CACI International Inc (CACI) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the CACI International second-quarter fiscal year '07 earnings conference call.

At this time all liens are in a listen-only mode. Later, we will announce the opportunity for questions and instructions will be given at that time. (OPERATOR INSTRUCTIONS).

A special reminder to our media guests who are listening in--please remember that during the question-and-answer session of this call, we are only taking questions from the analysts.

At this time, I'd like to turn the conference over to Dave Dragics, Senior Vice President of Investor Relations for CACI. Please go ahead sir.

Thanks, Matt, and good morning, ladies and gentlemen. I'm Dave Dragics, Senior Vice President of Investor Relations here at CACI International. We're very pleased that you are able to participate with us today.

Now, as is our practice on these calls, we are providing presentation slides and during our presentation will also make every effort to keep all of you on the same page as we are.

Moving to the next exhibit, number 2, before we begin our discussion this morning, I'd like to make our customary but important statement regarding CACI's 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 what we say today. Primary 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. Our safe Harbor statement is included on this exhibit and should be incorporated as part of any transcript of this call.

Moving to the next exhibit, to open up our discussion this morning, here is Jack London, Chairman, President and CEO of CACI International. Jack?

Thank you, Dave. Good morning, ladies and gentlemen, and thank you for joining us today. I'd like to personally welcome those of you who are new to CACI on our call this morning. We appreciate your interest and invite you to join us on future calls as they come along.

With me today to discuss our results and answer your questions are Tom Mutryn, our acting Chief Financial Officer, Paul Cofoni, our President of U.S. Operations, Bill Fairl, Chief Operating Officer of our U.S. Operations, and by phone from the United Kingdom, Greg Bradford, Chief Executive of CACI Limited UK.

Exhibit number 4 please--as you know, on January 17, we announced our revision to CACI's fiscal 2007 revenue and earnings guidance and indicated where we believe earnings would be for our second quarter ending December 31. Our fiscal midyear operating review had indicated that we would need to lower our guidance for the year. The closing out of our Quarter 2 results in the first couple of weeks of January completed the picture. In keeping with our long history of credibility in providing our public information to the investment community, we promptly went to the Street with our prerelease and projections. There were only about a couple of occasions the last 20 years or so that we've had to do this, and obviously we were quite disappointed.

As you know, we have seen a significant slowdown in contract taskings and this was compounded by an increased level of contract award delays and protests, continuing pressure on staffing for high-level security-cleared projects, and some timing issues on a couple of recompete losses. We also note that this overall market slowdown is being seen in other parts of our industry sector of government IT services as well. This is not a surprise to us.

The market factors causing these issues include the change in control in the Congress after the election in November and the [result] of rethinking funding commitments at the project levels. The movement of O&M funds towards the needs for the war in Iraq and the continuing resolution for the non-DOD side of government budgets. We've also seen increased contract competition and some pricing pressure in the sector.

At the same time, we believe CACI's long-term prospects are truly outstanding. Our bookings are strong. Our competitive contract awards scoreboard overall is growing steadily. I don't I want to make special note here of our recent success on Encore 2 with DISA, the Defense Information Systems Agency, where CACI was a stand-up winner on this major long-term Tier 1 level contract. Three major Tier 1 incumbent companies were passed over, with CACI obviously being recognized by this major customer as a Tier 1 performer. We believe this is an important statement of CACI's growing recognition as a major Tier 1 performer in this market space. I can remember it was only a decade or so ago when I said we would not have been able to make that statement.

As to market positioning, CACI is positioned directly in the United States government's highest priority domains--national security, national defense, the intelligence community, and government systems and IT transformation. For our market, these will be the highest priorities for the foreseeable future. Ominously, worldwide Islamo-fascist terrorist movements continue to gain traction and momentum, and the real threat of rogue government WMD capability is growing rapidly as well, as evidenced by the actions in Iran and North Korea.

The challenges in Asia from China, the challenge in South America from Venezuela and Colombia are also real. The Mid East continues in turmoil with the Lebanese and Palestinian conflicts, as well as the war, of course, in Iraq and Afghanistan. This all means that information and intel dominance are strategic drivers in national security responses.

The national security goal is prevention through awareness and preemption where needed. Thus IT and network systems and security are high priorities for these domains, and they are CACI's brand-name strengths. These needs are also drivers for rapidly deployable combat force structures. CACI's long suit strength in military logistics and support systems are well-known in our customer markets. Our further expanding capabilities and market recognitions, such as Encore 2 recently, and with CACI's S3 contract award with the Army for C4ISR work last year demonstrates that CACI is rapidly becoming a Tier 1 upfront performer.

I also want to emphasize that, in our space, CACI is the industry's leading strategic consolidator. We have successfully handled and closed some 31 transactions and acquisitions in the last 15 years or so, all of which have been successful and accretive to earnings.

M&A has been a core capability at CACI for close to two decades, and we have a well-developed team focused on M&A.

We fully intend to sustain our long-term growth record and our outstanding record for creation of shareholder value. We believe our long-term future is bright. We believe the current slowdown is temporary.

At this point, Tom Mutryn and Paul Cofoni will add important details here to round out the picture. Then we will open up to Q&A here in a bit. So, Tom, over to you.

Thank you, Jack, and good morning, everyone.

Our year-over-year revenue growth--please go to Slide number 5--for the second quarter of 13.7% was driven by the acquisitions we made last year, which accounted for 53 of the $57 million increase in revenue, while organic growth was around 1%.

