CACI International Inc (CACI) Earnings Call Transcript & Summary

All right. Good afternoon, everybody. This is Gavin Parsons with Goldman Sachs, and I'm happy to introduce John Mengucci, the CEO of the CACI. John, thanks for being with us today.

You bet. Thanks so much for having us, Gavin.

But thanks for being here virtually, I'll correct that.

Maybe diving right in on COVID-19. You discussed the impact at length a couple of weeks ago with earnings. Is it your sense that we're past the most disruptive impact of your work activity and the ability to complete work and or you having any discussions about reopening or kind of at least return to work for those that are disrupted?

Yes. Thanks, Gavin. You referred to our third quarter call, and that was where we shared that we have about 10% of all the hours that we invoice in any given month are going to be classified, what we would call, is CARES Act Recoverable Hours. And those are -- under the current legislation allow us to recoup our costs, but not fee and profit. The rest of all of our hours, rest of all of our invoices across the business, whether for technology or for expertise, this is as usual, invoice full fee full profit. Over the last couple of weeks, since the earnings call, I have been taking calls from customers. They are starting to put in place and beginning those discussions about how do we move from how we're situated today to how we're going to be situated tomorrow, a lot of that is Zip code based and building based at all. But as our customer moves to 20% occupancy, the 30% as we move from 10% to 20%. I think we will -- I don't think, I actually know, we will see things get better. We do have some folks who have work that they do in a secure classified environment, and they cannot do that today. That's what the CARES Act was there for to make sure that those very talented national security folks stay with our company and stay supporting our federal government customer. So those are the kind of folks we're going to try to look to bring that first. Again, making sure we're following every CDC rule and every bit of guidance to be able to bring them back. So a lot of moving parts. Have we seen the worst of it? I'd like to think we have. We did -- our fiscal year, as you all know, closes in June. We'll be going to FY '21 guidance shortly. We believe we have enough running time to understand sort of where we're positioned at. There are some other things that could happen in the future. But for right now, I'm very happy with the resiliency of this company and the fact that we've been able to drive top and bottom line growth even through all of this.

And you mentioned all the moving parts. On the revenue side, you sized the $65 million headwind this year. How much of that is just -- is lost versus something you can make up in the future, whether it be a slipped product sale or a customer to catch up on schedule?

Yes. So on the revenue side, there's a majority of that, that was profit dollars and hours not working alike and that's going to be revenue loss, frankly. On the net income side, about 1/3 of that net income was product-related timing. So that's just acceptance of product deliveries because of the reduced workforce on the government side to be able to accept some of these products. So that will come back. The -- but yes, the rest of it is all fee on those non fee-bearing and voices for we have CARES, which then connects back to the quicker we're able to get those folks back to full-time working off of using the CARES Act, then things will return to normal.

Got it. And then in terms of ability to hire and kind of execute on all the work that you've won that's currently in the backlog, any disruption to your ability to hire and get people started on new work?

Yes. So hiring wise, things are going fine. We're still able to do interviews and make offers. On the intelligence community side, the challenge we have is that they have virtually slowed down, if not stopped any clearance crossovers. So when I hire someone has a advanced security clearance that's being used at one agency and either put them on work in another one, that requires a sign off of sorts from our from the sender and the receiver of that individual, and those are happening very slowly, if not at all. So that's the one impact that we're watching, and we're keeping our eyes on. I know our customer is doing everything they can to sort of get that back up. That will pick up once they can increase the occupancy in some of their buildings. So I see that as a real short-term item. Attrition is down. So clearly, that helps us. And the programs we have to ramp up, given the large dollar value of wins we've had the last few quarters, that allows our hiring team to be able to focus on doing ramp up for those programs and not backfilling positions because we lost somebody due to attrition. So all in all, we're able to hold ourselves. It doesn't mean it doesn't come without challenges and risks and the like. But thus far, about 11 weeks into this COVID period, things remain on par.

That's good to hear. And if I take it to the 30,000 purview on the impact of COVID-19, I mean, do you think this changes the way the government thinks about national security, whether in terms of IT infrastructure or digital security or really just the ability to complete national security work and if it's something entirely unpredictable?

