Caci International Inc (CACI) Q3 2021 Earnings Call Transcript

Ladies and gentlemen, thank you for standing by. Welcome to the CACI International Third Quarter FY2021 Conference Call. Today's event is being recorded. At this time, I would like to turn the conference over to Dan Leckburg, Senior Vice President of Investor Relations for CACI International. Please go ahead.

Thanks, Aly. And good morning, everyone. I'm Dan Leckburg, Senior Vice President of Investor Relations for CACI, and thank you for joining us this morning. We are providing presentation slides, so let's move to Slide Number 2. There will be statements in this call that do not address historical facts, 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. Those factors are listed at the bottom of last night's press release, and are described in the Company's SEC filings. Our Safe Harbor statement is included on this exhibit and should be incorporated as part of any transcript of this call. I would also like to point out that our presentation will include discussion of non-GAAP financial measures. These should not be considered in isolation or as a substitute for performance measures prepared in accordance with GAAP. Let's turn to Slide 3, please. To open up our discussion this morning, here is John Mengucci, President and Chief Executive Officer of CACI International. John?

Thanks, Dan. And good morning everyone. Thank you for joining us to discuss our third quarter fiscal 2021 results and guidance. With me this morning are Tom Mutryn, our Chief Financial Officer; and Greg Bradford, President of CACI Limited, who is joining us from the UK. Let's turn to Slide 4, please. Turning to our third quarter fiscal 2021 results, we again performed well, delivering strong growth, profitability, and cash flow. We grew revenue by 6%, net income by 49% and earnings per share by 51%, compared to a year ago. We also continued to deliver double-digit growth in technology revenue, a key driver of our margin expansion. In addition to the increasing technology mix and our continued strong operational performance, our profitability again benefited from fixed-price program cost efficiencies in the COVID environment. This drove only about a third of our year-over-year adjusted EBIT margin increase; the rest was core operations. We generated strong cash flow from operations and strong free cash flow. Lastly, we won $1.6 billion of contract awards, representing a book-to-bill of 1.0 times for the quarter and 1.5 times on a trailing 12-month basis. Slide 5, please. As we've discussed before, we are investing ahead of need to ensure we solve our customers' and our nation's most critical priorities. This strategy enables CACI to provide our customers with high-value technology to execute their missions, enhance our competitive differentiation, generate improved profitability, and drive future growth and shareholder value. Broadly speaking, the need for IT modernization and the heightened global threat environment are two key market trends driving our investments, and both play to our core technology strengths.

Thank you, John, and good morning, everyone. Please turn to Slide number 9. Our third quarter was another excellent quarter of growth, accompanied by margin expansion. We generated revenue of $1.6 billion, representing overall growth of 5.9%, inorganic growth of 5.3%. Our technology business grew 12% from a year ago and our operating performance remains strong with both factors contributing to positive adjusted EBITDA margins. Adjusted EBITDA margin of 11.8% for the quarter was more than 200 basis points higher than last year.

Thank you, Tom. Let's go to Slide 15, please. We're very pleased with our third quarter and year-to-date performance. We delivered strong growth, margin expansion, and cash flow. And we deploy capital opportunistically, taking advantage of a disconnect between performance and equity valuation. All of this represents a relentless focus to deliver on our performance commitments and generate long-term shareholder value. Our business is purposely aligned with critical national security and modernization priorities, and we believe our strategy and differentiated technology capabilities will continue to deliver growth, margin expansion, cash, and shareholder value. I'm also immensely proud of our people and their commitment to our customers, our shareholders, and to each other each and every day. They embrace our culture of good character and innovation, which is foundational to our success. It is because of this that CACI was selected for the 10th time as a Fortune magazine World's Most Admired Company. In addition, CACI was selected as a 2021 Top Workplace and Top Technology Company by Energage. CACI is delivering value through growth, margin expansion, robust cash flow, and opportunistic capital deployment, and I continue to be excited about our prospects looking forward. With that, Aly, let's open the call for questions.

Our first question today will come from Robert Spingarn with Credit Suisse.

Hi, good morning.

Good morning, Rob.

