Caci International Inc /De/ Q4 FY2022 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the CACI International Fiscal 2022 Fourth Quarter and Full Year Earnings and Fiscal 2023 Guidance Call. Today's call is being recorded. At this time, all lines are in a listen-only mode. Later, we will announce the opportunity to ask questions and instructions will be given at that time. At this time, I would like to turn the conference call over to Dan Leckburg, Senior Vice President of Investor Relations for CACI International. Please, go ahead, sir.

Well, thank you and good morning, everyone. I'm Dan Leckburg, Senior Vice President of Investor Relations for CACI International. Thank you for joining us this morning. We are providing presentation slides, so let's move to slide number two. 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 three please. To open our discussion this morning, here's 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 fourth quarter and fiscal year 2022 results, as well as our fiscal 2023 guidance. With me this morning is Tom Mutryn, our Chief Financial Officer. Slide four, please. In July, CACI celebrated our 60th year of business. I'd like to start this morning's call with a quick moment of reflection on this milestone. Back in 1962, our two founders started CACI with modest means, a park bench and a telephone booth for an office. What they lacked in resources, they made up for in ingenuity, confidence and shared tenacity. That spirit survives today and is foundational to our culture. Today we generate more than $6 billion of revenue and support some of the most critical missions that keep our nation and the world safe. Our founders would be astonished and proud of what CACI has become, especially the positive impact we've had on countless customers, employees, families, communities and shareholders over the last six decades. We are all truly honored to carry on this legacy started over 60 years ago. So on to our results. Slide five please. Last night, we released our fourth quarter and full year results for fiscal year 2022. Our results were in line with our expectations. For the full year, we delivered revenue growth of 3%, adjusted EBITDA margins of 10.3% and strong free cash flow of nearly $700 million. And we also won $7.1 billion of contract awards, of which nearly 60% is new business to CACI. That represents a 1.1 times book-to-bill for the year with a good mix of recompete wins to support our base and new awards to drive future growth. Slide six, please. Turning to the external environment. As we look out over the next several years, prospects are positive. Demand is strong and there continues to be bipartisan support for national security priorities. A favorable government fiscal year 2023 budget is currently moving through Congress, with higher spending in Defense, the Intelligence Community and Homeland Security and in particular in key addressable areas, like Digital Solutions, Enterprise IT and C4ISR, cyber and space. This strong backdrop gives us confidence in our ability to drive long-term growth and margin expansion, robust cash flow and additional shareholder value. Slide seven, please. We continue to invest ahead of need in differentiated expertise and technology to address key priorities that will drive long-term customer demand and spending. Let me give you some examples. Within digital solutions, we are modernizing applications and consolidating disparate systems across the federal government to drive efficiency, improve data accessibility and enhance cybersecurity posture. As an industry leader in practical software development and scale, including executing two of the federal government's largest Agile programs, we are seeing increasing customer interest and pipeline opportunities to leverage Agile software development, DevSecOps and open architectures to enable digital application modernization. Enterprise IT, network modernization is the key trend. Agencies need to improve cyber defense, support an increasingly dispersed workforce and consolidate and modernize legacy networks for efficiency. In addition, real-time multi-domain integrated data and communications won't be available for efforts like JADC2 without modern network infrastructure. To address these challenges, we bring deep capabilities from past performance. And we are making investments in new technologies, like Commercial Solutions for Classified or CSfC to enable access to classified networks from commercial devices from anywhere in the world. Broad modernization of both digital solutions and enterprise IT across the federal government will drive healthy spending for the foreseeable future and is an area CACI is well positioned in, with both capabilities and past performance. Turning to C4ISR and cyber. The electromagnetic spectrum remains critical for intelligence collection and modern warfare. For more than a decade, we have invested to address critical priorities in the electromagnetic spectrum including signals intelligence, electronic warfare, counter-UAS and secured communications. For example, we provide software-defined capabilities to detect state-of-the-art uses by our adversaries, determine the location and degrade those uses as well as protect our own use of the spectrum. In the context of the global threat environment and near-peer adversaries, these are even more critical and are gaining traction with customers recognizing the necessity. Lastly, in the increasingly important space domain, we are leaning forward to position CACI in areas where we see the opportunity for a decade-long technology-driven growth. In photonics, we're very excited about our continued progress in optical communications in both the higher-volume LEO market and the more bespoke GEO and interplanetary markets. Our photonics capabilities have been successfully demonstrated in space, not just in the lab, and continue to generate interest and opportunities for government customers and space platform providers. In fact, we recently made our first production delivery of optical communication systems to one of our OEM partners. We also remain on track to put an upgradable, software-defined Assured Precision Navigation and Timing, or APNT, payload into low earth orbit early next year. This payload will demonstrate a unique technology, qualify its capabilities in space, and provide an alternative to the existing vulnerable GPS systems, a vulnerability that needs to be addressed. Slide 8 please. As you all know a number of years ago, we embarked on a purposeful strategy to create a different company within our market. We made significant investments in both expertise and technology to drive differentiation and value for our customers and ultimately increase the quality of our revenue. As we stand here today, our EBITDA margins are more than 200 basis points higher than they were earlier in this journey. We delivered sustained durable long-term margin expansion over those years. And even with the success, we remain committed to continued long-term margin expansion. Revenue growth plus margin expansion compounded by effective capital deployment drives our leading free cash flow per share growth and ultimately shareholder value. With that in mind, I'll turn to our fiscal 2023 guidance. We expect revenue growth of between 4.5% and 7.5%, adjusted EBITDA margin in the mid- to high-10% range. In addition, we expect to continue generating healthy cash flow and Tom will provide additional details on all elements of our guidance shortly. To wrap things up, we remain committed to our stated performance goals of long-term growth and margin expansion. CACI will continue to invest ahead of customer need to drive future growth and differentiation. As we've discussed many times before, our goal is to drive free cash flow per share. And our commitment remains consistent: to utilize CACI's strong cash flow in a flexible and opportunistic manner to deliver the greatest long-term shareholder value. With that, I'll turn the call over to Tom.

