CACI International Inc (CACI) Earnings Call Transcript & Summary

Good afternoon, everyone. This is Colin Canfield, Barclays' government services analyst. And today, we have the pleasure of hosting John Mengucci, CEO of CACI. John, thank you for attending.

Yes, Colin, thanks for having us.

Just starting off, I guess, we'll dig into kind of the multiyear framework. At Carlin, you discussed CACI's ability to outgrow its addressable market. In your mind, kind of what is the addressable market? What gives you confidence you can not grow? And how does CACI outgrow the addressable market as you think about the longer term?

Yes, thanks. So each and every year, we work with an outside firm. And sort of shred the U.S. government budget and look for things that are most applicable to CACI. We're about a $240 billion addressable market, a $6 billion company. And we're looking for about 3% compound annual growth rate from that targeted market for us. So we -- the last 7 years have grown better than that number, and that's our measurement for top line growth, but I'll also add ever-increasing margins. How do we focus on that? We support both expertise and technology. Growth rate in the expertise here is around 2, growth rate around in the technology space is around 4, but we'll get to 3. And -- but very much focused on moving our portfolio more from expertise into tech because that commands much higher margins.

Got it. Got it. We'll be sure to circle back on the margin dynamics. But just thinking about the growth cadence implied second half of your guide is roughly 3% organic. And if we think about kind of the steps that you need to reach or kind of the milestones that you need to hit in order to achieve that organic growth guidance. Can you just talk us through what needs to happen?

Yes. So we're a July 1 to June 30 company. So we're right in the middle of our fiscal year. As we look at wrapping up our fiscal year '22, we're going through, I guess, I'd say a series of paper cuts. Whether it's COVID and only 25% of our customer base is actually in office. So there's a lot of factors, CR, lack of a fully appropriated budget and the like. And that's causing some stress, and I was getting out of FY '22. So there's some short-term things. I talked about those during the second quarter earnings call. But as we look to the midterm and the longer term, it's really back to our fundamental strategy, frankly, and that's to invest ahead of customer need to make sure that we have the right capabilities and the right customer relationships that allow us to chase business in areas that are growing in funding. Again, as I mentioned, looking more towards a technology delivery and an expertise delivery. And by doing that, we're able to differentiate ourselves. I'm sure we're going to talk about acquisitions and the like coming forward, but we're very acquisitive company. We're making certain that we are top of game on both capabilities and customer relationships that continue to grow. Our addressable market allow us to continue to grow.

Got it. Got it. And if we think about CACI's exposure across defense, Intel and civil, where are you seeing the best demand signals? And how do you expect those to evolve near to longer term?

Yes. We get asked that question a lot. And frankly, we don't spend an awful lot of time looking at whether it's fed civil or defense or Intel. It's more about is the customer looking for expertise, which is delivering highly qualified people, looking for a technology solution. And we've done a lot of our reporting in our quarterly metrics around expertise in tech. We actually do that because it is how we manage the business. We want to have the right mix. We also look at the margins on our technology business, it's 300 to 500 basis points better than it is on the expertise side. So we do talk about what's in our backlog and what our current book of business is around those 2 numbers. Having said that, we are predominantly a DoD and Intel customer business. We do have some amount of federal civilian. DA -- DHS is our largest customer there. As you would imagine, as we go more towards technology base, and we're the organization in the federal civilian space, it really looks for new and creative solutions, more than just delivering people.

Got it. Got it. And if you think about key programs or key awards or certain technologies that you feel are really important to have such that you can outgrow, what are those? And kind of when do they materialize?

Yes. So we've always been very focused on anything in the electronic warfare world, so whether it's signals collection, reference geolocation and the like. But also if you look at it across the larger expanse of the federal government, looking at CACI being more of a software company, and by having the focus on that over the last 5 to 7 years, we've won the 2 largest agile software -- development software programs across the United States government. That's extremely important because it says that we can create repeatable solutions. We can do them in a very cost-effective manner. And we can be that government services provider that is looking at less providing people and more providing solutions. If we look at recent $1 billion NGA award, a customer looking for a new and creative way to bring AI into satellite-based imagery. We won that job based on our technology differentiator. We might have been the lowest price. We certainly were not the lowest, lowest margin provider that had been 7 years ago when CACI bid on that job, we would have bid the number of people that the customer was looking for. But instead, we worked really hard to shape that procurement so that customer to buy 3/4 technology solution and a quarter expertise. That one gives a lower overall cost to our NGA customer. So it's a lower price from us, but it's a much higher margin for us. And so as we continue to do that, we can continue to test solutions on customers that are traditionally customers who are buying people, that model continues to work, and then we'll be expanding where we go in the SIGINT collection and the like.

