CSRA's (CSRA) CEO Larry Prior on Q3 2017 Results - Earnings Call Transcript

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CSRA Inc. (NYSE:CSRA) Q3 2017 Earnings Conference Call February 7, 2017 5:00 PM ET

Executives

Stuart Davis - Vice President, Investor Relations and Strategy

Larry Prior - Chief Executive Officer

Dave Keffer - Chief Financial Officer

Analysts

Edward Caso - Wells Fargo

Gautam Khanna - Cowen & Company

Amit Singh - Jefferies

Frank Atkins - SunTrust

Brian Ruttenbur - Drexel Hamilton

Operator

Good day, everyone and welcome to the CSRA Q3 2017 Earnings Conference Call. [Operator Instructions] Please note that the event is being recorded. I would now like to turn the conference over to Stuart Davis, Vice President of Investor Relations and Strategy. Please go ahead, sir.

Stuart Davis

Thank you, William. Welcome everyone to today’s quarterly earnings conference call. Larry Prior, our CEO and Dave Keffer, our CFO, are here to discuss our financial results, business momentum and forward outlook. Today’s call is being webcast on the Investor Relations portion of our website, where you will also find the earnings release and supplemental financial presentation slides that we will be using during today’s call.

Turning to Slide 2 of the presentation please note that during this call, we will make forward-looking statements that are subject to known and unknown risks and uncertainties that can cause actual results to differ materially from anticipated results. For a full discussion of these risks and uncertainties, please refer to our SEC filings, including our Form 10-K from May and our most recent Form 10-Q. In addition, the statements represent our views as of today and subsequent events may cause our views to change. We may elect to update the forward-looking statements at some point in the future, but we specifically disclaim any obligation to do so.

Finally, as shown on Slide 3, we will discuss some non-GAAP financial measures and other metrics, which we believe provide useful information for investors. The slide deck for today’s call includes the reconciliations to the most comparable GAAP measures. It’s now my pleasure to turn the call over to Larry who will begin on Slide 4.

Larry Prior

Thank you, Stuart. Good afternoon, everybody. We are excited to report another strong quarter. The clear highlights for the third quarter were superb cash flow and another set of large, strategic new business wins. In addition, revenue was in line with consensus, and EBITDA and EPS were both a little bit ahead of consensus. Our EBITDA margin of 17.3% still leads the industry and is above our long-term target.

I will leave the financial results for Dave to do in detail so I can focus on four key points. Point number one to prepare for our fiscal year 2018, we crafted a clear and differentiated strategy to drive growth in our public sector markets supported by a new brand and tagline, Think Next. Now. And the three remaining points are that the key enablers of this strategy are all in place and all working today. So point number two, our growth engine continues to lead the industry. Point number three our technology leadership is creating key differentiators in the market. And point number four, our talent management approach is building a motivated workforce to execute our strategy.

Let me go a little bit deeper. Point number one on strategy. For a year, we have just been heads down and focused on the tasks in front of us, executing on programs, delivering on the synergy case, integrating two companies and two cultures, writing proposals and yes, each and everyday, collecting cash. I am product of the team’s hard work and tremendous accomplishments on all of these fronts. We are stronger today than we were a year ago as a result of the determination, the energy and the creativity of all 18,000 employees who show up to work everyday with a passion for our customers’ missions. In particular, we now have a much better balance sheet and a backlog of new programs that provides us strategic flexibility and growth momentum.

Over the last few months, we have taken the time to look beyond the horizon and chart our direction for the next 3 years. It’s been a very collaborative effort across both line organizations and leverage teams, with the board both fully engaged and rolling up their sleeves to help. We now have a holistic view of strategy and vision and our cultures and values are aligned and we are gaining buy-in throughout the company. Strategy is all about where you compete, how you compete and how you measure success. Our strategy is to drive sustainable industry leading organic growth across our federal and state local markets through customer intimacy, rapid innovation and an outcome-based experience.