Thank you, John, and good morning, everyone. Please turn to Slide number 9. Our fourth quarter results with increased revenue and strong cash flow were solid, although they continued to reflect the slower funding and other short-term headwinds we previously spoke about. We generated revenue of $1.6 billion in the quarter representing overall growth of 5% and approximately 2% organic growth. Fourth quarter adjusted EBITDA margin was 9.6%, impacted by delays in mission technology sales. Adjusted net income was $107 million for the quarter and we realized a lower-than-expected tax rate driven by certain state tax benefits. Slide 10 please. Fiscal year 2022 represents another year of top line growth, healthy margins and strong cash flow. For the year, we generated just over $6.2 billion of revenue representing 3% total growth and positive organic growth. Adjusted EBITDA margin of 10.3% was slightly below our point estimate of 10.5%, due primarily to fluctuations in mission technology sales. Our adjusted net income in FY 2022 was $422 million. As a reminder in fiscal year 2021, we realized a large one-time increase in net income from a tax method change which impacts the year-over-year net income comparison. Next slide please. Fourth quarter operating cash flow excluding our accounts receivable purchase facility was $152 million, reflecting continued healthy profitability and cash collections. Free cash flow was $117 million for the quarter. For the full year, we generated operating cash flow of $770 million excluding our AR purchase facility and free cash flow of $695 million. The year-over-year increase for both was primarily driven by the realization of $190 million of cash benefit from the tax method change we previously discussed. This was partially offset by the deferred payroll taxes under the CARES Act. In FY 2021, we realized the benefit of $52 million. In FY 2022, we had a $47 million outflow and we had been expecting an additional $40 million of tax refund in the fourth quarter associated with the method change, but that payment is still pending. We ended the year with net debt to trailing 12-month adjusted EBITDA of 2.5 times, similar to our leverage at the start of the year even after acquiring four companies for a total purchase consideration of $600 million. Given our strong cash flow profile, modest leverage and access to capital, we continue to have significant optionality to deploy capital in a flexible and opportunistic manner to drive long-term shareholder value. Slide 12 please. Now let's turn to our fiscal year 2023 guidance. As is our practice we undertake a bottoms-up program-by-program forecast of our expectations for new business, bid-specific opportunity and track risks and opportunities. We incorporate known market dynamics and external conditions as we finalize the plan and develop guidance ranges. For fiscal year 2023, we expect revenue to grow between 4.5% to 7.5% with growth in both expertise and technology. About $180 million of inorganic revenue is included in the guidance range. We expect adjusted net income to be between $420 million and $440 million inclusive of $56 million of after-tax intangible amortization expense. Adjusted EBITDA margin is expected to be in the mid to high 10% range. We are providing this range to reflect the dynamics of our business. Slide 13 please. To assist with following here are some of our key planning assumptions. Indirect costs and selling expenses are expected to increase around 6.5%, driven by fringe on direct labor and the recent acquisitions, which have a more commercial-type cost structure. Remaining expenses are increasing at a modest 1%, reflecting our continued efforts to drive operational efficiencies. Depreciation and amortization are expected to be approximately $150 million. Net interest expense should be around $61 million, up from $42 million in FY 2022 due to higher interest rates. About 50% of our debt is fixed. So while we have some exposure to increasing interest rates it is tempered. We are expecting a full year effective tax rate of 23.5%, up from 19% in FY 2022, which benefited from additional R&D and state tax credits. We expect typical quarterly sequential increases in revenue and profitability through the year, but I will remind you that certain factors can affect quarterly trends such as the timing of material purchases and delivery of higher margin technology. Slide 14 please. In FY 2023, we are expecting operating cash flow excluding our AR facility to be at least $495 million and capital expenditures to be approximately $80 million resulting in free cash flow of at least $415 million. A few other items to note regarding FY 2023 cash flow, we will make the final payment of $47 million in the second quarter to repay deferred payroll taxes under the CARES Act but that will not result in any year-over-year variance since we made a similar payment last year. We expect to receive the $40 million tax refund from the method change that we did not receive in fiscal year 2022. We expect incremental cash payments of $65 million as part of the method change we adopted in FY 2021. We expect a net use of cash of approximately $60 million, driven by increased net income more than offset by increases in working capital as the company grows. And we are assuming the repeal or deferral of Section 174 of the tax code relating to R&D expense. If this does not occur our operating cash flow would be around $95 million lower. Slide 15 please. Turning to our forward indicators. Performance remains strong. For fiscal year 2023, we expect 83% of our revenue to come from existing programs, 11% from recompetes and around 6% from new business. We have $12 billion of submitted bids under evaluation, over 80% of which is for new business to CACI. And we expect to submit another $17 billion over the next two quarters with over 90% of that for new business. In summary, we expect solid financial performance in FY 2023 with healthy growth, margin expansion and strong cash flow. With that, I will turn the call back over to John.

