CACI International Inc (CACI) Earnings Call Transcript & Summary

Good afternoon. Welcome back to the JPMorgan Industrials Conference for 2021, on the Aerospace Defense track. I am Seth Seifman, the aerospace defense equity analyst for North America and very grateful to have with us this afternoon, CACI. And we have Tom Mutryn, long-time CFO of the company; and Dan Leckburg from Investor Relations. And so maybe we'll start off with kind of an open-ended question. And then I've got a long list of questions here. We can look online as well. But I guess, just a very big picture, Tom, to kick us off. Maybe you can just share a little bit about what CACI does and sort of what you believe distinguishes it from your peers in the federal IT space.

Yes. Good afternoon, everyone, or good morning, everyone. Thank you for joining us today. And Seth and JPMorgan, thank you for hosting us. We do appreciate the opportunity to speak to current and potential investors. CACI has been around for 57, 58 years, providing services to the U.S. federal government. And the way we like to look at CACI is we provide both expertise and technology to both enterprise and mission customers. And when I talk about expertise, it's providing input, it's providing labor hours, it's providing people, it's providing expertise. Those inputs would be operated under government direction for particular outcomes. Technology is, we're providing outcomes. Those outcomes could be a software program. It could be a product. It could be a methodology where our performance is not measured on the input, but on the results. So expertise and technology is what we provide. And we look at our customers in 2 broad categories, one, our enterprise customers. Virtually, every government agency needs certain things to operate as a government agency. They need an e-mail system. They need facilities. They need to pay their employees. They need to have websites. So these are ubiquitous across government agencies. And so that is their enterprise. And different agencies have different missions to prosecute. The intelligence community may -- mission may be to find the bad guys or to provide cyber defensive or offensive capabilities or to pay tax or collect tax revenues or keep our borders safe. And so we provide areas in both those. And so we've created a quadrant for those -- for particular areas. And CACI is providing kind of work in services to our government customers in all four quadrants. And there's interactions and interplay between those quadrants, so they play off one another. And I think that's a good framework to look at what CACI does in how we think about different aspects of our business and how it fits into a larger framework.

Okay. That is excellent and a good starting point. We'll come back to, I think, some of the specifics there. But I guess, maybe first, I'll go to kind of the elephant in the room, which I'm sure people are interested in learning about, which was the news last week that you guys had initiated a share repurchase, which the company has done at times in the past, but rarely. And so maybe you could talk a little bit about the impetus for that, both in this particular case and also what it says about the approach to capital deployment going forward.

Good. Thank you. One of the characteristics about the company that we're very proud of is strong, dependable free cash flow, kind of growing top line, expanding our margins, very efficient collection processes, DSO still are low. So we generate a lot of cash. And we also have access to the capital markets to borrow money. And the question is, what do we do with the -- our cash and our capital structure. In the past several years, we focused almost exclusively on going through acquisitions. Seth, you mentioned several years ago, 8 or 9 years ago, we did some sizable share repurchases, but nothing since then. Today or last week, we found ourselves in a situation where we certainly have the flexibility and the capability to do both, continue to look at acquisitions. But we had relatively low leverage. Leverage was less than 1.9x. Our equity was attractively priced. The borrowing environment is kind of very robust. And we married that against our acquisition pipeline and came to the conclusion that we did have the capability to embark upon a share repurchase while preserving, again, the capabilities to continue with our acquisition strategy. So let's do both. And as a result of that, we announced and executed a $500 million accelerated share repurchase program. So happy with that, a nice way to return value to our shareholders. And at the same time, allow us to carry on with our, in our case, very successful M&A process.

Okay. And then when you think about going forward, is there something about the environment now that maybe we see there's -- I think, public market multiples for federal IT companies tend to be lower than private market multiples. And that doesn't mean that M&A never makes sense. But does that create an environment or contribute to an environment where share repurchase remains maybe a tool in the toolbox that we might see used more frequently?

Yes. So I will certainly say it is a tool in the toolbox, and we will continue to assess the uniques in circumstances. The current share repurchase period of execution will be anywhere between 4 and 7 months. And so our counterparty, which happens to be JPMorgan is in the marketplace, covering their kind of borrowed share position to kind of deliver the shares to themselves to cover the short. But as we go forward, we will look at the same set of circumstances, going to leverage levels, acquisition pipelines, relatively attractiveness of various investments. I will take a step back to talk about our M&A strategy in the context of kind of multiples, a question frequently comes up. We are very much of a present value decision-maker. And when we look at opportunities, we do our best to forecast future cash flows, which is not an easy task, hard to forecast the future. But we look at future cash flows, discount it back at the appropriate discount rate to determine what is the maximum purchase price that we could pay for an asset. That purchase price gets divided by either the last 12 months through the next 12 months, if it had to come over the multiple. To me, higher multiples, it is simply an indicator that this company is growing at faster, higher rates. And we will pay the appropriate amount for those future cash flows. Now within that context, we look for companies that fill strategic gaps. Here is our strategy, the number of different parts of our business. We may have gaps from a software or a product hardware perspective, gaps in terms of customers, gaps in terms of geographies and use those acquisitions to fill in those gaps in making sure that we pay the appropriate amount.

