for performance-based payments, which allow us to bill and collect cash prior to completing the work.
Accounts receivable is the principal component of our working capital and is generally driven by revenue growth with other short-term fluctuations related to the payment practices of our clients. Our accounts receivable reflects amounts billed to our clients as of each balance sheet date. Our clients generally pay our invoices within 30 days of the invoice date, although we experience a longer billing and collection cycle with our global commercial customers. At any month-end, we also include in accounts receivable the revenue that was recognized in the preceding month, which is generally billed early in the following month. Finally, we include in accounts receivable amounts related to revenue accrued in excess of amounts billed, primarily on our fixed-price and cost-reimbursable-plus-award-fee contracts. The total amount of our accounts receivable can vary significantly over time, but is generally sensitive to revenue levels and customer mix.
Operating Cash Flow
Net cash provided by operations is primarily affected by the overall profitability of our contracts, our ability to invoice and collect cash from clients in a timely manner, our ability to manage our vendor payments and the timing of cash paid for income taxes. Continued uncertainty in global economic conditions may also affect our business as customers and suppliers may decide to downsize, defer, or cancel contracts, which could negatively affect the operating cash flows. Net cash used in operations was $118.9 million for the six months ended September 30, 2023 compared to $227.1 million in the prior year period. Operating cash was aided by strong collection performance and overall revenue growth but was impacted by a $377.5 million outflow related to the U.S. Department of Justice matter noted above.
Beginning in fiscal 2023, the Tax Cuts and Jobs Act of 2017 eliminates the option to deduct research and development expenditures immediately in the year incurred and requires taxpayers to amortize such expenditures over five years for U.S. based research and development. This provision negatively impacted our fiscal 2023 cash from operations, but had an offsetting impact on the deferred tax asset. The Company expects a similar impact in fiscal 2024, although the impact to cash and deferred taxes is expected to be smaller than in fiscal 2023. Prospectively, the future impact of this provision will depend on if and when this provision is deferred, modified, or repealed by Congress, including if retroactively, any guidance issued by the Treasury Department regarding the identification of appropriate costs for capitalization, and the amount of future research and development expenses paid or incurred (among other factors). While the largest impact will be to fiscal 2023 cash from operations, the impact would continue over the five year amortization period, but would decrease over the period and is expected to be immaterial in year six.
Investing Cash Flow
Net cash used in investing activities was $37.0 million in the six months ended September 30, 2023 compared to net cash provided by investing activities of $14.3 million in the prior year period. The increase to investing cash used was primarily due to proceeds from the MENA divestiture in the prior year, partially offset by increases in cost method investments made by the Company in the current year.
Financing Cash Flow
Net cash provided by financing activities was $308.4 million in the six months ended September 30, 2023 compared to net cash used in financing activities of $180.8 million in the prior year period. The increase in net cash provided by financing activities was primarily due to an increase in net proceeds of $600.8 million associated with the Company’s debt transactions year over year, partially offset by an increase of $105.9 million in share repurchases and $9.2 million in cash paid for dividends year over year.
Dividends and Share Repurchases
On October 27, 2023, the Company announced a regular quarterly cash dividend in the amount of $0.47 per share. The quarterly dividend is payable on December 4, 2023 to stockholders of record on November 15, 2023.
During the three and six months ended September 30, 2023, quarterly cash dividends of $0.47 and $0.94 per share, respectively, were declared and paid totaling $62.1 million and $125.1 million, respectively. During the three and six months ended September 30, 2022, quarterly cash dividends of $0.43 and $0.86 per share, respectively, were declared and paid totaling $57.0 million and $115.9 million, respectively.
On December 12, 2011, the Board of Directors approved a share repurchase program, which was most recently increased by $400.0 million to $2,560.0 million on July 27, 2022. The Company may repurchase shares pursuant to the program by means of open market repurchases, directly negotiated repurchases or through agents acting pursuant to negotiated repurchase agreements. During the first six months of fiscal 2024, the Company purchased 1.7 million shares of the Company's Class A Common Stock for an aggregate of $180.1 million. As of September 30, 2023, the Company had approximately $675.9 million remaining under the repurchase program.
Any determination to pursue one or more of the above alternative uses for excess cash is subject to the discretion of our Board of Directors, and will depend upon various factors, including our results of operations, financial condition, liquidity requirements, restrictions that may be imposed by applicable law, our contracts, and our Credit Agreement as amended and other factors deemed relevant by our Board of Directors.
