CACI International Inc (CACI) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Jon Raviv. I'm Citi's U.S. aerospace defense analyst. Welcome back to the Citi's Global Industrial Conference, virtual style, obviously. We'll see you in Miami next year, probably, hopefully, definitely. Today, we're joined by CACI International. John Mengucci is the CEO. Very pleased to have him here, very honored to have him here. And also off camera on that side of things is Dan Leckburg, who heads up the Investor Relations effort over at CACI. It's going to be a 40-minute conversation, as everyone is used to. Looking forward to touching base with John, seeing where things stand right now. And also on however you're viewing this right now, there should be a place where you can input a question, if you want, that'll come to me. I'll try to fit it in there as we can, time permitting. And just happy to kick off here. So John, good to see you again, and thank you very much for joining us.

Yes. Jon, thanks so much for having us. Appreciate it.

Absolutely. So let's start the conversation where the conversation always starts. Not to be repetitive, but then again, I keep getting the question, so I'll pass it on to you. Growth is a big focus in this market right now. You all have talked about continuing your above-average -- or your above-market growth rates. What continues to give you that confidence? What are you seeing in the market right now? Is it particular customers, particular capabilities? And I know you guys talk a little bit about expertise versus technology. So where are you seeing that differential within those 2 buckets as well?

Yes. Great. Thanks, Jon. A couple of things to start off. One is we're in the national security space, that gives me confidence. We're in the right portions of the national security space, that gives me confidence. And as we look at budgets, I'm sure we'll talk more about budgets later, but at least for FY '21 and even some stuff that I read late yesterday, potentially FY '22, the budgets look relatively solid. The last point is we are a company that's working in the areas that are going to continue to be funded, whether it's cyber, it's SIGINT, anything in the RF spectrum, Counter-UAS as well as IT modernization, we're very well aligned in those growth areas. As you mentioned, we talk about our business either delivering expertise or technology. That's not by accident. We are in the right positions today. So we've sort of skated to where the puck is going. And we have been on a multiyear strategy to change this business versus maybe 8 years prior. So we like the technology capabilities that we have. We like the customer relationships that we've earned. And we have growth prospects in all 4 of our quadrants. So clearly, technology -- we see technology growing faster than the expertise side of our business, which is a positive for us. It's about 12% year-over-year, as I look back on the first half. And margins are doing very well in both sectors, but about 300 to 500 bps greater on the technology side. So after 8-year plan and restructuring this company going forward, things look good. We're seeing a lot of great awards and like our prospects going forward.

Yes. It's -- I mean it's a good point that the company -- the nature of the company really has pivoted. I mean sort of the nature of putting a nimble SMID cap kind of technology-oriented stock here. But you obviously made those changes when you came in. I know your predecessor, Ken Asbury, had a big hand in this as well in terms of affecting that change. But you all were responding to customer priorities and where you thought the puck was going. So can you talk about here? I mean we've had a year in which there's been a lot of change in the world, but you've also had a multiyear run where there's been a lot of change from a geopolitical standpoint. Not sure that COVID changes fundamentally the geopolitics of the world right now, but the past year has nevertheless been quite active in terms of disaggregated workforces, in terms of cyber attacks and intrusions, hitting a level of which that some had never expected to be the case. So long-winded way of asking, what are customer priorities right now, and how are you addressing them, obviously? And also how are they impacted, though, by what we've endured over the last year and continue to endure?

Yes. I think, look, at a high level, our customer set, there's always respected innovation, agility and being very cost-effective, right? That doesn't change. Where it's more predominant is when we're going into cycles like I believe we're heading into now, right? We're going to have more cost constrained budgets. There's going to be more choices, and the threats are not going to go away, right? So regardless of what some might hear, I believe, counterterrorism is there to stay, unfortunately. The threat from China is there to stay, unfortunately. And the threats from other near peers, like Russia and other. And there are those who like to believe that, that's an or, I tend to think that it's an and. Counterterrorism and China and Russia are going to continue to be threats. Cyber and everything in electromagnetic spectrum is very important capabilities that our customers absolutely need, and they need them on an advanced, more agile time line, frankly. These are not issues -- when we're talking about bits and bytes versus bombs and bullets, we're actually talking about threats that change continuously. So it's nothing that a 4- or an 8-year ACAP1 well-funded program is going to solve for us. So it doesn't make the platforms a bad thing, it just makes it an and thing, right? You've got to have platforms to defend against some of your more traditional kinetic threats. You've also got to be out there surveying the RF spectrum, understanding how do I discriminate what's going out there? How do I understand it? How do I attack it? How do I defend? So that would be a mouthful, right, without COVID, right? Back to your lead into this question. COVID and things like that, I've always believed that those only accelerate an existing trend. So here's a couple of examples. We've always talked about the importance of cyber. They have to admit that people doing work from their bedrooms versus doing it from a federal government contractor building or from a customers' facility, the landscape and the entire surface area of potential IT attacks has grown exponentially. That's not a fear monger statement, that's an actual fact. And if you look at more things being done on the cloud, that's different. So the other area we've always talked about within this marketplace of can we do distributed operations? And how resilient are our networks? And then when we develop code for classified missions, is all of that software classified? Or is some of it unclassified, we can develop in a different manner? We've had those discussions. Now we've sort of become that 1-year long petri dish, for lack of a better term, of here's what happens when I have less people in a government facility supporting that customer. Does the customer need the same number of employees, or have we learned to use technology more than maybe we thought that we could? And in the intelligence world, are we able to do more software development outside of a skiff that during times like COVID is a highly densified human breeding ground for things like COVID if we're not all appropriately spaced, right? So how do we keep the mission and keep that software development going in a very different manner? So I think the government is looking for new ways to do work. I think they've seen the art of the possible now, Jon. I would never call COVID that there's anything positive with it, but what results of going forward is a different cyber attack space we all know we had to protect better. We know we have to have funding there. We also recognize there's different, more creative ways for us to do work. And just -- it might just be at the CACI philosophy from a number of years back as maybe we should lead with technology and wrap some service around it is actually the better way for us to go going forward. And we at CACI find ourselves there. And I might say not by accident, but by actually moving this company more on a technology differentiator because we are looking to know the effects of long-term government shutdowns and sequestration. And my look is COVID another look of a long multi-month government shutdown, frankly. And somehow, we've handled that differently than we've handled other temporary budget-driven shutdowns. So customer priority is still in the same place, we're just attacking those differently.