Got it. Got it. And just following up on that, if we think of within the context of affordability, where are some of the technology areas that CACI can achieve the best affordability outcomes versus peers? And then kind of how does that feed the growth?

Yes. So a couple of areas. One is not as obvious, and that's that as customers buy what we would call products or devices to do a number of things. A lot of the ground force and enable forces are buying devices, want to do comms, want to do SIGINT collection. And to look at overhead UASs and where are they and what type of UAS are they, how do I handle out in the field cyber issues, and we're buying different devices for every one of those because what DoD traditionally does is it buys an item. What we've been moving to over the last 5 years is building software definable devices. I hate to use the iPhone as the -- example of that is the easiest example, there's 2.5 billion apps and there's 13 versions of the iPhone. I'd rather not be making money on the actual device that we really rather making it on the software that we can download to that device. So somebody out in the field, it's right about being -- having RF signal corrupted because of non-kinetic effects, looking for folks with electronic devices, looking for ground-based radars, looking for things that can cause harm or interrupt communications. All of those areas can be done with a single device out in the field. It's just whichever software loadable you want. Also, the pace of the threats is very, very different. I've been on record many times saying that whether we're talking about counterterrorism or we're talking about the Europe here. It is a world of bits and bites versus bombs and bullets, okay? We're always going to have bombs and bullets out. We're always going to have kinetic issues. But even today, as we look at some of the global issues that the U.S. is find themselves soon to be involved in, a lot of those are all non-kinetic needs. So how are we that provider that is able to quickly react to the ever-changing threat and not be part of the ACAP1 large production programs that are 7 years in duration. And 2 years into that duration, the actual threat has changed. So how do we come to that agile software solution provider and that's what's driven our technology growth, and that's what we would expect to bring more and more in the future.

Got it. Got it. Thinking -- switching over to margins, right? Last earnings call, you discussed the path to 11% adjusted EBITDA margins kind of beyond technology being 300 to 500 bps greater. Can you just talk about what the growth is required in technology to mix up your margins over time? And what gives you confidence that you can win new work that allows you to mix margins over time?

Yes. I guess the last question first. We've proven that we we'll continue to do it because we have done it. On the 11% comment, I sort of heard that comment come in many, many times. It was actually in response to our 2 latest acquisitions, what would we expect them to be bringing once their investment string is done. But having said that, we've been on a path for better than addressable market growth and ever-increasing margins. We began that drive about 5 to 6 years ago, we were in the high 70s of EBITDA margins. We're getting up close to that 11% range. It's really a mix. It truly is a couple of different avenues. One is we're a company that is software driven. We're willing to take additional risk and take contracts to others take in a cost-plus model and put those in a perfect price model. We've been able to drive margins there. And then our mix of business, our mix of business when we started down this path was about 80% expertise and 20% technology. And it's clear that margins on the expertise side are materially lower than what you can get on a tech solution. So we started to share and understand the fact that our technology programs are generating 300%, 500% -- or basis points better. So our mix has now gone to 50-50. So over a 5-year period, that's a dramatic shift of our baseline, which says that over a 5-year period, we've been able to drive about 300 to 400 basis points of margin growth sustainable, which means as we continue to invest ahead of customer need, we're very selective about the expertise work that has to come at better, better margins than it has in the past. And that's frankly why we're one of those companies in this sector that is not talking about how hard it is to find candidates, and we're not spending a lot of time talking about wage inflation. If I'm an expertise-driven business where the majority of my growth is going to be in selling people. Those would be the first 2 things as the CEO that I would mention during COVID, tough to find people, people's wages continue to climb. And the unfortunate thing is they're going to continue to climb. And if -- so if you're stuck on a 5-year expertise job and you've got fixed price time and material job, fixed rates, you're going to be complaining about somebody who wants to make $5,000 or $10,000 more. Only half of our business is there. And each year when that business comes up for recompete back on the margin piece, we're looking at the margin that we believe we deserve. Because at the end of the day, it is hard finding talent. I want to put that talent on the best long-term growth programs so we can and taking an individual, who is well schooled and well credentialed, and putting him on business, he is going to penetrate 4% or 5%. It's going to recompete every other year. For CACI and the government services sector, that is not a winning model for us. So we've proven it year after year that we've been able to drive both. So that's where we focus on. And at the end of the day, it's using acquisitions and partnerships and the key investments to make sure we're filling capability gaps because as the threat changes, we've got to be in the more and more areas of the federal government budget.