We just talked about organic growth, and John I wanted to ask you how you think about on a go-forward basis technology versus expertise organic growth under the new administration based on the little bit of strategic and budget insight that we currently have. Might this cause you to accelerate M&A to supplement that growth? And how does the M&A pipeline look today?

Okay, Rob. Well, first of all, thank you for that question. Let's talk a little bit on a qualitative level about how I see some of those, and I'll try to give a few comments about how we see FY2022 coming as well. Regarding expertise, enterprise and mission is a very well-understood foundational framework for us. As we look at the growth levels of expertise and technology, we do see differentiation there. There is no doubt in our mind, nor has there been doubt over the last three to four years, that expertise, at least on the enterprise side, would continue to face pricing pressures and the level at which you could differentiate there was going to be pretty much muted. I don't want to call enterprise expertise a commodity, but it's really tough, other than price, to be able to differentiate. And as you all very well know, we are a top-line and bottom-line growth company. So, if I look at the budget moving forward, there's a lot of nice work there. There's some good understanding of what's in the $753 billion. I think it gives a nice spending level for our customers to continue investing in critical requirements. I think their stated priorities are very much in our favor. There is a focus on technology field that is at the speed of software, not hardware. And I'm reading portions of it as just as much about bits and bytes as bombs and bullets. So, on the positive side, a strong budget on the technology side and a respectable budget on the expertise side. On the mission expertise side, we have to factor in this administration's commitment to withdraw from Afghanistan by September 11. So, there's a lot of moving windows, and as you would imagine, we are operating to those. I'd also say beyond the potential pullout from Afghanistan, which will still be a very dangerous place, there is a lot of budget and focus on near-peer threats that actually are an anchor to where counterterrorism goes. You asked me about gaps. We are a strategically based company; strategy is where we come from. We're pulling together our FY2022 planning thoughts now. We're about to re-review where we go in our five markets. I feel very comfortable, Rob, around the capabilities and the customer sets that we have today. But if I wanted to double down in any area, it would be, as I mentioned prior, in the mission tech area. Anything related to cyber and data analytics—I like our AI portfolio. I mean, I like it so much that I spent some time during my prepared remarks talking about it. We've got strong enterprise tech credentials, we've got strong agile software credentials; we move more applications to the cloud in the intelligence agency than the next five companies combined. So that's not a pure focus of where we would want to head next if we were to do M&A. I think your last part was around M&A prospects. Yes, there's a reasonable number of properties in the market that are coming to market. We're a highly acquisitive company; we do think that's a strategic differentiator against folks in our sector and outside of it, frankly. But there are some nice properties out there. We continue to look at those—Mike Lewis and his team do an outstanding job. And as I mentioned, talking about capital deployment, M&A is going to be one of our future capital deployment options as we move forward.

Okay. That's very helpful. Just quickly—thank you, John. Quickly for Tom, just this fixed-price contract that you've been recognizing the really strong profit on this year, could you talk a little bit about what that relates to? And does that contract or renewal of it extend into next year? Thank you.

Yes, thanks, Rob. For sensitivity reasons we do not want to signal to the customer that we're getting outsized profitability on a particular piece of work. So, we're going to be somewhat circumspect as we have been. It is a fixed-price contract. We're able to execute in the COVID environment at lower expenses, driving materially higher profitability. As COVID restrictions ease, we expect the customer to revert to a more normal operating tempo with that particular contract. So, we keep stressing the benefit is short-lived. But that is a piece of work we had for a number of years, and we expect to continue that piece of work, albeit most likely at lower profitability levels—still respectable, but lower than the outsized profitability we've been realizing.

Our next question will come from Gavin Parsons with Goldman Sachs.

Hey, good morning.

Good morning, Gavin.

Guys, I wanted to ask you about the pace of growth heading into the fourth quarter and into next year. Obviously, I think adding 5% to the midpoint this year, but there's more than 200 basis points of COVID impact. There's the state tax disruption in the fourth quarter, which I think is what drives the implied slowdown. But how do you think about the pace of growth next year, whether or not you can grow at or above 5% given you'll presumably have a large tailwind from COVID reversing? Thanks.