Looking at the longer-term results, our revenue growth has been impressive with $1.9 billion of revenue for the past four quarters, up from $1.1 billion in fiscal year 2004, a 21% annualized growth rate. Going forward, despite the current environment, we believe we can continue to grow revenue and earnings and continue to deliver value to our customers in attractive returns to our shareholders.

Turning back to the quarter, our year-over-year decline in operating income was due to both direct and indirect costs growing faster than revenue, resulting in lower margins. The disproportionate growth in our direct cost was due to a shift from CACI direct labor expense to other direct costs, or ODCs, which have lower margins. In addition, we had lower margins on acquired revenue. Our indirect costs in the second quarter increased disproportionately year-over-year, due primarily to unusually low healthcare-related expenses last year. Year-to-date, our indirect costs were around 25% of revenue, consistent with the same period last year.

Next slide, please. This past quarter, our operating margin was 7.8%, equal to the operating margin of 7.8% in our first quarter but down from 9.3% last year when we had lower healthcare-related expense. As a reference, both our first six months and full fiscal year 2006 operating margins were 8.6%.

Two distinct factors involving the mix of our work are putting downward pressure on margin. The first factor is the shift of our contract mix from time and material to cost-reimbursable contracts. Typically, time and material labor margins are higher than those for cost-plus contracts. We have seen the percentage of our work in time-and-material contracts move from 53% of our volume in the first three months of fiscal 2006 to 51% for the first six months of fiscal 2007. Driving this change has been a number of consolidating contracts that are cost-reimbursable in nature and include significant subcontractor work.

The second factor negatively impacting our mix is the shift in our direct costs from CACI direct labor to ODCs. This decline is attributable to in part to the movement to larger consolidating contracts which I just mentioned. Clearly, we're not pleased with these lower margins, and Paul will talk about the proactive steps we have been taking in this important area.

Next slide, number 7 please. Our UK subsidiary reported revenue of $19.1 million, an 18% increase over last year's second quarter. This growth resulted primarily from the acquisition of SoftFund Limited last June and favorable exchange rates.

Our low second-quarter tax rate of 35.2% is primarily a result of Congress passing the expansion of R&D credits in December 2006, retroactive to January 1, 2006. For all of fiscal year '07, we expect our tax rate to average around 37%.

We had another strong quarter of cash flows with healthy collections generating $27.8 million of operating cash flow.

In our first two quarters, our net debt position, our debt less our cash, declined by $71 million to $272 million. Our Days of Sales Outstanding were at 72 days, compared to the 73 days in the second quarter of last year.

Next slide, please. In terms of guidance for the third quarter, we expect revenue will range between 4600 and $495 million. We expect our operating margin will range between 7.1 and 7.6% and our organic growth will be flat to slightly positive. Interest expense should range between 1 and 1.1% of revenue. Diluted earnings per share is expected to be between $0.55 and $0.65 per share, compared to last year's $0.69 per share.

With that, let me turn the discussion over to Paul Cofoni. Paul?

Thanks, Tom.

Let's go to Slide number 9, please. Our prerelease on January 17 was a disappointment for all of us. We announced our revised guidance just as soon as we were confident in our analysis of the causal events and conditions. In that way, we did our very best to preserve our credibility with our investors by giving them the earliest possible understanding of the current market realities -- and providing analysts an early opportunity to dialogue with us to improve the quality of their analyses.

CACI is the same strong company we've always been. We have great customers with high satisfaction expansion levels. That's due to the fine efforts of our talented and dedicated employees, as well as the seasoned, committed management team.

We operate in a vibrant marketplace. The defense budget is at an all-time high, and the work we do for Department of Defense clients is important to our national security. As you know, our strategic focus is on those areas least at risk in the government appropriations process; that is national defense, intelligence, Homeland Security, and government transformation.

Over the last year, we have undertaken a number of initiatives to increase both our growth rate and our profit margin. I'd like to discuss these with you. Next slide, please.

With regard to growth, first we must return to our historically high rate of base business retention. Our strategies here include increasing client contact across the board to ensure we understand any performance issues early and that our offerings are aligned with our clients' future needs. We are also conducting more frequent executive reviews of our recompete strategies. We're training all our program managers on Best Practices for retaining their business. And, we've launched a new quality assurance program which reports directly to the CEO to give us timely and continuous understanding of client satisfaction.

Second, we must continue to win a meaningful share of Tier 1 competitions. The good news here is that CACI continues to win new, large opportunities at an impressive rate. The recent wins of the $330 million New Orleans SETA contract and the multiple-award, $13 billion ceiling DISA Encore 2 ID/IQ contract are perfect examples of this. Three Tier 1 incumbents were displaced on Encore 2, while we were one of six awardees.

Third, we are reviewing our M&A strategy to assure it capitalizes on current market conditions.

Next slide, please. With regard to profit margin improvement, we undertook a number of initiatives over the last year. For example, we are prioritizing our bidding proposal investments to opportunities for which CACI solutions represent a significant advantage for our clients. These opportunities have typically high CACI labor content and deliver greater value to our clients and greater earnings to us. However, we will still pursue strategically important opportunities that may have high ODC content. Examples here are programs where the client desires CACI to be the systems integrator for efforts of multiple contractors to ensure aligned and integrated solutions. These programs are important to our clients and their missions. CACI is well-suited to meet these needs. These efforts will lead, eventually, to other work that will have higher CACI labor content.

We are also developing profit improvement plans for programs that are not meeting our expectations. In addition, we continue to invest in our recruiting processes and personnel to shorten the timespan to hire. We're starting to see real improvement in this area but have more work to do.

Finally, we have an ongoing program that is aimed at improving internal productivity and eliminating unnecessary cost. We call it the Cost [Toss] program. These and other actions will lead to improvement in our operating margin.

