CACI International Inc (CACI) Earnings Call Transcript & Summary

Good afternoon, and welcome back to Day 3 of Morgan Stanley's Virtual Laguna Industrials Conference. My name is Matt Sharpe, and I'm the firm's government services analyst. With me this afternoon is John Mengucci, President and CEO of CACI. Now before I begin, I just want to read some disclosures. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosures website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, John, welcome, and thanks for joining us this afternoon.

Matt, thanks so much for having us.

Our pleasure. So I wanted to just sort of kick things off here with a high-level question around the CACI portfolio. You've obviously evolved your business quite a bit over the years, changing the mix and the content through M&A as well as organically. How do you see the right mix of business here? And where does it stand today? Maybe you can discuss this sort of in your quadrant framework that you've laid out for us.

Yes. Sure, Matt. Thanks. So yes, this company has been around since 1962. And if we were to talk about the quadrants that we have -- we delivered to enterprise and mission customers, and what we deliver to them is expertise, think about knowledge or technology. And we like to look at that in a couple of ways. One is in our expertise market, that's the part of our business that it's larger. It's slower growing, but it's -- it has a very, very large market out there. On the technology side, a little smaller market. Still large, but that one's growing faster. When I got to the company, we were about 80% expertise and 20% technology. So as we sit here today and we talk about margins, the margin profile of our expertise business is materially lower than our technology business. And whereby we used to be about 80% expertise and 20% technology, we've now moved our revenue split to about 50-50, and that was since 2012. And that's pretty much, when I came into the company, want to make a material shift towards technology in both organic and through M&As. We expanded first into the enterprise tech area and then now most recently into the mission tech world. And that's more of what you'll hear from us. We don't have a target revenue and quad mix. I'm always telling folks within the company, if all 4 quadrants grew at 20%, I'd be extremely happy. But what it does is, the benefit of the model we have is we're very strategically focused, and it's very flexible. So it's easy for us to adapt to either -- enter to either expertise or technology markets. So on the enterprise tech side, you talk about modernization and updated networks. And on the mission tech side, we're talking about electronic warfare, RF signals collection, counter UAS and the like. So we like to talk about our business as expertise in tech, and that's how we'll be describing our business more and more going forward.

Sure. Now on a consolidated basis, how should we think about growth in the coming quarters and even, if you're comfortable, years, right? You've got some healthy end markets there. You said high growth in tech, a little bit lower on the expertise side, but you've got a trailing 12-month book-to-bill of 2x. You just reached a record high backlog of nearly $22 billion. You've had some really strong wins over the last 12 months, CBP, BEAGLE and NGA, TCS, to name a couple. But then, obviously, we have a headwind on our hands in the form of COVID-19. So talk us through sort of the growth building blocks over the next 12 months. Can we potentially see an acceleration as we move past some of these headwinds? Or what can you give us to help us sort of characterize the coming months and quarters?

Yes. So based on what we've shared in the past and how we look at this business, we're going to see technology growing faster than expertise. And I'd say, year-over-year, I mean, quarter-to-quarter, there's so many different variations. But over time, technology growing faster, I mean, clearly, since 2012, so in the last 8 years, we pretty much doubled the size of the business. And we moved from 20% tech to 50% tech. So a lot of moving parts there. If we were to look going forward, about a $14 billion pipeline, well, you shared that during the fourth quarter. About 70% of that work, it will be new to CACI. And relative size, about 1/3 of the pipeline is in the mission tech area, and the remainder is pretty well equally distributed across all the other quads. So we're looking for growth in all areas. The way we use the quadrants, if -- all things being equal, if I had $1 of new business investment, all things being equal, I would bid on more tech jobs and less expertise jobs. It doesn't make the expertise jobs any less important, but the returns for us are greater. The ability for us to differentiate is greater. The need to have to recompete for that work is far less than what we see across the federal government in the expertise side. I mean most of the government services providers out there provide services, which is provide labor hours. And when you're doing that in the kind of marketplace that we're in today, pretty tough to differentiate on anything but your labor rate. And frankly, I want rates that support growth, which means I have to be able to deliver work that comes at slightly higher rates. And that's perfectly fine with us. It just means we do less expertise work. What we get from that is we end up winning larger awards and longer duration awards. So some of the key building blocks for us to continue to do growth, first, was to retool our business development, our marketing and sales team, and that we did about 5 years back. The next thing was to build the -- like we use -- we like to talk about quality of earnings. It's quality of our backlog business. We can now see enough in our backlog that says that backlog was one at margins that are greater than we operate at today, which then gives us great insights that we continue to build bottom line. But what it also does is provided to us contract duration. So contract duration in our world is very important. Because if I have contracts only lasting 2 to 3 years, I have to recompete on those constantly. A larger proportion of my investment dollars is going to go towards rewinning revenue that I already have today. So if you make that a priority of the company, 3 years ago, the average duration of our contracts were about 3.5 years long. And today, in our $22 billion backlog, those contracts have an average duration of 5 years. So if you put those -- all those building blocks together, you look at bidding less and winning more, we could be very strategic on what we're going to capture. We bring technology in more often than we used to. We're winning larger jobs at longer duration. All those pieces as well as a continually moving contract mix really does support both top and bottom line growth, which is very unique within this sector.

Absolutely. So it's interesting. You've got a fairly healthy book of business at this point in time. And obviously, with the challenges around COVID-19 and some of the customer unique situations, whether it's having a customer that performs classified work or has to deploy people overseas, there can be some complications and challenges around doing just that. So my question to you is, the environment in terms of pace of award and pace of RFP or RFI holding up in this current environment, just what are you seeing right now in terms of behavior on the customer side?