Yes, Gavin, this is John. Thanks. I'm not sure I'll give you a point estimate for FY2022. But part of your question stated something very well: there's a lot of moving parts here, and Tom and his team have done an outstanding job looking at taxes and other areas of savings. So there's an awful lot of data and numbers here. If I look at FY2021 and how that sets us up for FY2022, we're extremely proud of organic revenue growth performance. A major distinction of our growth is we're delivering margin expansion at the same time. I think we are uniquely differentiated compared with other entities. This growth plus margin expansion accelerates cash flow generation, which to me is extremely important to our strategy and commitment to deliver shareholder value. So tactically, COVID has had an impact on our top-line growth. But I also would note we continue to materially expand margins even facing that headwind. So COVID, to me, is a short-term blip in a long-term growth, margin, cash flow, and shareholder value creation trend. We don't have an exact number we're targeting for next year, Gavin, but what is important is that we continue to grow above our addressable market, and since we laid that strategy on the table, we continue to expand margins at the same time, compounding cash flow, which we're committed to deploy across any number of options to generate the greatest amount of long-term shareholder value. We expect this performance to continue over the long term. So you will probably hear me say that many times. We're highly confident in our ability to continue delivering on our commitments to grow above the addressable market at increasing margins.

Okay, that's helpful. And Tom, just to clarify that the $75 million headwind this year becoming a net $60 million tailwind, does that mean in future years you'll get back $135 million?

That is correct. Yes. And when I say future years, that will be over the next three years: 2022, 2023 and 2024. So, non-linearly, as we provide guidance for FY2022 in August, we'll be more clear on operating cash flow in that particular year. And I will remind you that we also have to repay the deferred payroll tax which we had some benefits from in the last two years associated with the CARES Act.

Okay, perfect. That was the context for my question as well. Then, is there a starting point free cash flow, like the 10.7% ex-COVID EBITDA margin? Is there a starting point normal free cash flow level that we should think of as the base to grow off?

Gavin, a reasonable number would be this year: the $600 million plus the $75 million. We're able to offset the tax, which is $675 million, less $50 million of payroll tax. So I would think roughly $625 million as a good kickoff line.

Okay, thank you very much.

Our next question comes from Cai von Rumohr with Cowen.

Yes. Thank you very much. John, you and your peers have talked over the last couple of quarters about the slowdown, administration changeover, and various issues. Two parts. One, you mentioned OCONUS. Could you just refresh us in terms of what percent of your revenues are OCONUS related? And secondly, could you give us an update: are we starting to see these delays abate or are they continuing? What do you look for in the next couple of quarters?

Yes, Cai, let me cover the OCONUS piece first and then talk a little about COVID. Ten years ago we were talking about how much work we were doing on S3 and how much pass-through war-related work we had, and those were numbers about 13% to 20% of our annual revenue based on efforts that were OCONUS. We have been tracking about 2% of our annual revenue tied to some of those OCONUS measures. So one, that is a large measuring stick that really explains the kind of company we've become versus the kind of company we were. I'll also tell you that we've been rolling out of our OCONUS work for some time. Afghanistan had a high of about 100,000 troops in 2011 and we're down to 2,500. So if I look at the couple of percent of revenue, that's not an overwhelming headwind as we move forward into FY2022. If we look at COVID, this is one that when Tom and I and the rest of the team sat down looking at the rest of FY2021, we really believed we were starting to see signs of things improving. But, in general, facilities have not fully reopened at the level we expected due to densification concerns. We saw the spike at the end of January, we saw another spike around March. So that continues to put pressure on us. Tom mentioned deployed resources remain sidelined. We're unable to travel due to different restrictions. We have to use military transport for some travel, we have to use military deployment processing. All of those things have been greatly slowed. We're at a point where that's an area we don't expect to come back immediately. If you tie in the commitment to withdraw from Afghanistan by September 11, we still see general slowness in taskings, which we've mentioned in the past. COVID impacts both direct and indirect are still here. Looking forward, I firmly believe that as the vaccination program continues to roll out, we're going to see those pressures lessen. I do believe that tasking pressures will begin to lessen because as more of our customers in the functional areas come back to work, that will free those up. In fact, we saw a couple of very nice taskings come out just recently, but we expected those to come out last June and they've just come out now. So I do believe things will pick up, Cai. I think we will see COVID abate. And we are very much looking forward to continuing our record of topline growth at ever-increasing margins.