Thank you, Tom. Let's please go to slide 16. I'm pleased that CACI was able to again deliver growth, healthy margins and strong cash flow and free cash flow per share in fiscal 2022. In addition with strong awards, robust backlog and pipeline and investments in differentiated technology, well-aligned with national security priorities, we have positioned CACI for strong financial performance in fiscal 2023 and beyond. As is always the case, we achieved our success because of our employees' talent, innovation and commitment to customer missions, our company and each other. I'm extremely proud of the CACI team for what you do for this company and our nation each and every day. I'm also very proud as you voted CACI a top workplace for the eighth consecutive year. Thank you all. Before we open the call for questions, I'd like to mention the release of our inaugural corporate responsibility report, which we issued yesterday on our corporate website. The report outlines information that is important to us as a company and our many stakeholders and includes topics that are impactful from an environmental, social and governance perspective. We're proud of our heritage and we are delighted to highlight our many accomplishments in the communities where we live and work. We look forward to an ongoing dialogue around the positive impacts we have made and the stewardship we intend to continue to demonstrate in the future. With that Nadia, let's open the call for questions.

Thank you. Our first question today comes from Bert Subin of Stifel. Please go ahead. Your line is open.

Hey. Good morning.

Good morning, Bert.

So John, you talked a little bit about mission technology. That's been something that's come up a little bit in recent quarters. Can you just say why some of your mission technology sales delayed, and what do you think leads them to pick up? I imagine this is a big portion of whether you guys end the year at 10.9% or 10.4% EBITDA margin. So, just curious, if you have any visibility on the sales or the process for RFP there?

Yes. Sure Bert and thank you very much for that question. Look, that's all folded into how we set up guidance for this year, and one of the visible changes that we have made is talking about EBITDA margin mid to high-10s. And you've actually hit right on that reason. It does not take a large dollar value award to move our EBITDA margin by even 10 basis points. To your specific question, there's a bunch of mission tech and other material purchases getting pushed into our fiscal year 2023 and there's some that did not. But our guidance does address both of those different cases. What we're most focused on is that we've been on this long-term drive to really establish a different-looking company that would depend on both expertise and on technology, and to not only talk about bottom-line growth but also top-line growth as well. So, I don't have a very specific list as to the two to three awards that have gotten delayed and whether they come forward or go away. What we are confident is that our FY 2023 guidance does a good job of putting lower and upper ends around our expectations that's focused on the issue that you directly brought up. On the low end we expect lower recoveries on some of those mission technology material buys. And on the upper end we're assuming coverage of all of those that slipped out of our fiscal year 2022. So, all in all, we are proud of the way we came out of fiscal year 2022 as an overall year, and we look forward to continuing this multiyear growth pattern on our bottom line. EBITDA margins are very much driven by our entire technology portfolio, not just mission tech but our enterprise tech as well.

Thanks for that guidance. Maybe just a follow-up on that. It seems like I'm trying to sort of delineate between your exposure set, which you highlighted a handful of items: cyber, C4ISR, enterprise tech. A lot of these things are seemingly growing a lot. And then we have budgets, which at least for the DoD started at 4% for 2023 and are clearly moving higher based on what we're seeing in the process. Yet your organic growth for FY 2023 is sort of low to mid-single digits, which puts it a little below that level. How should we think about why that's the case? And does that lead to a more significant ramp-up perhaps in the second half of the year and FY 2024?

