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CACI > SEC Filings for CACI > Form 10-K on 28-Aug-2014All Recent SEC Filings

Show all filings for CACI INTERNATIONAL INC /DE/

Form 10-K for CACI INTERNATIONAL INC /DE/


28-Aug-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition & Results of Operations

The following discussion and analysis of our financial condition and results of operations is provided to enhance the understanding of, and should be read together with, our consolidated financial statements and the notes to those statements that appear elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Unless otherwise specifically noted, all years refer to our fiscal year which ends on June 30.

Overview

We are a leading provider of information solutions and services to the U.S. government. We derived 94.0 percent of our revenue during the year ended June 30, 2014 from contracts with U.S. government agencies, including 72.3 percent from DoD customers and 21.7 percent from U.S. federal civilian agency customers


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including the Department of Homeland Security. We also provide services to state and local governments, commercial customers and agencies of foreign governments.

Budgetary pressures and sequestration have created a challenging environment for us and other companies in our industry. For further information on the trends currently impacting us, please see Item 1, Business - Industry Trends.

For the year ended June 30, 2014, 89.5 percent of our revenue was from contracts where we were the lead, or "prime," contractor. Our contract base has approximately 580 active contracts and 1,507 active task orders. We have a diverse mix of contract types, with 49.0 percent, 30.7 percent, and 20.3 percent of our revenue for the year ended June 30, 2014, derived from cost-reimbursable, fixed-price and time and materials (T&M) contracts, respectively.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires us to make estimates and judgments that affect the amounts reported in those financial statements and accompanying notes. We consider the accounting policies and estimates addressed below to be the most important to our financial position and results of operations, either because of the significance of the financial statement item or because they require the exercise of significant judgment and/or use of significant estimates. Although we believe that the estimates we use are reasonable, due to the inherent uncertainty involved in making those estimates, actual results reported in future periods could differ from those estimates.

Revenue Recognition/Contract Accounting

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee is fixed or determinable, and collectability is probable.

We generate almost all of our revenue from three different types of contractual arrangements: cost-plus-fee, T&M, and fixed-price contracts. Revenue on cost-plus-fee contracts is recognized to the extent of allowable costs incurred plus an estimate of the applicable fees earned. We consider fixed fees under cost-plus-fee contracts to be earned in proportion to the allowable costs incurred in performance of the contract. For cost-plus-fee contracts that include performance based fee incentives, and that are subject to the provisions of Accounting Standards Codification (ASC) Section 605-35, Revenue Recognition - Construction-Type and Production-Type Contracts (ASC 605-35), we recognize the relevant portion of the expected fee to be awarded by the customer at the time such fee can be reasonably estimated, based on factors such as our prior award experience and communications with the customer regarding performance. For such cost-plus-fee contracts subject to the provisions of ASC 605-10-S99, Revenue Recognition - SEC Materials (ASC 605-10-S99), we recognize the relevant portion of the fee upon customer approval. Revenue on T&M contracts is recognized to the extent of billable rates times hours delivered for services provided, to the extent of material cost for products delivered to customers, and to the extent of expenses incurred on behalf of the customers. Shipping and handling fees charged to the customers are recognized as revenue at the time products are delivered to the customers.

We have several basic categories of fixed price contracts: fixed unit price, fixed price-level of effort, and fixed price-completion. Revenue on fixed unit price contracts, where specified units of output under service arrangements are delivered, is recognized as units are delivered based on the specified price per unit. Revenue on fixed unit price maintenance contracts is recognized ratably over the length of the service period. Revenue for fixed price-level of effort contracts is recognized based upon the number of units of labor actually delivered multiplied by the agreed rate for each unit of labor.

A significant portion of our fixed price-completion contracts involve the design and development of complex client systems. For these contracts that are within the scope of ASC 605-35, revenue is recognized on the percentage of completion method using costs incurred in relation to total estimated costs. For fixed price-completion contracts that are not within the scope of ASC 605-35, revenue is generally recognized over the period when services are provided.


