CACI International Inc (CACI) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Brian Gesuale, I cover the government services space for Raymond James. Welcome to day 2. Still great to see everybody for the first time in 2 years. So definitely appreciate that. Delighted to have CACI here to present. The company's President and CEO, John Mengucci, is going to take us through the story. This is a stock that we upgraded a few weeks ago on really the view that the valuation was too low, that the business was going to accelerate and that we were in a heightened period even prior to the invasion Ukraine of geopolitical instability that was going to drive a multi-decade cycle of defense spend. So timing couldn't be better to catch an update from John. John, I appreciate you being here. Thank you so much.

Thanks for having us here. As always planned. Appreciate it.

John, why don't we maybe level set the audience? I think you just passed your 10-year anniversary at the company. Tell us about how the strategy is transformed since you got there to what it is today, you were really a bunch more of a pure services business, and now you've got a lot of tech knowledge behind it in product. Just maybe just give us the lay of land over the last decade.

So I guess after 10 years, you're no more excuses, right? It's all on you. Well, look, when I came to the company, we're about a $2.5 billion company, 9,000 employees, a mix of business between expertise, think of selling people, which most government services companies do versus our technology mix was around 80-20. EBITDA margins since we're a highly acquisitive company, that is the one measure that we watch, in the high 7s. And we're sitting here today a $6.3 billion company, 22,000 employees. Mix is pretty much 50-50. We've been on a very strong path of growing -- of targeting top line growth better than our addressable market growth, which is around 3% today, but at ever-increasing margins. So I've been a stickler from day 1 about making sure that we're always improving margins. It's not difficult to grow top line if you have a complete disregard for bottom line growth. We just wanted to make certain that we were in alignment. So we embarked on an ambitious acquisition plan. We've done 8, 9 acquisitions since the company was founded. July 9 will be our 60th year in business. So there's pretty much nothing that we haven't already seen, except for some of the short-term paper cuts and body blows that we sort of take now, but we'll have plans to talk about that. Very, very proud about how quickly the company came around to being more of a technology provider. There is good expertise work out there, and that's the kind of work that we would like to hold on to. But frankly, we've been able to continually grow top and bottom, even while we have discarded some of our expert -- expertise business. We used to have a lot of business at very low margins. We didn't take a large write-down there. The other factor that I'm most proud of is, we talked about driving this business more towards a longer-term business development model, where contracts in our backlog had a much longer duration to them. So we went -- we were not recompeting as often. Those of you in the audience have talked about Better Buying Power 1.0 and Frank Kendall and LPTA. I didn't want to be part of that noise for too many years. I had too many people like Brian asking me, what had just happened. But frankly, one of the major shifts that we made was to exit and not bid on a quicker recompete business. When I got to the company in 2012, the average duration of our contract in our backlog was 28 months. We're at 56 months, pushing 6 years now and much longer term. So we are bidding less and winning more. We're bidding larger versus smaller, very few pass-through jobs. So a very different looking company and 22,000 people to actually thanks for that.

So in this case, less is actually more.

Yes.

Okay. Perfect. I want to maybe zoom out a little bit on the geopolitical instability. I, for one, believe that the invasion of the Ukraine is going to kind of go down to the event, even though it's been a decade in the making that really ignites a great rival conflict. These next few questions that I want to engage with you on kind of want to get your take near term and long term of what this all means. Maybe in the near term, though. One of the overhangs in the industry has been operating under continuing resolution this year. Can you maybe talk about the outlook for that continuing resolution over the next few weeks to convert to a budget? And then what do you think this means or maybe the trajectory of funding that you're probably seeing already to support the conflict in Intel operations in Europe?

Yes. So CR, it's just that story has been updated and I think it updated 2 or 3 times today. I've been in a lot of one-on-ones, but the last information I got, which you probably already outdated is it's more positive than negative. It looks as though maybe an omnibus language by the end of the day getting through the CR by the end of the week, maybe a small extension and then getting funding out there. We spent some time during our second quarter call talking about some of the other challenges we've had. We've been under a CR many, many years. You've been in this industry for a very long time also, Brian. But what was different about this one is not only were we under a CR, we had a change in administration. We had changing priorities. We had 2 comebacks of COVID [indiscernible] tree. We had everything that could possibly go into this mix that really made the CR at and play itself out very differently. On top of that, a lot of near-term issues. If I look broader, do I believe we'll have an approved budget, yes? Do I think we'll have near-term sight as to where the $8 billion or the $10 billion or the $12 billion additional spend is going to go? Is it food? Is it cloth? Is it humanitarian? Is it munitions? And then beyond that, does it become more that we're closer connected to what that conflict in, which would then bring us into an Intel analysts, small handheld devices, software definable things around security -- cyber. Right now, it's sort of too early to tell. We're still trying to get some of those more near-term things cleared up.

It certainly seems like in this great rival conflict, nonkinetic warfare, which is an area that you're very well positioned in, is an area that we're going to see increased focus on.