Right. When you put your M&A pipeline and the target that are most likely to fit your criteria and fit that over sort of the quadrants, where do you tend to see more of the opportunity? Is it on the technology side because that's what seems to be growing faster? Or are there still significant gaps on the expertise side that you'd like to fill in?

Yes. Good question. Most of the gaps would be in the technology side. Kind of by definition, some of the expertise work that we do and other people do have less differentiators, capabilities. Let's kind of retain and attract the appropriate talent, who could, in turn, support a government mission. And in many instances, there are not huge differentiations associated with that. So we don't see too many gaps. There may be some on the mission expertise side, where there's some very specific skill sets in terms of kind of knowledge base associated with specific customers. But generally, there's less gaps there. More so the gaps would be in a technology perspective. And it's -- I'll now focus on kind of mission technology. Several of the recent acquisitions kind of dovetail and our congruent with what we did several years ago when we bought Six3 Systems, a lot of electronic warfare, signals intelligence, the RF spectrum. And since then, kind of the Mastodon acquisition fits into that broad electronic warfare, signals intelligence arena as does LGS, Lucent Government Services, as does AVT. And so I would think that in that fast-growing, ever-changing, technology-focused area, there will be more gaps simply because the technology evolved so rapidly.

Right. Okay. That's interesting. And it touches on what I wanted to ask next, which is within technology, the move into products that the company has made in recent years, including some of the acquisitions that you just mentioned. And so as you think about what unmet needs there are sort of that CACI could fill through product acquisitions, do they continue to tend to fall in that sort of mission systems, EW area? So basically, what are the most promising areas within products for CACI? And then with products being sort of a relatively new field for CACI. How do you think about making sure that you compete effectively and profitably in that area?

Yes. So yes, good. You're spot on. There are some kind of emerging technologies and my role in the company is such that I'm not the technology expert, but I do have some knowledge. But 5G is kind of wildly talked about; artificial intelligence; different photonics looking at communication using kind of sophisticated laser technologies; the whole ISR, intelligence surveillance reconnaissance; cyber, both from an offensive and defensive capabilities; a lot of specialized areas kind of within those, and that has been our focus. What we're trying to do is kind of differentiate ourselves by creating some kind of targeted capabilities, very much software-defined, where we'll have kind of lower size, weight and power, trying to be very agile in terms of being able to ensure that the technology is current. And that's kind of very important for our customer set. One example was a Counter-UAS solution in SkyTracker that we've been talking about and selling effectively and deploying for a number of years. The signal set for kind of drones or adversaries continues to evolve and change. And as we try to understand your signal sets, adversaries are trying to counter them and create some resilience in their systems. Our software is such that very easily we're able to refresh the software underlying those products to keep them current at all times. And so those software-led solutions are kind of very attractive and profitable for us as well.

Right. And you find, given that there are some incumbents that we kind of all know who are sort of in those areas, but that there are sort of -- I guess, starting off, are there niche areas that you choose to target where you feel like there's opportunities that maybe some of those incumbents haven't closed off yet? I guess, how competitive is it in that space?

Yes. Well, Seth, like, in most businesses, there is competition and there's hard to find businesses which are not competitive. Our focus though is trying to be partners with other organizations. There's -- kind of airplanes and ships and large platforms, and we're never going to be a platform provider, but we can provide collection devices, pods, support for some of those platforms, which are currently out there. Our AVT acquisition was such that they manufacture EO/IR devices, Electrico-Optical/Infra-Red, Gimbal sensing devices anywhere from the size of a cross ball to a bowling ball that can be mounted on a variety of ground or aerial vehicles with embedded onboard processing to very quickly gather useful information. And we see those programs and capabilities using in conjunction with other platform providers as part of the holistic ISR solution.

Right. Okay. Yes. I mean, that gets you to another question that I had. And over your time at CACI, it seems like -- have you seen and it seems like there are increasingly blurred lines between companies that make mission systems and companies that do IT services, and in some cases, companies that make platforms, and there is also opportunities potentially for commercial companies to bring in technology and there are start-ups out there. And so it's a little bit more of a dynamic environment. I was wondering if that's something you see as well? And what kind of opportunities that presents for CACI?