And it's -- I feel like your industry is always -- I shouldn't say battling, but maybe negotiating or discussing with the customer to do things a little bit differently, show them the art of the possible. Customer might say, well, I don't have to because what I'm doing right now works. Well, obviously, in the past year, a lot of things have had to happen by just like thoughtfully, or just by default, I should say. In order to support those conversations, though, clearly CACI has made a lot of investments, both organic and inorganic. This is not an M&A question specifically, John, it is just more of a question around the types of technologies and capabilities you have made investments in, either with your own dollars or on a funded basis? And how do you really measure the payback on those investments, if the opportunity set is shifted?

Yes. So we've talked many, many times around what our growth strategy is. And one of the elements of that clearly is to deploy capital to support future growth. We always find ourselves talking solely about an acquisition, so I'm really happy to hear this question around investments because we can invest, we can partner or we can acquire. And internally, our R&D and our bidding proposal funds are north of $100 million in fiscal year '21. That's materially different than it would have been 5 or 6 years back. So we've discussed things like cyber and AI/ML and RF spectrum and spectrum and come to UAS and customers moving to the cloud and making certain that we had a nice environment here in training skills so we can move to agile software development versus some of the ways we've historically done it. Today, those investments have driven us to own the prime contract position on the 2 largest agile software development programs in the federal government. And the payback for these investments is our ability to win more. Many, many years back, we were talking about we want to be that company that bids less and wins more, right? We want longer duration work. So we want to -- we've always wanted to win higher-value, more enduring work that we couldn't have done before because we weren't there to make the investments to drive technology first and get ourselves into different addressable market spaces where you couldn't just win on price and by delivering people, you had to have an outcome-based solution. So our pure expertise programs, we made investments to move those to technology first and wrapping that with expertise and then some of our mission tech work and getting into product development. So these are all different estimates. They all have different payback periods. Some pay back immediately, some pay back over multiple years. On the acquisition side, we can go back to maybe 7 or 8 years ago, we did the Six3 acquisition, and there was a lot of questions, well, that doesn't seem very core to where CACI is at. And I was -- I found myself applauding a lot, saying perfect, so the first step is done, right? People notice that we're going to go somewhere else. And now that was a foundational acquisition and step forward into being a more tech-minded company, and we've just built on that since.

Yes. It's you got to -- and you start to remind yourself of how -- I'm not going to say how wise one is getting when you start to talk about 6, 3, maybe approaching a decade with the company, but it's certainly...

Some things take time.

Yes. Absolutely. We're all still -- we all still look the same, right, John?

Right.

Within that context, you're making these investments. You're picking up a little bit more on the technology side in terms of growth. And you're delivering -- you're trying to deliver more outcome-based rather than more process-based. What are some of the margin drivers? So where do all those fit into the idea around what drives your margin as you've gone from, again, over the years, high single-digit EBITDA to mid- to high single-digit EBITDA to low double-digit. And now -- I know at one point, predecessor of yours talked about something even longer over the long term. But what are some of those drivers that we should be really watching here?

