Cautionary Note Regarding Forward-Looking Statements
All statements and assumptions contained in this Quarterly Report on Form 10-Q that do not relate to historical facts constitute "forward-looking statements." These statements can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements often include the use of words such as "may," "will," "expect," "intend," "anticipate," "believe," "estimate," "plan" and words and terms of similar substance in connection with discussions of future events, situations or financial performance. While these statements represent our current expectations, no assurance can be given that the results or events described in such statements will be achieved. 17 -------------------------------------------------------------------------------- Forward-looking statements may include, among other things, statements with respect to our financial condition, results of operations, prospects, business strategies, competitive position, growth opportunities, and plans and objectives of management. Such statements are subject to numerous assumptions, risks, uncertainties and other factors, many of which are outside of our control, and include, without limitations, the risks and uncertainties discussed in Item 1A "Risk Factors" in Part I of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 and in Item 1A "Risk Factors" in Part II of this Form 10-Q.
Factors or risks that could cause our actual results to differ materially from the results we anticipate include, but are not limited to, the following:
•failure to maintain our relationship with theU.S. government, or the failure to win new contract awards or to retain existingU.S. government contracts; •inability to recruit and retain a sufficient number of employees with specialized skill sets or necessary security clearances who are in great demand and limited supply; •adverse changes inU.S. government spending for programs we support, whether due to changing mission priorities, socio-economic policies or federal budget constraints generally; •disruptions to our business resulting from the COVID-19 pandemic or other similar global health epidemics, pandemics and/or other disease outbreaks; •failure to compete effectively for awards procured through the competitive bidding process, and the adverse impact of delays resulting from our competitors' protests of new contracts that are awarded to us; •disruptions to our business or damage to our reputation resulting from cyber attacks and other security threats; •failure to obtain option awards, task orders or funding under our contracts; •the government renegotiating, modifying or terminating our contracts; •failure to comply with, or adverse changes in, complexU.S. government laws and procurement regulations; •adverse results ofU.S. government audits or other investigations of our government contracts; •failure to successfully integrate acquired companies or businesses into our operations or to realize any accretive or synergistic effects from such acquisitions; •failure to mitigate risks associated with conducting business internationally; •adverse changes in business conditions that may cause our investments in recorded goodwill to become impaired; •the conditions to the closing of the proposed Merger may not be satisfied or waived, and the proposed Merger may not be consummated within the expected time period or at all; •our business may suffer as a result of uncertainty surrounding the Merger, and the proposed Merger may disrupt our current plans and operations or divert management's attention from ongoing business operations; •difficulties with our ability to retain and hire key personnel and maintain our business relationships as a result of the proposed Merger may occur; •we have incurred and expect to continue to incur significant costs in connection with the Merger, some of which are payable by us regardless of whether the Merger is completed; •the occurrence of certain events, changes or other circumstances could, under the terms of the Merger Agreement, give rise to termination of the Merger Agreement; •stockholder litigation in connection with the Merger could affect the timing or occurrence of the Merger and could result in significant costs; and •if the Merger is completed, stockholders will forego realization of any long-term value potential based on current strategy as an independent public company. We urge you not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report. We undertake no obligation to update any forward-looking statement made herein following the date of this Quarterly Report, whether as a result of new information, subsequent events or circumstances, changes in expectations or otherwise.
Overview
We provide mission-focused technology solutions and services forU.S. defense, intelligence community and federal civilian agencies. We excel in full-spectrum cyber, secure mission & enterprise IT, advanced data analytics, software and systems development, intelligent systems engineering, intelligence mission support and mission operations. We are continuing to monitor impacts of the global outbreak of the COVID-19 pandemic including new variants of the virus, specific impacts and mitigation protocols enacted in regions in which we operate, and the vaccination status of our employees. In preparation of the President's Executive Order requiring all federal employees and contractors supporting the federal government be vaccinated (or to have an approved accommodation) as well as to promote the well-being of our workforce, we have and continue to encourage our employees to get vaccinated. There is currently an injunction suspending the President's executive order requiring vaccination of our workforce. We cannot predict the potential impact of the 18 --------------------------------------------------------------------------------
vaccination mandate, if enforced, or the overall evolution of the pandemic and its further impacts on the economy or our business.
TheU.S. is currently experiencing the highest inflation in 40 years. In response to the increasing inflation rates, theFederal Reserve has begun, and is signaling the intent to continue through 2022, increasing interest rates. Increasing interest rates will increase the amounts of interest we pay on our outstanding debt.