To what extent does the feel of the slowdown reflect customers being much more cautious in tasking, not just because of COVID, but because of the anticipation of a Democratic administration and a much tighter DoD budget? Now that we're looking at like a 1.7% FY2022 request, they may start to loosen up a little bit. Has that been a factor?

Cai, from where we sit, not really. We're looking at a FY2022 increase of a couple percent. At a very high level, it's a balanced budget. We're the kind of company that benefits from investment in bits and bytes versus bombs and bullets. There is still strong bipartisan support. There is procurement increases for counter-UAS, Army RDT&E funding around cyber and electronic warfare, a lot of IT modernization priorities, network build-outs, and talk around where the military heads with respect to 5G. I believe customers understand where they can spend and where the threats are. The one area we're focused on is the continuing debate around near-peer threats versus counterterrorism. I hope the administration understands that pulling out of Afghanistan does not mean the counterterrorism mission goes away. It's just going to change shape and we'll need ways to maintain situational awareness. These are things we are well equipped to provide with our technology offerings. Overall, I believe the budget covers some of the key areas we want to see covered.

Our next question will come from Seth Seifman with JPMorgan.

Hey, thanks very much. And good morning, everyone.

Good morning, Seth.

When you talk about growing in excess of the market, should we think about that kind of 2% increase in the budget as the underlying market? Or are you looking at a segment of the budget that's faster growing than that?

Answering at a high level: in the FY2022 budget—which you know is not final—if we look at the skinny budget and start to parse it, that's a pretty good assumption for how our FY2022 shapes up. We believe our addressable market will track somewhere close to that number, and that will set the floor for what we're looking at growth-wise for FY2022.

And then as a follow-up, just to put a fine point on it: if OCONUS exposure is down to 2% or so, I assume Afghanistan is only a portion of that. There are troops deployed in different places around the world. So the maximum headwinds we could anticipate from Afghanistan for CACI would probably be in the range of 100 basis points or so?

Yes, the numbers I shared are closer to 2% of our revenue. We have a lot of folks doing a lot of other OCONUS work, which is very different from that number, and that is fully funded with no issues. So I would tell you that roughly 2% of our FY2021 revenue is tied up in the efforts related to what's going on inside Afghanistan. For protection of our own folks, I'm not going to give a finer point on that because I don't want to disclose the number of people we have there and the like, but appreciate the question, Seth.

Thank you very much, guys.

Our next question comes from Joe DeNardi with Stifel.

Hey, gentlemen. This is actually Rob in for Joe. How are you?

Yes, we're doing great. Thanks.

Good. So if I could just sort of ask the M&A question in a different way. Given some of the volatility in the industry over the past several months and the headwinds in the business environment, has that impacted the way you think about capital deployment between M&A versus buybacks? And then just to clarify the strategy, should we now assume more balance between the two going forward versus previously where it was pretty clear it was mostly M&A? Thanks.

Yes, Rob, thank you. There's been a lot of activity in the M&A world and we're always assessing opportunities. I don't pay an awful lot of attention to what everyone else is doing, but as it pertains to capital deployment, when we issued the press release and you heard my prepared remarks, we purposely talked a bit differently about capital deployment. That was intentional: a commitment to continuous evaluation. We consider all capital deployment options: additional repurchases, M&A, internal investments, debt reduction, and other potential uses. The order I mentioned is not meant to prioritize options; they're all on the table. We're in our semi-annual strategic planning sessions now, always looking for capability and customer gaps. I don't want to downplay M&A because it's a differentiator. But I want to signal more balance as the company moves forward. I would look at capital deployment year-over-year rather than quarter-to-quarter. There are attractive properties out there. We'll continually consider our equity valuation. We're at about 2.5 times leverage, Tom, and we have dry powder and will continually drive growth across the enterprise so we're always growing better than our addressable market with increasing margins. Tom, anything to add?

