Mountainous Investment Transforms Enterprise Management Software Vendor

Event Summary

To say that the last several years were "interesting" times for doing business would be a huge understatement for Deltek Systems, Inc. And while it intends to stay true to its roots, the period ahead promises to be equally fascinating. Lately, owing to new ownership and leadership, there has been a sense of a new era at the privately held, Herndon, Virginia (US)-based principal provider of enterprise software and solutions for project-focused organizations.

Part One of the series Mountainous Investment Transforms Enterprise Management Software Vendor.

After over two decades of stewardship and funding by its owners and founders, the deLaski father and son team, in mid-2005 Deltek announced that New Mountain Partners II, L.P. (sponsored and managed by New Mountain Capital LLC, a private equity firm based in New York) would make a majority capital investment in the company. Under the terms of the investment agreement, New Mountain would purchase 75 percent of Deltek's shares, while the deLaski family and management shareholders would continue to own 25 percent. New Mountain Partners II, L.P. is New Mountain's second fund, with $1.55 billion (USD) in committed capital; Deltek was New Mountain's second investment in this new fund. Interestingly, the Deltek move was the equity firm's third investment in a Virginia-based company: in 2001, the firm made an investment in Strayer Education Inc. (NASD: STRA), followed in 2003 by a majority control investment of Chantilly, Virginia (US)-based Apptis. New Mountain claims to invest for long-term capital appreciation through direct investment in growth equity transactions, leveraged acquisitions, and management buyouts. To that end, it focuses on niche, cash-flow-rich opportunities, as with other past investments such as Overland Solutions and National Medical Health Card Systems.

There have been no major changes in operations at Deltek as a result of the investment by New Mountain, nor there have been any staff reductions. Ken deLaski initially continued as Deltek's chair and chief executive officer (CEO), and was joined on the board of directors by New Mountain managing directors Alok Singh and Michael Ajouz, as well as Steven Klinsky, New Mountain's founder and CEO (who had previously co-founded Goldman Sachs & Co. Leveraged Buyout Group, and served as senior partner at Forstmann Little & Co.). Additional outside board appointees were to be named during the several months following the investment.

Soon after, in June 2005, Deltek named Kevin T. Parker as the company's new CEO. According to Deltek, the appointment was made to bring "a new level of expertise to accelerate the company's future growth and success" in the enterprise resource planning (ERP) marketplace. Ken deLaski, who co-founded Deltek in 1983, and who was CEO from 1996 until 2005, remained on as Deltek's chairman until May 2006, when he retired from the board of directors. Today, Parker serves as chairman.

As for Parker's history, he was appointed senior vice president (SVP) and chief financial officer (CFO) of PeopleSoft in 2000. Beginning in 2004, he was co-president and CFO, until the company's acquisition by Oracle later that year. He had led efforts to increase PeopleSoft's operating margin, and was actively involved in all facets of the business, including directing all shareholder communication and activity during Oracle's eighteen-month hostile tender offer. The architect and driving force behind PeopleSoft's innovative and protective Customer Assurance Plan (CAP), he also orchestrated PeopleSoft's strategic acquisition of JD Edwards in 2003, which added 7,000 new customers and 6,000 new employees, making PeopleSoft the world's second-largest enterprise software company at the time. Prior to joining PeopleSoft, Parker had held senior executive positions with Aspect Communications, a provider of contact center solutions and services, and Fujitsu Computer Products of America, a provider of data storage and imaging solutions.

Since its foundation, Deltek had been run as a successful business (albeit sometimes regarded as a family-run or "lifestyle" business). But in 2005 it decided that the time had come to embark on the next level of growth. To that end, Parker's business philosophies—high levels of customer service, technology leadership, and employee teamwork—are in tune with its core values. But the idea behind the new recapitalization and new management was to address many drawbacks that came from the company's traditionally lower profile. Already a recognized ERP leader for North American project-based businesses, Deltek is now looking to strengthen its global position in its target vertical in both the large enterprise and small and medium business (SMB) markets.

