CACI International Inc (CACI) Earnings Call Transcript & Summary

Thanks to everyone for rejoining us. Welcome to the -- I guess, the afternoon session of the conference. Excited to have CACI with us and CFO, Tom Mutryn for our hard-hitting interview here. For folks that are watching this, if you'd like to get questions answered, you can either use the Q&A function built into the Wall Street webcasting app or just e-mail them to me at [email protected], and I'll do my best to get him answered. And we reward participation, so keep that in mind. Tom, thank you for taking the time with us today, and good to see you.

Of course, thank you. But you didn't tell me if this was going to be hard hitting. So be easy on me, Joe.

It's all relative.

Okay. Thank you.

Maybe just to start, this isn't particularly hard hitting, just kind of an update on the business environment. I feel like the last couple quarters have been somewhat choppy for the industry in terms of COVID, and the award environment, the administration transition. So just kind of what you're seeing now in terms of award flow and employee productivity, that's sort of thinking?

Yes. We're good. Thank you. Good afternoon, everyone, and thank you for joining us. I'll speak less about the industry, but more about CACI. The last year has proven that our business is resilient. We had some impacts of COVID. But in the great scheme of things, kind of relatively minor in terms of kind of revenue and profitability. In some cases, work was delayed or we were not able to get people to travel to locations outside the United States. But we had some over costs associated with medical and travel, and we were able to perform admirably during this time period. Overall growth was approximately 5%. We told our investors at the beginning of the year, we hit margin levels of approximately 10.7%. From an EBITDA perspective, we're tracking to those numbers. Now within that, there has been some puts and takes, some good guys associated with COVID, some bad guys associated with COVID. We had some tax planning ideas, which impacted our fourth quarter. But generally, good numbers. You mentioned awards. Our book-to-bill, our total awards over trailing month 12-month revenue was approximately 1.5x, implying approximately $9 billion of awards. So awards are coming in, despite a change in administration and some COVID issues. I think the -- for us, we're not seeing a major impact of kind of a new administration. A lot of the priorities within the Department of Defense are exactly the same, making sure the nation is safe, focusing on technology and the like.

Tom, when you think about your cost structure and maybe margins on the other side of COVID, do you -- does the margin profile of the business change as a result of maybe some of the structural changes in terms of work from home and less travel? Or do those savings get offset by other stuff or reinvested?

Yes. There should be some savings as you articulate, less travel, work from home. It takes a while for us to adjust our real estate footprint, given the longer-term leases that we have in place. So we should see some relatively minor and positive impacts over the next few years. As you know, over 50% of our work is cost plus, and so 50% of the savings flow back to the government in terms of changes to our rates. But on the whole, it should provide a little bit of positiveness associated with some structural changes due to COVID.

Okay. And then just maybe more specifically on kind of the award environment or the customer behavior you're seeing. I think maybe there were 2 opposing views, 1 that the change in administration and some uncertainty around the budget led customers to maybe slow things down, particularly on contract awards. The other side being that there's a lot of pent-up demand from certain customers, mainly Intel who didn't award as much through COVID, and that's going to start to be released. So how do you view kind of the, I guess, the relative impact of those 2 forces on your business?

Yes. So right now, the good news is that the administration came out with a budget for FY '22, both for civilian and Department of Defense agencies. Growth levels of DoD at around 2%, higher than what many people anticipated. So to the extent that, that information is out there, people in the government, you have more certainty today than they did a few months ago. And so they're continuing to kind of press forward. Within that 2% we're seeing a 6% reduction in procurement, which is platforms, planes, aircraft carriers, tanks and the like, which is not part of our business. And decent demand in some space, cyber, C5ISR and the like, some of the technology areas. So we're seeing a clear picture of the budget, and as a result of that, the wheels of the government continued to turn. I mentioned seeing some decent awards in the last 12 months. That's certainly the case. And several years ago, when CACI had materially more expertise work and the budget control act, so-called sequestration came into effect. Government's departments needed to reduce budgets from ambient levels. And at that point in time, it was relatively easy to take 100 people working on a expertise program to reduce it to 80 or 75 people, death by 1,000 cuts across the enterprise. We're not seeing those cuts, and our business is more weighted towards technology today than it was in the past and we have more resiliency if those activities occur.