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Contract accounting requires judgment relative to assessing risks, estimating contract revenue and costs, and making assumptions for schedule and technical issues. Due to the size and nature of many of our contracts, the estimation of total revenue and cost at completion is complicated and subject to many variables. Contract costs include material, labor, subcontracting costs, and other direct costs, as well as an allocation of allowable indirect costs. Assumptions have to be made regarding the length of time to complete the contract because costs also include expected increases in wages and prices for materials. For contract change orders, claims or similar items, we apply judgment in estimating the amounts and assessing the potential for realization. These amounts are only included in contract value when they can be reliably estimated and realization is considered probable. Incentives or penalties related to performance on contracts are considered in estimating sales and profit rates, and are recorded when there is sufficient information for us to assess anticipated performance. Estimates of award fees for certain contracts may also be a factor in estimating revenue and profit rates based on actual and anticipated awards.

Long-term development and production contracts make up a large portion of our business, and therefore the amounts we record in our financial statements using contract accounting methods are material. For our federal contracts, we follow U.S. government procurement and accounting standards in assessing the allowability and the allocability of costs to contracts. Due to the significance of the judgments and estimation processes, it is likely that materially different amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. We closely monitor compliance with, and the consistent application of, our critical accounting policies related to contract accounting. Business operations personnel conduct periodic contract status and performance reviews. When adjustments in estimated contract revenue or costs are required, any significant changes from prior estimates are included in earnings in the current period. Also, regular and recurring evaluations of contract cost, scheduling and technical matters are performed by management personnel who are independent from the business operations personnel performing work under the contract. Costs incurred and allocated to contracts with the U.S. government are scrutinized for compliance with regulatory standards by our personnel, and are subject to audit by the DCAA.

From time to time, we may proceed with work based on client direction prior to the completion and signing of formal contract documents. We have a formal review process for approving any such work. Revenue associated with such work is recognized only when it can be reliably estimated and realization is probable. We base our estimates on previous experiences with the client, communications with the client regarding funding status, and our knowledge of available funding for the contract or program.

Costs of Revenue

Costs of revenue include all direct contract costs as well as indirect overhead costs and selling, general and administrative expenses that are allowable and allocable to contracts under federal procurement standards. Costs of revenue also include costs and expenses that are unallowable under applicable procurement standards, and thus are not allocable to contracts for billing purposes. Such costs and expenses do not directly generate revenue, but are necessary for business operations.

Accounting for Business Combinations, Goodwill and Acquired Intangible Assets

The purchase price of an acquired business is allocated to the tangible assets and separately identifiable intangible assets acquired less liabilities assumed based upon their respective fair values, with the excess recorded as goodwill.

We evaluate goodwill at least annually for impairment, or whenever events or circumstances indicate that the carrying value may not be recoverable. The evaluation includes comparing the fair value of the relevant reporting unit to the carrying value, including goodwill, of such unit. The level at which we test goodwill for impairment requires us to determine whether the operations below our operating segments constitute a self-sustaining business for which discrete financial information is available and segment management regularly


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reviews the operating results. If the fair value exceeds the carrying value, no impairment loss is recognized. However, if the carrying value of the reporting unit exceeds its fair value, the goodwill of the reporting unit may be impaired. Impairment is measured by comparing the derived fair value of the goodwill to its carrying value. Separately identifiable intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment if impairment indicators are present.

We estimate the fair value of our reporting units using both an income approach and a market approach. The valuation process considers our estimates of the future operating performance of each reporting unit. Companies in similar industries are researched and analyzed and we consider the domestic and international economic and financial market conditions, both in general and specific to the industry in which we operate, prevailing as of the valuation date. The income approach utilizes discounted cash flows.

We evaluate goodwill as of the first day of the fourth quarter. In addition, we will perform interim impairment testing should circumstances requiring it arise. We completed our annual goodwill assessment as of April 1, 2014 and no impairment charge was necessary as a result of this assessment. We have concluded that none of our reporting units are at risk of a goodwill impairment in the near term as their fair values are considerably greater than their carrying values.

Determining the fair values of the reporting units inherently involves management judgments regarding assumptions about future sales, profits and cash flows and the effect of the market conditions on those assumptions. Due to the variables inherent in the estimation of a reporting unit's fair value and the relative size of our goodwill, differences in assumptions could have a material effect on one or more of our reporting units and could result in a goodwill impairment charge in a future period.

