Due Diligence - National Contract Management Association

Mergers & Acquisitions for Contracts Professionals: How we fit into the puzzle Breakout Session #910 Jill Mitchell, Contracts Operations Manager, Raytheon Company Steffen Jacobsen, Contracts Manager, Raytheon Company Date Time

16 April 2008 1:30 pm – 2:30 pm

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… How We Fit into the Puzzle Acquirer PMO

BD

Ex/ Im

CONTRACTS

legal finance

HR

engineering

treasury HR

legal SCM

executives insurance finance

Acquiree

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Disclaimer and Non-attribution

• Disclaimer – The views in this presentation are those of Jill and Steffen only and are not to be construed as the views of the Raytheon Company

• Non-attribution – Do not attribute the discussions today to the speaker or those in the audience

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Scenario for this Presentation • Industry Contracts Manager’s Viewpoint • Federal and DoD Contracting • Practical “How-To” Guidance

• Checklists / Tools

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Learning Objectives Background The Challenge: How do I…? 1. Identify an opportunity for M&A 2. Contribute to a successful due diligence 3. Ensure successful transition and integration

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Background: Mergers or Acquisitions Merger • A transaction that results in a wholly new organization formed due to the merging of two or more organizations Acquisition • A transaction in which one firm is taken over by another firm. Alternatives not covered in this presentation but always worth considering: •Asset acquisitions •Technology acquisition / technology licensing with partial or total exclusivity

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Mergers and Acquisitions Today

Dubai Aerospace Buys Standard Aero, Landmark for $1.9B

Raytheon Acquires Oakley Networks 8

Mergers and Acquisitions Today “Defense spending remains at historic highs, and the commercial aerospace marketplace is at full stride. Industry players are flush with cash, and private equity money is pouring into the marketplace. In 2007 we could see the 1999 record finally eclipsed. Deals worth $25 billion have already been announced or completed—by far the fastest start we've seen this decade.” *

* Stuart McCutchan quoted on www.defenseindustrydaily.com article Defense & Aerospace M&A Hit 370 Deals & $40B in 2006 at http://www.prnewswire.com/cgibin/stories.pl?ACCT=104&STORY=/www/story/04-17-2007/0004567449&EDATE= (emphasis added)

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Mergers and Acquisitions Today • Defense and aerospace companies completed 370 transactions of M&A deals worth more than $40 billion in 2006* • Firms are poised and eager to divert cash to M&A opportunities that allow them to:  Meet ambitious investor expectations for year-to-year growth  Build and strengthen existing product lines  Diversify their portfolio to compete more effectively in a marketplace that can only cool off

www.defenseindustrydaily.com article Defense & Aerospace M&A Hit 370 Deals & $40B in 2006 referencing InfoBase/DACIS' “Defense Mergers & Acquisitions ” report

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The Government Customer’s Perspective Two options for excess cash:  Wall Street: pay cash out through larger dividends and stock repurchases  Pentagon: spend more on basic military research and further acquisitions that would streamline the industry even more*  potentially reducing costs and eliminating excess capacity

* Wayne, Leslie “Arms Makers Find Being Cash-Heavy Is Mixed Blessing” New York Times May 12, 2005: http://www.nytimes.com/2005/05/12/business/12cash.html?pagewanted=1&n=Top/Reference/Times%20Topics /Organizations/D/Defense%20Department&_r=1

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The Government Customer’s Perspective Concerns:  National security concerns associated with M&As by foreign firms  Competition  Vertical integration risks: acquiring contractors will –  prefer newly acquired suppliers over external suppliers even if the external suppliers are superior  increase barriers to market entry for their competitors  compromise proprietary information obtained on competitors through acquisition of their competitors’ supplier(s)  refuse to use suppliers owned by their competition  reduce competition at the subcontractor level

 Horizontal integration  Reduced private R&D investment to develop new and innovative technologies

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The Government Customer’s Perspective Concerns:  Spares availability

 Weapon system support  Interruption to on-going activities  Erosion of smaller, cheaper, more agile companies and competitors

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Candidate In-Process

Contracts Professionals Play a Crucial Role in the M&A Process:

Candidate Unsolicited

Initial OM/Info Review Indicative Offer Due Diligence Negotiations Closing Integration

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Opportunity Identification

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Identifying an Opportunity  Reasons to M&A (i.e., what to look for)  Good press  Public Profile  Reputation  Access to new customers  Complementary technologies  Adjacent growth markets  Advanced processing technologies  Benefit from lower rate structures  Expand product offerings  Focus on areas where the acquirer can integrate into the acquiree’s product capability and vice versa