Tom, maybe we can just talk about that for a little bit. Just in terms of the pivot that the portfolio has undergone the last several years and what seems to be kind of a continued pivot as technology grows faster than expertise. Can you talk about I think that the general message is that the better part, the higher-margin part is growing faster and it carries higher margins. Those are both good. Are there any challenges associated with that pivot? Is it more competitive? Is it less sticky? Is it more cyclical at certain times? Is it higher risk? What are maybe some of the challenges associated with moving more of the portfolio towards technology and hardware?

Yes. Yes. So when we talk about technology, to make sure everyone is clear, we're talking about delivering outcomes. As opposed to providing input, the way we define expertise. Some of our technology is enterprise based, large agile software development contracts where we're providing agile at scale in parlance is technology as is some of the mission technology, hardware focused of activities with a strong software component to those. Technology requires us to differentiate ourselves. And that differentiation doesn't happen by itself. We need to invest in internal technologies and capabilities, making sure we have the right people working at CACI, the skill set, the training, the credentials, we need to have invested in IR&D, making sure that we do have distinguish capabilities. So there is an upfront investment in that particular radar. The competition is different. Perhaps fewer people who have the ability to deliver, I'll say, large software programs at scale, business systems, enterprise IT, but they're capable competitors. And so we need to be on top of the game to be able to distinguish ourselves. So continue we'll focus on kind of refreshing our capabilities, staying ahead of current trends. The normal -- everybody saying, investors here repeatedly, data analytics, machine learning, artificial intelligence and the like. And so that requires a degree of focus and effort.

Tom, I think 1 of the challenges is folks hear that from a lot of companies that they're investing in some of those areas. What are you doing maybe differently than others that allows you to be more effective at it than your competitors?

Yes. Thank you. So what we're focusing on is developing past performance I'll talk about agile development, which I mentioned already. We won a couple of very large programs, 1 for Customs and Border Protection called BEAGLE. We're going to that agency and effectively rewriting large sections of their IT infrastructure at scale, $1 billion program over 5 years. Another large $1 billion-plus program with the national geospatial agency, providing communication infrastructure, software development to support those particular missions. And those are areas where we do have capabilities and trying to distinguish ourselves in a competitive environment. On the mission technology side, some of the -- a bit easier to differentiate ourselves with exquisite technology. Signals intelligence, Mastodon provided us kind of unique capabilities in those areas. The acquisition of LGS allowed us to become a world expert in wireless communication protocol in photonics, laser-based communications, and most recently, Ascent Vision Technology provided fairly unique capabilities in onboard processing in EO/IR imaging devices. And so part of it is just to make the right investments either through acquisitions or internal technology to create those differentiations.

Okay. That's helpful. And then I want to go back to the addressable market view a little bit. And I'm sure that defining your addressable market is more art form than maybe anything. I guess simply, if the DoD budget, as you see it is growing 2%, and you all focus on the fact that within that budget, you're aligned with faster-growing areas of the budget and less exposed to areas that are seeing declines, why isn't your addressable market within that 2% growing faster and why can't you grow 1% to 4% on top of that since you kind of -- you do better than your competition?

Yes. So every year, we do a detailed study on the addressable market informed by incurring -- years of budget and budget projections. Budgets are just coming out, so we're in the process of doing that work. At the most recent earnings call, as a proxy for the addressable market, we used DoD growth of around 2%, and we will refine those numbers going forward. When we look at the addressable market, we look at into our areas of focus. One will be enterprise IT, one will be business systems, one will be mission support less department focused, but on areas of capability focused, $200 billion addressable market in some of those large chunks Enterprise IT business systems, which I just mentioned, are growing at that kind of 1% to 2% level. So a big portion of that is growing at those relatively stable levels. Now they're massive sizes in terms of spending levels. And so we have opportunity to grow there, but those markets are not growing as much. Now there are some faster currents, cyber or space systems or C5ISR, but there are smaller portions of that overall addressable market for us. And so it's kind of mathematics to come up with a kind of weighted average number.

Okay. How do you see, I guess, based on what you've seen from the '22 budget? How do you see kind of the outlook for your addressable market maybe beyond '21 and your ability to continue to outgrow that? It looks like maybe you're 300 or 400 basis points ahead of that in '21, how do you see that beyond '21?

Yes. Our commitment, as we repeat kind of repeatedly, to grow faster than the addressable market and ever-increasing margins. We see that us continuing to execute upon that in FY '22 and beyond. The market is there overall, kind of the DoD budget kind of underscored the administration's commitment to maintain a very strong military intelligence community focus on emerging threats, technology based, a lot of future wars or actions will most likely be nonkinetic, a lot of experts talk about resiliency of our systems, protecting our systems, looking for in other people's systems, communication protocols. So those are areas where we do see continued growth. And we have some capabilities to address those particular issues. So I feel good about where we stand from a budget perspective.