Next slide, number 12, please. I'm proud to report that Q2, like Q1, was a banner quarter for contract awards and funding orders. Proposal activity remains robust. At the end of our quarter, we had $2.8 billion in submitted proposals under evaluation, both new and recompete. We expect that most will be awarded by the end of June, 2007. Also by the end of June, we plan to submit more than $2.7 billion in additional proposals.

Please go to Slide number 13. Turning now to our second-quarter awards, we received 1 of 15 large business [prime] contracts positions for the Army FIRST program, a 20-year task-order contract with a total estimated ceiling value of $36 billion. We also announced our award of the five-year, $70 million recompete contract to continue developing and enhancing Department of Defense's Standard Procurement Systems, or SPS. SPS is a large-scale systems integration program that we have supported from more than ten years.

Also this quarter, we received approximately $170 million in unannounced contract awards, supporting classified clients in the national security and intelligence communities. As Jack said, there is no better way to defeat terrorism than to preempt it. We are proud that CACI is at the forefront of intelligence support.

These examples illustrate our broad portfolio of business and our ability to win Tier 1 contracts. We have many contracts that renew long-standing relationships. We continue to win large contracts with long terms. Our backlog positions us well to overcome the short-term hurdles we are currently experiencing.

Jack, that concludes my remarks.

Okay, thank you, Paul. Thanks as well, Tom, for the updates.

The next slide, please, if you would? We believe our discussion today shows clearly that CACI has a focused portfolio of business which is the driver for long-term growth. We are well-positioned to expand customer relationships, take advantage of accretive acquisition opportunities, and add new customers and capabilities, which we are doing. We have proven over time that we can deliver shareholder value. We also take great pride in the fact that our CACI employees are customer-oriented, collaborate to win and remain dedicated to excellence. They are determined to deliver unsurpassed quality client service and best value to support our growth. They give us great confidence in our ability to keep CACI on a rapid path to Tier 1. We thank our talented and valued employees for their outstanding support and vigilant commitment to our company, our clients and our shareholders.

As I said earlier, we believe our long-term future is bright and we believe the current slowdown is temporary. So with that, Matt, we're ready to open up the call for questions.

Thank you, Dr. London. (OPERATOR INSTRUCTIONS). Tom Meagher, FBR.

Good morning. Thank you. Could you talk to your long-term growth strategy, the current poor operating environment notwithstanding? I think, historically, you've been aiming at kind of 12 to 15% organic growth, supplemented by another 5 to 8% through acquisition. Assuming we get back to a more normal operating environment in FY '08, are those metrics still relevant or would you see them perhaps focusing more on the M&A side of the house?

Well, I want to say that the corporation has had a long-term growth strategy about-as those numbers you indicated, and you've got the bracketing about right in terms of the mix between the organic and the M&A program. We found, over the years, that sometime there will be a bit short, sometimes they will be a bit above that, but that's been our long-term goal. We said that out as a challenge for our management team, but obviously throughout the year, things will vary from time to time. I think the M&A piece of our business is probably going to continue to be an important part, but Paul has been focusing on that. I'd like to ask them to share with you his vision as to where we take this thing next year.

Thank you, Jack. I believe here, Tom, that our goals that we've had for some time, 20%, is still appropriate. It is a long-term goal. It's inspirational to our entire management team. We see that we can use a multiple of techniques, both expansion of our existing contract business, Tier 1 wins that in many cases are market-grabbing events, opportunities for us to seize more market share, as well as the already strong M&A program. We continue to evaluate all of those. Each year, there will be some shift in the mix of where we get the growth. As Tom pointed out earlier, if you look back over 2.5 years, it's over 20% compound annual growth rate.

We also view our market from the standpoint of being a $2 billion per-year competitor in a $150 billion market--plenty of room to grow. In the near-term, it looks like much of that growth will be gaining market share from some of our competitors. But in the long-term, there will be new greenfield opportunities for us to pursue as well.

Okay, thanks very much. I appreciate it.

Edward Caso, Wachovia.

A couple of quick ones here--has there been any word yet whether Encore 2 is being protested?

Paul?

No, we have heard anything about the protest period has not elapsed yet, so--.

Okay. I was hoping you could elaborate a little bit more on the cost-plus, the shift of work from time and materials to cost-plus. I remember, two years ago, the big theme was the reverse and how it helped overall operating margin. Is this a big trend? Is this a temporary factor? Is this just sort of more war-related type of work?

Let me just start off by saying that, over the years, I've seen a shift back and forth in these areas. It tends to be a pendulum, if you will, if you've been around long enough.

I think we're going to see more cost-plus. There's a lot of heat in Congress right now. I don't know if you had your eye on a lot the oversight hearings that they're talking about. Certainly, the government reform--Congressman [Blacksman] is going to be looking at "contractor fraud, waste, abuse and all that business". Of course, I don't think that plays in almost any sector of the market except a very narrow one, but there will be some more cost-plus emphasis for awhile.

But Bill, you watch it real carefully. Why don't you add your perspective on this?

You bet, Jack. Ed, what I've seen is, particularly on the Navy side of our business, there's been, I would say over the last couple of years, a large-scale movement to cost-plus type cost-reimbursable engagements--less so in the other areas. As you know, the army is our single-biggest customer and today they remain mostly engaging with us on a time-and-material or (indiscernible) level of effort (multiple speakers). Some places in the intel community have moved into a cost-reimbursable environment as well, but it's not as broad there as it is on the Navy side.