We recommend that you read this discussion and analysis in conjunction with our
Annual Report on Form 10-K for the fiscal year ended
Proposed Merger
OnMay 13, 2022 the Company entered into the Merger Agreement with Parent and Merger Sub. Pursuant to the Merger Agreement, and in accordance with the terms and subject to the conditions thereof, Merger Sub will merge with and into the Company, with the Company surviving the Merger as a wholly owned subsidiary of Parent. As a result of the Merger, the Company will be acquired by the Parent, which will be controlled by investment funds managed by The Carlyle Group Inc. The consummation of the Merger is subject to the satisfaction or waiver of customary closing conditions specified in the Merger Agreement. Refer to Note 3, Proposed Merger, in the notes to the financial statements in this Form 10-Q.
Three Months Ended
The following table sets forth certain items from our condensed consolidated statements of income and the relative percentage that certain items of expenses and earnings bear to revenue, as well as the period-to-period change fromJune 30, 2021 toJune 30, 2022 . Three months ended June 30, Period-to-Period Change 2022 2021 2022 2021 2021 to 2022 Dollars Percentage Dollars Percentage (dollars in thousands) REVENUE$ 669,352 $ 648,578 100.0 % 100.0 % $ 20,774 3.2 % Cost of services 573,373 552,868 85.7 % 85.2 % 20,505 3.7 % General and administrative expenses 61,054 47,048 9.1 % 7.3 % 14,006 29.8 % OPERATING INCOME 34,925 48,662 5.2 % 7.5 % (13,737) (28.2) % Interest expense (2,033) (366) 0.3 % 0.1 % 1,667 455.5 % Interest income 46 39 - % - % 7 17.9 % Other (expense), net (11) (12) - % - % (1) (8.3) % INCOME FROM OPERATIONS BEFORE INCOME TAXES AND EQUITY METHOD INVESTMENTS 32,927 48,323 4.9 % 7.4 % (15,396) (31.9) % Provision for income taxes (10,090) (11,714) 1.5 % 1.8 % (1,624) (13.9) % NET INCOME$ 22,837 $ 36,609 3.4 % 5.6 %$ (13,772) (37.6) % Revenue The primary drivers of our increase in revenue relates to revenue from recent acquisitions, new contract awards and growth on certain existing contracts. This increase was offset by contracts and tasks that ended and reduced scope of work on some contracts, including contracts with variable material purchase requirements.
Cost of services
The increase in cost of services was primarily due to increases in revenue. As a percentage of revenue, direct labor costs were 50% and 49% for the three months endedJune 30, 2022 and 2021, respectively. As a percentage of revenue, other direct costs, which include subcontractors and third party equipment and materials used in the performance of our contracts, was 35% and 36% for the three months endedJune 30, 2022 and 2021, respectively. Profitability is relatively flat due to lower program profits and higher benefit costs. 19 --------------------------------------------------------------------------------
General and administrative expenses
The increase in general and administrative expenses was primarily due to additional legal and transaction fees incurred in relation to our Merger Agreement of$6.9 million as well as higher amortization expense associated with intangibles from our recent acquisitions. As a percentage of revenue, general and administrative expenses increased for the three months endedJune 30, 2022 as compared to the same period in 2021.
Interest expense
The increase in interest expense was due to interest on borrowing associated with the acquisitions of Gryphon and TMAC.
Provision for income taxes
Our effective tax rate is affected by recurring items, such as the relative amount of income we earn in various taxing jurisdictions and their tax rates. It is also affected by discrete items that may occur in any given year, but are not consistent from year-to-year. Our effective income tax rate was 31% and 24% for the three months endedJune 30, 2022 and 2021, respectively. The increase in the effective tax rate is primarily due to market fluctuations in the executive deferred compensation plan, lower stock option exercises when compared to the previous period and limits on the deductibility of transaction fees incurred with our Merger Agreement.