Got it. Got it. And if we think about some of the recent acquisitions within the context of your margins, right, IDT being kind of one of the first margin dilutive acquisitions that we've seen as of recent. Can you just talk to what extent are your technology margins now? What would -- if we would consider as new work mix and kind of defense hardware land? And how much of your natural margin expansion within the technology domain just comes from natural work maturation?

Yes. It's a combination of both, but let's talk about what we brought into the company in the way of our last 3 acquisitions. We did Bluestone Analytics. We did say SA Photonics. We did ID tech. I'll start with the last one first. As the government looks to better cyber protect networks, and allow networks to be built to carry not only unclassified information but classified secret -- top-secret at higher bandwidth. There's a large scope of work being done to re-architect networks. Think about router switches, pipes and at the network side. What a lot of people missed over and glossed over because we're very deep in the network side based on our LGS acquisition, is the devices that can connect to that network. The NSA about 18 months back came out with CSFC which is commercial for a classified is pretty much if, I have a laptop or a server or a handheld device, how about connect into that network and still keep it in a secure mode. The NSA is taking -- is allowing us to take commercial items. Think about a Dell laptop, immediately put a software wrap around that and connected to that secured networks. That is a complete game changers to how customers can get information from classified networks, either airborne assets, space-based assets, ground-based asset and the like. But I detect start off as the VAR many, many years back, bought a couple of high-tech companies to it and said, how do I give a software solution, which is a subscription-based model that allows you to our customers not to pay $10,000 for a specialized laptop. Let's pay $1,200 for a commercial one to allow that with a small software subscription to be able to ride. So the beauty of ID tech is that's what they bring to us. If we look at SA Photonics optical communications, given the bandwidth that our nation needs to bring down from space, given the fact that space is highly contested now. There's a lot of RF right up in space. And it's our belief and our customers beliefs that as we create optical cross links in between satellites and down to the ground, that's the way to get not only higher bandwidth data down when we get to the right cost points, we're seeing a lot of commercial neo folks come into that market as well. So a lot of those deals that we did, those 2 deals, bring in higher-margin tech in the '23, '24 time frame. We still got about another 12 to 18 months of investments in SA Photonics. So to your question, that would be the new, new that will be driving margins. The rest of the margin growth has really been on mix and making certain that we are finding some people who bought -- who awarded contracts in the expertise side and transform them to the technology front. And an easy example is a customer who has a network operations center with 200 people in it, who continually every other year recompete for the lowest rate for 200 people. It was our belief that we could partner with companies like Splunk and others and come back to the customer with a very different model, which says you need 45 people in this network operations center, the rest can be done with technology. How about you pay less, I make more. You worry about what you're paying and worry less about what I'm making and let that business deal work in a very different manner. And that is a great growth to margins. It's pretty much a 2x to 3x margin delta. So as a minimum, 300, 500 basis points more. So it is a nice mix. And we believe we have the right of capabilities going forward in space and in cyber and IT modernization to make sure that we've got a nice, nice path to grow...

Got it. Got it. At this point, in switching to capital allocation. At this point, it's pretty well documented that strategic earnings growth story is a multiyear basis. If you can maybe talk about how your perspective on the time frame for returns has changed or if it has changed at all in terms of your capital allocation strategy?

Yes. I mean we have traditionally put our free cash flow towards long-term growth and that meant to do more acquisitions, right? We're strategically based company, strategy is where we come from. Twice each year, we look at the gaps. We have gaps in capability or customer relationships, where the future -- or where our customers are going to go, we either are or we are not going to be well aligned there. We're a software-based company. We're very, very agile. We can move very, very quickly. We've done 89 acquisitions in space. So we are a disciplined acquirer and believe that one of the best uses of our capital is to continue to buy capabilities, customer relationships that allow us to grow that addressable market. Now recognizing that, also recognizing that opportunistic and flexible is the right kind of capital deployment at its strategy. This past year, we spent $600 million free cash flow on acquisitionsn and a $500 million ASR. I think what investors have gotten to know about us over the last 5 to 6 quarters is opportunistic and flexible is real. It's not just type of buzz term. There are plenty of times in our future where there aren't any acquisitions that are there that are going to fill our gaps or we have less gaps. And we have to be very opportunistic and make certain valuation of our stock is low compared to our own standards. And so our investors know that they should be looking for us to do at least in ANT case but just as much of one as another. Again, I'm not trying to make that equal, but there are times that makes sense for us to buyback our stock that gives us some very nice short-short term free cash flow per share. And our longer-term acquisitions have proven over time to grow this company from $1.5 billion company 11 years back to a $6 billion company. So we're buying them in the right way, in the right manner. We're buying with the right financial discipline and allows us to continue to grow top and bottom.