 Acquire past performance and backlog of acquired companies to help you go after prime contracts

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Identifying an Opportunity Government “Hot Topics” are

for acquisition focus:

 Military readiness and logistics  Intelligence operations and analysis  Network-centric solutions  Information interoperability  Base realignment  Military health care modernization  Cybersecurity From Richard Knop’s article To Stay on Top, Make Sound Investments in Washington Technology; 06/11/07 issue; Vol. 22 No. 10

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Business Size Considerations Large Business vs. Small Business M&As Large businesses: – Size allows acquirers to get more of what they are looking for in terms of revenue, contractors or employees – Usually have less customer concentration and more administrative support than small businesses

but…

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Business Size Considerations Small business: – May be more nimble and, until recently*, had some advantages in obtaining certain government contracts “The Small Business Administration’s new size recertification rule could radically change the landscape for small businesses interested in being acquired and their potential buyers. Any small business will need to recertify its small-business status after being acquired, and if it is no longer small, its contracts will no longer count against the congressionally mandated targets for small-business contracts… Although the new rule’s effects won’t be apparent for some time, many observers fear that it could lead to agencies terminating contracts. The value of those contracts would therefore be diminished when potential acquirers assess the acquisition target.” From Matt Swartz’s article Small Businesses on the Block Should Explore ESOPs in Washington Technology; 06/11/07 issue; Vol. 22 No. 10

Contract portfolios may not be as valuable as they once were

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Brainstorming Wall Street Journal  Industry magazines  Industry associations  Get input from others 

– – – –

Other employees Friends Family Customers  

Don’t ask who they think we should acquire, rather  Ask what we are aren’t doing well; follow-up by asking who does it well

Think outside the box - growth will come from adjacent market opportunities 20

Factors to Consider Alignment with Strategy  

 

Greater corporate strategy Strategy and future state • Mission Support • International • Competitive Pursuits Individual P&L strategies Adjacent markets or whitespace

Solid Operating History   

Business operating history 3+ years Strong leadership Desirable customer relationships, technology, contract, etc.

Financial Hurdles    

Robust revenue growth outlook Operating margin is not dilutive Positive cash flow High ROIC business

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Summary of Prioritized Gaps Gap

Business Area

Rationale

1

2

3 4 5

6 7 8 9 ?

Legend:

Gap Closure by M&A Most Likely Solution

Gap Closure by Partnering / Internal Actions Most Likely

Gap Closure method in development could be by M&A

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Summarize Once you’ve identified the opportunity, collect as much data on its financials, strategy, and synergies and summarize it for management…

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Key Candidate Target Summary Overview:

Summary Financials: (FYE = 6/30)

 Public company established in 1977

 Provide solution for lifecycle support with program, financial, test and logistical services and training Information

$80 $70 $60 $50 $40 $30 $20 $10 $0

17% 12% 7% 2% -3% -8% 2004A

Strategic Rationale:  Expand customer relationships: ABC, NOP, XYZ  Access to new programs: Seagull, Bluebird, Goldfinch  Adds a leap forward in imaging

2005A

2006P

2007P

Synergy Opportunities:  Audubon Networking Capabilities; visual realization; mapping and modeling  Interoperable tracking software

 Adds credentials in ID/IQ arena

 Sensors, digital video broadcast and surveillance technologies

 Supports our recent win on Sparrow with network solutions and decision support systems

 Complex decision-making algorithms

 Supports our effort in Condition Based Maintenance

EBITDA %

 Provide information connectivity solutions that capture, analyze and present real-time information

Revenue ($m)

 Headquarters in San Francisco, 123 people

 Total Asset Visibility  Logistics Situational Awareness

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Why Do M&As Fail? In a study by Watson Wyatt: • 66% of companies failed to meet their profit goals following a merger • 54% did not meet their cost cutting goals In a study by A.T. Kearney: • 58% of mergers failed to achieve their stated goals • 58% of global mergers managed to outperform competitors after two years *From Why Do Mergers Fail? What Can Be Done to Improve Their Chances of Success in Key Strategy, January 2006.

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Why Do M&As Fail?  Lack of Communication

 Lack of Direct Involvement by Human Resources  Lack of Training  Loss of Key People

 Loss of Customers  Cultural Differences  Power Politics

 Inadequate Planning

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Why Do M&As Succeed? 