Six Months Ended
The following table sets forth certain items from our condensed consolidated statements of income and the relative percentage that certain items of expenses and earnings bear to revenue, as well as the period-to-period change fromJune 30, 2021 toJune 30, 2022 . Six months ended June 30, Period-to-Period Change 2022 2021 2022 2021 2021 to 2022 Dollars Percentage Dollars Percentage (dollars in thousands) REVENUE$ 1,344,897 $ 1,281,802 100.0 % 100.0 % $ 63,095 4.9 % Cost of services 1,149,344 1,095,585 85.5 % 85.5 % 53,759 4.9 % General and administrative expenses 116,790 95,134 8.7 % 7.4 % 21,656 22.8 % OPERATING INCOME 78,763 91,083 5.8 % 7.1 % (12,320) (13.5) % Interest expense (4,275) (720) 0.3 % 0.1 % 3,555 493.8 % Interest income 99 79 - % - % 20 25.3 % Other income (expense), net 101 (133) - % - % 234 175.9 % INCOME FROM OPERATIONS BEFORE INCOME TAXES AND EQUITY METHOD INVESTMENTS 74,688 90,309 5.5 % 7.0 % (15,621) (17.3) % Provision for income taxes (20,510) (21,371) 1.5 % 1.6 % (861) (4.0) % Equity in losses of unconsolidated subsidiaries - (1) - % - % (1) (100.0) % NET INCOME$ 54,178 $ 68,937 4.0 % 5.4 %$ (14,759) (21.4) % Revenue The primary drivers of our increase in revenues relates revenue from recent acquisitions, new contract awards and growth on certain existing contracts. This increase was offset by contracts and tasks that ended and reduced scope of work on some contracts, including contracts with variable material purchase requirements. We expect revenue to increase in the remainder of 2022 due to our recent acquisitions as well as new contracts and growth on existing programs. 20 --------------------------------------------------------------------------------
Cost of services
The increase in cost of services was primarily due to increases in revenue. As a percentage of revenue, direct labor costs were 51% for the six months endedJune 30, 2022 and 2021. As a percentage of revenue, other direct costs, which include subcontractors and third party equipment and materials used in the performance of our contracts, was 35% for the six months endedJune 30, 2022 and 2021. We expect cost of services as a percentage of revenue to decrease slightly for the remainder of 2022.
General and administrative expenses
The increase in general and administrative expenses was primarily due additional legal and transaction fees incurred in relation to our Merger Agreement of$7.3 million as well as higher amortization expense associated with intangibles from our recent acquisitions. As a percentage of revenue, general and administrative expenses increase for the six months endedJune 30, 2022 as compared to the same period in 2021. Whether successful or not, we expect to incur additional expense in relation to the proposed Merger. We expect the merger to be completed in the second half of 2022.
Interest expense
The increase in interest expense was due to interest on borrowing associated with the acquisitions of Gryphon and TMAC. We expect interest expense may increase in the short term as interest rates rise, but to decrease later in 2022 as we expect to reduce our outstanding loan balances.
Provision for income taxes
Our effective tax rate is affected by recurring items, such as the relative amount of income we earn in various taxing jurisdictions and their tax rates. It is also affected by discrete items that may occur in any given year, but are not consistent from year-to-year. Our effective income tax rate was 27% and 24% for the six months endedJune 30, 2022 and 2021, respectively. The increase in the effective tax rate is market fluctuations in the executive deferred compensation plan, lower stock option exercises when compared to the previous period and limits on the deductibility of transaction fees incurred with our Merger Agreement.
Backlog
AtJune 30, 2022 andDecember 31, 2021 , our backlog was$10.4 billion and$10.6 billion , respectively. Our funded backlog was$1.7 billion and$1.6 billion as ofJune 30, 2022 andDecember 31, 2021 , respectively. Backlog represents estimates that we calculate on a consistent basis. For additional information on how we compute backlog, see the disclosure under the caption "Backlog," contained in "Item 1. Business" of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 .
Liquidity and Capital Resources
Our primary sources of liquidity are cash provided by operations and our credit facilities. OnJune 30, 2022 , our cash and cash equivalents balance was$46.8 million . There was$300.0 million outstanding under our credit facilities atJune 30, 2022 . As ofJune 30, 2022 , we were contingently liable under letters of credit totaling$3.0 million , which reduces our availability to borrow under our credit facilities. The maximum available borrowings under our credit facilities atJune 30, 2022 were$797.0 million . These sources of liquidity have met the short-term and long-term liquidity needs for financing of acquisitions, working capital, payment under our cash dividend program and capital expenditures. Cash provided by operating activities has been adequate to fund our operations, including payments under our regular cash dividend program. When there are short-term fluctuations in our cash flows and level of operations, we may from time-to-time increase borrowings under our credit facilities to meet cash demands.