Let me unpack the statement a bit. Our primary focus is profitably growing the company. We are the most efficient company in our space and we will remain so, but this is a dramatic shift. We have moved from the legacy mindset of only improving the bottom line by cutting costs to one centered around and devoted to a growth culture. We will measure our success, first and foremost through revenue growth, which provides better career opportunities for our employees, more solutions that we can provide to our customers and greater returns to our shareholders. Next, we will remain focused on our current markets where we have about a 3% market share. The federal government and related state and local and international markets provide plenty of opportunities for us and the market dynamics are improving after years of government budget cuts. We will support the United States and the vital interest of our allies across the globe. We are well positioned with many of the new administration’s priorities, including defense, border security and the critical care for our veterans.

We will compete through three primary differentiators: first, customer intimacy; second, innovation; and third, outcome-based delivery. Our customer intimacy derives from talented teams who deliver flawlessly, who build trust-based relationships with our customers and provide mission and technology thought leadership. We deliver rapid innovation through partnerships, shared delivery models and cross-agency capabilities. Our customers are looking to move towards paying for outcomes instead of inputs, and we are the industry leader in delivering outcome-based experiences through developing, bidding and executing the shared delivery methodologies. Our mission, vision, strategy and importantly, our culture and values are then encapsulated by our brand of Think Next. Now. This message is one the entire company created and can rally behind, enabling us to approach the market with a unified purpose and direction. It imagines a better future and delivers it today for our customers, our partners and ultimately, all the people our missions touch.

Point number two, our business development engine continues to rev at high RPMs. We posted our eighth straight quarter with a book-to-bill ratio of 1.0 or greater. In what is typically the slowest quarter for awards, we achieved $1.9 billion in bookings for a book-to-bill ratio of 1.5. Our trailing 12-month book-to-bill ratio was still tracking at 1.3. Our backlog of signed business orders at the end of the quarter was $15.8 billion, which increased 3% year-over-year. I firmly believe that if we continue to post industry leading book-to-bill rates, we will lead our industry and organic growth, which is our goal. The $1.9 billion in awards were rich with new business. 73% of bookings in the quarter were for new business and our win rate on new business was 46%, again, well above our target rate of 25%. So far this year, we have won $3.1 billion in new business, ahead of our target run-rate of $4 billion each year even though we are just now seeing the full effect of our accelerated bids submissions.

Our bid pipeline remains robust. At the end of the quarter, we have $12 billion in submits outstanding. Looking only at new business, we had about $5.7 billion awaiting decision, including 15 opportunities that are each greater than $100 million in total value. This quarter’s awards showcase how we are combining deep domain knowledge of the customers’ mission, expertise in our IT enterprise and next-generation capabilities and partners to deliver compelling solutions for our customers.

Let me highlight just a few of the major wins in the quarter to give you a sense of what I mean. Our largest win was the $744 million award that was in protest at the time of our last call. With that protest resolved in December, we are now supporting the Army’s communication electronics command, providing a wide range of mission essential logistics, maintenance and sustainment work for current and future C4ISR systems around the world in support of this administration’s priorities. Building on the delivery excellence of our program manager, Larry Crop, our General Manager for this business, Alan Smith, was instrumental in crafting the strategy for this consolidated procurement. We expect our work growing from current revenue levels of $30 million a year to well over $100 million each year as we ramp over the next few quarters. In another consolidating contract, Kamal Narang led a team that engineered a wonderful technical solution on a $323 million program called HIGLAS to host, operate and maintain the general ledger system for the Centers for Medicare and Medicaid Services.

Our world class database team has been working on the application side for 5 years, but taking over the infrastructure work was a tall task, one that was perfect for Rebecca Miller, our Civil Group BD lead overseeing the capture. We were able the team well with Oracle to engineer a compelling solution using the Oracle Exadata that was low risk, innovative and cost efficient and improved performance by a factor of 10. On this program, we will introduce and implement DevOp methodologies and potentially migrate the application to a cloud environment.

Final example, we received a new single award blank purchase agreement – blanket purchase agreement with $150 million ceiling to help the Department of Commerce reduce costs, enhance customer service quality and prepare for the 2020 census. Under the leadership of Chris Hegedus, SRA will develop and implement cloud based services in the areas of acquisition, financial management, human resources and information technology. This is a shared service deal with the foundation and a solution that leverages both service now and our own integrated technology center in Bossier City, Louisiana.