Do you see your addressable market slowing?

No. I don't. I would think over the next couple of years, based on the information we have today, it should be relatively kind of stable, growing, causing in line with inflation expectations, somewhere along there. There had been some thought about kind of reductions in kind of discretionary spending civilian and DoD agencies. That is not coming to fruition based on current kind of budget proposals, and there doesn't seem to be a concern across the political spectrum of large deficits in federal debt. And so put it in another way, the DoD budget is $721 billion. If it's $700 billion or $740 billion, that $20 billion difference doesn't matter to $28 trillion of federal debt. And in terms of impacting our addressable market, it depends on where that extra $20 billion come from. If it's less aircraft carriers, it's really not impacting us that much. And so within that large number, there's plenty of opportunities for us to continue to grow.

Yes. I guess to that, if the $20 billion isn't an aircraft carriers, if it's -- where would it kind of hurt you if it came out of?

Well, in the areas where we're focused on. We no longer need to -- let's do less spending in electronic warfare. Let's do less spending at C5ISR, which are very closely tied to the missions of the kind of DoD. And to me, it's extremely unlikely that those activities would occur.

Okay. Yes, Tom, I recall a few years ago when tax rates came down, you took an academic view on it and then lower input costs should lead to lower pricing. I'm wondering kind of what you make of -- what you just referred to that you have additional spending in other areas, why wouldn't that eventually pressure discretionary spending and defense budgets, what's your view, maybe medium-term on that?

Yes. So a couple of things. One is the administration in both parties recognize the need to have strong defense intelligence capabilities. Secondly, it's somewhat logically inconsistent. If the administration believes spending more money is going to stimulate the economy, that is a good thing to do, then it would be somewhat logically inconsistent to cut spending elsewhere government employees or government contractors. If more spending is good because we want a stronger economy, why would you cut investments which reduce economic activity. And so there's a logical kind of inconsistency there. And at some point in time, maybe far, far in the future, there will be a consideration of federal deficits. But given the size of the debt, again, another few billion dollars really doesn't make a difference. So I think the focus is let's continue to fund critical areas.

Okay. And again, for folks that are watching, if you have questions, feel free to use the Q&A function here, just send me an e-mail, [email protected]. Tom, for a company that deploys some portion of capital towards M&A, does your perspective on kind of budget pressures? It sounds like your view is that the fiscal pressures created by COVID shouldn't really impact spending in your markets materially at least over the next several years. Does that mean kind of from a valuation standpoint, what you're willing to pay for other businesses hasn't really changed now versus 18 months ago?

That's a fair way to put it, Joe. Let's use an example. Recently, we bought a company Ascent Vision Technology, a company that makes collection devices and provides onboard processing. When we analyzed that company, we try to forecast future cash flows of that particular organization. What does your pipeline look like, what does demand characterizations look like, what is their technology versus competition, how sustainable is their ability to grow kind of double digits for multiple years, how does that fit into CACI strategy? The fact that top line DoD budgets are up or down, in a way, it's not really relevant to looking at that particular instance. And the example I use and maybe I'm exaggerating this stretcher point, if I was going to buy a consumer goods company, let's say, organic grocery store, would I look at overall kind of retail demand kind of in the U.S. or would I go down 5 levels to look at what American consumers are spending on food, what are the trends in food and how does this company position itself against other organic food suppliers. And so it really becomes a micro view of the world. And while the overall environment may provide some insights, it's not deterministic in terms of how we value acquisitions.

Yes. Tom, it's a good point. It's 1 that I think of from time to time. And I feel like what you're saying is you don't look at the budget as a proxy for addressable market when you do acquisitions, and yet, that's kind of what the investment community has to look at as a proxy for your addressable market. And it's really how you frame your ability to grow is based on the budget. And maybe it's not the best way to do it. I would guess that your growth over the next few years is going to be a function of how much work you bid on and how much of that you win. And so when you look out over the next few years, regardless of what the budget is doing, what do you see your pipeline or the amount of work that you bid on doing over that period? Is it growing 5%? Is it flat?