Indebtedness
Booz Allen Hamilton Inc. (“Booz Allen Hamilton”), Booz Allen Hamilton Investor Corporation (“Investor”), and certain wholly owned subsidiaries of Booz Allen Hamilton are parties to a Credit Agreement dated as of July 31, 2012, as amended (the “Credit Agreement”), with certain institutional lenders and Bank of America, N.A., as Administrative Agent, Collateral Agent and Issuing Lender. As of September 30, 2023, the Credit Agreement provided Booz Allen Hamilton with a $1,608.8 million Term Loan A (“Term Loan A”) and a $1.0 billion revolving credit facility (the “Revolving Credit Facility”), with a sub-limit for letters of credit of $200.0 million. As of September 30, 2023, the maturity date of the Term Loan A and the Revolving Commitments is September 7, 2027. Voluntary prepayments of the Term Loan A and the Revolving Loans are permitted at any time, in minimum principal amounts, without premium or penalty. Booz Allen Hamilton’s obligations and the guarantors’ guarantees under the Credit Agreement were secured by a first priority lien on substantially all of the assets (including capital stock of subsidiaries) of Booz Allen Hamilton, Investor and the subsidiary guarantors, subject to certain exceptions set forth in the Credit Agreement and related documentation; such security was released in connection with Booz Allen Hamilton obtaining investment grade ratings from both Moody's and S&P. On September 7, 2022 (the “Ninth Amendment Effective Date”), the previously outstanding Term Loan B loans under the Credit Agreement were prepaid in full.
On July 27, 2023 (the “Tenth Amendment Effective Date”), Booz Allen Hamilton entered into a Tenth Amendment (the “Amendment”) to the Credit Agreement (as amended prior to the Tenth Amendment Effective Date, the “Existing Credit Agreement” and, as amended by the Amendment, the “Amended Credit Agreement”) with Bank of America, N.A., as administrative agent (in such capacity, the “Administrative Agent”), and the lenders and other financial institutions party thereto, in order to make permanent certain changes to the Existing Credit Agreement in connection with Booz Allen Hamilton obtaining investment grade ratings from both Moody's and S&P and prepaying the Term Loan B loans in full and to make certain additional changes in connection therewith, including, among other things, (i) removing the requirements for the obligations under the Amended Credit Agreement to be secured, (ii) removing the requirement for any subsidiary or other affiliate of Booz Allen Hamilton (other than the Company) to provide any guarantee of the obligations under the Amended Credit Agreement and (iii) removing or modifying certain covenants applicable to Booz Allen Hamilton. Pursuant to the Amendment, all guarantees in respect of the Existing Credit Agreement have been released. The Amendment did not impact any of the terms of the Credit Agreement related to amortization or payments.
On the Tenth Amendment Effective Date in connection with the Amendment, the Company entered into a Guarantee Agreement (the “Guarantee Agreement”) in favor of the Administrative Agent, pursuant to which the Company guarantees on an unsecured basis the obligations of Booz Allen Hamilton under the Amended Credit Agreement subject to certain conditions. Pursuant to the Amended Credit Agreement Booz Allen Hamilton has the option, though not any obligation, to join one or more of its domestic subsidiaries as a guarantor under the Guarantee Agreement.
The Term Loan A amortizes in consecutive quarterly installments in an amount equal to (i) on the last business day of each full fiscal quarter that begins after the Ninth Amendment Effective Date but on or before the two year anniversary of the Ninth Amendment Effective Date, 0.625% of the stated principal amount of the Term Loan A and (ii) on the last business day of each full fiscal quarter that begins after the two year anniversary of the Ninth Amendment Effective Date but before the five year anniversary of the Ninth Amendment Effective Date, 1.25% of the stated principal amount of the Term Loan A. The remaining balance of the Term Loan A will be payable upon maturity.
The rate at which the Term Loan A and the Revolving Loans bear interest is based, at Booz Allen Hamilton’s option, either on Term SOFR (subject to a 0.10% adjustment and a floor of zero) for the applicable interest period or a base rate (equal to the highest of (i) the administrative agent’s prime corporate rate, (ii) the overnight federal funds rate plus 0.50% and (iii) three-month Term SOFR (subject to a 0.10% adjustment and a floor of zero) plus 1.00%), in each case plus an applicable margin, payable at the end of the applicable interest period and in any event at least quarterly. The applicable margin for the Term Loan A and the Revolving Loans ranges from 1.00% to 2.00% for Term SOFR loans and zero to 1.00% for base rate loans, in each case based on the lower of (i) the applicable rate per annum determined pursuant to a consolidated total net leverage ratio grid and (ii) the applicable rate per annum determined pursuant to a ratings grid. Unused Revolving Commitments are subject to a quarterly fee ranging from 0.10% to 0.35% based on the lower of (i) the applicable fee rate per annum determined pursuant to a consolidated total net leverage ratio grid and (ii) the applicable fee rate per annum determined pursuant to a ratings grid. Booz Allen Hamilton has also agreed to pay customary letter of credit and agency fees.