These wins are largely driven by next generation thinking enabled by strong technology partnerships, which takes me to my third key point. CSRA works really hard to attain technology leadership. The breadth and the depth of our partnerships with key technology innovators is unmatched because we offer unmatched access to the federal government IT enterprise and we bring a focus and a passion for technology insertion that will help missions be successful. With the full involvement of our line organizations, we develop and invest in our partner relationships, especially our seven strategic alliance partners; Amazon Web Services, Cisco, Microsoft, Oracle, Salesforce, SAP and Service Now. For example, our recent Greenway submission under Leigh Palmer’s leadership with the intelligence group leveraged six of these strategic partners in the bid and clearly differentiates our technical offering.

We are already a premier consulting partner in the AWS partner network. And this quarter, we successfully completed the independent third-party audit to join their elite managed services program. That enables us to deliver added value to cloud solutions by offering proactive monitoring, automation and management of our customers’ environments. We also recently added Amazon’s commercial and Amazon’s Gov cloud services to the GSA IT Schedule 70, which is the largest most widely used acquisition vehicle across the federal government. These added qualifications and channels will even further our leadership in cloud migration, especially within Paul Nedzbala’s health and civil group whose customers are often the most forward leaning in adopting next-generation technologies.

Now our other strategic partner in the cloud, Microsoft, we just signed with them a 3-year enterprise agreement to use their products for the Azure cloud platform. We are proud to be a gold partner in the Microsoft partner networks and we are now the first government systems integrator to migrate its own workload to the Azure government cloud platform. By investing in ourselves, we minimize risk and then accelerate solutions for our customers as we act as customers of Azure. We believe that the market for Microsoft’s cloud services will expand rapidly, especially within the Department of Defense. The DoD just granted Level 5 accreditation for Azure and Office 365, making them the only commercial cloud provider at that level of security and trust. Ken Deutsch and his defense group team are working hand-in-hand with Microsoft on many large and strategic bids that could be major drivers for both of us in this critical market.

Microsoft was also the major sponsor along with Splunk of a hackathon that we hosted in December. Led by Sally Sullivan’s Homeland Security Group, this hands-on competition style training event brought together technologists from across the company to engage in collaborative computing, challenge conventional thinking and solve real-world problems in the cloud and really leverage data analytics, which brings me to my fourth key point, our talent. This is the driver behind really improving customer intimacy, earning trust based relationships and delivering flawless execution. We continue to up our game in hiring, retaining and developing our workforce. In the third quarter, we had more job applicants than we have ever had and 42% of our new hires are millennials. Our voluntary attrition rate in the quarter was the lowest we have had since going public. Employees are seeing enhanced opportunities through growth and the culture is evolving in all sorts of positive ways. Our employees like the opportunity for continued technical education and more than 400 of these employees added new technical and professional certifications in the quarter.

Before I turn it over to Dave, let me briefly address how we are thinking about the market under President Trump’s administration. For context, let’s keep in mind that we are less than three weeks into the new administration, so we are in the very early stages. For example, just seven members of President Trump’s team have been confirmed by the Senate, which means we have only got 1,235 to go. Transitions after two term Presidents are generally a little chaotic and they all take time. So I expect industry book to bills for the March quarter to be a bit dampened, but all of us remain convinced this is a growth opportunity for the marketplace. We have seen a steady flow of forceful executive orders, tweets and interviews. Nothing has changed our fundamental view that the market for our services and solutions will grow in the coming years. The administration has signaled a willingness to engage in deficit spending to fund a strong commitment to the military and the border security. And with the freeze in hiring for non-military government personnel, service contractors stand ready to enable mission success.

Given our efficient onshore staffing models, CSRA can be an engine for American job growth, clearly a key priority for President Trump. We may face headwinds in some areas, such as our support for the EPA, but on balance, we believe we are well positioned for future growth with this administration. Perhaps most importantly, CSRA should benefit from a more businesslike approach to contracts with more fixed price contracts and a greater focus on cost efficiency, both major advantages for us. Ultimately, this environment will favor those who are ready to move quickly, who are agile and act like a business and we are doing that on all cylinders.

Now, Dave will provide more detail on the financial results and the forward outlook.

