David L. Dragics - Former Senior Vice President of Investor Relations Kenneth Asbury - Chief Executive Officer, President, Director and Member of Executive Committee Thomas A. Mutryn - Chief Financial Officer, Executive Vice President and Treasurer John S. Mengucci - Chief Operating Officer and President of U.S. Operations.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division Edward S. Caso - Wells Fargo Securities, LLC, Research Division Amit Singh - Jefferies LLC, Research Division Cai Von Rumohr - Cowen and Company, LLC, Research Division Brian Gesuale - Raymond James & Associates, Inc., Research Division.

Ladies and gentlemen, thank you for standing by. Welcome to the CACI International Second Quarter Fiscal Year 2014 Conference Call. Today's call is being recorded.

[Operator Instructions] A special reminder to our media guests who are listening in, please remember that during the question-and-answer portion of this call, we are only taking questions from the analysts. At this time, I would like to turn the conference call over to Dave Dragics, Senior Vice President of Investor Relations for CACI International.

Please go ahead, sir..

Thanks, Janine, and good morning, ladies and gentlemen. I am Dave Dragics, Senior Vice President of Investor Relations of CACI International, and we're very pleased that you're able to participate with us today. And as is our practice, we are providing presentation slides, so let's move to Slide #2.

Now about our written and oral disclosures and commentary. There will be statements in this call that do not address historical fact, and as such, constitute forward-looking statements under current law.

These statements reflect our views as of today and are subject to important factors that could cause our actual results to differ materially from anticipated results.

And factors that could cause our actual results to differ materially from those we anticipate are listed at the bottom of last evening's earnings release and are described in the company's Securities and Exchange Commission filings.

And our Safe Harbor statement is included on this exhibit and should be incorporated as part of any transcript to this call. Now I'd also like to point out that our presentation today will include discussion of non-GAAP financial measures.

And these non-GAAP measures should not be considered in isolation or as a substitute for performance measures prepared in accordance with GAAP. So let's please turn to Slide 3. And to open up our discussion this morning, here's Ken Asbury, President and Chief Executive Officer of CACI International.

Ken?.

winning new business, deliver operational excellence to our customers and use our capital to make investments to improve our long-term performance. Let me start with the first element of our strategy, winning new business in a large addressable market. We continue to optimize our business development capability and like the results that we are seeing.

Our contract awards were significantly higher this quarter than a year ago with 25% of them coming from new business wins. We continue to focus on the government's high-priority missions and bid selectively in that space.

We also began the first of what should be many strategic campaign pursuits for large contracts requiring cross-company collaborations. This is and will be an important part of our business development strategy for growth going forward. The second element of our strategy is driving operational excellence.

Here we continue to invest in credentialing our value delivery systems and enhancing our program management capabilities with the consistent goal of delivering innovation and affordability to our customers. I am proud of the efficient, effective and ethical way we manage our programs has resulted in increased contract awards.

This attests to the fact, especially in these austere times, it matters to the government whom they buy from. The third element of our strategy is deploying capital in support of our future growth. We closed on the acquisition of Six3 Systems in mid-November. And to that point, I'd like to set a strategic context for you. Let me turn to Slide 6.

For the past dozen years, our nation has been involved in conflicts, largely in Southwest Asia, against state and nonstate adversaries, where we and our allies have held overwhelming advantages in training, expertise and technology.

As our involvement in those wars wind down, the focus of our national defense policy and strategy shifts to the vast expanses of Asia and the North Pacific. The potential adversaries in these regions are technologically sophisticated and economically advanced.

For our forces to operate effectively in this antiaccess, area-denial environment, our military must employ new methods to conduct ISR and deliver kinetic and nonkinetic effects against a full spectrum of electronic warfare and cyber environment.

The ability to anticipate, locate, understand, plan for and successfully conduct military operations against war-capable adversaries is paramount to the strategy of the United States. Slide 7, please. Now let me put Six3 into this overarching context. This is exactly what Six3 was built for and where they excel.

Six3 has developed highly-specialized and differentiated capabilities in signal processing, precision geolocation and nontraditional cyber and electronic warfare. Many people see the potential of cyber attacks as the #1 threat to our nation's security.

Today, much of that discussion centers on the ability to defend or disrupt a computer, server or network architecture. CACI has a growing cyber business that addresses this very space.

At the same time, Six3 has been principally focused on another important aspect of cyber, that involving the signals emitted by weapons systems, satellites and airborne platforms. Together, we now cover a full spectrum of cyberspace. Six3 possesses nationally recognized expertise in digital signal processing and analysis.