Cash Flows From (Used In) Operating Activities
Our operating cash flow is primarily affected by our ability to invoice and collect from our customers in a timely manner, our ability to manage our vendor payments and the overall profitability of our contracts. We bill most of our customers monthly after services are rendered. Our accounts receivable days sales outstanding were 69 and 64 for the six months endedJune 30, 2022 and 2021, respectively. Our net cash flow from operating activities was$43.9 million and$66.5 million for the six months endedJune 30, 2022 andJune 30, 2021 , respectively. The decrease in net cash flow from operating activities over the 21 -------------------------------------------------------------------------------- comparative period was primarily related to the timing of payments to vendors, an increase in estimated tax payments related to the capitalization of Section 174 expenses, and a decrease in net income, offset by the timing of customer collections. Beginning in 2022, the Tax Cuts and Jobs Act of 2017 requires expenses that meet the definition under Section 174 of the Internal Revenue Code to be deferred over 5 years. Absent a repeal of this provision in the tax code, we expect amounts paid for income taxes to be increased by approximately$20 million in 2022.
Cash Flows From (Used In) Investing Activities
Our cash used in investing activities consists primarily of business combinations, purchases of property and equipment and investments in capital software. For the six months endedJune 30, 2022 our net cash used in investing activities was$18.4 million , which was due to the purchase of equipment to support managed IT service contracts and infrastructure investment, partially offset by proceeds from our corporate owned life insurance. For the six months endedJune 30, 2021 our net cash used in investing activities was$30.9 million , which was due to the purchase of equipment to support managed IT service contracts.
Cash Flows From (Used in) Financing Activities
For the six months endedJune 30, 2022 , our net cash used in financing activities was$32.1 million , which was primarily due to dividends paid. For the six months endedJune 30, 2021 , our net cash used in financing activities was$11.9 million , which was primarily the result of our dividend payments, offset by net borrowings under our credit facility.
Credit Facilities
OnJuly 20, 2021 , we amended and restated our credit agreement with a syndicate of lenders led byBank of America, N.A ., as sole administrative agent. The Third Amended and Restated Credit Agreement includes an aggregate principal amount of up to$1.1 billion made available through (i) a$500 million revolving credit facility with a$100 million letter of credit sublimit and a$50 million swing line loan sublimit and (ii) a$600 million delayed-draw term loan facility. Under the delayed-draw term loan facility, borrowings are available to be drawn prior to the first anniversary of the Third Amended and Restated Credit Agreement in up to three separate drawings in a minimal amount of$50 million . The Third Amended and Restated Credit Agreement also includes an accordion feature that permits us to arrange with the lenders for the provision of additional commitments. The maturity date of the Third Amended and Restated Credit Agreement isJuly 20, 2026 . Borrowings under the Third Amended and Restated Credit Agreement are collateralized by substantially all of our assets and those of our Material Subsidiaries and bear interest at one of the following variable rates as selected by us at the time of borrowing: a London Interbank Offer Rate base rate plus market-rate spreads (1.25% to 2.00% based on our consolidated total leverage ratio) or Bank of America's base rate plus market spreads (0.25% to 1.00% based on our consolidated total leverage ratio). There was$300.0 million outstanding on our credit facilities atJune 30, 2022 . As of and during the six months endedJune 30, 2022 , we were in compliance with the covenants under the Third Amended and Restated Credit Agreement.
Capital Resources
We believe the capital resources available to us from cash on hand, our capacity under our credit facilities, and cash from our operations are adequate to fund our anticipated cash requirements for at least the next year. We anticipate financing our internal and external growth through cash from operating activities, borrowings under our credit facilities and issuance of equity.
Cash Management
To the extent possible, we invest our available cash in short-term, investment grade securities in accordance with our investment policy. Under our investment policy, we manage our investments in accordance with the priorities of maintaining the safety of our principal, maintaining the liquidity of our investments, maximizing the yield on our investments and investing our cash to the fullest extent possible. Our investment policy provides that no investment security can have a final maturity that exceeds six months and that the weighted average maturity of the portfolio cannot exceed 60 days. Cash and cash equivalents include cash on hand, amounts due from banks and short-term investments with maturity dates of three months or less at the date of purchase. 22 --------------------------------------------------------------------------------
Dividend
During the six months ended
Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance withU.S. generally accepted accounting principles (GAAP). The preparation of these condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting estimates are set forth under the caption "Critical Accounting Estimates" in Item 7 of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 , previously filed with theSEC . There have been no material changes to our critical accounting estimates from those discussed in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 .
Recently Adopted Accounting Standards Updates
Accounting Standards Updates that became effective during the six months ended
Recently Issued But Not Yet Adopted ASUs
ASUs effective after
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