Yes. I've been talking to a lot of our folks on this, and it's become an absolute focus of mine. I think it's likely that the government is going to take a look at national security and actual concept of operations in continuity ops. I have to believe that a pandemic or some event like it that create a large dispersion of the workforce, how do we continue to protect this nation and deliver the solutions and the support that the government needs during -- under something like this. There's going to be a lot of technology and communications infrastructure, as you mentioned, and systems are going to have to be put in place behind this effort. The CARES Act contained a little over $300 billion worth of additional funding. And if you read the language, a lot of it is around improving IT infrastructure, improving communications, and the like. And we've been doing some really nice stuff over the last year, partnered with Blackberry, creating a product that we call SteelBox that allows agencies to sort of picture them being able to encrypt their voice and their text messages and share files in a very highly protected, secure manner. It's tough to not see the usefulness of that during COVID. So number of briefings and the number of start-ups that we've had in the last 10 weeks have been far beyond what we believe. And there's a lot of other customers out there that are receiving additional funding. A little bit more broadly, above 30,000 feet, national security doesn't end because we're under a pandemic, right? So some of the bad actors out there and some of our adversaries remain being dangerous, and they don't realize the fact that we're under COVID. It doesn't mean they shouldn't be looking at ways to test our systems and test our resolve. So that's going to sustain the current work we have, if not grow, we're doing in EW in the SIGINT world that I already talked about secure comps. So I do think it's going to change the way the government thinks. They're going to have to want to take a look at where we get the work done now, and we're going to have to have some fundamental changes there. Because I think we're learning through COVID that human element is very fragile. And nothing like having 70% of your team teleworking, when 3 months ago, if I asked our customer, can 70% of my people telework, I wouldn't have gotten a very receptive response. So we've all come along the way, we've got a much, much longer way to go. The good news is we both recognize that problem, and I'm very confident that we'll be able to help our government customer in a manner that helps them and helps us.

It sounds like a lot of structural drivers, and I mean that might tie into this next question. But I mean, are you expecting any pressure on the overall budget from the current fiscal deficit? And if so, when might that be?

Yes. I talked about this a little bit during our third quarter call. I think near term, very, very simply, no. FY '20 is fully appropriated, the balance Care Act, the balancing -- the Balance Act in 2019 did set caps for government FY '21. We expect to pretty much know that, that's going to be played right down the middle. You look at government fiscal year '22 and '23, it's certain that $3 trillion or $4 trillion, $5 trillion of additional debt is going to weigh on those folks who are in the positions that they're going to have to assess. I already mentioned earlier, our adversaries are continually testing us. The world is going to continue to be a dangerous place, and we're going to have to deal with a growing federal debt, and we're going to have to deal with testing in vaccines and the like. Every other time I've seen us here, whether it was 9/11 or during the Financial Crisis and rarely became an or, it became an and. We have to do all of these things. We can't cross national security off. I mean can we raise additional revenue through higher taxes to the mandatory spending programs get cut? I'm not that good at being able to judge where. What's important for leading this company is that we're very well positioned where the critical national security challenges are today and they're going to continue to be. Electronic warfare, signal collection, geolocating bad actors, how do we allow folks to work and share information in a very secure manner, cyber offense and cyber defense, all of those things are going to be very important with or without COVID. So I think the consistent bipartisan support will be there again when we go out to fiscal year '23. The other thing about what makes us relatively unique. We're not a platform provider. We're not a metal bender. I don't have 400,000 square feet of production facility and unionized workforces. I've got a software [ definable ] everything model. It's really software-driven with very low weight, low power devices that are applicable to many, many missions out there. And at the end of the day, we're positioned well, where the government is going to continue to spend, and that's in those very trick areas like EW, SIGINT and others.

And if you look at that positioning, how is that -- or how has that changed relative to kind of where you were ahead of the Iraq, Afghanistan drawdown?