Yes. I'll answer the first part of that and I'll let Tom talk about how our quarter-to-quarter looks. Look, our guidance, as it has in other years, reflects a lot of different assumptions Bert and different scenarios in terms of how a multitude of those factors play out. If I were to look back at FY 2022, some of the things that we knew about coming in were the 100% Afghanistan withdrawal. We were still dealing with COVID and its effects on government operations and funding, and questions about continuing resolutions. Clearly nobody anticipated a large invasion of a sovereign nation. We look at Omicron and we look at contracting officer constraints and how the government moves between counterterrorism and near-peer threats in the middle of a fiscal year. Those are all items that some we saw coming and tried to provide guidance around, others we did not. As we look at fiscal year 2023, we're looking at supply chain and funding dynamics, which are things that we didn't fully anticipate earlier, and we've got a growing defense budget but we still have concerns as to how contracting officer shortages and funding release will play out. So, we're looking at a number of variables: the labor market and inflation as well. So, there's so many variables out there that I'd love to be able to say if it was only for a $12 million mission tech order, we'd be a much more stable business. We are a very stable business. We continue to grow; we finished 2022 within our stated range and we plan on completing FY 2023 within our guidance range, having to balance a lot of those different areas that I earlier spoke on.

Yes. And Bert I think you talked about kind of momentum going into FY 2024 in terms of growth because right now we're obviously hyper-focused on FY 2023. And I will say that we expect a sequential increase in revenue in quarters one, two, three, and four. That's what we're expecting today. There are some fluctuations as we mentioned vis-à-vis either pass-through materials which are high revenue low margin or some of the mission tech sales. And so there may be some variations associated with that. As a result of that we're guiding for a full year trend; it's better to look at the company on a trailing 12-month basis than in any particular quarter. So, I think we're positioned well this year and we'll see the momentum going into FY 2024.

Thank you, John. Thank you, Tom.

Thanks.

Thank you. Our next question comes from Peter Arment of Baird. Peter, please go ahead, your line is open.

Yes thanks. Good morning John and Tom.

Good morning.

John regarding the budgets and just looking at maybe the intel markets specifically for 2023 it looks like the budgets are going to be up high single-digits and that's roughly maybe 30% of your revenue. So, how quickly should we think about that converting? And then just maybe related to that is regarding the funding delays what maybe changes the pace of activity there? Thanks.

Yes Peter. So, I guess, first off, budgets in general — the world is a really dangerous place and it's good that we continue to see bipartisan support for national security spending. I do think that Ukraine is a wake-up call but I believe that China and other near peers as well as lingering counterterrorism are still going to be out there. We like the overall budget laydown. It's much more constructive today than it was in the past. I'm talking about purely on budget versus funding. Clearly look, we like the increased defense funding. The $54 billion supplemental for Ukraine doesn't directly involve CACI for the most part, but as non-kinetic technology becomes more required we will be in those discussions. We started to have some late fiscal year 2022 discussions around some of our capabilities and I would assume that those would continue to go forward in FY 2023. Clearly about 30% of our revenues are within the Intelligence Community. We've got a wide range of advanced cyber, intel, and analytical technology as well as expertise. We like what those budget numbers look like. That's why we have spent the last seven to eight years positioning so that we could be talking about our addressable market and how we address our Intelligence Community needs. We're also pretty excited about the increase in spending within DHS and across the government as it impacts IT modernization and the space domain. So, what we sort of set the stage for is we have an outstanding budget, right? What we have to work our way through is how that is going to be funded and how that funding will be released. Whether it's in the Intelligence Community where we've seen about a 30% to 35% reduction in contracting officers, or the broader DoD where contracting officers have moved on, these are factors beyond budgets that affect execution. So, we think we set the right prudent guidance for that.

Yes. And Peter on the last call we cited some funding being lower than the prior year and that was one of the reasons for the slightly downward tone in the last call. Since then in the last four months, we've seen a pickup in funding. I'm looking at the April through July period. And we are close to closing the gap. Funded backlog at the end of June was down around 3% versus the prior year. So, a decline but not as severe as we saw earlier. We're monitoring this carefully. As John mentioned, there are some issues, including government contracting offices being short-staffed. We are comfortable that we'll have sufficient funding to perform within our guidance range. We're controlling and monitoring it carefully and making sure that we do have the funding to execute within the guidance.

Appreciate the color. I'll jump back in the queue. Thanks.

Thank you.

Thank you. Our next question comes from Robert Spingarn of Melius Research. Robert, please go ahead, your line is open.

Hi, good morning.

Good morning Rob.

Tom I wanted to — this touches on what Bert was asking about. I wanted to ask a math question if I could about the FY 2022 sales and the technology — the mission technology sales that got pushed to the right. Is our math correct that these higher-margin sales that went to the right were about $22 million and the EBITDA associated with that was about $15 million?