Yes. No. Thanks. A more dynamic environment. It makes business fun, and it's an opportunity kind of rich environment. And getting back to the framework we spoke about kind of earlier, 10 kind of years ago, CACI was very heavily in the expertise side of the equation. And kind of more recently, in the last 5 to 7 years, we've purposefully and consciously shifted some of our focus to get into the technology areas and some of the mission technology areas. And that brings a host of either competitors or partners or technologies that we can kind of bring to bear, to solve solutions and capabilities that we were not looking at previously. Those needs were still out there or the needs are expanding, but we did not focus on that aspect of the market. Our addressable market, the amount of business that we could conceivably go after has expanded materially as we increase some of those parts of our portfolio.

Okay. I guess in thinking about the addressable market and where sales can go. We've seen the backlog for the company. I think over the past almost 3 years or so, the backlog has probably doubled, the total backlog. We've seen sales probably up about 40% or so since then. How do we think about the relationship between those 2? And maybe what it says about where sales might be headed?

Yes. Yes. So backlog is a very good kind of leading indicator for CACI. And can we -- just running our business, we want to try to look into the future and try to come up with certain measures and our investors similarly want to see those kind of leading indicators. So backlog consists of the sum total of all our award potential. Assuming that we win a $500 million award, we generate $100 million in year 1, that program has $400 million left in backlog. So it's a sum of all our programs. A few things to note in terms of the size of the backlog. One is as we go after successfully different types of work, the contract duration is different than it used to be. In the last 2 or 3 years, we added approximately 18 months to our average contract duration. So before we would think that we would burn our backlog off within a certain time period, that has expanded. So some of the increase in backlog is driven by a different type of work. Now that's all very good because we have longer-term sustainable, mission enterprise critical types of kind of work that we've embarked upon. But I simply can't take the backlog to divide by old statistics come with those future revenue characteristics. Dan, anything you want to add to that?

Yes, spot on. I mean, yes, the backlog duration is important. At the same time, pursuing the -- some -- being more focused and selective in areas we pursue such that they're higher value contributes to margin expansion. We've also focused on larger programs as well, which is, as we've been quite successful as -- winning our share of business and adding to that overall backlog quite nicely. So that backlog growth is up quite a bit, gives us a lot of visibility into the future as do those extended durations, which we think is quite nice.

Okay. Speaking about some of those large opportunities, maybe if you could update us on the ramp-up thus far for some of the bigger recent, within the past year or so, contract wins, TCS and BEAGLE?

Yes. BEAGLE, the first one I'll talk about is providing work for customs and border protection, a very large award, billion-dollars award over 5 years, where we're kind of supporting the agency, in effect retooling a lot of their enterprise infrastructure, software, agile software development to continue to refresh a number of applications. And the program is up and running probably in a full-scale right now, brought a large number of people in it, and it's contributing quite nicely. Some very nice success stories. Certain applications, which used to take perhaps 4 weeks to undertake a particular task, now take a week to undertake that same task using some agile developments. TCS, as we work for the NGA, that provides kind of transport and cyber for some of the NGA systems. Transport, meaning connectivity, kind of network enhancements. Again, a multiyear program. What's unique about that program was, there's a series of kind of base work that is being done. And then some additional work where the NGA may add new scope of work for more sites or more capabilities, and we structure the contract to have a catalog type of pricing. So if you want to add to the scope of it, we've redefined those units of additional scope and like a fixed price associated with it. So it's nice to have that fixed price component, and our experience is that generally fixed price work comes at higher levels of profitability. So that's another program that's performing quite well so far.

Yes. I guess speaking of contract mix, do you target any particular type of mix? Do you target more fixed-price work because it's higher margin? I always kind of feel like cost-plus work has its benefits here. There's a certain amount of the risk profile of cost plus work, the level of customer intimacy can be very positive as well. And I think sometimes there's an assumption in the market that, "Oh, it needs to be fixed price because that's why margins are high." But how do you think about that distribution within your contract mix?