They have coupled that expertise with communications and cyber engineers to adapt tools and techniques that could identify, characterize and develop countermeasures for a broad and evolving array of adversary weapon systems.

Six3, as part of CACI, will help our customers openly build the capability and capacity to defend against and fight through cyber attacks on U.S. systems while delivering desired effects against potential adversaries. The U.S.

government agencies are increasingly contracting for the unique solutions and services that Six3 developed for the Department of Defense and the intelligence community. As the U.S. and other countries continue to boost their cyber defenses and offensive postures, we believe this market will expand, giving CACI an advantage.

Together, CACI and Six3 will provide our customers with agile and affordable technical products and solutions to counter this dynamic and persistent set of threats. That is what made this acquisition of Six3 so compelling for CACI. With that, let the turn the call over to Tom for some insights into our financials. Over to you, Tom..

Yes. Well, thank you, Kenny, and good morning, everyone. Let's go to Slide #8. From November 15 to the end of the quarter, Six3 generated $49 million in revenue and $2.4 million of net income from their ongoing business during the period which included the Thanksgiving and Christmas holidays.

This was offset by $2.3 million of after-tax intangible amortization and retention expenses. The intangible asset associated with the acquisition is about $164 million, which will be amortized on an accelerated basis over 14 years.

In conjunction with the acquisition, we entered into certain retention agreements with associated GAAP pretax expense in year 1 of $6.7 million and $3.3 million in year 2. We view these agreements as one-time transaction-related expenses.

So one-time transaction after-tax costs in the quarter were $6 million, consisting mainly of banking, rating agency, audit, legal and debt extinguishment expenses. The incremental after-tax interest expense associated with the acquisition for the second quarter was $1.6 million.

We will amortize the cost of the recent financing over the 5-year life of the loan at an after-tax cost of $1.6 million per year, a noncash interest expense. Slide 9, please.

For the quarter, excluding Six3-related revenue, CACI's revenue decreased 9%, was driven primarily by a number of reductions on existing contracts and delays in contracting activity as our customers faced the prospects of the government shutdown, additional longer sequestration and budget uncertainty.

In addition, the government shutdown resulted in a reduction of second quarter revenue of approximately $20 million. Let me note that the IDL and Emergint acquisitions, both of which closed in the second quarter of 2013, contributed about $10 million to $15 million of revenue during this quarter.

Indirect expenses, excluding fringe on direct labor as well as Six3-related transaction and ongoing expenses, were down around $17 million as a result of continued focus on cost efficiencies and the cost-reduction actions taken last year. Reported net income was $35 million for the quarter.

Excluding the ongoing contribution of Six3 and all related one-time and ongoing expenses, net income would have been $43 million, up 8% from last year despite the shutdown and a tougher environment. Net income, excluding Six3 was positively impacted by lower bonus compensation expense and few positive nonrecurring items.

Operating margin excluding Six3 was unusually high at about 9%, driven by seasonally high award fees in the quarter, the lower bonus expense and the positive items I alluded to. In addition, lower-than-anticipated revenue positively impacted the margin in that the denominator was lower.

Operating margins are expected to revert to more normal levels in the second half of the year with operating margins for CACI, excluding Six3, for the full year to be a bit north of last year's margin of 7.4%.

Our diluted share count for the quarter and, as a result, our earnings per share was impacted by additional 1.5 million shares associated with our convertible debt. Let me remind you that 1.1 million diluted shares representing dilution up to a share price of $68.31 will be offset by a bond hedge when the convert comes due in May 2014.

Turn to Slide 10, please. We generated second quarter operating cash flow of $17 million. Days sales outstanding increased from 59 last year to 67 at the end of December. The government shutdown and the move by the government to pay at terms rather earlier than required drove the higher DSO.

We are expecting DSO to remain in the mid-60s for the foreseeable future. On a trailing 12-month basis, free cash flow was $190 million or $7.74 per diluted share. This translates to a free cash flow yield of 9.9% at the share price of $78. With $1.46 billion of total debt, our net debt to pro forma EBITDA leverage ratio is at 3.5x.

Let me turn to the remainder of the year. Slide 11, please. We will be reporting revenue and earnings results for Six3 for each of the next 2 quarters of the fiscal year. As been our practice, our revenue and earnings guidance will be provided at the consolidated CACI International level without specific guidance for certain parts of our business.

With the acquisition of Six3 we expect our revenue for fiscal year '14 to range between $3.65 billion and $3.8 billion with Six3 contributing $275 million to $325 million of revenue. The lower CACI base revenue is a result of reductions and [indiscernible] on existing programs and delays and cancellations of new programs and the government shutdown.