Yes. So to be clear, Rob, we didn't say specifically they were pushed to the right. We said that they did not materialize. And so some of them could have been pushed to the right. Some of them reflected changing government priorities, and so it's a mixed bag. I will not take a one-for-one movement from the fourth quarter to the first quarter.

Tom, I guess I shouldn't have phrased it that way, but sales that didn't materialize or moved or whatever. The math still applies the $22 million and the $15 million. What I'm getting at, is the margins.

Okay. Yes. So, kind of what was margin impactful. John mentioned the kind of leverage associated with some of the mission technology sales. Our EBITDA is approximately $700 million, and some of the mission technology sales, which are high-margin, can generate $5 million, $10 million, $15 million of contribution. And so one or two sales shifting, disappearing, or reoccurring is impactful on margins. But I think your arithmetic is generally correct with regard to how the fourth quarter turned out versus a 10.5% EBITDA expectation.

Okay. It just highlights the fact that some of this mission technology work is very profitable. That's really where I'm going with this.

Yes, absolutely. In fact, we spoke about that in the past when we talked about some of the acquisitions; some of those companies had EBITDA margins in the 35% to 45% range. So they are quite profitable and can have a material impact on a particular month or quarter.

So just as a follow-up, and this one is for John. Sticking with this discussion, on mission technology versus expertise so to speak. You and Leidos and a number of peers are all moving in this direction. What is the optimal mix of these two types of business? And how do you compare the growth? For example in the guide for 2023, what is the contemplated growth for these two areas?

Yes, Rob. I guess at a macro level, optimal to me — and I have been very transparent on this — there are quarters where the technology part of our business grew at 10% and our expertise shrunk by 3%. I don't view them as mutually exclusive. I love both to be growing at 10%. I don't think there's an optimal dial you can set universally. When we set this course a number of years back, we were a $2.5 billion revenue company and at about 8.8% margins. We looked at where government budgets were going and how to position for the next decades of growth. We wanted to avoid commoditized services where pricing and margins would erode. So we embarked on a path to increase technology content and move away from commoditized labor-only work. That makes the company stickier and more differentiated. Over time, that drives higher-quality earnings. Optimally, a 50/50 mix works for us, but I would love to have a bit more push toward technology than expertise. Some of our acquisitions are still early in the integration process. This is a multi-year journey. The long-term trend is driving a higher quality of earnings business, which will make us a much stronger company over the long haul. So while some years our EBITDA margins may fluctuate, the trend line over multiple years is what we are focused on.

Well, I was going to ask Tom and John, in the current environment, is there any way to characterize the relative growth in those two areas, even if we're just looking at a snapshot now?

Yes. So in our FY 2023 guidance, we're assuming that both technology and expertise grow, with technology growing at a higher rate, but both are positive. There is variation: if expertise grows at 1% to 2% then technology needs to grow greater than that to hit the top-line guidance. Two observations: technology margins are on average higher than expertise margins and that continues to hold. And from our acquisition strategy perspective, further acquisitions would more likely be in technology, which over time would tend to increase technology at a faster rate.

Okay. Makes sense. Thank you both.

Thanks, Rob.

Thank you. And our next question comes from Gavin Parsons of Goldman Sachs. Gavin, please go ahead. Your line is open.

Thanks, good morning.

Good morning, Gavin.

I just wanted to go through the cash flow bridge and maybe try to understand kind of normalized cash flow a little bit better. So maybe if you could give us a little bit more detail on the methodology change but I think that looks like the $40 million and the $65 million almost offset each other this year, if we add back the $50 million CARES reversal and then maybe the $25 million from that net methodology change. Is that about the normalized cash flow starting point, or how should we think about that?

Yes. So Gavin, there's a few numbers you're referencing. The CARES Act reversal — we had an outflow in both 2022 and 2023 repaying deferred payroll tax of $47 million. So on a year-over-year basis that's a wash and doesn't go into the bridge. The method change was a tax planning strategy we embarked upon in FY 2021 generating approximately $60 million benefit to CACI. That benefit was realized over a multi-year period such that the first year had a cash outflow, the second year (our FY 2022) had a large inflow, and then some outflows in FY 2023 and FY 2024. Adjusting for that you'll see that walk down on Slide 14 in terms of the cash flow. The last piece deals with a combination of working capital and other items. As the company becomes more profitable we should be generating more operating cash flow, which is the case, but that's being offset this year by some expected increases in working capital. Large companies when growing consume working capital. We're seeing some inventory increases as we deliver more mission technology products and plan to buy ahead of need for critical components due to supply chain. That's another use of working capital. We also had an increase in payables at the end of June versus last year; we expect a normal outflow to normalize Accounts Payable which impacts cash. Lastly on DSO, we ended the year with DSO at 55 days; we got as low as 52 days at the end of our first quarter. Right now we're assuming DSO should be somewhat flat for FY 2023. We've seen some delays in government payment offices driven by short staffing. We're planning for flat DSO but we'll work to drive it lower.