Yes. So kind of good question. Everything else being equal, your fixed-price contract should generate more margin. They're riskier. So they're classic risk-return trade-off. And we, in our minds, do a very good job of meeting the risk on those fixed-price contracts. So we do kind of prefer those. That being said, oftentimes, we're not the decision-maker. The customer is the decision-maker, and they're awarding contracts under this particular auspices, and we'll bid what's appropriate. LGS, you had a large number of sole-source cost-plus contracts, kind of margins in the double digits, which is kind of very high for cost-plus type of work. But given their capabilities, they were able to kind of generate high margins. The other way that I think it's useful to think about margins is our expertise in our technology work. Earlier on, again, I defined expertise and technology. We are reporting expertise and technology revenue in one of the tables in our quarterly financial in a press release. For the first half of this year, our expertise revenue grew approximately flattish. So in a stable book of business, generating nice profitability. Expertise grew about 12%. So our growth was driven by our -- excuse me, our technology grew by 12%. So our growth was generated by technology. Technology margins on average are anywhere between 300 and 500 basis points higher than expertise. So what gives us confidence in projecting ever-increasing margins is the fact that we are able to grow technology at a faster rate and that mix will help us. Now within that technology, there will be cost-plus T&M fixed price, but it's really that technology component is another way to look at margins.

Okay. Okay. That's very helpful. I guess a couple of questions on that. I mean one other contract structure is just the difference between in terms of IT engagements, company-owned assets versus government-owned assets and that has implications for capital outlays and EBITDA margins and things like that. Is that something that the customer usually decides? Or does the company have a preference and seek out a certain mix in that regard?

Yes. I mean so the customer kind of generally decides when they put out an RFP or a proposal as to those 2 different alternatives. I know some other government service providers are very comfortable with the model, whereby they will have company-owned equipment and provide it for government use, requires the sizable capital outlays or various leasing arrangements and able to charge the government to recapture their costs on these new programs. That is not a construct that we've been impressive with. Kind of most of our enterprise work is using either kind of government networks. A lot of it has been, as you know, transitioned to the cloud, various as-a-service type models. And most of our work is kind of government-owned equipment, and we will be supporting their networks or supporting the cloud kind of based networks.

Great. Okay. Okay. Looking at the outlook for the remainder of fiscal '21, which is 2 more quarters. And I think the outlook for organic growth is for some acceleration in the third and fourth quarter. I wonder if you could talk about the drivers of that growth, the degree to which it is driven by or dependent on how quickly the pandemic recedes. And as part of that, I guess, whether it's particularly Q4 weighted into the back of the year or something that's more distributed across the second half of the year.

Okay. Good. Yes. Thank you. So we provide annual guidance. Our revenue guidance this year at this point is $6.05 billion to $6.25 billion. And so we will be kind of within that range. At the midpoint, that translates to organic revenue growth of approximately 6%. For the first half of the year, we were at 5%. So therefore, in the back half, roughly 7%. So as you're playing out at the midpoint through that acceleration. Nothing singular that's driving it. It's a series of programs, some new business that we won which starts ramping up, profiles of existing programs kind of which is kind of driving that. We do have some product sales which are episodic. We recognize that kind of revenue, either the 30th of the month or the 2nd of the following month. So sometimes there's lumpiness as to how those flow. But generally speaking, it's just kind of the run rate business in the way it's kind of ramping through that time period.

Right. Okay. And then on the flip side of that. I think the margin guidance would suggest that there's going to be some contraction in the second half of the year in the EBITDA margin. And so maybe if you can share sort of what drives that. And it seems thus far during the pandemic for a fair number of IT service providers, margins have been fairly strong. And to the degree that, that reflects that margin -- some pressure on margins reflects a return to more normal operating conditions.

Yes. Yes. So one of the items impacting CACI on a very positive basis in the first and second quarters of this year was a nice elevated level of profitability on a fixed price contract, and we're -- for competitive and customer kind of reasons not going to talk too much about the specific contract. But that added, I think, Dan, probably $20 million-ish to...

$30 million in the first half.

Yes, $30 million of additional profitability in the first half. And so we got a really nice kind of work and of -- when we provided guidance, we didn't -- we weren't clear if any of that benefit would continue into the third and the fourth quarter of the year. And so I think that is one of the major reasons for a shift in kind of EBITDA first half, second half because of that kind of unusual piece of work. The underlying business, generally, it's kind of very similar. There's not singular activities going on, with one caveat, and I mentioned product sales in terms of the lumpiness and how they impact revenue. But they are just proportionate in influencing EBITDA generally at high levels of kind of EBITDA performance. COVID also has created a bit of a distortion. Some of our employees are working blue-gold shift work to keep secured locations free of the negative impacts of COVID. We are being reimbursed by -- for our expenses under Section 3610 of the CARES Act, but we do not receive any profit on those. And so that has -- creating a big drag on profitability. That being said, we're seeing some lower indirect costs in a number of areas. Kind of medical expense is still lower than it had been prior to COVID. Travel, conference expenses are down kind of materially, hence a Zoom call instead of an in-person conference. And so a series of other puts and takes impacting the market profiles.