Dave Keffer

Thanks Larry and good afternoon, everyone. As Larry said, we had another strong quarter across the board, but especially around cash flow, which is the life blood of the company. Turning to Slide 5, revenue for the quarter was $1.22 billion, down 3% sequentially and down 4% from pro forma revenue in the third quarter of fiscal year 2016. The sequential decline was consistent with normal seasonal leave taking patterns and was in line with our expectations. Our contract mix continues to exhibit a high concentration of fixed price work, which is a key driver of our profitability. As a percentage of total revenue, 46% was on fixed price contracts, 21% on time and material contracts and 33% on cost plus contracts. There were a few unique items impacting the expense and earnings lines, though for the most part they affected the GAAP treatment, not the adjusted numbers and we are able to preview most of the larger items on our last call.

I will now walk through these major drivers as I progress through the income statement. First, we extended a voluntary offer to former employees who participated in qualified pension plans to receive immediate lump sum payments. Based on participant elections, in the third quarter of fiscal year 2017, we made lump sum payments of $320 million and reduced pension obligations by $333 million, so a net improvement of $13 million in the pension funding status. This roughly 10% change in the overall size of the pension program necessitated a pension plan re-measurement as of December 1, 2016. We recorded a non-cash mark to market benefit of $101 million in the quarter. We do not project making any meaningful contributions to the pension program in the foreseeable future and we reduced the GAAP underfunding of the program by about $136 million. With the lower asset base and higher projected interest rate, the remeasurement costs recurring non-cash pension income to fall from $24 million in the second quarter to $23 million in the third quarter and a $21 million quarterly run-rate thereafter, although this could change again with our usual annual remeasurement in the fourth quarter.

Second, GAAP stock compensation expense during the quarter was $18 million, $14 million of that was a non-cash charge from performance-based awards for former SRA shareholders. The performance targets for the awards were met when Providence Equity Partners, formerly SRA’s majority shareholder, sold its CSRA Holdings after our second quarter earnings call. We were delighted that our existing and new shareholders purchased more than 15 million shares with no visible disruption to the market. Compared to the time of the spin, we believe our investor base is now much more focused on CSRA as a long-term holding.

Third, pre-tax merger and integration costs were $5 million, down $3 million from last quarter. Despite relatively modest EAC adjustments in the quarter, profitability continues to be strong with an EBITDA margin of 17.3%. This is down from last quarter’s record margin and consistent with the view that we have laid out for some time that EBITDA margin as we have defined them would end up in the low to mid 17% range for FY ‘17 and over the longer term, land in the 16% to 17% range as we drive top line growth. On a volume basis, adjusted EBITDA for the quarter was $211 million. Below EBITDA, the quarterly variances were more muted. We completed the re-pricing of our term loans, consistent with the plans we laid out on our last call. In connection with the re-pricing, we incurred a non-cash charge of $8 million for a write-off of deferred financing costs in the third quarter. Going forward, the re-pricing will reduce interest expense by approximately $5 million annually. Excluding the charge, interest expense was $28 million in the quarter, down about $1 million from last quarter.

Depreciation and amortization, excluding the intangibles amortization expense associated with SRA’s funded contract backlog, was $50 million or $3 million more than last quarter. The intangibles amortization expense associated with SRA’s funded contract backlog, which is included in GAAP earnings per share but not adjusted EPS, was $11 million or $5 million less than last quarter and it will go to zero in Q4. Our effective tax rate was 37%, which is close to our long-term target rate, but up about 2 percentage points from last quarter. With that, adjusted diluted earnings per share for the quarter were $0.48, unchanged compared to the third quarter of fiscal year 2016.

Now turning to Slide 6. Cash flow performance was our best as a public company. Operating cash flow for the quarter was $227 million and free cash flow was $191 million or more than 2.4x adjusted net income. My thanks go out to our entire team of invoicers and collectors for their hard work in generating this tremendous outcome for the company. In addition, we did not make the $30 million intellectual property maintenance payment to CSC in the third quarter as anticipated under our original separation agreement. We are currently in discussions with CSC regarding a variety of matters related to our separation agreements. Note that during the question-and-answer period, we will not take questions regarding these discussions with CSC.

