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May 6, 2014

2014 Spring Education Series. May 6, 2014. Welcome on behalf of the GovConnects Advisory Council. “Exit Strategy”. Moderator: Michael N. Mercurio, Esq., Offit Kurman, PA Panelists: Pat Lowry, PVG John Hagan, BB&T Chuck Phillips, KCI Larry Davis, Aronson. Larry Davis Partner

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May 6, 2014

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  1. 2014 Spring Education Series May 6, 2014

  2. Welcome on behalf of the GovConnects Advisory Council

  3. “Exit Strategy” Moderator: Michael N. Mercurio, Esq., Offit Kurman, PA Panelists: Pat Lowry, PVG John Hagan, BB&T Chuck Phillips, KCI Larry Davis, Aronson

  4. Larry Davis Partner Aronson Capital Partners ldavis@aronsoncapitalpartners.com

  5. Aronson is a Leading Advisor on Notable Federal IT Transactions Differentiated Approach Notable Federal IT Transactions Insert text here Advised Advised Advised Advised portfolio company of on its sale to on their sale to on its sale to on its acquisition of Portfolio company of Advised Advised Advised Advised on its sale to Portfolio company of Portfolio company of on its sale to on its sale to on its sale to Advised Advised Advised Advised on its sale to portfolio company of on its sale to on its sale to on its sale to

  6. Government Services State of the Industry NOW (2009 – 2014) THEN (2000 – 2008) • Budgetary contraction • Contract award activity is weak • Delayed procurements; depressed backlog • Pricing pressure and margin constraints • Significant competition and bid protests • Robust period for budget growth • Increasing percentage of spending to contractors • Awards occur on schedule • Best value procurements • Higher margins, strong cash flow

  7. Government Services State of the Industry THEN (2000 – 2008) NOW (2009 – 2014) • Only differentiated firms experience growth • Focus on priority markets • Special operations forces • Technology driven mission solutions • Everything is growing • Generic IT services is a good market to be in • Large scale troop deployment and corresponding warfighter support • Staff augmentation • Valuations for public companies increase • IPO markets flourish • M&A markets are highly active • Continued sector growth expected • Valuations for public companies decline • IPO markets have gone dry • Buyers are more discerning with strict criteria • Stagnant sector growth expected

  8. Defense & Government Services Index Stock Performance • Stock appreciation is largely tied to the expectation of future sector growth in free cash flow • 2004 – 2008: Market growth, sector outperformance • 2009 – 2012: Future budget uncertainty, “dooms day” forecasts • 2012 – 2014: Better than expected performance, active capital deployment initiatives (buybacks, dividends) Mid-Tier Index: Active Tickers - BAH, CACI, CUB, EGL, ICFI, LDOS, MANT, NCIT; Inactive Tickers – DRCO, GTEC, SRX, SXE Tier-1 Index: BA, GD, HRS, LLL, LMT, NOC, RTN

  9. Defense & Government Services Index Valuations • The government services market has performed better than expected over the last 18 months • Unobligated funds from prior years lessened the impact of disastrous sweeping cuts due to sequestration • Re-compete pricing cuts have not been fully realized as contracts have been extended under current rates • Primes have cut SG&A expenses to maintain profitability • Aggressive share buyback programs and increasing dividends have bolstered performance Mid-Tier Index: Active Tickers - BAH, CACI, CUB, EGL, ICFI, LDOS, MANT, NCIT; Inactive Tickers – DRCO, GTEC, SRX, SXE Tier-1 Index: BA, GD, HRS, LLL, LMT, NOC, RTN Source: CapIQ

  10. 2013 Sector M&A Observations • Buyers were active but highly disciplined • Acquisition criteria has become more precise – smaller number of available targets that “check all of the boxes” • Budgetary uncertainty and lack of clear revenue visibility for most privately held targets resulted in delayed processes or broken deals • Contractors without differentiated services need to have scale • 2013 was a down year for M&A • Transaction activity down 20% from 2012 with buyers focusing more on return on capital through dividends and share repurchases rather than deployment of capital through M&A • Buyer and seller valuation gaps due to uncertainty (delayed awards, fear of spending cuts to programs, lack of visibility into program budgets) • Tier 1, Mid Tier and Private contractors were hesitant to close transactions in the uncertain environment • Valuations were deal specific • Value depends on a company’s capabilities, customers, and contracts • Continued perception of downward pressure on valuation • Structured transactions (i.e. contingent payment) are prevalent

  11. 2014 Sector M&A Observations M&A Valuations by Sub-Market (last 2 years) • Buyers looking to reposition their business into the priority markets via acquisition • Premium valuations • Differentiated services perceived to be insulated from cuts • Solutions vs. services focus • Buyers acquiring targets to gain critical mass and realize cost synergies to drive down rates • Lower valuations • Less differentiated services • Non-priority markets • Targets that need to sell due to weak balance sheets, OCIs, or poor financial performance • Divestiture opportunities associated with OCIs or portfolio reshaping • Distressed sales driven by weak balance sheets • Valuations vary depending on the target and exact rationale for sale