As of September 30, 2023 and March 31, 2023, the Company was contingently liable under open standby letters of credit and bank guarantees issued by our banks in favor of third parties that totaled $4.4 million and $6.1 million, respectively. These letters of credit and bank guarantees primarily support insurance and bid and performance obligations. At both September 30, 2023 and March 31, 2023, approximately $1.3 million of these instruments reduced the available borrowings under the Revolving Credit Facility. The remainder is guaranteed under a separate $7.5 million facility of which $4.4 million and $2.7 million were available to the Company at September 30, 2023 and March 31, 2023, respectively.
The Company occasionally borrows under the Revolving Credit Facility for our working capital needs. As of March 31, 2023 and September 30, 2023, respectively, there was no outstanding balance on the Revolving Credit Facility.
The Credit Agreement contains customary representations and warranties and customary affirmative and negative covenants. In addition, Booz Allen Hamilton is required to meet a financial covenant at each quarter end based on a consolidated net total leverage ratio. As of September 30, 2023 and March 31, 2023, Booz Allen Hamilton was in compliance with all financial covenants associated with its debt and debt-like instruments. In connection with Booz Allen Hamilton obtaining investment grade ratings from both Moody's and S&P, activities restricted by certain negative covenants are permitted subject to pro forma compliance with the financial covenants and no events of default having occurred and continuing.
The following table summarizes interest payments made on the Company’s term loans:
| | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
September 30, | | Six Months Ended
September 30, |
| | 2023 | | 2022 | | 2023 | | 2022 |
| Term Loan A | $ | 27,007 | | | $ | 7,846 | | | $ | 53,098 | | | $ | 14,165 | |
| Term Loan B | — | | | 2,793 | | | — | | | 5,209 | |
| Total | $ | 27,007 | | | $ | 10,639 | | | $ | 53,098 | | | $ | 19,374 | |
Borrowings under the Term Loan A, and if used, the Revolving Credit Facility, incur interest at a variable rate. As of September 30, 2023, Booz Allen Hamilton had interest rate swaps with an aggregate notional amount of $550.0 million. These instruments hedge the variability of cash outflows for interest payments on the Term Loans and Revolving Credit Facility. The Company's objectives in using cash flow hedges are to reduce volatility due to interest rate movements and to add stability to interest expense (See Note 9, “Derivatives,” to our condensed consolidated financial statements).
Senior Notes
For information on the terms, conditions, and restrictions of the Company's 4.000% Senior Notes due July 1, 2029 (the “Senior Notes due 2029”) and 3.875% Senior Notes due 2028 (the “Senior Notes due 2028”), see Note 10, “Debt,” of the Company’s consolidated financial statements included in the fiscal 2023 Annual Report on Form 10-K.
In connection with Booz Allen Hamilton obtaining investment grade ratings from both Moody's and S&P, certain negative covenants in the indentures governing the Senior Notes were suspended, and guarantees of the Senior Notes were released.
On August 4, 2023, the Company completed an offering of $650.0 million aggregate principal amount of its 5.950% senior unsecured notes due August 4, 2033 (the “Senior Notes due 2033”, and, together with the Senior Notes due 2028 and Senior Notes due 2029, the “Senior Notes”). The Senior Notes due 2033 were issued pursuant to an Indenture, dated as of August 4, 2023 (the “Base Indenture”), among Booz Allen Hamilton, the Company, and U.S. Bank Trust Company, National Association, as trustee, as supplemented by the First Supplemental Indenture, dated as of August 4, 2023 (the “Supplemental Indenture” and, together with the Base Indenture, the “Indenture”). The Indenture contains certain covenants, events of default, and other customary provisions. The Senior Notes due 2033 are fully and unconditionally guaranteed on an unsecured and unsubordinated basis by the Company, pursuant to the Indenture.