As far as the trend goes, I would say that, on the Navy side, is actually pretty much complete at this point, so in terms of any more of our existing work migrating to TNMS. That's probably not going to happen because (multiple speakers) right, cost-reimbursable. That's all done at this point in time.

As Jack said, over the course of my career, I've seen this kind of ebb and flow as well. There are folks that--and cost-reimbursable isn't necessarily the best way to go, either, because you don't really have your costs defined, so--.

My final question is contract awards versus actual funding of program--are you seeing push-outs to the right, both in existing funding and funding on new endeavors?

We are. In the case of the newer wins, it's been most pronounced through the protest volume that we've seen. I think we covered that two weeks ago, but many of our programs have been under protest, some as long as a year after we've won, they are still hung up in protests, so that has the effect of moving things to the right.

Then we've seen this shift in funding priority toward the war, which has had the effect of giving a little shaving to the existing task orders we've had where we've had 30 people or 50 people. We are asked to not (indiscernible) through natural attrition not replace 4 or 5 on a base of 30 or something like that. Even though the funding order volume is up very high, we are experiencing kind of a stretch-out of the funding, the customer asking us to run at a lower rate for a longer period. So we have more months of burn time in our backlog but at a little bit lower run-rate is the way of thinking of it. Does that answer your question?

Brian Gesuale, Raymond James.

Good morning, guys. Thanks for taking my question. I wanted to dig into margins a little bit here and help to kind of quantify some of these pressures that I think you're seeing. Maybe if you can put some meat behind the change in direct versus indirect labor, and then pass-throughs, maybe the effect of the acquisitions on the margin decline. Then maybe talk if you have any problem programs or anything like that that you guys are trying to rectify.

Yes, this is Tom. I will begin with this call. As I articulated, we have seen some declining margin (indiscernible) 8.6% last year, 7.8% (indiscernible) of this year. I articulated the factors which were driving those. One was the contract mix, which was the largest factor, and that has several components in it. Some of the lost recompetes we had had higher margins; we were seeing some shift to--from time-and-material to cost-reimbursable, as well as a shift from CACI labor to ODC costs and ODC labor. So that is the major impact on our margins--had a decline.

You know, I also articulated that one of our acquisitions had lower margins as well. If the acquisition is accretive, we are happy we did the transaction. It fit well into our strategic strategy going forward. Often, it did have some temporary margin pressure. The margin issue is a larger issue, kind of a battleship to revert back to some historically higher margins. Paul articulated four distinct areas that we're focusing on, and you know, I am confident that we are focused on the issue and moving forward.

I'd like to say, I think we've got a pretty good handle on our indirects, certainly the labor. We've managed that very tightly. I want to make sure that the caller understands that there's been perhaps some indirect costs that we're moving out on. We've got our cost [talk] program that Paul mentioned. Maybe you'd like to fill in a little on how you see that coming along. But we are watching the costs carefully and we're going to work that side of the margin (indiscernible) activity as best we can.

On the question of troubled programs, we don't have trouble programs right now. We had a few last year; we fixed them and turned them back around. Nothing is in the ditch; there's no gashing wounds or bleeding going on. (LAUGHTER). I know what those look like, unfortunately, but we don't have any right now is the good news. That's because our team, our management, our team and our people are doing wonderful work.

The area of the cost [talk] program Jack mentioned, now, this is not a recent thing; we started this about six or seven months ago. It was us looking at this market and sort of saying, you know, one of the things we ought to do--we've had years of growth, four or five years of growth. In years of growth, your focus is on how do I tend to the needs of the clients and get the people on board, etc., as fast as you can? So it was an appropriate time for us to take a look and say, okay, rapid growth--there may be some inefficiencies that have built in along the way. We backed off and took a top-down look seven months ago. We built this cost talk program. There's probably about 60 different actions in that cost talk program. It's comprehensive. It covers all of our business and it's starting to drive costs out of the equation and in significant numbers. I think Tom pointed out that we've had good overhead management; our overhead has been well under control. In fact, our overhead rate has been reducing over the last two years. It's been on a continuous (inaudible). That's just us trying to manage our overhead ahead of our direct to make sure that we stay in control of that. So I think we are managing these fundamental things very well. I'm quite pleased with the way our team is reacting (inaudible).

I appreciate the color. Maybe just one follow-up here--in regards to recompetes, there's been a lot of folks out there mentioning heightened competitive-ish pressures out there and it sure seems like not only is everyone protesting every single large award, but it seems like everyone is bidding on everything. Is that historical 95% win rate bogey--is that more of a goal but less of a reality today, or how should we look at that going forward?

Okay, let me weigh in here. That's (indiscernible) the Indian burial ground there. (LAUGHTER).

We have a goal for 100% win rate on all recompetes. We are so feverish about that, you can't imagine. Our people understand we have zero tolerance for anything less than 100% recompete win rates. We will be ferocious in defending each and every one of our contracts.

We have had, as we pointed out to you, a few disappointments. I can tell you how this place shook and vibrated for weeks afterwards. There is no chance our people are going to allow that to become a trend. I view those as escapes, things that got outside of our process, and we are taking the quite corrective actions to get that back. The goal is 100% and always will be.

Mark Jordan, A.G. Edwards.

Good morning, gentlemen. First, a question for Paul. I guess, historically, we've tended to look at contract awards and more specifically funding as a good metric of future growth. Given the fact that those seem to be failing us here in the current environment, what metric or metrics are you focused on to try to identify when the market starts to grow for you?

I think we continue to look at--we look at the funding orders every week; they are stretching out and that is--we might have to adjust our correlation on that--correlation factor on that to revenue. It's still the best--I think it's our best indicator of future revenue.