Thank you, Rob. We continue to evaluate continuously, given changing facts and circumstances. The valuation of CACI stock is a key factor—are we attractively priced? We believe we are, hence the accelerated share repurchase (ASR). The acquisition pipeline—John mentioned attractive candidates in the next three, six, to twelve months—influences our thought process, as do debt levels, interest rates, and the like. So it is a real-time continuous evaluation of what makes the most sense. The definition of 'what makes sense' is how we drive long-term value to our shareholders. That is the ultimate decision, and it is a continuous process we take seriously.

Thank you.

Our next question comes from Jon Raviv with Citi.

Hey, good morning, everyone. John, you referenced that this administration is pitching a modestly growing defense budget: a big number, still a very high number, but the big focus seems to be on non-defense. One of the things that has been starved over the last four years is IT modernization, which still requires complex technology solutions like the IRS, for example. Is there any comment or perspective on current and future exposure to other non-defense end markets?

Yes, Jon. As we look at the overall government funding budgets, IT modernization appears to be a priority, and perhaps its time has finally come. I'm very excited about the monies this administration is putting towards IT modernization—not only given continuous cyber attacks, but because of COVID and the need to update systems. COVID taught us we will likely not return to the same facilities for work, and that is emblematic of the broader IT and technology world. We think there are ways to save and improve efficiencies. We have plenty of non-defense customers today: the legal program with Customs and Border Protection, large desktop, systems software and solution support work with DHS. We're always looking at those. When we talk about defense funding and spending, much of our human capital, financial systems, and enterprise technology build-outs, although they may find their way in the defense budget, are large-scale projects built in an agile manner. There's plenty out there for us to continue to grow whether it's in enterprise tech or mission tech.

And one quick follow-up on your European exposure. I know Greg is on the line. Remind us how much of the total corporation is exposed to the UK business and how you see that trending? Any changes in customer behavior, commercial programs, or demand coming out of COVID?

A couple of things. Greg's UK business is about 4% to 5% of overall revenue. Greg faces a UK that is still heavily affected by COVID: many people working from home. Greg and his team have done an outstanding job; revenue is slightly off but profit is very strong. That will change as Greg's cost structure changes. Greg, anything you want to add?

Yes, John. I appreciate the question about the UK. We're a mixed business over here: about 30% government and 70% commercial, and we sell a mixture of technology and enterprise services. Our government business has performed very well over the past 15 months despite COVID, especially our defensive intelligence work. We have been hit a little on the commercial side because we work with retail, shopping centers, restaurants, pubs, and leisure—those industries have been closed for parts of last year. But despite that, revenue is up quarter three versus last year's quarter three; it's up 1%. We have cause for optimism: net income is significantly up—our operations are up 20%—driven by operational performance and COVID-related savings. We have a strong EBITDA margin of almost 20% for quarter three. The UK is starting to open up a little; there's talk that by the end of June it will be pretty much open. We're starting to see many of our commercial clients come back to life, prepare to conduct business more normally, and we're seeing increased orders. We look to finish the year well and see likely potential growth in 2022 on the commercial side and our government business continuing to grow as normal.

Thanks, Greg. To be clear, revenue is a little south of 3% with materially higher levels of profitability. In the last few years we made acquisitions in the UK with some national defense businesses, which gives us access to another market. We're creating connectivity between some of the mission technology products we're developing—counter-UAS, EOIR devices, signal collection devices—and our counterparts in the UK. That is a nice potential market for us to pursue with that technology.

Thanks, John.

Our next question comes from Tobey Sommer with Truist Securities.

Thank you. I was wondering if you could comment on the spending environment and change in administration, and whether that may impact any of the trends you've been seeing in recent years, such as customers at the margin being more willing to look at solutions and other types of contracting that can be advantageous to you from a profitability perspective.