 



Extensive and Regular Communication  Following announcement of the M&A, maintain open lines of communication with middle management and lower level employees on the going-forward plans  Be clear and consistent, even if the message isn’t always positive Effective Planning at All Stages  Realistic goals and timeframes  Only 1 out of 5 companies that have acquired another has developed a clear and satisfactory implementation plan Retain Key People  25% of top performers leave their company within 3 months of a major organizational event  47% of senior managers leave within the 1st year Manage Cultural Differences Training and Development  Train everyone • Managers overseeing the M&A process • Employees of the M&A company Post M&A Integration Teams

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Due Diligence

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Due Diligence •

Contracts role is fact finding only – Review the contractual documentation and provide input on risks and issues

– No negotiating; no decision making

•

Trust is critical – The team must be composed of members that are mature and trustworthy enough to remain silent on the entire fact of M&A discussions (this protects against turnover and maintains moral)

•

Expect ¾ to full time support for 30 to 45 days

•

Recognize the due diligence team’s effort, regardless of whether the the acquisition is made

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Q&A Format  Questions and answers are processed through the intermediary (e.g. bank) 

Demand same day responses

date

CONTRACT QUESTIONS AND ANSWERS

Contract Question Date of Question Number Contracts_001

Question

PROJECT NAME: Sector Answer

Date of Answer

1/23/2008 Does Sector have any open requests for equitable adjustment (REA) invoices, or is Sector involved in any customer claim actions that may affect the ability to collect on an open accounts receivable

Contracts_002 PROPRIETARY INFORMATION

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Due Diligence The seller (or intermediary) should establish a virtual collaboration environment / data warehouse  Populate it with all contractual documentation  Contracts and modifications  Non-disclosure agreements  Current proposal efforts

 Allows for “virtual” due diligence from the comfort of your own office  Availability of documentation is critical!  Each folder in the collaboration environment should contain a 1-2 page synopsis describing the documents that are housed in that folder  e.g.: contract, period of performance, value, type, deliverables, and status

 The collaboration environment should be constantly updated with all new modifications, RFPs, etc

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Due Diligence  Work in close cooperation with the company you’re acquiring – an adversarial posture will always backfire  The due diligence process may seem excessively intrusive, but it builds relationships and provides the opportunity for the acquiree to better understand his own company while at the same time pleasing the acquiring company  Hesitancy or hostility during due diligence is often a sign that a deal’s value will be more difficult to realize than originally expected

Be Patient – Don’t be Disappointed if the Decision is Made to “No Go”

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Due Diligence – Document Review Checklist Evaluate every current contractual document the acquiree has as if you were reviewing one of your own contracts for risks and opportunities:  Contracts  Non-standard terms and conditions (i.e. H-clauses, special T’s and C’s, etc)

 Non-Disclosure Agreements  Who are they with?  What is their duration?  What proprietary data is outstanding that would be important to request returned or destroyed?

 Teaming Agreements  Look for exclusivity or conflicts of interest with your own company’s pursuits and teammates  List teaming agreement and exclusivity

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Due Diligence – Document Review Checklist  Small Business Innovation Research (SBIR) contracts  Current and upcoming RFPs that the company is responding to  Requests for Equitable Adjustment  Agreements granting or obtaining rights to intellectual property or the use of intellectual property  Offset agreements: what are the company’s obligations  Government Terminations  Debarment  Waiver of claims agreements

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Due Diligence – Document Review Checklist  Ratings  Contractor Performance Assessment Report (CPARs)  Evaluations and complaints by customers during the past 5 years  Consider approaching customers directly to understand how well the company manages them  Award fee ratings

 Organizational Conflicts of Interest (OCI)  Mitigation plans currently in effect and for the past 3 years  Correspondence relating to OCI matters

 IDIQs, GSA schedules, and any other task-order contract vehicle-based business  Identify roles, prime and sub, and experience  The extent of the company’s utilization of the IDIQs  Assess the rates used on the IDIQs

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Due Diligence – Contract Review Checklist Review contracts, modifications and RFPs for key terms and obligations:  Insurance requirements  Does the acquiring company maintain sufficient umbrella insurance or will additional insurance coverage be required?