We stay very focused on two things here; there's two things we have to do to be successful. We have to make bold promises to our customers to win new business and then deliver on those promises. So to me, I look at things like win rates and I look at customer satisfaction scores as the two primary long-term indicators of our health and growth.

But in terms of the next quarter or six months, I would throw it open to Tom or Bill to say if you see anything different than looking at funding orders.

I think, Paul, the other thing we've done is we've kind of dug down a couple of levels into our funding orders to look at the specific programs and where the funding is. That kind of gives us a better indication of where the spending (multiple speakers). That and--as Paul has mentioned, we are very focused on increasing our headcount as well, so that would be the other one I would say, Paul.

One other when you can throw in there is a [sometime] important, and that's the mix of the other direct costs. They rise up. You'll see a revenue spike maybe and without the margin to go along with it, because the ODCs don't carry the margin. I think we've covered every relevant metric that we know of that makes any sense to monitor, and we do monitor.

All right. Relative to the recompete losses that you've had recently, again, historically, as you mentioned, past performance is very important in terms of evaluation. In those events that you had so far this year, were the losses on a basis of performance, price, or where there other task consolidation issues that brought about the missteps there?

This is Bill Fairl again. What I can say to you is that they were not due to price. I will go back to what Paul said. He describes it very aptly there--was the talking about shaking and vibrating. We lost these jobs, quite frankly, because we, in a couple of specific cases, specific cases, we really weren't listening carefully to what the customers' needs were and what they were really telling us. That's why this program that Paul described earlier reporting directly to the CEO to increase our ability to sense, through what Paul calls triangulation, three different parties sensing what the customer is telling us, is important to us that if we don't do that again--that's the really frustrating thing about it. It wasn't a price issue. It was, in those two specific cases, listening clearly to what the customer wanted.

The good news is that's very fixable for us.

Bill Loomis, Stifel Nicolaus.

On the acquisitions and the one you said is hurting margins, I assume--is that ISF that you are referring to?

That is correct.

How much of that has been--I know the Army intelligence training contract was slow to ramp up. How much of it was that program versus others, versus additional stuff that hurt the margins? Is it because the revenues haven't ramped up as quickly as you thought on that or is it a profitability issue?

I would say, Bill, that we are a little light on the top. The margin issue--maybe Bill can handle that one. I'm not right on. I know that we had a little slow, slowness associated with the build-up. The military training contract, University military training contract down at (indiscernible) has been slow, I know, and the mix on that has been heavy ODC, so there's been a margin erosion on that a bit or little bit of a setback I would say.

Cash flow has been strong. They are able to win deals and have been able to use the ancillary contract, if I'm not mistaken, Bill, to stay ahead. I feel very good about the leadership over there. But Paul, you (multiple speakers) echo in here.

I think we had--you know, every time you begin one of these new M&A activities, there's always a little period of introduction to a new culture. I think that they have really come along quite nicely here. We're coming up on the first anniversary of the ISS acquisition, and what we are seeing out of that leadership team is exactly what we imagined. When we first met with them, we saw a team that was quite aggressive in the marketplace, especially in the ID/IQ task order world. They are continuing to demonstrate that. We're starting to use them to help leverage us on other ID/IQ vehicles by integrating some of their people into our business-development organization who have unique skills at turning these task orders quickly, these proposals.

So it was primarily that program and the higher ODCs at ISS (multiple speakers)?

(multiple speakers) This is Bill Fairl. I would add one more point to that. One of the things that we are so pleased with bringing the ISS folks into our team is of course they brought us the answer vehicle and then as you know, we won one of the ITES-2S contracts. Now, that one is a perfect example of what Paul was talking about earlier with the protest period. That was protested. That protest period went on a good seven months, I think, and was finally resolved here right at the end of calendar year 2006. That affected their ability to grow their labor content. We had been looking forward to some additional labor on that.

Gautam Khanna, Cowen & Company.

I'm just wondering. Long-term, when you think about your gross margins and kind of the factors that affected ODC mix, mix shift of time and materials to cost-plus, etc., and utilization most importantly, if you were to keep utilizations level today, where do you think gross margins would be kind of over the next two years?

Yes, this Bill Fairl. You know, we've taken a look at that and I think Paul talked earlier about our desire to move our ODC mix back more towards heavier CACI labor content. That will improve our profit margins, if you will, the focus of our B&P on those opportunities with higher labor content as well, and then growing the headcount. But as to predicting anything in the near future here, I think it's a little bit of a crystal ball kind of exercise.

I think both Jack and Paul (indiscernible) mention (technical difficulty) kind of the markets change. Margin is one indication of our business. We're focused on margin but we are also focused on earnings per share. So going forward, there may be some activities that we will entertain which are lower margin but still positive from an earnings-per-share shareholder value perspective.

Right--Tom. We have to make those trade-offs each and every day. An example--there are a number of examples where our clients have turned to us and we're proud of the fact they've turned to us and asked us to integrate the efforts of a number of partner contractors under one contract. Now, what that does is it raises our stature and it gives us more mind-share with those clients. It also gives us a more complex task and therefore helps our people learn and grow and take on more complicated efforts along the way. All of that is very healthy matriculation toward Tier 1 performance and ultimately will lead to assignment of tasks at that will have high labor content, independent of those specific contracts.

So I think, if you take a long-term view of that, we make those trade-offs; those are strategic opportunities for us. There are a number of those in the intel environment and in the Army environment, where we've stepped up, at the request of the client, to do exactly that. If we had to make those decisions again, we would make the exact same decision because it's a long-term view.

Understood. Just a quick follow-up, a housekeeping question. What were the cash taxes paid in the quarter?