We are maintaining our FY '14 net income guidance of $142 million to $152 million. We expect Six3, excluding the retention expense associated with the acquisition, will generate at least 5% accretion and 10% accretion on an adjusted cash basis for both the second half of our fiscal year and all calendar '14.

And we expect another year of solid cash flow with operating cash flow at approximately $175 million, down from earlier estimates due to the facts that I mentioned earlier. We will be filing an 8-K/A within the next day, which will contain interim and audited Six3 financial statements as well as pro forma financial statements.

With that, let me turn the call over to John..

Thanks, Tom. Let's go to Slide 12, please. I am pleased with our second quarter performance. Operations continues to perform very well and respond with agility for our dynamic market. There are several factor and focus areas that continue to contribute to net income and cash flow.

First, our organization structure is appropriately sized to our business, driving an efficient and agile organization and allowing us to competitively price our offerings. Second, we invest in new technologies and capabilities to drive affordability for our customers through cost-effective delivery, not by sacrificing profit.

Third, the organization is pursuing contracts, which fulfill our customers' enduring core missions, and we do so with a focus on contract type, direct labor and increased solution content. As a trademark of CACI, it is our record of successfully delivering to program commitments within our customers' budgets. Let's go to Slide 13.

A testament to this focus is our strong Q2 awards. We won $717 million of contract awards, which is 40% higher than the same period last year. And almost 25% of those awards came from new business wins.

Our high-volume markets drove approximately 75% of our total awards, coming primarily from more than $300 million of new and recompete task orders on our U.S. Department of Justice Mega 4 IDIQ contracts.

We noted this investigative and litigation support IDIQ win in our first quarter and continue to successfully capture task orders during this current quarter. Overall, we're proud of our Q2 awards as they reflect the cost-effective quality and value we consistently deliver.

We also booked $600 million of funding orders in Q2, which is approximately 4% lower than the same period last year. Funding actions were delayed by the government shutdown, which resulted in contracting officers having less time to issue our incremental funding. This brings our funded backlog to $1.8 billion.

In addition, total backlog is now $7.6 billion, driving an estimated 26 months of total backlog at our current revenue run rate. Let me also note that this backlog does not yet incorporate any contributions from Six3. Please go to Slide 14.

Our fiscal year 2014 revenue guidance in June 2013 consisted of 65% existing business, 25% recompete and 10% new business. I am pleased to report with only 2 quarters behind us, our revenue guidance now consists of 93% existing, 5% recompete and 2% new business.

In addition, with the $600 million of funding orders received in Q2, our existing contract revenue is now 84% funded, consistent with this time last year. This is a direct result of the important missions we serve and the levels of funding those missions continue to receive even in a tough budget environment. Slide 15, please.

Our pending contract awards total approximately $7.3 billion. 75% of those pending awards are for new business for CACI and approximately 30% are in our high-growth market areas. In addition, we plan to submit another $8.5 billion of bids over the next 6 months, reflecting our significant addressable market.

80% of those bids will be for new business and about 30% are in our high-growth market areas. Again, these metrics do not include the contribution of Six3's robust solution-centric pipeline. Our focus on business development remains a priority.

We're confident in our market-driven strategy and committed to support what will continue to be an enduring mission in support of our nation. And I'm excited about the long-term contribution from Six3's mission-focused capabilities. With that, I would like to turn the call back over to Ken..

Thanks, Tom and John, you two, for providing the details. Let's go to Slide 16, please. Our results reflect solid progress on our strategy during the difficult market environment. CACI is committed to providing the essential solutions and services to our customers.

We are also committed to serving our shareholders with a strong, growing, profitable company that outperforms its peers.

To continue building and delivering long-term shareholder value, we will remain focused on optimizing our business development capability, driving operational excellence, integrating Six3 and maximizing its value to the CACI enterprise, delivering solid cash flow and exercising our M&A program to acquire new capabilities and customers.

Let me conclude my remarks by thanking our people for their character, talent, total commitment to our customers. CACI employees continually perform with integrity and excellence, remaining ever-vigilant in support of our customers' core missions while helping to build long-term value for our shareholders.

With that, let's open the call up for questions, Janine..

[Operator Instructions] And our first question will be from Bill Loomis of Stifel..

On Six3, if I look at your revenue contribution for fiscal '14 and look at particularly the upper end and kind of run that out through to calendar '14, I'm getting revenues of roughly $550 million. And it seems a little bit higher than what you would have thought when you announced the acquisition.

Is there anything that's changing in Six3's business that gives you confidence at that upper end?.