Stock-Based Compensation

Under our 2006 Stock Incentive Plan, we issue equity instruments on an annual basis to our directors and key employees. These instruments may take the form of, among others, shares of restricted stock, restricted stock units (RSUs), stock settled stock appreciation rights (SSARs) and non-qualified stock options (NQSOs). We also issue equity instruments in the form of RSUs under our Management Stock Purchase Plan and Director Stock Purchase Plan.

We account for share-based payments to employees, including grants of employee stock awards and purchases under employee stock purchase plans, in accordance with ASC 718, Compensation-Stock Compensation, which requires that share-based payments (to the extent they are compensatory) be recognized in our consolidated statements of operations based on their fair values. We determine the fair value of our NQSOs and SSARs at the date of grant using option-pricing models such as the Black-Scholes or binomial lattice model. We determine the fair value of our market-based and performance-based RSUs at the date of grant using generally accepted valuation techniques and the closing market price of our stock. Stock-based compensation cost is recognized as expense over the requisite service period.

Under the terms of the various equity instrument agreements, vesting of awards may accelerate to varying degrees based on the age of the grantee and the type of equity instrument. Depending on the instrument, vesting may accelerate upon retirement at either age 62 or 65 with the amount of acceleration based on the length of service provided.


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Results of Operations

The following table sets forth the relative percentages that certain items of expense and earnings bear to revenue.

                     Consolidated Statements of Operations

                              Years ended June 30,



                                                                                                                                                        Year to Year Change
                                        2014              2013              2012            2014          2013          2012               2013 to 2014                     2012 to 2013
                                                         Dollars                                       Percentages                    Dollars         Percent          Dollars        Percent
                                                                                                   (dollar amounts in thousands)
Revenue                              $ 3,564,562       $ 3,681,990       $ 3,774,473         100.0 %       100.0 %       100.0 %     $ (117,428 )         (3.2 )%     $ (92,483 )         (2.5 )%

Costs of revenue
Direct costs                           2,426,520         2,535,606         2,598,890          68.1          68.8          68.9         (109,086 )         (4.3 )        (63,284 )         (2.4 )
Indirect costs and selling
expenses                                 815,458           821,465           819,772          22.9          22.3          21.7           (6,007 )         (0.7 )          1,693            0.2
Depreciation and amortization             65,181            54,078            55,962           1.8           1.5           1.5           11,103           20.5           (1,884 )         (3.4 )

Total costs of revenue                 3,307,159         3,411,149         3,474,624          92.8          92.6          92.1         (103,990 )         (3.0 )        (63,475 )         (1.8 )

Income from operations                   257,403           270,841           299,849           7.2           7.4           7.9          (13,438 )         (5.0 )        (29,008 )         (9.7 )
Interest expense and other, net           38,158            25,818            24,101           1.1           0.7           0.6           12,340           47.8            1,717            7.1

Income before income taxes               219,245           245,023           275,748           6.1           6.7           7.3          (25,778 )        (10.5 )        (30,725 )        (11.1 )
Income taxes                              83,326            92,347           107,537           2.3           2.6           2.9           (9,021 )         (9.8 )        (15,190 )        (14.1 )

Net income including portion
attributable to noncontrolling
interest in earnings of joint
venture                                  135,919           152,676           168,211           3.8           4.1           4.4          (16,757 )        (11.0 )        (15,535 )         (9.2 )
Noncontrolling interest in
earnings of joint venture                   (603 )            (987 )            (757 )        (0.0 )        (0.0 )        (0.0 )            384           38.9             (230 )         30.4

Net income attributable to CACI      $   135,316       $   151,689       $   167,454           3.8 %         4.1 %         4.4 %     $  (16,373 )        (10.8 )%     $ (15,765 )         (9.4 )%

Revenue

For FY2014, our total revenue decreased from FY2013 by $117.4 million, or 3.2 percent, primarily related to a decrease in revenue from DoD. Six3 Systems, acquired November 15, 2013, generated $268.4 million of revenue from its date of acquisition through June 30, 2014. Excluding the Six3 Systems revenue, revenue decreased by 10.5 percent year over year. This decrease in revenue was primarily attributable to delays in planned awards, lower run rates on professional services contracts, reductions in Afghanistan-related material purchases, and the government shutdown which occurred between October 1 and October 16, 2013.