The cash taxes paid in the quarter? Let us get that and get it to you. We will get that back to you. We don't have it right in front of us here.

Colin Gillis, Canaccord.

Could you just talk a little bit about if you are seeing an increase in the appetites (indiscernible) fees?

Yes, this is Bill Fairl. Yes, in the course--in some of our Navy work and also in certain parts of the intel community, we have in fact seen an increase in the number of cost-plus award fee type contracts. I don't have a specific percentage on it but I can tell you that is becoming a more popular tool for certain parts of our customer.

Do you think that's a trend that we can see going forward? I mean, it's still a very small piece of the portfolio right now currently, correct?

Yes, generally speaking. I think, again, it's those parts of our customers set that are inclined towards cost-reimbursable contracts. Again, that's primarily the Navy side of our business, so for us, I don't see a market, at least in the near term, a market movement in that direction.

Julie Santoriello, Morgan Stanley.

Good morning. I wanted to talk a little bit more about the source of the pricing pressure that you've been seeing. Is this primarily just driven by the competitive environment? Is it smaller competitors or is it the larger defense contractors that are coming out more aggressive on price?

I think what we are seeing in the environment is more competitors on each opportunity, which naturally leads to, therefore, more competition across the board, which is a healthy thing. But it also sometimes can lead to what we call irrational pricing by people who are semi-desperate to get some business to make a number, make a quota. I would say that is maybe a little more prevalent than what we've seen in historical periods, but it's not some dramatic factor right now. There is a continuing price pressure in the environment, and that comes from the customer, mostly coming from the customer demanding or needing a lowering of price so that they can meet their budget targets. With a shift of priority toward the war, we have to react to that. So there is more pricing pressure in the environment, but I'm cautious about letting you believe that there is some dramatic thing going on here. There's more--.

Or something we can pinpoint, per se.

Yes, it's not a dramatic effect and it's not something we figure everyday and say oh, my G-d, the competition is so hard or the prices are going so low. You know, we're focused more about innovation and value in our proposals to our clients. We know it's generally true that that's what wins--is innovation and value, because customers will pay a little more in fact for exciting new things that you can bring to them. That's how we focus, but others will sometimes dive and take a low price to get into the business.

Okay, that's helpful. Somewhat along the same lines, I'm wondering if I can get your read on the competition with the large defense contractors. At least from the little we hear in their conference calls about their IP services business, they do seem to be faring a bit better and don't seem to be painting such a tough outlook for the next few quarters. Anything that you can read into that, in terms of why they made (multiple speakers)?

I would say that you should ask ten more questions about that, because we don't observe that here. We observe almost the opposite phenomenon.

Well, I know we've been taking business away from some of the major aerospace houses, three or four hits recently, very contesting in that area. I don't feel, with any particular debilitations or holdbacks. We were able to go very aggressively against them. I will say one thing; we are taking significant pieces of business from the, so they can't be all that great.

We aren't taking that business based on price. We are taking that business based on value and innovation.

S3, Encore 2, and we could name four or five others, especially in the black area.

There are a number of those Tier 1 companies you're talking about, you are referring who would envy our track record on Tier 1 wins in the last 12 months.

Tim Quillin, Stephens Inc.

Good morning. Could you talk about the swing factors? I know we've probably discussed this a little bit on your most recent conference call--but the swing factors that might influence your guidance either towards the low end of the rage or the high end of the range? Are there any specific opportunities that might serve as swing factors or specific factors?

When we provide the guidance, we're trying to provide the kind of middle-of-the-fairway type of guidance and kind of give you our best expectations. You know, there's [uncertainty] with regards to government funding, which we articulated both today and on January 18 on the call. There are no kind of singular events which may dramatically swing it one way or the other. A lot of the funding is kind of the longer-term (indiscernible) programs and so we are not that susceptible to shorter-term in fluctuations.

I think more of what we've seen that has moved us toward the lower edge of guidance recently has been the things we mentioned earlier, the shift in priority toward the war and budgetary pressures, continuing resolution, protest activity, degree of difficulty in hiring. These are the factors that principally--if those factors continue, then it steer us toward the lower end.

To the extent that we--and the ones we control, of course, are hiring, winning our recompetes and hiring. The others, the protests and the (technical difficulty) resolution and budget pressures to support war, we have no control, literally no control over those. So those are the things that are having the great effect on whether we are at one end of the guidance or the other.

I would only add, just to reach to give you some perspective on a lower probability or less-likely side, is the wild-card that you observe day to day in the Congress right now with regard to their view of the new Congressional profile in terms of view of the War on Terror going forward. That's a kind of wild-card. I don't think it's very likely that it will have an impact, but you're asking me to stretch a bit and that's my stretch for you.

Sort of if I were in your shoes kind of statement, I would take all the protests that are out there and build a little matrix of all the companies that are on those big vehicles that we've talked about that are still being protested or have been just recently come on protest. I would watch carefully when those protests resolve themselves and how they resolve themselves; that would give you some sense for--I know we look at that.

Do you have a specific sense of pent-up demand for task orders under certain of those protested ID/IQ?

We do, but it's not--when you say specific, we can't seed like a queue of task orders that are lined up underneath them, but we know there is, in general, latent demand on ITES-2S, for example, which we will start seeing task orders on this quarter, towards the end of this quarter and into the fourth quarter. For example, FIRST of course has gotten latent demand because FIRST is all about resetting the force. There's a huge requirement there. Nobody is--15 awardees but nobody can get started on the work, so there's pent-up demand on that one.

You're talking about Army FIRST.

Army FIRST.

The contract, right?

The big Army FIRST contract. Bill, can you think of any others like that?