Okay. So if I strip out anything abnormal this year and it doesn't sound like working capital falls in that category, approximately what is free cash flow or a conversion ratio?

Well, the free cash flow that we're forecasting is $495 million of operating cash flow, less $80 million of CapEx gives you $415 million of free cash flow. I think that's a reasonable normalized level, and then conversion is simply dividing that by net income.

Got it. Okay. Thanks. And then maybe just on the long-term growth outlook. I wanted to ask if you updated your kind of rolling forward view of the addressable market growth rate and thoughts on to what extent you could outgrow that?

Yes. When we look at the addressable market five-year CAGR it's about 4.5% historically; this year we've had to consider inflation, the Ukraine supplemental, and other factors. We see our addressable market roughly where we expected coming out of FY 2022 — north of $240 billion. A $6 billion company with a $240 billion addressable market growing at about 6% in 2023 feels about right to us.

Okay. Thank you very much.

Yes. Thanks, Gavin.

Thank you. And our next question goes to Matt Akers of Wells Fargo. Matt, please go ahead. Your line is open.

Hi. Thank you. Good morning. I wonder if you could talk on capital deployment and especially share repurchases in general. If you go back to when you did the ASR a little over a year ago it sounded like that could maybe be a bigger part of capital deployment. Is that still the right way to think about it, or are you more focused on M&A at this point?

Yes Matt, thanks. Look we are still on that path. As we mentioned during fiscal year 2022, we were about 50-50 in how we deployed capital between acquisitions and the ASR. Over the last 12 to 18 months that's reflected in what we did. We're sitting here at leverage around 2.5 times. We'll continue to assess those gaps we want to fill quickly and we'll look at stock valuations and other factors when deciding on ASRs. Both repurchases and M&A receive equivalent consideration. You should expect flexibility from us during fiscal year 2023. There are known items and unknown items; our job is to deploy capital in a way that maximizes free cash flow per share.

Okay. Great. And then, I guess, just one more at a high level. There's been a lot of delays in procurement and funding with COVID and budget issues. To what extent is there pent-up demand that once things normalize could grow above that long-term market growth, or to what extent is that work a lost opportunity at this point?

Yes Matt thanks for that question because that's really at the crux of what we're discussing. This is about what we can control and what we cannot. Budgets can be strong but funding and contracting officer capacity matter. When contracting offices are understaffed, priorities shift and timing slips. Our focus is to continue to run the business, drive operational efficiencies and invest in the right areas. When things normalize — and many of these items should be resolved over time — we'll see more normal award pacing. Mission technology is higher margin and lumpy; our job is to be prudent in guidance and execution. We're in the right markets and positioned well; we just need some of these external factors to settle.

Yes, that’s great. Thank you.

Thank you. Our next question comes from Seth Seifman of JPMorgan. Seth, please go ahead. Your line is open.

Thanks very much and good morning. Just to follow up a little bit on that question. You talked about some mission technology work that slipped out which is something we see across the sector and some of it may not materialize. With regard to the stuff that may not materialize, how do we think about how that happens? Are there implications for your market share? What gives you confidence it will materialize in the future given plans to build working capital and buy ahead of need going into fiscal '23?

Thanks. At a macro level, our strategy is to drive revenue from both expertise and technology across enterprise and mission areas. The strategy is playing out well: our revenue quality has improved over the last seven to eight years. There will be awards that come in and not come in — awards are lumpy. We have a balanced pipeline and a strong foundation in C4ISR, AI, cyber, and analytics across our customer base. We're making prudent investments and positioning for the long term. So while individual awards may not materialize, over the long term we expect our positioning and pipeline to translate into wins and revenue growth. That's reflected in our guidance.

Great. Thank you. And a follow-up — we've seen efforts at the Department of Justice to block some large acquisitions. I don't expect you to comment on those specifics, but does the more aggressive approach by regulators enter into your thinking about M&A strategy?

Short answer: no. We operate in a large, relatively fragmented market. Small business programs create new entrants and opportunities. The level of regulatory scrutiny on some large deals does not change how we handle our M&A program. We remain strategy-driven, selective, and disciplined. We look for quality assets at the right price and the right cultural fit. Recent regulatory focus will not materially change our approach to M&A.

Thanks so much.

Thank you. Our next question comes from Sheila Kahyaoglu of Jefferies. Sheila, please go ahead. Your line is open.