 Liquidated Damages  The company’s liabilities and probabilities of incurring those liabilities •

Consider schedule and on-going performance

 Limitation of Liability  Quantifies the company’s exposures  List dollar-limits of liability w/ time-frame limits

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Due Diligence – Contract Review Checklist  Assignment and novation clauses and restrictions  Indemnification  Intellectual Property terms      

Have restricted/limited rights been asserted? Licensing agreements negotiated? Commercial vs. non-commercial-but-restricted-use technologies? Was IP developed at company expense or using government funds? List all rights asserted by contract List 3rd party software license requirements, such as reporting, royalties, and payment obligations

 Small business re-certification requirements

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Due Diligence – Contract Review Checklist  Deployment terms and liabilities when deploying for military operations  Does the company have any deployed personnel? If so, what are the contract’s Defense Base Act (DBA) requirements? Is DBA coverage provided for war zone deployment?

 Organizational Conflicts of Interest (OCI)  For each contract that contains an OCI clause, process an OCI sweep through your company to confirm there’s no conflict  Where programs are similar or related to your company’s programs, ensure there’s no conflict

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Due Diligence – Contract Review Checklist  Warranty exposure: List all outstanding warranties and quantify liabilities associated with them  Be on the lookout for: • Warranty claims, lawsuits, recalls, or post-manufacturing remedial measures from the preceding 5 years for any products or services • Written materials or documents that may create implied warranties • Oral warranties • Defects or other potential problems with products or services that could give rise to a warranty claim • Is warranty expense “pay as you go” or reserved in the P&L and balance sheet?

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Due Diligence – Tracking Checklist Record and catalog all agreements and identify any terms and conditions that may raise a red flag  Look for:  Items (risks, liabilities) that may affect the purchase price of the company  Items that may change once the company is purchased.

This cataloging and categorizing is critical!

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Tracking

E-room Folder Contract # Description Customer 7.B.1 a to e DAAB07-08-D-B001 Support Services Contract under US Army: CECOM the ABCD Program . Provide engineering support, modeling/simulation support, and support necessary to implement new tactics.

Label As:

Value $5,000,000

Options Options Values Contract Type Unique Ts & Cs 2 options, $10,000,000 CPFF with FFP There is a clause (H14) entitled unexercised components "Software Development" that requires the delivery of "executable code to the government with the release of each patch/version of software."

"PROPRIETARY INFORMATION"

Use Template for Tracking Organization

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Due Diligence – Reporting Checklist Submit a weekly report to the due diligence lead summarizing progress and flagging issues and recurring themes  Summary of Diligence Scope (# of contracts in review/already reviewed by contract-type by sales)  Key findings (% of contracts as prime; % of contracts as subcontractor; next-year contract projections/back-log; list of customers; etc.)  Outstanding Issues / concerns (intellectual property, export, OCI, Safety Act issues)

 Mitigation Plans  Financial Impact  Integration Concerns  Outstanding Data Items  Recommendations

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Due Diligence – Out-brief Checklist Prepare a final out-brief for the decision makers containing:  Due diligence results from all functional reviews

 A schedule of accomplishments and items remaining to be accomplished  The major due diligence tasks concluded by the Contracts function  The top due diligence issues  A color-coded status with key comments from the weekly reports

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Transition and Integration

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Transition and Integration • Smoothness of integration largely depends on:  How friendly/hostile the merger/acquisition process has been thus far  Whether the employees played a role in the decision making  Whether the company is employee-owned such that they stand to benefit financially from the deal

• Utilize the due diligence team, though at a much reduced frequency, to take advantage of existing relationships

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Transition and Integration Do not guarantee “no change”  Stress that there will always be change - but good change  Recommended reading: Who Moved My Cheese by Spencer Johnson, about adjusting and embracing changes and transitions at work with an open mind and motivated spirit • Quick read • Buy it for all employees

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Transition and Integration  Form a Mentor-Mentee relationship with the contracts manager(s) of the acquired organization  Host face-to-face staff meetings with the acquired company contracts managers to socialize with the rest of the team  Be available and responsive to phone calls and questions from the acquired company  It makes a great impression and leaves them excited about joining your team

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Transition and Integration  Be a salesman: sell them on working for/with you and the company  Be flexible: let the integration process happen gradually in certain areas 

Communicate which policies and procedures are critical



Particular terms and conditions Proceeding on contracts at risk Teaming agreements OCIs Signing Authority Gating



… and which policies and procedures are less critical

    

 

Filing requirements Specific NDA language

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Integration Checklist Share:          

How and where to search for company data online Listings and copies of applicable policies and procedures Certifications and Representations Copies and examples of weekly and monthly reports A list of policies and procedures that must be followed immediately Scenarios that require higher-level approval Metrics Company, Business Unit, and Contracts specific organizational charts A list of common acronyms Descriptions of key program, pursuits, and initiatives the acquiring company is involved in