For FY2013, our total revenue decreased by $92.5 million, or 2.5 percent. Our revenue from existing operations decreased 5.7 percent, or $216.8 million, primarily related to a decrease in revenue from DoD. This decrease was partially offset by $124.3 million of revenue associated with acquired businesses.


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The following table summarizes revenue earned by each of the customer groups for the three most recent fiscal years:

                                                                Years ended June 30,
                                         2014                           2013                           2012
                                                           (dollar amounts in thousands)
Department of Defense          $ 2,578,024         72.3 %     $ 2,735,102         74.3 %     $ 2,944,924         78.0 %
Federal civilian agencies          771,662         21.7           741,053         20.1           620,870         16.5
Commercial and other               199,521          5.6           190,142          5.2           193,840          5.1
State and local governments         15,355          0.4            15,693          0.4            14,839          0.4

Total                          $ 3,564,562        100.0 %     $ 3,681,990        100.0 %     $ 3,774,473        100.0 %

Revenue from DoD customers decreased 5.7 percent, or $157.1 million, to $2.6 billion for FY2014 as compared to FY2013. This decrease was attributable primarily to lower other direct costs (ODCs) as a result of both the draw down in Afghanistan and sequestration-related reductions, the government shut down which occurred between October 1 and October 16, 2013 and resulted in a reduction of approximately $13.0 million of revenue. DoD revenue includes services provided to the U.S. Army, our largest customer, where our services focus on supporting readiness, tactical military intelligence, and communications systems. DoD revenue also includes work with the U.S. Navy, and other DoD agencies.

Revenue from DoD customers decreased 7.1 percent, or $209.8 million, to $2.7 billion for FY2013 as compared to FY2012. This decrease was attributable primarily to lower other direct costs (ODCs) as a result of both the draw down in Afghanistan and sequestration-related reductions.

Revenue from federal civilian agencies increased 4.1 percent, or $30.6 million, to $771.7 million during FY2014 as compared to FY2013. This increase is attributable to recent acquisitions as well as growth in certain on-going federal civilian agency programs. Federal civilian agency revenue also includes services provided to non-DoD national intelligence agencies.

Revenue from federal civilian agencies increased 19.4 percent, or $120.2 million, to $741.1 million during FY2013 as compared to FY2012. Of the federal civilian agency revenue growth, $96.6 million was attributable to acquisitions.

Commercial and other revenue increased 4.9 percent, or $9.4 million, to $199.5 million in FY2014 as compared to FY2013. Commercial revenue is derived from both international and domestic operations. In FY2014, international operations accounted for 71.7 percent, or $143.0 million, of the total commercial revenue, while domestic operations accounted for 28.3 percent, or $56.5 million.

Commercial and other revenue decreased 1.9 percent, or $3.7 million, to $190.1 million in FY2013 as compared to FY2012. During FY2012, we had a commercial product sale that generated $12.0 million in revenue. In FY2013, international operations accounted for 70.8 percent, or $134.5 million, of the total commercial revenue, while domestic operations accounted for 29.2 percent, or $55.6 million.

Revenue from state and local governments decreased by 2.2 percent, or $0.3 million during FY2014, as compared to FY2013. In FY2013 as compared to FY2012, revenue from state and local governments increased by 5.8 percent, or $0.9 million. Revenue from state and local governments represented less than one percent of our total revenue in each of FY2014, FY2013, and FY2012.


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Income from Operations

Income from operations decreased 5.0 percent or $13.4 million, in FY2014 as compared to FY2013. Our operating margin was 7.2 percent, down from 7.4 percent during the same period a year ago. This decrease in margin is primarily attributable to acquisition-related costs and the amortization of intangibles acquired in the Six3 Systems acquisition plus one-time expenses associated with the acquisition of Six3 Systems. Income from operations decreased 9.7 percent, or $29.0 million, in FY2013 as compared to FY2012. Our operating margin in FY2013 of 7.4 percent decreased from 7.9 percent in FY2012. Operating margin during FY2012 was favorably impacted by greater than expected profitability on a large fixed price contract.