And if we think about what's left in terms of capability or customer gaps kind of where do you see the best opportunity to add capabilities to?

Yes Look, I'm firm believer that the entire world works in the RF spectrum. It's just who we've become and both good and bad folks operate anywhere in the RF spectrum. So anything that is electronic warfare connected, we really can't talk about where we go next unless we spend a minute on convergence of SIGINT and cyber and electronic warfare is here. Oddly, as a government contractor, I received as many meetings talking about the current threats in the Ukraine, what that means for our networks just as much as what it means for what the U.S.'s role is going to be in that -- in this urgency, which is just more proof, right, that there is so much around this globe, that's going to be more non-kinetic in nature. And whether it's the start of the fight or the middle of the fight there are going to be RF solutions and our devices that can find those sources of RF and geo-locate them and provide commanders courses of actions as to how to make sure they don't interfere with comms how they don't interfere with GPS signals, what are some different alternative GPS signal sources that DoD is consistently working for. And with the acquisition of LGS and Six3 and other acquisitions we've done over the last 4 to 5 years, it really positions us well. So anything in that RF world, anything in IT modernization that we don't have covered, in the cyber area. If we were to look at all of our revenues and see which ones are cyber driven, we're probably a top 5 cyber company in the nation, frankly. It's just that 50% to 75% of what we do, we can't talk about to open audiences. So it's more on the offensive side. So...

Got it. Got it. And if we think about your M&A pipeline, obviously, pretty serious price dislocation among the publicly traded services names. How much of that dislocation are you seeing in your private M&A pipeline? And kind of as you think about going out, what are the key factors that we can watch that allow you to deliver more M&A?

Yes. I mean one is strategically, again, there are gaps, we believe we need to fill. Clearly, if I went back 6 to 7 years, there's many less gaps we have today than we had 5 to 6 to 7 years back, which is positive because that growth strategy of doing some acquisitions in the technology space. It took us 2 to 3 years to prove that we could do a large-scale technology acquisition. Second, can you prove you can do this without destroying value. Third, are you actually buying them in the right places where the government is out there. I'm pretty confident in the strategic team we have to make certain that we're hunting in the right areas. If I looked at acquisition valuations as we went over the last maybe 18 to 24 months, there were a lot of factors there, too. I mean, it was just one factor, it would be easy, right? But you have founder owners who are looking at capital gains saying, "Boy, I'm going to -- if I ever am going to sell, I got to solve because by the end of the year, capital gains is going to be different." That turned out not to be absolutely true. Capital is cheap. So therefore, these companies who do acquisitions could afford to pay more. A disciplined acquirer is not going to use the fact that capital is cheaper to go pay more for an asset. And frankly, in terms of conditions of those deals, we're not very conducive. So we did 4 smaller ones that actually gave us the right kind of technology growth that we wanted to see, and we stayed away from deals that just didn't make the right sense. We have the right hurdle rate set. We look for the right IRR. Even on the 2 acquisitions, frankly, that -- we got a lot of feedback. The fact that they were EBITDA margin dilutive, sort of knew that when we actually signed a deal. They both had IRRs that were high teens and greater than 20%. So a great long-term investment for the customers in space are going to pay -- spend tens of billions of dollars that they're not spending today. So it's all new, new for us. And that's what we mean by being a long-range growth company. We will grow over the short term, but our focus is not always making right acquisitions, they're going to allow us to grow year-over-year.

Got it. Got it. As we think about just tying off capital allocation, as you think about kind of your lower capability gaps and kind of how you're weighing multiyear cash accretion, where are you seeing better accretion now split between M&A and share repurchases?