I'm never going to shake that one-sentence response, you and I my predecessor had. But focused on your question, look, I mean, first off, our technology addressable market is growing faster and comes with higher margins, and we've been saying that for a while. About 3 quarters back, we decided in our quarterly statement to actually show information around that and be much more transparent there. It's not only growing faster, our technology has a margin level 300 to 500 bps better than it does on the expertise side. Now when I say that, I always fear, people will say, well, then get out of expertise. And we're not a light switch company. We're more of a dimmer nob. In due course, when we can, when it's wise, we move more towards technology. What I tell the team, dollar-for-dollar, pound-for-pound, if we do a dollar investment and we can drive a technology win versus a pure expertise win, anyone in my seat would pick that technology job, okay? Second, though, what goes hand in glove with driving margins is prudent cost management that actually -- where we allow revenue to grow faster than overhead costs. Third, we make certain that we bet more often right than wrong in our IR&D investments. And the LGS acquisition gave us a fantastic framework as how to not only say invest in need, but how to measure that and how to determine when some of these have to hold, some of them -- sometimes you have to fold, the market moved in some different direction. And I always find myself talking about the fact we're spending $100 million of B&P and IRAD. What if we could spend something less there? But it is a cost, but also supports winning better work, right? So to invest in technology so you can win means you have to continually invest, but that's where the margin growth is. And we are that company, we've said many, many times, we want to grow better than the market. We want to continually drive margins because I'm still a huge fan of the quality of earnings that we have directly proportional to the quality of revenue and the quality of our bids. And I want to go out there and spend more B&P winning new business than I do winning low-margin, recompete expertise work on a faster and faster schedule. When you're going to differentiate on price, you're not going to drive margins, you're not going to drive long-term growth. You're going to drive all your investments going towards holding on to the revenue that you're actually generating today. So bid less, win more, and go after longer-term jobs, more tech than expertise. And the proof is in the pudding, right? The last 4 years, we've grown our EBITDA margins, based on where your takeoff point is, somewhere from 8% to 10%, 10.5%-ish. And we'd like to firmly believe that we can continue to grow that in the future.

Is there a natural -- again, years ago, it seemed like in the government services industry, there was this natural ceiling to margin rate just based on the type of work you did, the way you delivered it, and that was just it. It's a high single-digit margin, it's a high single-digit EBITDA margin business, and that's the business. A lot of companies have done very well, a lot of folks have done very well in that kind of business. But now with the bit spikes over bombs and bullets dynamics, what's kind of required in the market, demand in the market, the pivots that you're making, is there a new -- I hate this phrase, is there a new normal for what the margin opportunity is for a company like yours or like your industry set where high single digit, obviously, were beyond that. If you look at defense primes, they've generally been in that kind of low to mid-double-digit, depending on where they are in their maturity level. Is there -- can government technology really start to emphasize the technology side of the word? I'm not looking for 50% margins per se, but more than 10%.

Yes. It all comes back to your mix of business, right? If we were the company that we were in 2012, would I answer that question? No, I'd say probably 8% is sort of where we live at. But a lot of things changed, right? LPTA changed the ability to rewin your recompete work, right, at the same or better margin. It started to be the same, if not lower. So -- and what that tells me is -- I went to business school and took business classes, too, and when things go from differentiated to more of a commodity, right, where the barrier to entry is lower, number of competitors go up and it's price-sensitive, that's not a long-term growth model, frankly. So you can sustain it for longer if you, one, cut all investments; two, drive your rates down. But if you're a $2 billion or $3 billion or $4 billion, $5 billion company, you're not going to keep up with that $10 million company who can deliver people cheaper forever, right? If I'm making 2% margin, 3% is exceptional. But I'm used to making 8% and I have to suffer with 3%, that's not, right? So we were one of the first that sort of looked at this area and said we can call it expertise, we can call it consulting, it doesn't drive any better margin, okay? Because the dynamics of how the government buys it is in an even more rapidly more competitive manner, right? So if you're bidding pure expertise to the government, those programs are not being recompeted every 10 years. In some instances, it's every other year. And if I'm the customer, I get lower prices, then I'm going to continue to do that. So I think if your portfolio looks more like that and you, many years ago, cut costs at the expense of growth, then the only way you're going to grow is continually bid things on a more and more repetitive nature. You're going to spend more of your pure investment dollars rewinning today's revenue. You can always grab those one-offs if margins aren't important. You can win a $200 million job at 2% margin and show great top line growth, but the reward for that is 1/4 of pure enjoyment and then 3/4 worrying about the next recompete. And we just decided to make a student body shift that technology is where it's at, that the old-style government services provider, professional services, is not the company we wanted to be. We saw a large growth market in the technology area, not competing against the primes all the time but being a technology provider to customers and to those primes and then using M&A, frankly, to go find some of those capability gaps that we needed. So we're -- we like where our margins are today. We haven't changed in our commitment to continually grow top line and then always increasing margins. I won't try to put a higher end out there. I think it's more relationship and mix of business. If our product business takes off, Jon, will that drive materially higher margins over the longer term? Absolutely so. If it's a nominal growth, will it still drive margins? Yes, but probably not to such a large number. But again, we're going to be a good mix company, and we're going to continue to make our investments because no matter what, technology offerings, you can differentiate there, and there's far less competitors there. And that's the kind of marketplace that will always perpetually drive margins.