Yes. Thanks. You're bringing an awful lot easier. If I were to rewind the clock, I guess, back at that point, higher OCO exposure, a lot of material pass-through, less differentiation, a lot of expertise, very little technology. Today, it's a very different story. We've been executing on a model of bid less and win more, bid larger versus smaller and ensure that we're making a fair and respectable profit for the value that we're delivering to the federal government. So if it was 7 or 8 years back, Better Buying Power 2.0, an LPTA, we went in a different direction. We went into go invest and take some short-term knocks to deliver our shareholders' long-term growth. So while people were cutting costs and driving rates to the bottom, we were no bidding some of that work, and we continued to invest and try to grow incredibly eye water in critical national security technologies in SIGINT and EW, communications and cyber. We re-upped our M&A program to make we could quickly fill gaps in LGS to Mastodon, our just 2 outstanding acquisitions alongside many of them. They really brought in great intellectual property and great hardware. So it's hard to say what's going to come the next 3 to 4 years out, but I do believe that we're inherently better positioned now than we were in the last budget downturn. And the fact that we're not only saying -- or we have a strategy in place and we're delivering top and bottom line growth, which is very unique and highly differentiated in our market and those who we see in our sector, I'm very, very pleased with where we're at and the SOPs working, and we're looking for continued top and bottom line growth.

Great. And I definitely want to circle back to where you're focusing your R&D and especially LGS and Mastodon, but maybe translating that budget outlook and your positioning back to kind of your current backlog, right, which you've doubled over the past 2 years? And how do you think about that translating into growth over the next few years? And how much added visibility that gives you relative to where you were years ago?

Yes. Thanks, Gavin. So a couple of things here. One is we have studied our backlog for a number of years and, therefore, put the strategy we thought would be the right strategy to put new stuff into that backlog that would do many of the things that you just mentioned. One is give us a much clearer picture of what our out years were going to look like. So let's talking -- let's start talking 2 to 3 to 4 years versus 2 to 3 to 4 quarters. If we look at our backlog today, we've gone from a backlog of 2.5x revenue 2 years ago to 3.5x. The average contract duration of programs in our backlog has grown by 18 months over the last 3 years. So that -- what I'd like to tell folks, that supports reliable, visible growth into the future. And then it all comes down to the type of work that's in our backlog and that duration is that technology work that ramps up in a revenue and profit model slower and really get hot towards the end. And once I've stacked 2 or 3 years of outstanding awards, and you lay those things out that are going out 4, 5, 6, 7 years instead of 1 to 3 years, it really gives our investors a really good, clean picture of just how long this growth trajectory we're on. We are very much committed to continually growing 1% to 4% above what our addressable market grows at, and always increasing bottom line margins, nominally in that 10 to 30 basis points, although last year had things not been for COVID, we would have been at 90 basis points. So we're very focused on both. And that's not a place that you get to that you thought about last quarter. It's a place you got to 5 years back when we rebuilt our business development team, make certain we had absolute focus, did the investments we had to make and just make sure that at the end of the year, we've met what our financial commitment is to our investors and our customers and our employees.

The 1% to 4% above the market target? I mean when I think about the layering backlog and growth comment that you talked about, you've exceeded that for the last couple of quarters here. And I mean, obviously, even ex COVID this past quarter, the growth was very strong. I mean is there -- are there any headwinds I'm not considering? Or is it possible that you could actually exceed that or continue to exceed that outgrowth rate over a longer period?