Yes, Tobey. A couple of things. More because of COVID than because of where the budget sits, there's a renewed or expedited interest in talking about technology and how it can be used to solve customer needs without as much labor-intensive expertise being delivered. A few examples: three years ago this July we created our shared service center in Oklahoma City, which saved us $20 million to $30 million annually. That team is saying they can do more if we use tools like RPA. If we use more technology, rewrite some policies, and take some of the personal hand-touch out of transactional and tactical work, AI, data analytics, and machine learning will play a large role. Under budget pressures, the word 'joint' is no longer a bad word; building once and using in many places is a priority. I think we'll see RFPs talk more about technology and less about needing a fixed number of people for a number of years. Over the next three to five years some enterprise expertise RFPs may look more like enterprise tech. The administration shows concern about cyber and bits-and-bytes security; SIGINT and situational awareness are ongoing priorities. Protection against UAS is an expanding threat. There are absolutes that require continued spending and platform investments that may have different spending models, and this administration will have to balance spending across those areas.

Thank you.

Our next question comes from Sheila Kahyaoglu with Jefferies.

Hey, good morning, John and Tom. John, I think you mentioned your technology business was up 12% in the quarter. What was driving that? And on the other side, does that mean the mission businesses were down on the quarter? What's going on there?

Yes. If I look at our technology versus our expertise business, technology was up about 12% and expertise was around flat. Would I be elated if both were up 12%? Absolutely. It was predictable for us years ago to build a strong technology offering because our customers would move in that direction. The old days of pure government services are becoming cloudier. Customers beyond large platforms ask: what do I need to have done and what's the most cost-efficient, agile way to deliver it? You're seeing impacts from things like Customs and Border Patrol's Beagle program, which we won; we had a large ramp-up plan and even through COVID we have achieved phenomenal growth on that program. It's crucial to administration priorities. Programs like Mastodon and LGS are involved; Mastodon on the mission tech side came in as a small business and has positioned us well by providing hardware that allows us to deliver software-definable devices. In the future, I think that trend will continue. It doesn't mean expertise is bad business; we have phenomenal people doing phenomenal work. But we're a top- and bottom-line growth company, and as expertise starts to face more pricing pressure, that's not where we're going to focus as much.

Okay, that helps. Tom, in your remarks you mentioned EBIT improvement, and you referenced 120 basis points of core profit improvement. How much of that is sustainable as we enter FY2022? Is some of that COVID-related? Could you clarify?

Sure, Sheila. There is some COVID impact in that 120 basis points. I referenced medical expense, travel expense, and the like; I do not have that fully quantified, but there is some of that in those numbers. Another point is that technology margin performance is typically 300 to 500 basis points higher than expertise. By growing technology faster, that will be productive to margin performance. The fact that it has higher margins is not surprising: differentiated skills, solutions, more fixed-price work all contribute. I did point out in prepared remarks that looking forward, 10.7% is a good estimate for a clean, unadjusted margin in FY2021.

Well, thank you very much.

Thanks, Sheila.

Our next question comes from David Strauss with Barclays.

Thanks. Good morning.

Good morning, David.

Based on what you see in recent bookings and what's in your pipeline, how do you think your mix shift will trend going forward between tech and expertise? This quarter you were about 51% tech versus 47%–48% previously. How does that mix shift based on what you see in your book of business?

David, thanks. Based on awards to be made in the near term and the bids we've submitted and recently won, the tech versus expertise mix is likely to continue to favor tech. Some of the taskings that had been held up through COVID showed up in mission tech that we've been waiting for a long time. If that's any indication and using the government's skinny budget, I would expect tech to grow faster than expertise, which should give investors comfort as technology has higher margins and contributes meaningfully to bottom-line growth.

Following up, should we think about your tech portfolio as being more exposed to modernization budgets versus O&M? At a high level of your revenue base, how much is exposed to O&M versus modernization?

It's a pretty even split. We've been successful at using O&M to do modernization through sustainment; that allows us to do system upgrades, wholesale changes, taking dated boxes out of platforms and inserting ours. Those are O&M dollars rather than pure RDT&E. We're well positioned because we invest ahead—we own IP and can provide catalog items that customers can buy with O&M dollars instead of just RDT&E. That flexibility benefits our business.

Thanks.

Our next question comes from Josh Sullivan with The Benchmark Company.

Good morning.

Good morning, Josh.

Following up on the commoditization of the expertise side and the focus on technology: can you talk about the development risk profile of that longer-term transition? Where do you see risks and how do you mitigate them? Tom mentioned the tech margin uplift of 300 to 500 basis points—does that include potential overruns or other hurdles with technology development?