Hey, good morning guys. John maybe another big picture one for you as you continue to shift the strategy and move towards technology and mission. How are you doing that with your bid pipeline? Are you deciding to bid on certain contracts? Are you hiring people that focus on that more? Can you expand upon your strategy? I know it's been ongoing for several years, but how you're continuing to focus on it into fiscal '23?

Sheila thanks. Historically we were part of more commoditized work. Today we are evolving to have expertise inform technology and to further differentiate ourselves. Tactically, as recompete bids come up, particularly in expertise areas, we take hard looks at whether to bid — we weigh strategic fit, expected margins, and long-term value. Some programs we choose not to pursue if they are commoditized and would dilute our margins. Over time, these disciplined decisions have improved our revenue quality. We're also investing in technology, building partnerships, and hiring people in technology and business development who understand the market and client needs. This combination enables higher-technology content in bids and the ability to win those opportunities.

Yes, and the other enabler is our R&D investments. We've invested ahead of need to develop the right technologies to sell to customers. We've hired people in technology, business development, and client executive roles to propel that growth. We also partner with top technology companies. Those actions enable us to pursue higher technology content in bids and win them.

No, that helps. Thank you, both. And then Tom, maybe one more follow-up for you. In terms of slide 14, it's been highlighted a lot, but do we think about working capital as a continued usage going forward for the business, or is it just a fiscal 2023 anomaly given supply chain shortages?

Good question. Perhaps a bit of an anomaly in FY 2023. Over the last several years working capital has been a source of operating cash flow as DSO moved from the mid-60s down to the mid-50s. We're reaching levels where further material improvements are more difficult. Growing companies often require increased working capital. We'll try to keep working capital somewhat neutral relative to operating cash flow going forward, but this year there's a bit of a headwind and we'll do what we can to minimize it.

That's great. Thank you.

Thanks, Sheila.

Thank you. Our next question comes from Tobey Sommer of Truist Securities. Tobey, please go ahead. Your line is open.

Thank you. Could you give us some commentary on particularly the optical part of your business in space, maybe talk about the competitive positioning, any kind of lead you have in having a sort of a viable commercial product or not? And then, maybe in the context of that, describe what success looks like from your perspective three or four years from now?

Tobey, thanks. We're very pleased with our photonics and laser communications progress. We have production units in space and are involved in several missions. I view the market in two areas: bespoke GEO/interplanetary communications and higher-volume LEO connectivity. The initial entry was with bespoke, high-performance terminals and that work has matured with units flying and operating. For higher-volume LEO markets, we're building manufacturing scale and believe we have the capabilities to produce high-volume, small form-factor devices. Part of our thesis is taking advanced processing and algorithms from bespoke solutions and applying them to small, high-volume devices to enable robust links without excessive cost. We've had production units in space transferring data at rates around one gigabit per second or higher, and we have programs with DARPA and SDA. We see the photonics business as real and tangible, operating across space and airborne domains. Success in 3–4 years looks like material revenue contribution from photonics as we scale volumes and penetrate both defense and commercial markets.

Certainly does. From a capital deployment standpoint, could you just comment what higher interest rates mean to you? You're at 2.5 times leverage. Are you less aggressive in share repurchase and acquisitions as a result of the interest rate environment and your variable exposure there?

Because last year LIBOR averaged around 35 basis points and today it's around 2.4%, we've seen an increase of about 2 percentage points. In the grand scheme that's not material to our decisions. Share repurchases will continue to drive incremental free cash flow per share, albeit at a slower level given higher interest costs, but it shouldn't materially impact acquisition decisions. Whether borrowing at 2.5% or 4.5% should not materially change our investment decisions.

And I can assume that you have embedded in your guidance continued rise in LIBOR at least for the next several months?

Yes. What we have embedded in the guidance is an expectation that LIBOR will get to approximately 3.5% in June of 2023. That's kind of a middle-of-the-road view consistent with economic and forward curves.

Thank you very much.

Yeah. Thanks.

Thank you. Our next question comes from Colin Canfield of Barclays. Colin, please go ahead, your line is open.

Hey, thanks for getting me in. Can we talk a little bit about the potential growth and EBITDA impact on the TSA, the TSA impacts on contract track and what you're assuming with respect to the guidance?

Colin, that job is currently under protest. We have some amount of revenue in our FY 2023 plan and we're including it in our guidance assumptions. We won't comment further until the government's outcome is clear, but we believe we've sized the program sufficiently within our FY 2023 guidance.

Got it. And maybe, if you can talk a little bit about the multiyear margin environment. Is 11% still possible considering the level of underbidding we're seeing in both expertise and technology and the pricing pressure there, and you mentioned in your remarks that photonic pricing needs to come down. Maybe you can talk about that margin framework versus your 11% visibility?