Yes. Clearly, if you look at the focus we've had on how do we grow top line, accelerate organic growth and most importantly, with margin expansion, and strong cash flow. That all goes into that mix 2 years ahead of us going after a business to say, here's the kind of work we need to win. So let's go fill the gaps we have. Let's go shape our customers' views. Let's show them they are the possible. Let's be very, very innovative and very, very creative. All of that is sort of in that mix of what's been able to drive it. As for a headwind, COVID, clearly, any kind of black swan event is going to impact things in some manner. And I've been sharing this with the entire team for some time now. I was okay listening for COVID as an impact the first 3 weeks. And frankly, just came back in one day and told the team start using the word opportunity. And that's not in a negative connotation. We have people who are impacted by the virus, that's not showing any indifference towards them. But at the end of the day, we run a publicly traded business. It's our job as a senior management team to figure out so where do we go within this area. The good news is we don't have to make a draconian turn left or right. We're -- with the beneficiary having a great paying customer, one who has continued awards coming, one who enjoys working with us, one who is eye water every time we deliver something to the field. We haven't gotten up to our FY '21 guidance, and we're in the middle of our annual planning. But it's suffice it to say that I'll take my backlog over anybody else's as I look to FY '21, '22 and '23, a consistently high book-to-bill. You always hear me say that awards are lumpy. But on a year-over-year basis, we continue to see things grow. And we continue to see things that were -- that we positioned for 2 years ago come up for bid now. So that, I would say, that machine is primed. And I really like where we're going to go. And we'll remain on track for at least 7% organic growth in FY '20, and we'll take a look at where COVID is going to present itself over the next 2 to 3 quarters and we'll come out with FY '21 guidance shortly.

Yes, that makes a lot of sense. And earlier, you mentioned kind of the idea of providing an outcome for a customer. And in your discussions with the customer you've explained that to me before. I think the example you gave was that a customer typically want a call center with 100 heads and you say we can answer many calls in this amount of time, let us worry about the headcount. I mean what kind of inning are you in, in having those customers or helping them? And feel free to alter that example if I had that off. What inning are you in getting the customer to buy an outcome rather than a service from you?

Yes. I think, first of all, your example was excellent. But the way we look at this is we're not a services company, your traditional consulting company. I don't talk about direct labor hours versus material labor and margins on each and billing codes and nonreportable indirect costs because I have a large bench of consultants that can't go out there. It's really down to how can I utilize technology for efficiency. And we do that 1 of 2 ways. So one example is yours, which is, if I'm running an enterprise IT call center, and the RFP by the customers said they need 120 people to man a call center, I'm going to get paid by the hour. I have 120 people there. I love the customer that says, "I want all the calls and the problems we resolved in less than 4 hours. And what is that going to cost me every time I call your number? Because now I get to decide, is it 20 people? Is it 300 people? Is it technology based? Is it sneakernet base? Is it high-tech solution? Let me help create what I can do best to deliver you the best outcome that you're looking for. So the outcome is fix every enterprise IT problem I have within 4 hours, then let them ask and there and then measure me again against that. We talk to a lot of our intel analyst customers. We have an operations center. They won't need 325 people. We ask, well, how many sorties to 325 people get you. Anywhere between 60 and 140. All right. How many sortes do you want to do? 200? Great. At 200 sorties, let me bring the technology in. Let me help you solve your problem. At the same time, I am bringing different kind of folks into the customers and focus them on my employees, given the customer what they need, and I'm giving a better outcome that advantages our shareholders as well. If I can deliver technology one time, that comes at higher margin, but the price to my customer overall is lower, everybody wins. My customer gets to pay less. Because you're not paying for each individual hour billed. They get to pay for an outcome, a guarantee they can handle x number of sorties in this example per hour or per day. And we generate additional margin. That additional margin, some of that goes towards discretionary funding that we can go invest in a new intellectual property, and then that pump becomes prime. So in that model, everybody wins. It takes a while. You can't say this quarter, I'm going to start doing that next quarter. You can't say this quarter or the next quarter, I'm going to start building products. It just doesn't work that way. So it's worked very, very well for us, and that's a couple of really good examples of it to focus on the customer's outcome and don't get involved in every element of cost, then it actually becomes cheaper, and it becomes much more effective.

So it sounds like maybe a slower transition to help the customer, that's the best value proposition. But once they've done that, then they can actually see that, that is the case?

Yes. Not every customer moves to that immediately. But we've done it in a number of cases where we have some really good benchmark data that we can bring in to customers and say, here's -- if I look at DeEtte Gray, in her sector, she handles all of the enterprise work across the entire government. So she can work a great concept and deal with Department of Homeland and say securely collect 2 years of data, walk in Department of State and saying, don't believe me, here's what the actual information shows. They spent less, and they got more accomplished. And we got out of debating costs and really talking about what is it that you need done. And overall, you're getting a better product, therefore, it should come at a slightly higher margin but overall lower price. Right.