Days sales outstanding were 57 days in Q3, which is unchanged from last quarter. We will look to shave a couple of days off DSOs over time through continued strong collections performance. We followed our balanced capital allocation program in Q3, deploying $50 million to pay down debt and $38 million to return to shareholders, $17 million in dividends and $21 million in share repurchases. As of December 30, 2016, we had $162 million in cash and cash equivalents and $2.6 billion in debt.

Now on to the forward outlook. As we approach the end of our fiscal year, we have modified guidance as shown on Slide 7. Specifically, we now project fiscal year 2017 revenue between $4.96 billion and $5.01 billion. Including the lower non-cash pension income, we project adjusted EBITDA between $857 million and $867 million and adjusted diluted earnings per share between $1.98 and $2.02. Our free cash flow guidance remains between $300 million and $350 million. For adjusted EPS, specifically, this guidance equates to fourth quarter performance of $0.44 to $0.48. Compared to our original guidance ranges, we expect to land near the low ends for revenue and adjusted EBITDA and near the high end of our adjusted earnings per share range. The pension re-measurement has lowered our FY ‘17 adjusted EBITDA guidance by about $4 million and our adjusted EPS guidance by about $0.02.

Our fourth quarter outlook reflects slow startups on some large programs, such as the OPM background investigations contract and the large Army C4ISR program as well as potential interruptions on current contracts at a few agencies and fewer Q4 awards as a result of the administration transition, but it does not change our fundamental view of an improving picture for CSRA. It takes some time for new wins to reach their ultimate revenue run-rate, especially during an administration change. When they do, our growth will surely follow. We continue to see an opportunity for FY ‘18 to produce organic growth in line with our long-term model of 2% to 3% and EBITDA margin slightly below current levels, but on the high side of our long-term model of 16% to 17%, including pension income, which brings me to my closing point.

As we introduce guidance for fiscal year 2018 on our call in May, we plan to exclude recurring pension income from adjusted EBITDA and adjusted EPS. Pension income will still be in our GAAP numbers and the adjusted numbers defined in our credit agreement. Many of you have requested that we remove pension income from what we report in our non-GAAP measures. And we want to enhance the comparability with our peers’ results and limit confusion for potential new investors. As we have said repeatedly, pension income is non-cash in nature and should not change the fundamental valuation of the company.

By way of comparison, our updated fiscal year 2017 guidance assumes $92 million of pension income within adjusted EBITDA, which equates to about $0.35 of adjusted diluted earnings per share. So if we hit the midpoint of our guidance, fiscal year 2017 performance excluding pension would be $769 million for adjusted EBITDA and $1.65 for adjusted earnings per share, which should be the basis of comparison when we introduce FY ‘18 guidance. Another point of consideration is our long-term EBITDA margin target, which translates to 14% to 15% excluding pension income. Naturally, there would be no impact to our free cash flow guidance. We hope that signaling this change now will help all of our analysts and investors prepare their models going forward and avoid any confusion.

With that, operator, we are now ready to take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And the first questioner today is Edward Caso with Wells Fargo. Please go ahead.

Edward Caso

Hi, good evening. Congratulations. Can you give us any update on Groundbreaker/Greenway and how that’s progressing?

Larry Prior

Yes, Ed. We have done another submission. I think it only took one truck this time as opposed to two. The government is still in the evaluation mode. We are hoping they will be doing something towards the latter end of summer. It is incredibly complex, especially as the administration goes through transition. So it may get delayed a bit. You heard my reference to our technology team with all of our partners that we think is critical in the solution that’s cost effective for that customer, but we also just love the experience that we have done with the 123 SLAs that are all performing well and the risk that the government can avoid as they really take advantage of our technical solution and our hands on experience.

Edward Caso

Can you talk a little bit more about the fourth quarter sort of lowered expectations for revenue here, is the – has your view changed on the Trump administration impact and will that extend out for some of the contracts, the big ones you mentioned, are they just ramping slower than you thought, I mean just help us out why the view is changed versus three months ago? Thanks.