Well there was our (multiple speakers) S3, and also I would say the--you've probably noticed the award through our new joint venture that was just made to us, the $330 million job down in New Orleans. Now, that was initially subject to a protest but that was resolved a couple of weeks ago. We are just beginning to ramp that one up now so that one will really gain steam beginning in our fourth quarter of this year.

I know that's one that we think all these protests and we have a spreadsheet of all these protests and the revenue that we plan to get and the revenue that we will get, we expect to get. So, we watch that very carefully, is the point, from a standpoint of analyzing where we're going to be.

Jason Kupferberg, UBS.

As we're talking about current environment, I guess we can appreciate the reasons why the government customers are being so cautious. What kind of indications are they giving you what they really need to see happen before they would consider moving forward more actively with RFPs, awards, funding actions? I mean, is it just as simple as seeing some of the protests resolved and seeing troops surges turn into troop withdrawals at some point in time? Or if you kind of really drill down to the day-to-day, what are they telling you they need to see to get more comfortable?

The thing that I pick up, and I walk the streets on these topics obviously, is a concern about the war in Iraq. I think if I were to say what is the single over-arching driver, it would be that. There are other things that play in there as well, but I think that's the one thing is sort of the lack of clarity right now on intent to support the war. I'd say it's the overhang; I will use that term.

I think the one thing that is going to happen in the government fiscal '08 budget, David tells us, is that the supplemental will be subsumed into the normal defense appropriations bills. That will probably help a little to give our clients a sense of what they have to spend earlier in the process. But other than that, the protests, they are as anxious as we are to see these protests end so they can get their work done, you know?

One thing I would mention, just because it's important, is the conventional wisdom we picked out on the streets--is that the army is going to continue to get the funding priorities, along with the United States Marine Corps ground forces. The taxpayers, if you will, on this are going to be mostly Air Force and Navy. We hear more and more Air Force, but on the other hand, the Chief of Staff, General Mosley, just came out with an announcement here the other day that they are setting up an intelligence directorate within the Chief of Staff of the Air Force. So they are moving in areas where I would have anticipated. It's, again, trying to get out in front on the intel requirements so we can get ahead of what the opposition and the enemy forces, if you will, how they are maneuvering out there. So we are going to see that kind of money still flowing in those areas.

Okay. Just to switch gears for a second, when you guys make job offers, what kind of acceptance rate do your target and are you currently in that range?

What kind of acceptance rates?

Yes. When you offer a job to someone, what's the acceptance rate your target in terms of them (multiple speakers)?

We don't have that in front of us, but my general impression, from talking to our people, is very high--that by the time we make someone an offer, we're pretty sure they are going to take the offer.

(multiple speakers) I would say extremely high, but that doesn't play against how many people we've talk to.

Right. I think you would probably see the shakeout occurs before the offer is made. The shakeout happens in the interviewing process, based on the individual's attraction to the type of work we're talking about. The exact compensation value is going to be about the same as some competitor would offer. There are not real bidding wars generally that go on for people.

Ferat Ongeron, Citigroup.

Good morning. My first question is on your intelligence business that is in the DoD side. Could we just talk about the trends that you see there, both in terms of revenues and margin? Are you seeing the same shift to cost-plus with that customer?

Yes, this is Bill Fairl. In terms of the shift to cost-reimbursable, certain parts of our intel community clients, we have seen some shift to cost-reimbursable contracts. It's not broad; it's not across the board. I think, as I mentioned earlier in answer to a question, there is a little bit of an uptick in cost-plus award fee type of arrangements as well.

In terms of revenues, what were the trends under the DoD side of the intelligence business?

Well, we have combined that. We look at intel as a single basket and we are about 28% of our revenue now. That's up about 10% from last year at this time.

I see, okay. Then a quick one on M&A--one of your competitors suggested that they basically saw the private variations holding up. Obviously, your multiple has come down significantly, even on lower numbers. The question I have is whether you're thinking about returning any cash to the shareholders via buyback, etc., as opposed to making higher-multiple deals.

I think you are asking a question that has to do with the buyback. I don't think that the Company will be moving into a share buyback situation. Certainly, we've done that in the past and it's accretive, obviously. There's always some consideration but the Board, CACI, our strategy, our game plan has been always to focus on using our dollars to acquire or to develop business. I think that has been a successful program here.

In terms of multiples, I don't think we have any issue on multiples for now. We are still looking at acquiring companies in the pricing (indiscernible) so what we're seeing out there, both private and some of the smaller publics. I think the takeout numbers are still very consistent with what we can afford (technical difficulty) moving out. So we don't see that right now as being a barrier or an impediment to our game plan proceeding forward.

Now, we do have sort of a two-track thing going on here. We have what I will call a smaller tuck-in strategic acquisitions program which has been very effective for us. We are also looking at larger deals, opportunities from larger companies that I would call more strategic positioning or defining event-type transactions, which we've been good at as well. A couple of them (indiscernible) Questech acquisition back in the late '90s. Bill Fairl came to us through Questech. Welcome aboard, Bill! The AMS contract base defense intelligence that we bought off when AMS went out of business I think was a very successful transaction. So we were looking at significant, defining-event transactions as well as smaller tuck-ins.

Christine Pezino, JPMorgan.

Good morning. Thanks for taking my question. Just a couple kind of broader questions, I guess. You know, as we are gearing up here for that fiscal '08 budget proposal from the President next week, do you anticipate any further cuts in defense and civil agencies, or is there any kind of preliminary view you can give us on what you're looking for there?