Right. Pivoting back to R&D spend. And obviously, you significantly increased the focus on SIGINT and electronic warfare over the last couple of years. And you talked about that a little bit earlier. And how big of a market could that become for you? And can you give us a couple more specific examples of some programs or contracts?

Yes. I'm not going to share all of our secrets, but I mean here's a couple though that actually have really paid off well. As I mentioned, 3 to 4 years back, talk about electronic warfare and really spending a good 1.5 years talking to customers in the field, not folks in the "leadership side" but folks in the field. When you prosecute this mission, does it have the components of EW and it's yes. Do you feel as though somebody can find your location because you have one piece of electronics on? Yes. What makes that easier? What makes your situation awareness, your ability to make that mission go better? What's important to you? I need to have an electronic device on than no one else can find, and no one else can hear. And then I also want the ability to find everybody else's electronic devices and decide whether I want them to be able to communicate over them or not. At the same time, it's got to be light enough for me to carry. It can't take 100 different batteries per day. And it has to have -- here's what I need. This is the thing that I need to have done. So the R&D spending and the shaping is really going out, and that's where we drove this software definable anything. I hate to give you the iPhone in example, but it is the living example. It is a device that has a lot of memory and that's something that you can interact with, and it does a million, billion things because it does everything every app can possibly want from it. And that's what software definable means. It's not a commercial item. It's something that's been rugged eyes and hardened. It's just the methodology as to how you deliver solutions. So we've been spending some great R&D projects there. Agile Solutions Factory would be another one. We are officially the largest provider of agile software solutions to the United States government. And that was an investment in a facility on Ashburn about 5 years back. The win of a smaller project, the acquisition of what was the L-3 National Security Systems business, coupling those 2 things together, building the state of our facility and now winning that multiyear $1.1 billion [ Bigo ] award, which was all predicated on past performance, having infrastructure in place, having 3 years of information and data to show upcoming customers. That's another example of investing ahead of need. So when our customers needed it, it was already there. It was readiness level 10. All the customer had to do was sign on to the Agile Solution Factory to be able to get everything that comes out of there. And that was a tremendous win for us over folks, very formidable competitors, but they started their shaping when the RFP came out. And that's just too late.

Does it diversify the areas of kind of budget funding that you're exposed to? I mean I'm thinking DoD investment budget or RDT&E and that would maybe more typically be reserved for big hardware programs?

Yes. We see a little bit of RDT&E, Gavin. A lot of this is more operations and maintenance money, right, because it's something that they already have in inventory, they want something slightly better. We're actually working one project right now, which is we've convinced the customer instead of having a multiyear, multi-level down-select cost-plus procurement, change the RFP to ask for or a nondevelopmental item, which is let's take the 6-year development cycle and get it down to 6 months. We already have inherently all the pieces you need. And if you select us, you can come in and pick the pieces you want and we'll connect them in software, and we'll deliver that device about 5.5 years earlier than you're going to see it from anyone else. That is something that really makes such a definable everything come alive. So that's one where we quickly try to move it out of RDT&E and a large-scale production kind of job and move it into operations and maintenance phase where the first phases can happen with money that they readily have. Then when they go into production, they'll have a readiness level 10 device they can go use RDT&E money. So it helps change the color of money for our customers. And at the end of the day, we'll sell that as a fixed-unit price item, just like Apple sells you, your iPhone. There will be material margins in that, but we will have already made all of those precursory events with.

That's really interesting. Coming back full circle to LGS and Mastodon. I mean those seem like very unique assets. I mean can you talk about the capabilities that those companies have brought maybe that you didn't have before that old some of this that you've just been talking about?