During the fiscal years ended June 30, 2014, 2013, and 2012, as a percentage of revenue, total direct costs were 68.1 percent, 68.8 percent, and 68.9 percent, respectively. Direct costs include direct labor and ODCs, which include, among other costs, subcontracted labor and materials along with equipment purchases and travel expenses. ODCs, which are common in our industry, typically are incurred in response to specific client tasks and may vary from period to period.

The single largest component of direct costs, direct labor, was $1.0 billion, $1.0 billion and $977.7 million in FY2014, FY2013, and FY2012, respectively. ODCs were $1.4 billion, $1.5 billion, and $1.6 billion in FY2014, FY2013, and FY2012, respectively. This decrease from FY2013 to FY2014 was primarily driven by the October 2013 government shutdown and reductions in ODCs in Afghanistan related material purchases and subcontract labor.

Indirect costs and selling expenses which include fringe benefits (attributable to both direct and indirect labor), marketing and bid and proposal costs, indirect labor and other discretionary expenses, decreased $6.0 million or 0.7 percent in FY2014 as compared to FY2013. The decrease is primarily attributable to cost reduction activities that were implemented in the second half of FY2013 and during FY2014. As a percentage of revenue indirect costs and selling expenses were 22.9 percent, 22.3 percent and 21.7 percent for FY2014, FY2013 and FY2012, respectively. Indirect cost and selling expenses in FY2014 included $11.7 million of expenses associated with the acquisition of Six3 Systems including $4.2 million of expenses associated with retention bonuses that are part of the agreements we have with certain Six3 Systems executives. In addition, indirect costs for FY2014 included $4.1 million loss on extinguishment of indebtedness.

Indirect costs and selling expenses increased $1.7 million or 0.2 percent in FY2013 as compared to FY2012. As a percentage of revenue indirect costs and selling expenses were 22.3 percent and 21.7 percent for FY2013 and FY2012, respectively. In addition to an increase in fringe benefit expense associated with our increase in direct labor, indirect costs and selling expenses were increased by $7.1 million of severance expense and $2.3 million of lease-related expenses associated with cost reduction activities. These actions resulted from a strategic review of our business in response to sequestration and other government actions which negatively impacted our operations. Bonus expense recorded in FY2013, which in large part is based on the Company's performance, was $34.3 million lower than bonus expense recorded in FY2012.

Depreciation and amortization expense increased $11.1 million, or 20.5 percent, in FY2014 as compared to FY2013. The increase was primarily attributable to amortization of intangible assets associated with the Six3 Systems acquisition. In FY2013 as compared to FY2012, depreciation and amortization expense decreased $1.9 million, or 3.4 percent. The decrease was attributable to decreased amortization of intangible assets offset by increases in depreciation and leasehold improvement amortization expense.

Net interest expense and other increased $12.3 million, or 47.8 percent, in FY2014 as compared to FY2013. This increase was primarily attributable to the additional indebtedness incurred in connection with the Six3 Systems acquisition. Net interest expense and other increased $1.7 million, or 7.1 percent, in FY2013 as compared to FY2012 primarily as a result of an increase in interest expense related to higher outstanding debt. Interest expense and other includes a reduction for our share of the net income of AC First, LLC, a venture between us and AECOM Government Services, Inc. of $1.5 million in FY2014 and $2.6 million in FY2013.


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The effective income tax rates in FY2014, FY2013, and FY2012, were 38.1 percent, 37.8 percent, and 39.1 percent, respectively. The tax rate in each year benefitted from tax benefits related to deductions claimed for income from qualified domestic production activities and non-taxable gains on assets invested in corporate-owned life insurance (COLI) policies.

Quarterly Financial Information

Quarterly financial data for the two most recent fiscal years is provided in Note 25, Quarterly Financial Data, in the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K.

Effects of Inflation

During FY2014, 49.0 percent of our business was conducted under cost-reimbursable contracts which automatically adjust revenue to cover costs that are affected by inflation. 20.3 percent of our revenue was earned under T&M contracts, where labor rates for many of the services provided are often fixed for several years. Under certain T&M contracts containing IDIQ procurement arrangements, we do adjust labor rates annually as permitted. The remaining portion of our business is fixed-price and may span multiple years. We generally have been able to price our T&M and fixed-price contracts in a manner that . . .

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