Christine, this is Dave Dragics. There have been a lot of budget leaks lately. I can take those up with you after the call. Basically, there's been no significant shift in the priorities of the Bush administration with regards to the budget. I think the significant thing that we will see next week on Monday when the budget comes out are two things. In the FY '08 appropriations you will see, both as mentioned earlier on the call, both the full appropriations for the Department of Defense and the request for appropriations for the war, which will put defense spending somewhere well over $500 billion for the year.

The second thing you will see is the supplemental to the FY '07 supplemental come out, which will be anywhere between 100 and 107 billion because I think the Bush administration is going to obviously put the surge in the supplemental. When the supplemental is considered, some of the cuts under the continued resolution that will start after February 15 that they did with regards to the [BRAC] and some military expenses may be added to that. But still the priority is going to be on national defense, intelligence, and homeland security.

Okay, great, that's helpful. Thanks, Dave. Then, you mentioned task order cancellations. Can you maybe elaborate on the extent to which you are seeing task orders get canceled? Is it in certain areas? Then when was the last time you had seen task order cancellations at this level?

When was the last time we had seen this phenomena?

Yes.

The kind of canceled -- what we are seeing is less of a cancellation of a task order; that has occurred on smaller task orders on occasion recently. But predominantly, what we are seeing is the customer asking us to stretch the work out over a longer period of time

(multiple speakers)

--and therefore not ramping the staff up to what you would expect would be required normally, and in some cases, customers coming back and asking us to take a reduction, saying, out of 50 people working on this project, we need you to reduce 5 off that. It's more like that than it is somebody canceling a task order although (multiple speakers).

(multiple speakers) (indiscernible) but that's not the same as canceling.

Does that help?

(OPERATOR INSTRUCTIONS) Tim Quillin, Stephens Inc.

Yes. Just really quickly, I guess, in my view, there's a lot of symptoms of the market issues, but it really comes down to the cost of the war squeezing out funding for other federal programs. What changes the environment? Do we have to wait until the war starts winding down? Do you think that Congress will start appropriating more money to fund modernization, IT modernization efforts? What changes the environment? When does it change?

Dave (indiscernible)?

I think I can address--the underlying cause of a lot of the reduction and delays that we are seeing in the funding orders is due to the way, at least up through this fiscal year, '07, is the way that the Defense Department-the total appropriations, appropriations plus supplemental, have occurred. Because you get the appropriation bill passed first, there's a supplemental or bridge loan in it that lasts them so long, like for instance for the FY '07 appropriation which had $70 billion of supplemental funding. The Department of Defense has informed Congress that they would like to see the new supplemental be proposed next week, passed by mid-April, otherwise they will run out of what was originally given to them in the appropriations bill and have to start reprogramming funds.

So it that 1-2 step that we've seen this year and previous years, whatever, since 9/11, where you have seen the supplemental funding, which will now total over $500 billion when you add in what's going to be proposed next week. That will be alleviated next year when you see the full request upfront, Tim, and then you won't get this "I've got--here's my appropriation; I've got to wait for the supplemental."

Yes, unless, of course, there's unforeseen costs of the war and there's another supplemental down the road.

Yes, I think David's point is a good point, that that is a part of the phenomenon. The other part of the phenomenon is the we see shifting of funds to support, directly and indirectly, the war, at least when we ask our customers, and we have. We went back and did an analysis of all of this slowdown, and we went to our customers and asked them what's causing it. Their answer was hey, we've got budget pressures; there's a need to shift more toward support of the war. If you are looking for a theme or a trend in the answers we got back from our customers, that was it. That was the big thing we heard from the people who have the checkbook to write the checks to us.

A lot of this--I would just speculate from a global and strategic standpoint which we also keep a close eye on--is there's some wild-card out ahead of us that nobody necessarily can predict. That's the gaining momentum that you see in Iran, for example, and its involvement in the Middle East. Admiral Fox Fallon is going to be taking [setcom]. He's somebody I've known for a number of years. He is going to be going over there as a naval officer. I recognize that that's a very dramatic shift. There's never been a naval flag officer in that command but in part that would be because if things do move into an uncomfortable situation with Iran, the battle groups will be a big play in that area, the carrier groups. So you've got a whole raft of things that could pop out on us in a very adverse way over the next 12 to 18 months.

So I wouldn't get too locked down on exactly what's happening in the Congress. I don't believe, for example, that the Democratic-controlled Congress is going to jeopardize its prospects in the future by cutting back on monies and take a risk that things really go Deep Six in the Middle East. I would be very surprised to see them take that kind of a political risk.

There's a lot of posturing; it's political posturing, in my opinion, right now, but the threats are real. I just attended a conference yesterday on the monies, how the monies are still flowing in the al-Qaeda nets and they are still working the electric systems around the world. The money is still flowing and is gaining momentum. So this thing is real. There's a lot of wild-cards ahead of us. So I would not get too concerned about things that are deep-sixing on the budget lines, no matter what the budget next week comes out. The world is dangerous as hell, and I think that is going to be responded to, first and foremost.

At this time, we have no other questions. I'd like to turn the call back over to management for any additional or closing comments.

All right, well, I certainly want to thank you, Matt, for your help today and I certainly appreciate it. I would like to thank everyone on the call for your participations and questions and your interest in CACI International. We feel like we've had a good exchange with everyone today, a lot of fine questions. We know that there may be some other questions you folks may have or some of you have for us. As is our custom, we will have the team available here in about 20 minutes to take any further calls you may have on some of the details.

So, thank you all for coming aboard with us this morning. That concludes our second-quarter conference call. We wish you a good day and thank you.

Again, that does conclude today's call. Thank you for your participation and have a good day.