Yes. Sure. So if I look at LGS, singles, intelligence, electronic warfare, communications stack for everywhere you could communicate CMA, TDMA, 2G, 3G, 4G, all the backbone infrastructure knowledge and optical communications. An absolute mouthful portfolio of algorithms and knowledge that allows me to pick apart anything in the other spectrum and understand? Is it video? Is it data? Is it voice? If it's voice, was it this? If it's data? Was it that? And then help drive commanders to make much better courses of action decisions. Mastodon, size, weight and power, low power, high ability hardware devices, a very strong manufacturing capability, multi mission table products software defined everything and the like. The real peanut butter meets chocolate moment was get both of those at the same exact time. And looking at the synergy that was going to immediately be created between those 2. Now admittedly, we have some overlap that was bound to have happened. But on the whole, those 2 teams have done a phenomenal job working with our products team. Because customers are no longer accepting long, slow expensive procurements. They want capability deployed and field it quickly. And at the end of the day, even the financial measures of these 2 acquisitions, generating greater than 17% EBITDA margins that we signed up to about 14 months back. They've done an outstanding job. We continue to generate additional intellectual property. We've got the model working just like we'd like it to go work. COVID has sort of slowed that down slightly. You saw some product deliveries slipping. But we're always going to look for those kind of companies. And we like to actively work with them. We get to know them and then evaluating when they be a good fit for CACI and then close on the deal, and that really was the repeatable playbook we had for both Mastodon and LGS.

Got it. And I know you paused M&A for the short term, but are there other assets out there like that?

Yes. We -- yes, I did say on the third quarter call, we were going to put our M&A program in a slight hiatus. I think I told somebody earlier, it's like telling a whole stable of bulls while you're reading red to not charge. They -- but what's nice about our program, it's a long-established program. Dr. London created the original M&A program 30, 30 years back it's based on having a strategic knowledge of where you want to head in funding those gaps. There's plenty of companies that Mike Lewis and his team are out there communicating with even today. That hiatus part was I had a look at M&A in the view of the shareholder during this period of time. And I don't want to be the publicly traded company that puts additional debt on our books without being able to get that message out to our shareholders in a clear and concise manner. There's a lot of fast money in the market today. And we just decided it was prudent for us to wait 60 to 90 days and also it gives us a better chance to more fairly and accurately evaluate the incoming financials of that company as well, pre-COVID through COVID and then post COVID. So yes, there's a lot of nice properties out there, folks we've been working with for over a year now. And I would hope in the future months and all to come that we would be back on our M&A pass filling capabilities.

Got it. As I come on time. Maybe I'll finish up with just a couple of questions on margins. I mean you're 10 to 30 basis points of annual expansion, your commitment to that. You have a lot of new work ramping, right? I mean you're currently equipment organically, and I assume that's fairly dilutive. I mean even if you're going high single digits organically, can you still hit that 10 to 30 basis points? And what are the key drivers?

Yes. You called out one major watch for us, and that is, as we continue to win business, the more that is technology and nature and the more of that, that is in a perfect price model, right, our "booking rates" are going to be lower in the early years, they'll be much greater in the outer year. So it doesn't make it a challenge short. But any company willing to put in writing, last 3 years, we're going to grow top and bottom line and be successful at it. There's going to be some level of challenge to that. Part of our growth this past year was LGS and Mastodon. That will always be the case. If when we continue to look at companies in the enterprise and mission technology area, they'll command potentially a higher multiple. But they're going to be driving much greater bottom line growth and bringing us additional capabilities we can compete with. And how we get margin, it's clear, multitude of programs consists of a multitude, a real range of margins. There are some strategic reasons for that. So yes, you should continue to expect the business to generate 10 to 30 basis points of expansion annually. The stuff we have in our backlog is at or if not above, those EBITDA margins with a lot of upside because some of those are going to be product sales and solutions under a firm fixed price arrangement so we can turn that knob based on when we mitigate risks enough to be able to use a higher booking rate. But it's -- our goal and our focus is to go to the bottom line faster than the top line, and we're going to continue to do that. I don't know where the ceiling is. I've been asked that a lot. But all I'll tell you is that we're going to continually long-term wise, keep stepping up that sort of margin stairs.

Yes, ceiling question, one that Tom loves, I'm sure. But this is a perfect way to wrap up there. John, really appreciate your time.

Yes. You bet. Thanks very much, Gavin.

Great. Thanks, everybody.