Excellent question. We think in a risk-reward model, which is why we created our two-by-two framework. We want high-quality revenue and quality of earnings year over year. Given our capabilities and customer sets, it's possible to bid less and win more, by focusing on 'sweet spots.' Delivering expertise involves lower risk: the primary risk is finding and retaining the individuals the customer wants, and that market can be price-sensitive. With technology, there is higher development risk: more labs, development programs, and engineering effort. We've invested heavily in our development environment, hiring talent from top engineering schools and focusing on retention. We also are disciplined in how we structure fixed-price engagements; we have strong conviction in our ability to deliver and manage EACs and booking rates. So yes, tech has higher risk, but we are well positioned to manage it.

Got it. Thank you.

Our next question comes from Mariana Perez Mora with Bank of America.

Good morning.

Good morning, Mariana.

After a year of working under this COVID-19 normal, according to your ongoing discussions with customers, what kind of headwinds are expected to abate and which are here to stay for longer—say two to three years? How should we think about that as COVID and vaccinations proceed and the environment normalizes?

If I look forward, COVID is a horrific generational pandemic, but there will come a day when we are out of it. Some things will be permanent changes and tailwinds for what we do: IT modernization, network security, and how we build networks. I expect we can do more software development in a distributed manner, which relieves pressure on government facilities and our facilities. How we come back to work will be a tailwind. Some changes will take one to three years. Some headwinds will persist until redensification is safe: labs and operations centers need more than just shift work to be safe. Overall, I'm more positive than negative. Budgets around cyber and protection will continue to increase as attack surfaces grow with distributed work. So I'm optimistic because budgets will support doing things differently, which means growth for us.

Thank you. Could you give more color on the lower order processing related to specific agencies? Is it related to technology versus expertise contracts or ramping contracts? What do we need to see for that to normalize?

On deployment orders: when we deploy folks overseas, they must be processed through government facilities and policies. When processing centers handled 100–200 people a day but are down to 10–20 people a week, that's effectively a near shutdown. Military transport availability is limited, so deployment is slower. If processing centers loosen up, you'll see revenue pick up. As it pertains to Afghanistan, it's about 2% of our annual revenue under careful watch as we get into the first and second quarters of FY2022. We operate in 60 to 80 countries prosecuting military operations globally, so these processing constraints materially impact deployment and timing.

Our next question will come from Matt Sharpe with Morgan Stanley.

Hey, good morning, gentlemen.

Good morning, Matt.

I hate to beat this to death, but I want to touch on margins heading into Q4. If I back out the $16 million headwind, it looks like implied margin is around 10%, stepping down about 150 basis points from the first three quarters. Is that reversal the result of COVID benefit reversal or is there anything else causing the sequential decrease?

Matt, I'll take that. When we look at margins, we guide to a full year; any particular quarter may be higher or lower due to fluctuations. As you point out, a state tax impact changes our fourth-quarter EBITDA margin by about 100 basis points. In addition, we expect higher medical expenses, which had been depressed during COVID and appear to be returning to more normalized levels. We also have product sales that are lumpy and high margin and can affect quarter-to-quarter results. There are other expenses we expect to realize in the fourth quarter—a $1 million here, $2 million there—that add up and are primary drivers of the sequential margin decline. There's no one singular cause beyond those factors.

Okay, got it. Thanks, Tom. And John, real quick with the President's skinny budget and the administration's priorities, any update to the view on expertise and technology market growth? The last time you updated, it looked like 1% and 3% respectively, with a composite around 2%.

Matt, when we look at the skinny budget today, we're looking at about a 2% increase and we see our addressable market pegging out around that 2% number. We're in the middle of strategic planning, but roughly 2% feels like the right addressable market growth as of end of April.

This concludes our question-and-answer session. I would like to turn the call back over to John Mengucci for any closing remarks.

Okay. Well, thanks, Aly. And thank you for your help on today's call. We'd like to thank everyone who dialed in or listened to our webcast for their participation. We know many of you will have follow-up questions. Tom Mutryn, Dan Leckburg, and George Price are available after today's call. Please stay healthy, and all my best to you and your families. This concludes our call. Thank you, and have a great day.

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