Larry Prior

Yes. I mean the principal driver is OPM didn’t ramp as fast as we would have liked. And when you think of getting an authority to operate, having the cyber capabilities as a new participant as well as I think the government is doing a really good job of adding some layers of security, so that’s taking a bit longer and I think well worth the time. The second was working through the protest for the C4ISR work and getting through that and doing the ramp, both are slowed a bit relative to what we thought the planning would be. There is a little bit of noise. There was a week where EPA was freezing contracts on a Monday and then freeing them up by a Friday. We put that in the category of yes, we had administration for 8 years and there is always going to be growth pains. The good news is they didn’t steal the tees off, the typewriters, so I think we are in better shape than the last one.

Dave Keffer

Ed, it’s Dave, I can add a little bit to that as well. Over the last few quarters, we have been noting that our revenue was trending towards the lower end of our prior guidance, right around $5 billion, which is not far from the midpoint of our updated guidance. It is as you pointed out, related to the timing of ramp-ups on some of our current new business awards as well as the state of the market as we go through continuing resolution environment coinciding with an administration change. So we are every bit as optimistic about long-term growth and looking forward to the quarters and years to come.

Edward Caso

Alright. Thank you.

Operator

Our next questioner for today is Gautam Khanna with Cowen & Company. Please go ahead.

Gautam Khanna

Hi. Good evening guys.

Larry Prior

Hi Gautam.

Dave Keffer

Hi Gautam.

Gautam Khanna

So a couple of questions, first on the ‘18 commentary with the transition to organic growth with some margin pressure coincident, does that net a relatively flat adjusted EPS year in your view or should we expect better?

Dave Keffer

Hi Gautam, it’s Dave. So obviously, we are three months away from providing our ‘18 guidance. I think you have heard the right signals on our call today in terms of what we are seeing today which is, in our scripted comments, the fact that we see revenue inflicting towards growth. So far this year, we have been hovering in that minus 4% to minus 5% range, Q3 now a little better than minus 4 and our Q4 guidance, roughly minus 1 to minus 5, so you are seeing that gradual inflection. We see as we pointed out earlier, the opportunity for growth in ‘18 to reach the long-term range of 2% to 3% that we have mentioned. That will take the form of gradual sequential growth over time. And the compares get a little bit easier when we get into Q1 and that will certainly help as well. At the end of the day, it’s about the pace of new business award activity continuing, the really strong book to bills that we have produced over the last three quarters, four quarters continuing into FY ‘18 and our ability to ramp up each of those as well as we have today. So on the bottom line, as you pointed out, we have got confidence that as revenue and flex towards growth that, that should lead toward earnings growth as well. Even if in a year where EBITDA is flat, we should see EPS growing. If EBITDA grows, we should see EPS grow even faster. So that’s the kind of the dynamic that we should look at going forward, given net interest and other lines between EBITDA and EPS should be helpful.

Larry Prior

Right. But I guess, the point – I am just trying to make sure we are calibrated, it’s not unreasonable to assume that as fiscal ‘18 transitions to growth, we might see a more flattish earnings curve and then obviously ‘19 and beyond gets better as the new work seasons, I don’t want to put words in your mouth but make sure I have…?

Dave Keffer

Well, you are also a quarter ahead of us in guiding ‘18. So as we come into that, we are expecting revenue growth. We have got the business engine that’s fueling that growth. And as I have said several times, as we start to see sequential growth quarter-to-quarter, that’s the beginning of the change in the curve. We have got relatively fixed cost and we continue to work to improve a lot of those. But when you see interest amortization come down as a percentage of growing revenue that will help us and we will also, I think – I talked to the great work done by Dave and the team to turn our balance sheet into a real lever to give us certain advantages and we will be able, I think to take down share count through opportunistic buybacks as we strengthen that balance sheet.

Gautam Khanna

Thank you. That’s helpful. And then could you guys refresh us on some of the other outstanding re-competes in the near-term and did you win or retain all of your re-competes in the December quarter, if you could just give us a refresh on what we should be looking out for, besides Greenway, of course?

Stuart Davis

Sure Gautam, this is Stuart. Obviously, the two big ones that are out there are Greenway, but also I have mentioned the TSA ITIP growing to impact procurement, so that’s again a 3% kind of revenue contract. That should be early in our fiscal year ‘18 where we will hear about that. This is in adjudication right now. And again, we think we are delivering great value and great proposal, but we will have to see that plays out. I wouldn’t say that there are any other – anything nearly of that size that’s out there, specifically to your question around re-competes, I mean the re-compete rates in the third quarter themselves were a little depressed, but that’s actually STRATCOM came in. We have been a little bit below our target for this year, but in the kind of 75%-ish range as opposed to the 85%-ish range.