  12. John Hagen Managing Director BB&T Capital Markets|Windsor Group jhagen@bbandtcm.com

  13. Strategic Alternatives Overview Sell to a Strategic Buyer Sell a Majority Equity Stake to aPrivate Equity Group Current Strategic Alternatives Under Consideration Continue Current Strategic Plan (Do Nothing) Other: ESOP, Sale of MinorityInterest, Public Offering

  14. Sell To A Strategic Buyer Positives: – Achieve full liquidity; sale of 100% of company – Simple transaction – usually all cash – If buyer utilizes publicly-traded stock, which is unlikely in the government contracting sector, potential for tax advantageous transaction – Often results in an attractive valuation as acquiring company may enjoy cost or revenue synergies Considerations: – Potential cultural effect of a transaction on company/management/employees/customers – The Company is no longer an investment vehicle for management/shareholders Questions: – What happens to management, back-office, and personnel upon sale? – What happens to the company name and other autonomy issues? – Full integration versus a separate subsidiary? – Employee benefits same or change?

  15. SELL A MAJORITY EQUITY STAKE TO A PRIVATE EQUITY GROUP Positives: – Interested shareholders may have option of retaining an equity position, while others may fully exit – Private equity groups can often pay as much as strategic buyers – Management may retain leadership role within company and often receives equity options – Company often retains name and independence – Potential for significant cash investment that could position the Company for rapid growth through acquisitions or internal initiatives Considerations: – If retained ownership is a minority position; current shareholders will not control the Company – Private equity investor has a finite horizon and will likely require another liquidity event within five years (sale or IPO) – To finance the acquisition, the private equity firm would likely place significant leverage on the balance sheet- Financial Risk Questions: – Are the shareholders “leaving money on the table”? – Do shareholders believe in future performance and want to benefit from such through a “second bite at

  16. Continue Current Strategic Plan Positives: – Continue to build/generate value – Continuity for management and employees – Retain corporate identity – Avoid potential disruption associated with sale process – Retain 100% equity ownership Considerations: – Provides no additional liquidity/diversity to shareholders – Value could go up, subsequently, but could also go down Questions: – Is this what shareholders want? – What are the risks/rewards of continuing to operate on a stand-alone basis?

  17. OTHER OPTIONS 3 Go Public: – Control – Size/Scale – Valuation – Governance 2. Minority Sale: – Control – Valuation 1. ESOP: – Control – Valuation – Leverage

  18. Charles Phillips Senior Vice President, Site & Facilities Discipline Manger KCI Charles.phillips@kci.com

  19. Employee Stock Ownership Plan ESOP Benefits to Owner Allows for the transfer of the company ownership from a single owner or ownership group to the employees of the company Allows current management team to stay in place during transition if desired Can provide significant tax benefits that allow owners to be paid with little impact to existing cash flow of the company Payout can be staggered to allow current owners to plan for tax obligations

  20. Employee Stock Ownership Plan ESOP Benefits to Employee Creates a pension plan for all employees that does not require personal contributions Employee performance and contributions matter everyday Excellent performance leads to personal wealth growth as company stock value increases Creates greater loyalty and employee retention

  21. Patrick Lowry, ASA, AVA, MBA Partner Patuxent Valuation Group LLC plowry@pvgroupllc.com

  22. Estate Transfers • Part of Succession Planning/Exit Process • Sale to Trusts (GRATs, GRITS, QPRT, GRUT) • Gifts to family members • Transfer to Charitable Trust

  23. Advantages Wealth Transfer/Estate tax planning • Individual Lifetime Gift/Estate Exemption $5.3 million • Total Exemption $10.6 million Maintain control Continuity of legacy

  24. Why is valuation important? • Estate and Gift transfers require “fair market value” valuation • Report serves as evidence of value • Value of company vs. fractional interest • Lack of Control • Lack of Liquidity • Combined discount 40% - 50% • Discounting maximizes benefit of exemption

  25. Example • ABC Contractor valued @ $10 million • Owner sells 50% of stock to a Trust for benefit of kids worth $5 million. • Gift tax return filed with discounted valuation • 5 years later owner sells for $30 million • Estate value reduced by $15 million owned by Trust

  26. What types of assets work best for estate transfers? • Business interest that you expect to appreciate • Fractional interest in real estate partnerships • Consider transfer prior to award of “game changing” contracts

  27. Valuation Issues • Facts/circumstances as of transfer date • Consider likelihood of sale • Voting control • Provisions of shareholder agreement

  28. Summary • Significant long-term tax savings available • It’s legal/legitimate • Hire team of professionals • Expect IRS challenges

  29. 2014 Cyber Conference Tuesday, June 10, 2014 Johns Hopkins Applied Physics Lab/Laurel, MD www.govconnectscyber.com 2014 Fall Courses begin September

  30. Have you told us what would be helpful about today and completed your survey? Thanks for your feedback!

  31. Thanks for your participation GovConnects Advisory Council

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