Yes. So I like your framework, and that is a good way to look at our business. We provide statistics as how much at any point in time awards are under evaluation and what our pipeline is for the next kind of 6 months. And so a combination of looking at the awards that are going to be submitted in our win rate will allow us to generate awards, which, in turn, generate growth and profitability. Our trailing 12-month book-to-bill 1.5x. So we're winning more than our current base of business, backlog is growing, which are all positive signs of future growth. I think it's fair to say as we continue to develop capabilities, we would like to bid on interesting work, but interesting work that we have a high probability of winning. We can increase the number of bids that we're submitting. But that may not increase the amount on bids that we win. So it's being selective in using some differentiated capabilities, i.e., technology to help with those new business awards.

Okay. Okay. And then a couple questions from our audience. Is there an upper limit on margins? Does your annual margin expansion come from all lines of business? Or is it from the mix benefit of higher growth technology acquisitions?

Yes. Yes. So the margin expansion is coming from several of those. The mix certainly helps us. Technology work comes at higher margins in enterprise work. So the fact that we're growing technology at a faster rate is productive to margins. But within that, we're -- we have goals within the various buckets of our work. Expertise work would like to see that improve in terms of efficiency and we'd like to see some -- let's not be satisfied with the status quo of our technology margins, let's serve to increase those. Acquisitions, if they're coming at higher margins, some product-related businesses is very helpful as well. So all of those are contributing. In terms of an upper limit, hard to answer that particular question. We believe that we should be able to continue to expand margins that as our commitment. And over the next in 5 to 10 years, we see us continuing to do that. What happens beyond that? It's hard to speculate whether there is a kind of natural ceiling. I know that there are other defense contractors or government service contractors, which have EBITDA margins, which are a bit higher than ours. And so other companies are able to provide services to the government at higher margins than us.

Okay. And then a couple others from the audience. How much of your backlog is typically converted into revenue over the next 12 months? How has that changed as contract lengths have increased?

Yes. Good question. Contract lengths have increased. Probably average contracts have increased by 18 or 24 months. And so while we have record backlog it's taking us longer to convert that backlog into revenue. So there's not a one-to-one correspondence. The fact that we have longer duration contracts is viewed by us as being very positive. This gives us a very sustainable book of business. And Joe, earlier on the call, you mentioned a government agent may want to -- agency may want to reduce a few heads here, a few heads here, and it's easier to do that on smaller, shorter cycle of contracts. But when there's a longer kind of developmental type of contract, it has more staying power. So that's quite helpful for us.

Okay. That's interesting. And then maybe just a couple on M&A. I feel like up until semi recently CACI's view on capital deployment was as clear a strategy as there was in the industry. Tom, you spoke pretty directly around almost your view that you have a competitive advantage in M&A, and that's the best use of capital. That's the best -- produces the best return on the capital that your business produces. And I think that, that shifted a little bit recently towards more balance. So I'm wondering what's driven that? Maybe to start, kind of what drove that shift? If there was one and kind of messaging in terms of how you want to deploy capital?

Yes. There was a shift, a more balanced opportunistic capital deployment strategy, where prior to that, we leaned heavily on M&A. Now we did share repurchases in the past, but the last 1 was 9 years ago. So this has been in our toolkit so to speak. And most recently, in the spring of this year, we found ourselves with leverage less than 2x, a stock price, which we thought was attractively priced. Very low borrowing rates and we kind of determined that we could kind of return capital to our shareholders, driving longer-term value in our remaining stock price. Earnings per share go up as a result of share repurchases. And at the same time, leave capacity for acquisitions. After the ASR, we were leveraged at 2.5x, leaving us at least $1 billion of capacity for acquisitions. And so we're focused on being more balanced and kind of more dynamic. And so on a real-time basis, we will look at several factors, the ones I articulated, the acquisition pipeline, stock price levels, leverage and the like and make those decisions to provide, again, kind of more battles.

As you sit here today, how would you rank those kind of 3 deployment opportunities?

Yes. As we sit here today, we're leveraged at around 2.5x, interest rates are still low, the stock is attractively priced in our minds. And at the same time the information I will not share with investors is that there was an acquisition pipeline out there of some interesting opportunities. And we want to preserve some capacity to provide that value through shareholders. And so I'll leave it at that.

Okay. Tom, unfortunately, I've got to let you go. So I know there are some questions left in the queue, but so apologies, I can't get those answered. But Tom, thank you for taking the time. Always nice to chat with you.

Okay. Joe, thank you. It's been a pleasure as well. And we're always available for our calls and follow-ups. So thanks, everyone.

Thank you.