Nurturing What Works

Indeed, what has not changed much is the fact that Deltek remains a company with project DNA strands pervading all its products (either developed in-house, or acquired and maintained) and corporate culture, which has been helping it in terms of focus, and in terms of fending off generic enterprise applications providers (in spite of their typically larger size, higher global profiles, and market clout). In other words, having designed all its products with project ID/No. as the key field in all system database tables (as opposed to the order ID/No., account ID/No., or item ID/No. of traditional generic ERP systems), Deltek is a natural fit for several project-based market segments. Moreover, large generic ERP systems typically require serious customization and retrofitting to achieve the required functionality. Possibly less known and expected is also the fact that scalability is also what enables Deltek to compete successfully, even against the likes of Oracle and SAP, in larger deals, such as with organizations with 60,000 employees (the vendor is glad to demonstrate load test results upon inquiry).

Most ERP systems have been tailored for businesses handling physical products. In order to follow well-defined, often high-volume and repetitive production cycles and traditional supply chain management (SCM) principles, these systems typically do not have to (and thus cannot) provide an estimate of completion for accounting (in other words, there is no interim snapshot basis for revenue recognition, job costing, cost allocation, and so on). The same holds true for shipping processes, which typically do not allow a percentage of completion, and cannot be ongoing and specific; they are rather binary (either the process is completed, or it isn't). Conversely, project-based businesses have to follow project lifecycles varying in length and complexity, and have to rely on a snapshot "estimate to complete" value for job costing, revenue recognition, and cost allocation. In a manner of speaking, project business is SCM "for people" (in terms of scheduling and resource management); the same "inventory" can be shared across multiple projects and processes. Customer relationship management (CRM) can also be viewed in this way, since project-based CRM solutions do not focus on call centers but rather on pipeline generation and opportunity and lead tracking.

Project-oriented organizations require the ability to perform many other project-specific business and accounting tasks, including tracking costs and profitability on a project-by-project basis; providing timely project information to managers and customers; and submitting accurate and detailed bills or invoices, often in compliance with complex industry-specific and regulatory requirements. Many project-oriented organizations provide products and services under government contracts, and project accounting for these organizations often requires the use of sophisticated methodologies for allocating and computing project costs and revenues. There are many different types of contracts used by government contractors (such as cost-plus, fixed price, time-and-material, and so on), and within each of those there are dozens of variations or more; each variation drives its own type of billing, revenue recognition, and requirements for reporting back to the customer. For more information, see Project-oriented Software: Many Choices, Many Differences.

For over twenty years, Deltek has been a recognized leader in providing systems (and built-in controls) for firms that do business with the US federal government. Its solutions provide capabilities that enable customers to maintain their accounting records in a manner approved by the Defense Contract Audit Agency (DCAA) and other governmental oversight sets of rules such as federal accounting regulations (FAR) and cost account standards (CAS). The US government requires its contractors to collect and allocate cost in certain ways. For example, according to DCAA rules, labor costs must be recorded daily. Also, a contractor is required to keep track of several contracts simultaneously, meet the rules for different types of contracts, and be consistent in accounting for a number of indirect costs. Thus, of 11,000 Deltek customers, over 2,100 are federal contractors, and they account for more than half of the vendors' revenue. The remaining customers are from the commercial sector, which Deltek started to target quite a bit later in its existence.

With the new US emphasis on improving homeland security and on expanding anti-terrorism operations around the world, many of these firms have already experienced and will likely experience significantly greater demand for their services, along with rapid growth over the next several years. Due to an expected increase in defense and national security spending, US federal government contract spending and activity are also expected to increase in the next several years, but this will come at some additional costs for aspiring contractors. The government has increasingly been issuing cost-reimbursable contracts, which usually triggers dreaded DCAA audits (this is usually not the case with fixed-cost or time-and-material based contracts). While the government might be a generous customer, it is most certainly a demanding one, and its auditors insist on transparency and audit trails, so that they can trace a transaction from a source document (like a timesheet or an invoice from an end-supplier) all the way through to billing to the government. Aside from the fact that contractors have to supply a pile of documents about their business operations to customer agencies, government pre-award and post-award audits also cover a wide range of particular business practices, such as price checks and billing, use of subcontractors, time-sheet verifications, contract scope checks, financial statements, executive compensation reviews, compliance with the US Department of Labor's Trade Adjustment Assistance (TAA) program, and payment of industrial funding fees for US General Services Administration (GSA) schedule sales.