Gautam Khanna

Okay. And my understanding is there was a large NASA consolidation, is that one of the contracts you are incumbent on, is that meaningful?

Stuart Davis

Not a meaningful driver of any of the results or guidance we have provided today, Gautam.

Gautam Khanna

Okay. Last question for you, Dave, sorry to take up all this time, EACs in the quarter and if you could give us what the underlying gross profit dollar level was because I know there were some items that ran through, the cost of sales this quarter, so what sort of the clean cost of sales and gross profit number and what were the EACs?

Dave Keffer

Sure. The net EAC pickup was $5 million in the quarter, roughly in line with the average of the first two quarters, Gautam. Those are tough to project looking forward in any given quarter, but that’s been fairly consistent with the year-to-date trend line. In terms of the cost of services, SG&A breakdown, you are right. This is a tricky quarter to parse out all of the non-GAAP items, particularly the pension mark to market gain. But I think you should notionally think of our SG&A as a percentage of our revenue running between 3.5% and 4% on a kind of run rate adjusted basis and that you can back into our cost of services, depending on how you want to calculate it from there.

Gautam Khanna

Okay. I guess just to be very specific about it though, so with SG&A on an underlying basis around $45 million in the quarter to get to the $0.48, I am just having a hard time following the adjustments here and then gross profit dollars on a reported level, but...?

Dave Keffer

We haven’t presented it in exactly that fashion, either in the Q or the press release as well, but you are notionally in the right ballpark with those figures Gautam.

Gautam Khanna

Okay, thank you.

Dave Keffer

You bet.

Operator

Our next questioner today is Amit Singh with Jefferies. Please go ahead.

Amit Singh

Hi guys. Thank you for taking my question. Now with just two months left for the year to finish, could you tell us like what is driving this range in the top line guidance? Do you guys still need to win some business to reach the bottom end of this updated top line guidance?

Dave Keffer

No, there is no new business required to get to that bottom end. In any given quarter for us, you have contract specific requirements, material buys on certain contracts or contracts ramping up or down in a given quarter where a few million here or there across over a thousand contracts can really add up to a meaningful range of possibilities and that’s why we will never be ultra-specific down to a $5 million or $10 million range or anything like that. We have narrowed it meaningfully from our original guidance range down to a $50 million range in Q4 and I think that’s a reasonable approach at this point in the year.

Amit Singh

Alright. And just for the EPS guidance, I mean, if you look at the midpoint of your top line and adjusted EBITDA guidance, the midpoints are brought down for both of those with the midpoint of EPS guidance was raised, so to speak. So anything change in your tax rate and share count expectation since last quarter?

Larry Prior

I mean think of it as a narrowing of earlier ranges. We were trending toward the high end of the EPS range over the last couple of quarters, trending lower on EBITDA, given that as the year has progressed, the tax rate has been better and share count and interests have been improved by our deployments of cash. And so this is just the results of the trends we have seen over the first several quarters. EBITDA on a volume basis has come down in line with revenue given that our margin has been, as we projected, in the low 17s for the year-to-date. And EPS, certainly, we are pleased that it’s toward the high-end of the original guidance. And if you adjust the $0.02 of non-cash pension reduction from the original guidance to the re-measured level that we mentioned on the call today, it’s even $0.02 better on an apples-to-apples basis compared with the original guidance.

Amit Singh

Right. And just one last one quickly, how many employees net-net were hired in the quarter?

Larry Prior

Yes, there was not a significant change in headcount in the quarter on a net basis.

Amit Singh

Alright. Thank you very much.

Operator

Our next questioner today is Frank Atkins with SunTrust. Please go ahead.

Frank Atkins

Thank you for taking my questions. I want to see if I could get any color, you have been putting up some strong bookings on bookings by segment. Any trends among the two segments that you see?