Okay. As vaccinations scale up, are you starting to see or at least in a very kind of -- have a close view on people returning to more normal working conditions in SCIFs?

So we're keeping a close hand on that. And so far, we haven't seen that switch being flipped yet. And so that kind of ambient level today is very similar to where it's been the last -- in a few months. But a variety of anecdotal evidence also kind of nationwide trends, the number of vaccines, which have been administered already, different areas, Northern Virginia, and different government projections of the percentage of the population that will be vaccinated. We expect that to ease up considerably in the next -- in a few months, let's say.

Great. Okay. Kind of a standard question, but any kind of -- as we think about the rest of this fiscal year and into fiscal '22, number one, any major recompetes coming up that we should be aware of? And number two, any major contract pursuits? And one, if you could touch on would be the DISA Enclave effort? And what that might mean both from a -- as an opportunity and as a risk?

Yes. So -- and first of kind of recompete some, our book of business is such that we have a relatively unconcentrated set of business. And so there's no contract that we have, which is greater than 5% of our revenue. On a typical year, anywhere between 10% and, let's say, 15% of our work is going to be recompeted just kind of mathematically and don't foresee any unusual amounts of recompetes this coming year. We're not going to -- I won't talk specifically about a particular contract, like the DISA Enclave. But I would say, suffice it to say, we perform a variety of enterprise services for DoD agencies, besides the Army, the Navy and to kind of the Air Force. And so that is a piece of activity that we're quite aware of. And Dan, I'm not sure you want to add to that, but I think perhaps that should suffice.

That suffices. Yes.

Okay. Maybe if you could talk a little bit about the hiring environment as you continue to grow. How competitive is it? What's your strategy with regard to hiring within and also outside the national capital region?

Yes. So what we're interested in doing as a company is to be an employer of choice. Once someone comes to work for CACI, we would like them to stay with CACI. So let's try to minimize attrition and at the same time, make us an attractive place to work. And we've been embarked upon a number of initiatives in the past 5 to 7 years, which have been successful. Recognized as the Best Place to Work in a variety of locations, Fortune Most Admired. We do employ engagement surveys on a regular basis and get high marks in a number of areas with regards to employee engagement, flexibility, confidence in management and the like. And so that's foundational. It helps us kind of distinguish ourselves as an employer. And I think that's going to continue to pay off kind of dividends for CACI. The hiring environment is a competitive hiring environment. The people that we're looking to fill in important positions have different levels of skills, but a lot of highly skilled employees, a good number of employees with clearances, which reduces the pool kind of even further. So a constant focus to kind of attract people into CACI. In many instances, we're able to work remotely, SCIFs out of the exception, but we've proven that kind of remote kind of working is very effective for us. And so we are encouraging our employees to kind of work remotely as possible. And that has opened up some ability to hire outside of the Washington capital region. And even before COVID, we had presences in a variety of locations: San Antonio, Austin, Texas; Colorado, Fort Collins, Denver; kind of Rochester, Tampa, et cetera, which allowed us to get the right skill sets and expand our geographic sort of reach for hiring people.

Okay. Okay. I think we're coming up on time. Maybe as a final one. I know you probably get the -- it feels like there's a question on all the defense conference calls is sort of how are you going to grow in a flat budget environment? But maybe if we take it a different way. And if you think about your growth in recent years, is there a way to kind of dissect it into a portion which you'd attribute to the fact that we've been in a -- or we've been feeling the tail end of the budget increases that happened in 2016, '17, '18, et cetera up until now? And then a portion that was more maybe underlying and structural?

Yes. So what we've been trying to do is to go after kind of areas in the budget, which have higher growth potential. So kind of within a very large federal budget, some areas are going to get more funding, some less and some about the same. And a lot of the areas which are going to get more funding is things that President Biden has articulated, becoming more agile, focused on electronic warfare, ISR, intelligence, kind of more nimble in the capabilities that we have been developing, both on the mission and the enterprise side fit into those buckets. And so focus on those faster swim lanes or those faster currents and that should allow us to continue to grow, again, greater than the underlying market with those expanding markets.

Okay. Excellent. Well, I think we're at the -- we've reached our time here. So I want to thank you both for joining us. Really appreciate the time and the insight and look forward to hearing from you again soon.

Okay. Well, thank you, and thank you for everyone who participated this afternoon and appreciate your support. And if anyone has further questions, Dan, myself, and George Price are available to entertain any types of dialogue. So thank you.

Thanks very much.

Thank you, Seth.