Yes, I would tell you for us. One is on the shorter term, one is on the longer term, right? And anything that drives free cash flow per share and both of those do that, which is why we put in and capital deployment model in place. We've been doing all the right things to, first of all, transform this business so that if we were back in 5 to 7 years back, we were going through a lot of government shutdowns. And we were constantly asked, so how much revenue did you lose because of the government shutdown? And frankly, it looks like a Thursday, 6 years ago, I said I'm tired answering those questions, okay? So we moved our business more towards tech. We paid what we thought was a fair price and a well-balanced price. People looked at them, all multiples. Some people said it's too high of a multiple. Some said that's -- I'm not quite sure where. Then the end of the day, we own the asset, we did transform this business. We moved it from 80-20 expertise, which is a highly monetized partner government services today, moving into 50-50 or a company that's not talking about, it's hard to find people. We're a company that's not complaining about wage inflation, and we're out there delivering software-driven technology on a scale of about $3 billion to $3.2 billion each year. As for share repurchase versus acquisition, we're going to continually get asked that. And my only point there is our capital deployment strategy is an ANT. And where it's opportunistic and the right thing for us to do share repurchases. Our investors have now seen that when we say we're going to be in ANT business, we've done that. We've been 1 year at it, and we've done both in the same year. If I find a part of the government business that based on current threats that we should get capability an area that I can't invest in it to be there to meet the market in time. We're going to do an acquisition because once you do one, we're not trying to do acquisitions to fill a 3-year gap and then that market goes away. These are long and dirty markets. So the trick is if I could invest internally. First, Colin, I would invest in internally, I don't know all the intellectual property. But there are times when that time line doesn't support an investor partner and it has to be in an acquired mode. And we're extremely proud that a company-wide differentiator for us not only in our sector, but across the Fortune 500 is we've done 89 acquisitions, and we're good at it. We're very disciplined at it. And that to me is a strategic differentiator as well as trusts continue to change, but just move around, we're able to get access to those markets in a very, very quick manner.

Got it. Got it. Switching over to strategy. If we think about the convergence of singles intelligence, electronic warfare, electromagnetic spectrum superiority, how does someone looking at it from the public side differentiate what CACI is doing versus some of your hardware peers or hardware competitors yet?

The most obvious area is the fact that I'm not looking at selling the next 24-month version of what I just sold the government 2 years earlier. I don't want the government to buy on my product time line. I want the government to be buying devices and capabilities that are on their threat time line. The only way you can do that is take that out of the 100% hardware domain and put as much into the software domain as you absolutely can, right? And I sort of get myself back to apps change on your iPhone all the time, but there's only been 13 versions of the iPhone. I hate to say it's the razor and the razor blade model. But the real money and the ability to even deliver in the future is not going to be, can I deliver what I believe the next version is that you and my customer need and because that's what I have to sell. I may have talked to you. I've got my device here. It does this. I got another device that does that. I've got a third device that does that. I've got fourth device that does that, right? It's no different than the iPhone, right? We had to have a GPS receiver. We had a phone that we could talk and we had to carry our camera. And that's all software driven. It's all on one simple device. The military needs are no different. Does it take longer to move the buying customer towards that, absolutely so. But we're a very patient long-term company. July 9 will be 3 years old. And we've got plenty of time to see customers move to that model because once you move to that model, which you're really saying is moving far away from the current model. So not looking for a number of devices sold, looking for dollars that we're doing that we used to spend chasing expertise business, but now we're totally tech. So differentiator is it's mostly software-driven, it's modular. We're an agile company. We'll take that work at firm fixed price versus cost plus and they're not large ACAP1 program. So funding is more resilient when you do it in smaller spiral chunks than when you're looking for one overall solution.

Sure. Last question here as we kind of wrap up. But if you think about CACI's space portfolio, is there a good way to think about the total percentage of revenue or earnings that ties off of the space operating environment?

Yes. I don't have that number. We don't look at it in that manner, but a very valuable part of that question. We're not going to be a satellite provider. There's things that we're not looking to do. There's some phenomenal platform companies out there used to work at one, and they're all phenomenal at what they do. But in the space area, we're very much focused on processing information that comes from those satellites at the numerous ground stations out there. We have a long heritage in that. We do $500 million to $600 million of that. That work is all classified work. And then we looked at space and instead of being involved on the satellite side optical comms is where we believe we could make a large move. It was in my thoughts when we looked at LGS, they had a very small photonics business. There are some optical cost links that are out there today. They're very bespoke solutions. I think 3 -- 3 or 4 are very high priced ones. And that's going to go all the way down to something that's the size of a Tangerine that's pushing terabits of data all over space. So we have the right credentials there. So they'll be in the comms world. It will be in the post-processing of satellite data, also coming up with new algorithms as new assets go up, having software-based algorithms onboard, so we could do much more onboard processing. So again, not in direct competition with the prime, but really riding on their satellites and other buses.

Sure. Sure. With that, it's the end of question and answering. We do have some survey results if you guys have participated. Hopefully, we can get through those now up on the screen. Perfect. Next slide. Next slide. We've had some skew today with the results. Obviously, above peers. Next slide. I see you so. There's your feedback.

Yes, I know. Get it all first thing.

Got it. Perfect. Well, thank you all for joining us today. We definitely appreciate it being back live and in person.

Thanks, Colin. Thanks so much.

John, thank you.