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Integration Checklist  An appropriate level of delegated signature authority  “Empowered official” status for purposes of export/import and the Directorate of Defense Trade Controls (DDTC)  Administrative support – where the acquirer has centralized administrative services  Details on IDIQs (GSA schedules, GWACs, etc) – opportunity for two-way synergies  Terms and conditions guidelines for contracts  Copies of standard teaming agreement and NDA formats  Pertinent leadership and training development programs  Past performance data

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Integration Checklist Assignment Clauses:  Will typically only require notification to the customer or prime contractor.  Novation is not required as long as the same company is performing the work, with the majority of its assets unchanged.

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Concluding Comments

Identify the opportunity + due diligence + successful transition and integration =

Contracts Business Acumen Acquirer PMO

BD

Ex/ Im

CONTRACTS

legal finance

HR

engineering

treasury HR

legal SCM

Synergies Sales Solutions Success

executives insurance finance

Acquiree

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Contact Information • Jill Mitchell – 972.344.4145 – [email protected]

• Steffen Jacobsen – 703.204.6515 – [email protected]

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Questions and Answers • • • • • •

You have comments – please share You have questions – we have answers Audience help in answering is welcome Share the time with others Must conclude formal part on time Be glad to discuss afterwards outside room

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It’s Been an Honor! Thank You!

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BONUS: EXPORT / IMPORT CHECKLISTS

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Due Diligence – Export/Import Checklist Identify:  Any commodities, technical data, software or services the company has exported within the last 5 years  Next to each item exported, identify the pertinent licenses and/or agreements in place for that export  (TAAs; State/Commerce export licenses) and the U.S. government agency which issued the license

 Products subject to Commerce Department jurisdiction  Business activities involving items on the U.S. Munitions List in any of the countries proscribed by section 126.1 of the ITAR  Import tariff classifications for all imported products  Contact information for freight forwarders used within the past 5 years that facilitated these exports  Empowered Officials

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Due Diligence – Export/Import Checklist  Any outstanding or ongoing export licensing, export jurisdiction or other export control issues  Non-routine issues that are the subject of correspondence with one or more government agencies  ITAR violations

 Any person in the company who has been or is the subject of an indictment  Any person in the company who has been convicted of violations of any of the U.S. Criminal Statutes enumerated in section 120.27 of the ITAR, the EAR, Customs regulations, EU trade controls and customs requirements, or any foreign country trade control and customs regulations  Any person in the company who is ineligible to contract with, or to receive a license or other approval to import articles or defense services from or to receive an export license or other approval from any agency of the US Government, the E.U. or foreign government

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Due Diligence – Export/Import Checklist  Does the company conduct business or have any know business activities or representation in any of the following countries:  Algeria, Bahrain, Comoros, Cuba, Djibouti, Iran, Iraq, Kuwait, Lebanon, Libya, Mauritania, Morocco, North Korea, Oman, Palestine, Qatar, Saudi Arabia, Somalia, Sudan, Syria, Tunisia, UAE or Yemen

 Boycott requests received over the last 5 years or certification that no requests have been received  Include copies of reports to US Government

 All foreign national employees  Any foreign ownership and/or control  Commercial products specifically configured, adapted, modified, designed, or developed for a military application

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Export/Import Identification Description of Exported / Import Tariff Issuing State Commerce ITAR 126.1 US Freight Contract # Imported Item Part Number Export License/Agreement Classification Agency Jurisdiction Jurisdiction Munitions List Forwarder Used DAAB07-08-D-B001 Software Description Document NA DSP-83 NA DoS X no none

Use Template for Export/Import Identification

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Integration Checklist – Export/Import Provide copies of all policies and procedures related to Export/Import Compliance including anything related to:           

Classification Process for Hardware and Technical Data Record keeping Process to handle any Non-U.S. National Employees/ Visitors/Residents/ Dual Nationals Shipping/Receiving BATF Requirements Classified Export Process Re-exports/Retransfer Procedures Security Forms – non-U.S. National Visitors Screening for “Denied” Parties Anti-boycott Requirements Part 130 Process Anti-boycott screening and reporting procedures: identify procedure for screening and reporting of boycott requests  Recordkeeping Requirements: provide instructions/details on location of export documents such as Shippers Export Declarations (SED), invoices, airway bills, bills of lading

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