Well, listen. Basically, just the entire dialogue, Bill, around where the cyber threat is emerging, we're -- a couple of key points, I think, are worth noting. Last week, we heard the PACOM commander talk about 2 things related to the Asia-Pacific region.

The first was about how the gap in capability between the Chinese and the United States was sort of narrowing a bit from a technology point of view, obviously something of great interest to a business like what I described in my opening comments.

And second was they're beginning to test or they're beginning to feel sort of capabilities that could cause a problem for U.S. operations, particularly naval operations around the development of hypersonic missiles.

And I think yesterday's testimony by the DNI, really kind of bringing forth the idea that cyber is a huge problem for our country, I think underscores the fact that we'll see some growth in Six3 going forward.

Tom, would you like to add anything to that?.

Yes. Bill, a question for you.

The math that you said you're suggesting that Six3 would have $550 million in calendar year '14, was that your number?.

Right. So you're saying that $325 million at the high end less the $49 million they did in the second quarter. And then I doubled that back for the full year..

Sure. At the high end, absolutely, yes. At midpoint, closer to $500 million. And so we gave a range. But clearly at the high end, your arithmetic is correct..

And just one thing on Six3, the revenue breakout by the segments that you have, defense, civil, commercial, can you give us a sense of that for this year, so we know how that's going to split out?.

Well, I can tell you that most of Six3 is in the kind of defense sector. Both the national intelligence agencies, they provide service through our generally classified as defense agencies, as well as the work they do for the Department of Defense, heavily NRO defense agency..

The next question is from Edward Caso of Wells Fargo Securities..

This comment was made that about 80% of your pipeline was for new business. And I was curious if this was in areas that are new to CACI and therefore you have sort of develop the new client and embrace new competitors.

Or is it just new contracts within existing power alleys?.

Ed, this is Ken. The majority of that is going to be in just existing customer sets. We are looking to see where there's whitespace in the marketplace. But the majority of ours are going to be for existing customers that we know and have relationships with today.

We just see if we're in that cycle where there's a lot of new business opportunity in the current customer space..

Great. The other question was the mention about the change in the payment cycle.

What's been the guidance now for operating and free cash flow?.

Yes. For the operating cash flow for the year, approximately $175 million. Free cash flow would be $15 million to $20 million less. The only difference between free cash flow and operating cash flow is capital spending. And that's our normalized run rate for capital spending..

The next question is from Jason Kupferberg of Jefferies..

This is Amit Singh for Jason. If you could just quickly run through the math of the guidance being increased by -- the midpoint of guidance being increased by $125 million but the EPS guidance being reduced by around $0.10. If you could run through the expenses, obviously most of them are one-time that are leading to the EPS guidance decline..

Yes. Clearly, a lot of math elements kind of involved in this particular situation. We have Six3, we have the base business, a lot of kind of moving parts. You mentioned earnings per share. We have additional diluted shares. So I think we all understand why we have additional diluted shares due to the convertible.

So focused on net income, we're keeping net income guidance the same while at the same time kind of reducing our -- or increasing our revenue guidance. I will point out that the guidance by definition is in a range, kind of a relatively broad range for net income and we're not specifying kind of where we are kind of within that range.

CACI base business is generating less revenue for the reasons I articulated. Some of that is due to other direct costs, which come out in a relatively low margin. So that revenue decline is not one-for-one profit decline since greater than half of the majority of the kind of revenue decline is associated with lower -- the other direct costs.

We're doing a good job of controlling indirect expense. That's certainly helping base CACI to perform at what we consider solid levels. And then turning to Six3, we have 2 phenomenon. On an ongoing business, this third and fourth quarter, Six3 is performing in our minds admirably.

In the second quarter, we incurred a variety of one-time expenses associated with the acquisition. Eyes wide open, we knew those expenses were coming when we embarked upon this particular process. And so that is such that for the full year, Six3 contribution is offset either all or largely by these one-time expenses.

And so those are the major building blocks to get to the guidance that we're providing..

All right. Perfect.

And what margins does Six3 generally operate at so that we'll get a sense of going forward after fiscal '14 how to model out the margins for that business?.

Yes. So when we announced the transaction, we spoke about a 14% EBITDA margin for Six3. So an ambient level of EBITDA margins were around 14%. They may fluctuate, come down a little bit given some of the pressures that we're all under. But we expect them to have higher-than-average EBITDA margin.

CACI's EBITDA margins are at 9%, so they're going to be certainly north of our kind of EBITDA margins. Their indirect spending is kind of reasonable. I did point out that they will be incurring additional expenses associated with the retention payments that we spoke about. And so that's going to be a drag to their operating margin as well.

And in addition, intangible amortization expense which will flow through Six3, a noncash item which is impacting the markets. So those are the primary building blocks..