Yes. So let me tie a little bit of COVID, and then we'll talk about awards, Matt. So on the -- during this period of COVID, we actually saw a couple of headwinds. We saw the direct impact of COVID. And back to an earlier comment that you made, when we think about COVID to our business and the financial impacts to it, it's that work that we do in a customer facility that has to be what we call de-densified, less people in the same square footage that they were in prior to this past March. And that predominantly rears its head in the intelligence community, where we're doing classified secret -- top secret work has to be done in a skip. So the square footage is fixed. We can put less people in there. And even if we go to shifts, we still can't get the full complement of folks. On top of that, we need to make certain that between us and our customer, we have the staff that's available in the event that we have one shift or when people are going to be infected, the mission has to continue. So the CARES Act and 3610 was created for the government to cover just the cost without profit on those people who are sort of on hot standby to come in and have to take over the mission work. So from a COVID aspect, those were the direct costs, not being to put people out there. As it pertains to indirect costs, and this gets towards the awards question, as COVID moved through June, July, got into August and September, we could see some indirect things. So the -- a lot of the clearance processing offices to our intelligence customers are only open, let's say, a day a week versus 5 days a week. The ability to get military transport to get our folks, who are serving overseas to get them into situ, were greatly delayed. It started to pick up now. And the number of hours that government employees are working, whether they're acquisition folks or finance folks and the like, we started to see a slowdown in task orders that were being let to us. More recently, we're starting to see a couple of awards slip. I would say it's a major item. You've always heard me say awards are very lumpy. So maybe that normal August and September for contract awards, we may or may not see that, but it's really just based on the health and welfare of the acquisition folks that will probably put some level of slowdown to that. That's not going to immediately impact growth for us. As you mentioned, we had $22 billion worth of backlog. We have a $230 billion addressable market or a $6 billion company. I think as we get through the first half of our fiscal year or through December of 2020, we'll see COVID have a much smaller impact on us and be less of an issue as we get into the third and fourth quarter and then as we get into fiscal year 2022. So COVID is an impact there. We'll see most of that impact show up in the first 2 quarters, and we'll see much less of that as we move out of this fiscal year.

Got it. Now maybe how are you thinking about the broader D.C. dynamic at the moment, right? We've got a situation in terms of the budget where we're entering a CR shortly. We are waiting on extension of CARES, in particular, Section 3610. And then we've also got an election looming. Maybe you could just sort of talk us through how you're thinking about that or those dynamics in either risk to the business or shifts in the business. Or any sort of implication that we need to be thinking about in that context.

Yes. So awful lot there, right? We can probably talk for hours. I'm waiting for the locus to actually start next, right? But look, if we look at budgets and elections and the legislative piece, I'll take the legislative piece first, which is the CARES Act. You're right. Section 3610 provides authorization to all government contracting officers that they can pay for those reserved status folks using currently appropriated funds. We and my peers are looking for a similar authorization to be extended. I can't tell you whether that's going to happen exactly on October 1 and when because of us being an election year. Sorry to say whether you're an R or whether you're a D, whether you like what's going on or you don't like it, things like extending 3610 actually matter to the national security of this nation. I know a lot of the hill folks have been spoken to by myself and others. I do believe we're on a path to get that extended, but there's never any thing as being guaranteed during an election year here. For us, personally, we were at about 10% of our labor hours were on 36 10 at our first -- at our FY '21 guidance call, we were down to 5%. We're somewhere in the 3% range now. We expect that to continue to drop, given that there's not any further COVID spikes down to 0, which means we would not use 3610 -- and, I mean, we wouldn't need it. So more to come on at 1. Budgets FY '21 are in the -- can feel very good about that. And FY 2022, I believe, it looks a lot like 2021. An awful lot of work's already been done. Even a change in administration doesn't really leave much time to impact that budget. And for CACI, based on our backlog and where we are providing exquisite technology and the mission and the enterprise thing quadrant, we don't see any funding impacts there. So I like the hand that we're playing. I like where we operate in, and those budgets continue to remain full. I think government fiscal year '23 is where we start to see the first budget for either a second term Trump or a first-term Biden. At the end of the day, we're in an elevated threat environment today. If anybody in the nation believes that our nation's state enemies and others put their guard down because we're all dealing with COVID, just the opposite. We've got near-peer adversaries and the like. We've got a lot of critical national security, and modernization priorities aren't going to stop. So from a budget side, clearly, COVID in the federal deficit, in the '23 time period, we'll have to figure out a way how do we fund all of that. But again, I'm going to harp upon, we're a $6 billion company with a $240-some billion addressable market. And you've got to go pretty deep in the defense and the intel of the Fed civil budgets before it really directly impacts us. Last, I think you talked about elections. The way I've looked at this over the last 6 to 9 months is it's the first time in history where both people running for office will have been present at 7:30 a.m. national security briefing. So this is not like the -- typically, you have the incumbent who understand how dangerous the world is. Sometimes you have someone running for office. And their rhetoric is they're going to cut the defense budget. And I say it so often that they are shock stricken and when they sit in the first 5:30 a.m. briefing. Both Biden for 8 years and Trump for 4 have sat in that briefing. And I think we're starting to hear some words from the Biden camp now around IT modernization and cyber and electronic warfare and IT and the like. It's always been a bipartisan part of the federal government budget. I don't believe what we're hearing today is going to leave us to any other position. And I like the positioning that we have today vis-à-vis where we were 5 years back. So I see years of continued top line and bottom line growth for us.