Summarized Financial Information
The Senior Notes due 2033 were issued by Booz Allen Hamilton pursuant to the Base Indenture, among Booz Allen Hamilton, the Company and U.S. Bank Trust Company, National Association, as trustee, as supplemented by the Supplemental Indenture. The Senior Notes due 2033 are fully and unconditionally guaranteed on an unsecured and unsubordinated basis by the Company pursuant to the Indenture.
The tables below present the summarized financial information as combined for the Company and Booz Allen Hamilton as of March 31, 2023 and as of and for the six months ended September 30, 2023, after the elimination of intercompany transactions and balances between the Company and Booz Allen Hamilton and excluding the subsidiaries of the Company that are not issuers or guarantors of the Senior Notes due 2033, including earnings from and investments in these entities. The summarized financial information is provided in accordance with the reporting requirements of Rule 13-01 under Regulation S-X and is not intended to present our financial position or results of operations in accordance with GAAP.
Summarized Statements of Financial Condition
| | | | | | | | | | | |
| (in thousands) | September 30, 2023 | | March 31, 2023 |
| Total current assets | $ | 2,557,931 | | | $ | 2,160,182 | |
| Intercompany receivables from non-guarantor subsidiaries | $ | 20,765 | | | $ | 162,431 | |
| Goodwill and intangible assets, net of accumulated amortization | $ | 1,603,380 | | | $ | 1,463,800 | |
| Total non-current assets | $ | 1,469,013 | | | $ | 1,239,763 | |
| Total current liabilities | $ | 1,551,615 | | | $ | 1,845,691 | |
| Intercompany payables to non-guarantor subsidiaries | $ | 154,042 | | | $ | 249,999 | |
| Long-term debt, net of current portion | $ | 3,389,152 | | | $ | 2,770,895 | |
| Total non-current liabilities | $ | 1,076,295 | | | $ | 870,176 | |
Summarized Statement of Operations
| | | | | |
| (in thousands) | Six Months Ended
September 30, 2023 |
| Revenue | $ | 4,939,965 | |
| Revenue from non-guarantor subsidiaries | $ | 253,971 | |
| Operating income | $ | 214,618 | |
| Operating income from non-guarantor subsidiaries | $ | 205,607 | |
| Net income | $ | 268,900 | |
| Net income attributable to the Obligor Group | $ | 268,900 | |
Capital Structure and Resources
Our stockholders’ equity amounted to $1,072.1 million as of September 30, 2023, an increase of $80.1 million, compared to stockholders’ equity of $992.0 million as of March 31, 2023. The increase was primarily due to net income of $332.1 million and stock-based compensation expense of $37.5 million during the six months ended September 30, 2023, partially offset by $194.5 million in treasury stock resulting from the repurchase of shares of our Class A Common Stock, and $124.6 million in quarterly dividend payments for the six months ended September 30, 2023.
Capital Expenditures
Since we do not own any of our facilities, our capital expenditure requirements primarily relate to the purchase of computers, management systems, furniture, and leasehold improvements to support our operations. Direct facility and equipment costs billed to clients are not treated as capital expenses. Our capital expenditures for the six months ended September 30, 2023 and 2022 were $27.4 million and $29.7 million, respectively.
Commitments and Contingencies
We are subject to a number of reviews, investigations, claims, lawsuits, and other uncertainties related to our business. For a discussion of these items, refer to Note 15, “Commitments and Contingencies,” to our condensed consolidated financial statements.