The next question is from Cai Von Rumohr from Cowen and Company..

So that very strong 9% margin, could you comment on that fixed-priced contract, where the revenues and profits kind of don't line up, how big of a plus was that? And how much is left for the second half?.

Yes. Cai, this is Tom again. The fixed-priced contract had a material negative impact on our first quarter. On the second quarter, the profitability of that contract was comparable to where it was in the second quarter of last year. So I did not reference it as a variance or a driver of either increases or decreases to margin.

And for the rest of the year, it's somewhat of either consistent kind of with the rest of our business. It's not kind of large enough and material enough to talk about for the third and fourth quarter..

Right. So per your guidance, if we look at the second half, it looks like the operating margins may be close to the second quarter with Six3 moving to be accretive and CACI standalone kind of down, given the very strong quarter you've had.

But as we look at next year, I would assume if you have kind of normal margins at CACI, we should get a big benefit from Six3 because we don't have the transaction expenses, we have lower retention expenses as a percent of sales. And so we might hope for a more robust uptick in your operating margins.

Does that make sense?.

Yes, absolutely. Six3 is material to cycle acquisition. Their EBITDA margin performance is strong, kind of reflective of the work that they do, kind of mission-critical, highly-specialized, fixed-priced contracts, just performing and doing very important things. And that translates into higher profitability characteristics.

And as we get into 2015, we expect that to have a positive impact on our kind of cash flow and margins and profitability. Absolutely, yes..

And Cai, if I may add, this is Ken. I think up to this point, we've probably seen that our customers have developed their plans for how they're going to live in a sequestered world. And with the budget agreement in place, we may see these customers get a little bit relief. There's obviously some additional money in it.

But more importantly, they get a couple of year planning horizon. And we would expect that '15 would be a better -- it's just going to -- it's setting up to look like a better year..

[Operator Instructions] The next question is from Brian Gesuale of Raymond James..

Maybe a quick one for Tom. And then Ken, I want to follow up with you. Tom, can you talk a little bit about the dollar magnitude of some of those one-time items that helped the quarter? In this quarter, you broke out the $9.7 million as a negative impact from the acquisition.

But could you maybe show us what maybe the positive offset was?.

Yes. The positive offset is kind of in the range of $3 million to $5 million..

Okay, wonderful. And then Ken, a question for you. As you integrate Six3, how do you really maintain the culture, so we don't see what happened with Lockheed when Sanders was acquired? And then I guess, also along those lines, we've seen very few businesses on the services side be able to maintain a 14% EBITDA margin as they grow.

How do you preserve and actually expand those margins as you try to grow that business?.

Yes, so great questions. So let me start with the culture part first. I mean, the one thing we noticed as we went into due diligence was their culture was pretty similar to us. They had a lot of the attributes about being very customer-focused, being very focused around their growth.

Their BD culture was almost identical to ours, which frankly when you started into these conversations, in fact, that part of the conversation we're having today, they're so like ours that we have a tough time discerning between the 2. So we're excited about that playing forward.

But honestly, it really had to do with the quality of the kinds of people that were there, the kinds of dialogue we're able to have. So we didn't see that as being -- as opposed to acquiring somebody like Six3 and putting them into a factory-like environment, where I spent most of my career, very different sort of vibe.

So I'm just trying to compare and contrast that for you, Brian. Next, on the 14% margin, I think there's a couple of things. Let's go back to the kind of the work that they are doing today. Today, largely a big part of their work is very, very unique, obviously very classified, so I kind of skimmed the surface about what their capabilities are.

But that work -- the work that, that -- that those activities are really looking into is expanding at a pretty large rate with regard to the need for it across the U.S. government space. A lot of their work today is so specialized, it comes sole-sourced because there aren't any other sources for it.

I'd expect that to continue just frankly because of the speed at which new capabilities and new solutions are required to be to come up with. Obviously, they -- there's a portion of their business that's a services business like ours.

I think it probably goes through the same pressure cycle that the industry is going through on the professional services side. But frankly, they've been pretty adept over the past several years at growing that business as well.

So I couldn't be more pleased about how -- to have them, so we can fully address the cyber challenges that are going on in the nation and frankly, amongst our allies. So hopefully, that gives you some insight into that, Brian..

I am showing no further questions in the queue and would like to turn the conference back for any further remarks..

Well, Janine, thank you. I thank everybody on the call today for your interest. And I hope everybody has a great day. Thank you. We'll be looking forward to talking to you in the future..

Ladies and gentlemen, thank you for your participation. This does conclude the conference. And you may all disconnect. Everyone have a great day..