We're on a continued path to grow top and bottom line. I don't think 11% is a magic number. Given our FY 2023 guide, we believe the mid-to-high 10s is a prudent starting range. Some expertise work is being bid down, and that's why we shifted strategy years ago to raise technology content and avoid commoditized services. The last seven years have shown progress: margins moving from 8.8% to over 10% as we shift the business. Optical communications pricing will come down with volume; nothing brings pricing down like scale. We believe we have a head start with products in space and the right technical solutions. Over the long term we expect margins to improve as technology scales, but I won't forecast a specific magic number for a single quarter — it's about the decade-long trend.

Got it. Thanks for the color.

Thank you. Our next question comes from Mariana Perez Mora of Bank of America. Mariana, please go ahead. Your line is open.

Good morning everyone.

Good morning, Mariana.

So my question is a follow-up on M&A. You already mentioned that you would bias towards technology. However, we have heard that space technology for example is getting quite pricey. Could you please give us some color around your M&A pipeline and the M&A environment?

Yes. Our pipeline has flattened off 2021 levels over the past six months. There are opportunities out there but I wouldn't characterize the market as robust. Our acquisitions are quality driven: right price, right cultural fit, the right enhancement to our expertise or technology portfolio. We'll continue focusing on SIGINT, EW, cyber, AI, analytics and anything that supports IT modernization and customer presence. Private equity is active and some valuations remain high; we remain selective and disciplined. Recent government attention to large M&A won't change our approach. We will continue to be very selective and disciplined in M&A.

Perfect. And then on FY 2023 guidance, I want to understand where conservatism comes from. You have a robust pipeline with $12 billion of submitted bids and an additional $17 billion expected to be submitted, with a high content of new work. Yet you're only expecting like ~6% contribution from new work. So where is this conservatism coming from? Is it award environment, win rate, protests, timing? Please give more color.

Mariana, a good way to think about this is the low end versus the high end of our guide and the many variables. Our bottoms-up forecast incorporates program-level assumptions and known market dynamics. At the low end we model slower and uneven funding release and slower adjudication. At the high end we assume better funding release and that some slipped mission tech awards come into our fiscal year. There are also natural revenue falloffs as programs end, and recompetes where we don't win 100%. So new wins have to replace program declines and lost recompetes. Contracting office capacity, protests, funding timing, wage inflation, and supply-chain issues are all part of the uncertainty. So the guidance range reflects those risks and opportunities. We believe the range is prudent given the many known and unknown variables.

Mariana, also remember that some of our work naturally phases out; new business wins partly replace that falloff. We like to win recompetes but we don't win all of them. So the new business has to both grow the base and fill natural declines. That arithmetic helps explain the guidance math.

Amazing. Great color. Thank you.

Thanks, Mariana.

Thank you. Our next question comes from Josh Sullivan of The Benchmark Company. Josh, please go ahead. Your line is open.

Hey, good morning.

Good morning, Josh.

You mentioned counter-UAS. You guys were early to the game with SkyTracker in tactical environments and Ukraine highlights the threat. Can you talk about how that market is evolving, how you get the upfront wins given increasing competition, and how big an opportunity do you see that as?

Josh, counter-UAS was one of the early areas we pursued as we moved toward higher technology content. We acquired capabilities in this area and have deployed over 1,200 systems globally protecting critical assets. We have the largest library of signals of interest from two decades of work, and capabilities that range across Group 1 small commercial UAS up to Group 5 larger systems. Recent draft legislation around counter-UAS is a step in the right direction and could expand addressable markets to critical infrastructure like power plants and water facilities. We see increased volume and sustained demand there as we continue to upgrade and support deployed systems.

Got it. Thank you for the detail. Then a follow-up on photonics: as you work into the commercial pricing environment, any thought of offering usage models to penetrate commercial opportunity?

We are considering a number of business models, some of which may succeed and some won't. They are all going to depend on volume. We believe we have the right technical and hardware-software solution. To move to lower price points you need volume and partnerships. We're still early in that multi-decade market, but we have a tactical approach to scale and partner where appropriate. On the bespoke side we've been delivering for years and have proven performance.

Ladies and gentlemen, we have lost connection with our speaker line. Please standby while I reconnect them. We have reconnected and are back live on the line.

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Operator, this is the speaker line here with CACI, John Mengucci and Tom Mutryn. We were at our last call. Can you hear our last question?

Yes, we can hear you.

Okay. Thank you. I'm going to turn the call back over to John Mengucci for a quick wrap-up to end the call.

Okay. Well thanks Nadia and thank you for your help on today's call. We'd like to thank everyone who dialed in or listened to the Webcast for their participation. We know that 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 my best to you and your families. This concludes our call. Thank you and have a good day.

Thank you. And ladies and gentlemen, this concludes today's call. Thank you all for joining. You may now disconnect your lines.