Special Note Regarding Forward Looking Statements
Certain statements contained or incorporated in this Quarterly Report on Form 10-Q, or Quarterly Report, include forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “could,” “should,” “forecasts,” “expects,” “intends,” “plans,” “anticipates,” “projects,” “outlook,” “believes,” “estimates,” “predicts,” “potential,” “continue,” “preliminary,” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we can give you no assurance these expectations will prove to have been correct. These forward-looking statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance, or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These risks and other factors include:
•any issue that compromises our relationships with the U.S. government or damages our professional reputation, including negative publicity concerning government contractors in general or us in particular;
•changes in U.S. government spending, including a continuation of efforts by the U.S. government to decrease spending for management support service contracts, and mission priorities that shift expenditures away from agencies or programs that we support, or as a result of the U.S. administration transition;
•efforts by Congress and other U.S. government bodies to reduce U.S. government spending and address budgetary constraints and the U.S. deficit, as well as associated uncertainty around the timing, extent, nature and effect of such efforts;
•delayed long-term funding of our contracts, including uncertainty relating to funding the U.S. government and increasing the debt ceiling;
•U.S. government shutdowns as a result of the failure by elected officials to fund the government;
•failure to comply with numerous laws and regulations, including but not limited to, the Federal Acquisition Regulation (“FAR”), the False Claims Act, the Defense Federal Acquisition Regulation Supplement and FAR Cost Accounting Standards and Cost Principles;
•the effects of disease outbreaks, pandemics, or widespread health epidemics, such as COVID-19, including disruptions to our workforce and the impact on government spending and demand for our solutions;
•our ability to compete effectively in the competitive bidding process and delays or losses of contract awards caused by competitors' protests of major contract awards received by us;
•variable purchasing patterns under U.S. government General Services Administration Multiple Award schedule contracts, or GSA schedules, blanket purchase agreements and indefinite delivery/indefinite quantity, or IDIQ, contracts;
•the loss of GSA schedules or our position as prime contractor on government-wide acquisition contract vehicles, or GWACs;
•changes in the mix of our contracts and our ability to accurately estimate or otherwise recover expenses, time, and resources for our contracts;
•changes in estimates used in recognizing revenue;
•our ability to realize the full value of and replenish our backlog, generate revenue under certain of our contracts, and the timing of our receipt of revenue under contracts included in backlog;
•internal system or service failures and security breaches, including, but not limited to, those resulting from external or internal threats, including cyber attacks on our network and internal systems;
•risks related to the operation of financial management systems;
•an inability to attract, train, or retain employees with the requisite skills and experience;
•an inability to timely hire, assimilate and effectively utilize our employees, ensure that employees obtain and maintain necessary security clearances and/or effectively manage our cost structure;
•risks related to inflation that could impact the cost of doing business and/or reduce customer buying power;
•the loss of members of senior management or failure to develop new leaders;
•misconduct or other improper activities from our employees or subcontractors, including the improper access, use or release of our or our clients' sensitive or classified information;
•increased competition from other companies in our industry;
•failure to maintain strong relationships with other contractors, or the failure of contractors with which we have entered into a sub- or prime- contractor relationship to meet their obligations to us or our clients;
•inherent uncertainties and potential adverse developments in legal or regulatory proceedings, including litigation, audits, reviews, and investigations, which may result in materially adverse judgments, settlements, withheld payments, penalties, or other unfavorable outcomes including debarment, as well as disputes over the availability of insurance or indemnification;
•failure to comply with special U.S. government laws and regulations relating to our international operations;
•risks associated with increased competition, new relationships, clients, capabilities, and service offerings in our U.S. and international businesses;
•risks related to changes to our operating structure, capabilities, or strategy intended to address client needs, grow our business or respond to market developments;
•the adoption by the U.S. government of new laws, rules, and regulations, such as those relating to organizational conflicts of interest issues or limits;
•risks related to a possible recession and volatility or instability of the global financial system, including the failures of financial institutions and the resulting impact on counterparties and business conditions generally;
•risks related to a deterioration of economic conditions or weakening in credit or capital markets;
•risks related to pending, completed and future acquisitions and dispositions, including the ability to satisfy specified closing conditions for pending transactions, such as those related to receipt of regulatory approval or lack of regulatory intervention, and to realize the expected benefits from completed acquisitions and dispositions;
•the incurrence of additional tax liabilities, including as a result of changes in tax laws or management judgments involving complex tax matters;
•risks inherent in the government contracting environment;
•continued efforts to change how the U.S. government reimburses compensation related costs and other expenses or otherwise limits such reimbursements, and an increased risk of compensation being deemed unreasonable and unallowable or payments being withheld as a result of U.S. government audit, review, or investigation;
•increased insourcing by various U.S. government agencies due to changes in the definition of “inherently governmental” work, including proposals to limit contractor access to sensitive or classified information and work assignments;
•the size of our addressable markets and the amount of U.S. government spending on private contractors;
•risks related to our indebtedness and credit facilities which contain financial and operating covenants;
•the impact of changes in accounting rules and regulations, or interpretations thereof, that may affect the way we recognize and report our financial results, including changes in accounting rules governing recognition of revenue;
•the impact of ESG-related risks and climate change generally on our and our clients' businesses and operations; and
•other risks and factors listed under “Item 1A. Risk Factors” and elsewhere in this Quarterly Report, as well as those listed under “Risk Factors” in our Annual Report on Form 10-K for the year ended March 31, 2023.
In light of these risks, uncertainties and other factors, the forward-looking statements might not prove to be accurate and you should not place undue reliance upon them. All forward-looking statements speak only as of the date made and we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.