Here's an example of how a tight vertical fit works compared to generic solutions: In aerospace and defense (A&D) project manufacturing, there is a requirement for automated collection of detailed cost information for standard National Aeronautics and Space Administration (NASA) monthly and quarterly contractor financial management reports (NASA 533M and 533Q). While generic accounting solutions would require manual compilation and reporting, or custom programming, the flagship Deltek Costpoint industry-specific solution comes up with native support for these complex NASA reporting requirements. Likewise, in government contracting, the value-added general and administrative (G&A) allocation requirement is often fulfilled by generic solutions via pesky and dangerously insecure spreadsheets and manual inputs of calculations (with no audit trail or centralized control), whereas Deltek Costpoint and Deltek GCS Premier feature configurable allocation options that are automated in the job cost process, and that are highly integrated across financial and project reporting. For more information, see Project-Oriented Versus Generic GL-Oriented ERP/Accounting Systems.

To use a medical analogy, Deltek can call itself a specialist, whereas most other solutions are general practitioners. For general accounting or ERP products— numerous as they are—to emulate Deltek's out-of-the-box functionality, it usually takes an enormous amount of customization. Specialized project-oriented products provide compliance-ready solutions, and less time and money spent on implementation should equal better value. Thus, Deltek clients typically talk about a reasonably low total cost of ownership (TCO), high return on investment (ROI), and ease of deployment (EOD). To meet these specific project-based needs, Deltek has built its products from the ground up since day one, starting with DCAA compliance. To meet these stringent government contract requirements, in 1985 Deltek introduced its former flagship DOS- and Cobol-based product, System1, which was one of the first government contracting solutions (GCS). Deltek next released GCS Premier in February 2000 as the successor to System1, delivering a Microsoft Windows-based accounting solution designed for small-to-medium government contractors. Deltek's founders managed the company with great success by also expanding client focus into the commercial sector during the late 1980s. In 1991, Deltek reached its thousandth customer on System1, at which time its revenue was about $15 million (USD), and the company began to configure its software for larger customers.

To that end, in 1995, Deltek released Costpoint, a more comprehensive ERP application for large or complex firms. This application took advantage of the previous ten years of project accounting experience. Also in 1995, Deltek released ET Enterprise (now named Deltek Time Collection), an automated timekeeping and collection system. By the time Kenneth deLaski took over as CEO in 1996, Deltek's revenue had grown to more than $30 million (USD), and the company had more than 300 employees. For more information on the company's genesis, see Deltek Remains the Master of Its Selected Few Domains.

Furthermore, the company's profitability (with over twenty consecutive profitable years) and growth (except for a flat period from 2002 to 2003, which spared hardly any player) remain untarnished. Deltek started as a supplier of accounting systems to the federal government suppliers and contractors, but has evolved into a specialist provider of project-based back- and front-office systems, primarily to such sectors as architectural, engineering, and construction (A/E/C) industries; professional services firms; government contractors; project manufacturers; and program-based non-profit organizations. Fueled by new product introductions, ERP market consolidation, and federal spending growth, in 2004 Deltek's software bookings grew by 23 percent, with over 500 new customers, and total revenues of $123 million (USD). Early in 2006, Deltek announced record-breaking total revenues exceeding $150 million (USD) for its fiscal and calendar year 2005, which was a 25 percent increase over the year before. License and professional services revenues both recorded increases in excess of 25 percent when compared to 2004, and this was the second consecutive year that Deltek's growth had exceeded 20 percent. In the next part of this series, we'll take a look at how some key acquisitions have given even more cause for optimism.