Larry Prior

No. It’s pretty consistent across the businesses and you will get a swing quarter-to-quarter where they will bring in like defense did with the C4ISR work, but we have been favorably impressed by both the qualified pipeline and how consistent it is across the segments as well as the energy they are putting into new submits as well as the wins. So, it’s been fairly broadly distributed across the company, so it was a pleasant surprise this year.

Frank Atkins

Okay, that’s helpful. And then you announced a few cloud relationship, I guess, incremental news on those. Can you talk a little bit about how cloud is impacting your business and what demand and what you are hearing from clients on that front?

Larry Prior

So I mean, first, in both releases, it just shows how deeper we are going. Internally, we are moving the majority of all of our own company workloads to the cloud where we have got just a ton of compute and storage on the Amazon cloud. And as we look at our own 365 with Microsoft, we are going to move that to the Azure environment. So we think as a company committed to next-gen IT, you have got to walk the talk and all of your workload ought to be in the cloud. We love working with Amazon. We love working with Microsoft Azure. And we think you couple that with our own private cloud capability, it’s a nice troika that gives any government customer really good choices. We are seeing greater adoption. I have mentioned what Paul, Batsakis and the healthcare, civil guys have been doing in their arena. Now you have got to really obsess on the security around it. So the authority to operate the parameters and the understanding of where is your data at rest, how do you touch it and how do you make sure that all the cyber professionals are as comfortable with their infrastructure as the folks who are advocates for better performance. So I think you are seeing greater adoption, but with the caveat that you have got to obsess and really pay attention to the security professionals as you do it.

Frank Atkins

Thank you very much.

Operator

[Operator Instructions] Our next questioner today is Brian Ruttenbur with Drexel Hamilton. Please go ahead.

Brian Ruttenbur

Yes, thank you very much. I just want to understand a couple of things. First of all, on revenue, the lower guidance is because of slow startups in the new administration. Just want to make sure that that was the reason for the lower? And then on the EBITDA side, the lowering was partially due to pension and what else, because pension only accounts for about $4 million. So if you could answer those two real quick?

Larry Prior

Yes, I will take the first part and then hand it to Dave. So yes, the slow starts were the main reason for where we are with the revenue guide. Those slow starts would have happened in any administration. Now, there was some minor noise around a couple of our programs as you think of the first weeks of this administration. Most of those have self corrected. So I think you are going to see in this fourth quarter kind of that normal 8-year change of leadership as you change parties in the executive branch and a slow uptick when you think of nominations. But for us, really, the substantive aspect of the revenue was OPM didn’t go as fast as we wanted, C4ISR didn’t and they are both doing great now. And we think as we go into fourth quarter, first quarter, they will ramp with all of the expectations that we have had for them.

Dave Keffer

EBITDA is a similar story, largely volume-driven beyond the pension income change that you mentioned. So the revenue being in the range of the low end of our prior guidance brings EBITDA into the same range given that our margins have been coming in where we expected them on a year-to-date basis, so largely volume-driven.

Brian Ruttenbur

Okay. And then two other quick follow-ups. The cash flow for the year, is cash flow going to be weaker and this fourth quarter will be negative?

Dave Keffer

Our guidance implies positive cash flow, free cash flow performance in the fourth quarter, and so that’s what we are anticipating. Certainly, we had an outstanding third quarter for free cash flow and wouldn’t project that level to be maintained going forward, but we have got good momentum in the invoicing and collections process, good working capital management discipline and we anticipate continuing that going forward.

Brian Ruttenbur

Okay. And then last question on Groundbreaker, you mentioned the TSA is going to be early fiscal ‘18 decision as in the first or second quarter of ‘18. Groundbreaker is going to be when will be the decision?

Larry Prior

We were first surmising that it be August or September of this summer. It may delay just due to the immense complexity of it, but sometime around summer or fall.

Brian Ruttenbur

Okay, thank you very much.

Larry Prior

William, it looks like we no longer have anybody in the queue, so I would like to bring the call to a close. Thank you for your help on today’s call and obviously thank everybody for their interest. Larry and I are going to be hitting the road. We will be at the Cowen Conference on Thursday and we look forward to talking to as many of you as we can. That concludes our call.

Operator

The conference has now concluded. Thank you all for attending today’s presentation. You may now disconnect your lines.

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