Yes. We are looking at a customer set that, frankly, during this last budget year, sort of had a bunch of fits and starts to it, right? It was that common language of we're going to pull out of Afghanistan. That was one definitive motion that the administration put into place. But I think the part that was grossly misunderstood is it's not -- and then we're going to shift to a near-peer threat. Because the terror threat never stopped. It's not as though nation states here, we're going to spend money on near peers, and they say, okay, you're not going to spend money defending against us, we're going to stop attacking. In fact, the next 4 months after no longer worried about terrorists, there were a far greater number of terrorist actions and my company knows that we've got 700 and some people on the wrong side of the wire reaching every night around this globe and nobody is going to tell me that the car terrorism mission was stopped. What added the complexity to that is under a CR, whereas the operators and the folks, the agency leads would spend no worse than 1/12 of last year's budget to sort of keep the services and the solutions that we provide going, they spend about 70% of that money. Because they were holding back some funds to figure out what does near peer mean. And I would challenge that what we're seeing in the Russians in Ukraine right now is not quite the near peer we envisioned. We sort of looked at near peer being that very narrow definition if they come for us. But now they're in a somewhat defenseless country, we're watching that from far, what's our role in that. I'm not sure that gets the intelligence agencies in DoD in the federal civilian world into a peer/near-peer fight. So there's so many variables in there, Brian now. As we said during the second quarter, there's a lot of things beyond where the government would like to spend money on. I think we've got to really figure out what that near peer threat is and then make certain that we have the right budget for it. Clearly, getting the CR cleaned up would be a huge plus being able to spend all '22's budget be an absolute plus. I'm not sure where the September slip-up money goes as I stay within the DoD. Just go back to the government treasury. There's a lot of variables there. But overall, larger spending is better than less spending and it was in a mere 6 months back, we were talking about a declining bunch of spend over the next 18 months, right? So things are in flux.

Yes, we've come full 180 on that. Maybe if we think about longer term, we certainly think over the last 5 or 6 years, there's been this great pivot to the Pacific, if you will. Certainly, what's going on in the Ukraine and the broader footprint of NATO reaction in Europe, it certainly mandate spend in both areas. How are you going to stretch the dollars, the existing dollars if you're the DoD? And what does that mean maybe for long-term budget growth?

Yes. Look, if -- it's my belief that we are going to have to fund counterterrorism efforts and near peers and conflicts such as one that we are all witnessing now as well as expansion of some of those conflicts into the Greater Europe, where we're hearing about greater NATO country spend and the like. So there's no doubt in my mind that we're going to see continuing increasing budgets because the threats are. We're not replacing one with another. I'm a very big and person versus an or person. I've said that on numerous open my calls...

Especially with [ dessert ].

Especially with [ dessert ], that's right. So we are going to have to defend against many, many more. What we need to correct is how we need to fix the efficiency of getting dollars put onto contracts today. Even if we had a much larger budget today, I'm uncertain with the lack of contracting officers across the federal government, if we could actually get that money put on to contracts in a time fast enough for us to be able to deliver what is we have to deliver. So it's another extension we talked about during our second quarter call that we're still very, very focused on. We're going to defend ourselves to greatest extent. But again, those are very short-term hiccups along the way. Are the threats getting more? Yes. Are they getting more differentiated? Yes. And are old threats going away? Absolutely not. They're never going to go away. And we're going to have to be smarter about defining against more.

Makes a lot of sense. Just real quickly and last point on this topic. Typically, the government is very deliberate. But when we think of government services, we think of your group as being quick cycle and first to respond positively or negatively to inflection points in either spends or conflict. What we're hearing a little bit now is a lot of kind of plus up on incremental contracts are growing a little bit in scope. You've got the contract mechanisms. Is that what you're seeing as you start to support these global operations?

Yes. In some areas, yes, and some areas, no, Brian. We have a very strong book to bill over the last few years, 1.6x to book to bill a very strong healthy backlog of business. The demand signal is not what's hurting us. It's actually getting funding output out there. And then right now, we said it's not that there isn't any funding just that we're having trouble getting to put on onto contract. Even as we see some very near-term issues popping up, we still have some fundamental blocking and tackling that we have to grow out there across the entire company and across what it is we deliver are very strong in second devices and mission technology. We deliver out there, defending against drones both offensive and defensive cyber frankly, much more offensive than defensive. We don't talk about that a lot. Many of those awards are done with the intelligence community. We don't even discuss what those awards are, but the majority of that, if you looked at some of our key capability areas would be more in cyber and the like. And you're going to see a lot of that deployed in near-term fights as much as you will with the current terror fight.

Great. I want to zoom back in near term, you kind of intimated a little bit earlier that there was kind of this perfect storm with the CR. Can you maybe just talk about some of the things that impacted some of that funding flow when this budget ultimately comes into place? How transitory those issues will be and how quickly we'll see an acceleration?

Yes. I think it really comes down to can we get the process of once funds are there can we get those dispersed and on contract. That's where the hiccups are right now. That's why we emphatically state, it's not a demand issue, it's more of a getting funding on contract. Even some of the development programs we have are literally funded quarterly. They're funded quarterly because they're under a CR with a bunch of agencies, not sure what near peer is. Even though they know that those systems are going to support both, those systems were initially acquired under a counterterrorism mission and you'd be surprised how much discussions are around what does it still fit to a near peer? And if so, but I only got 70% of the funding, and I asked for more funding, I got all these other things to go fund, I don't have enough contracts with people here. So again, this is so much more about just getting blocking and tackling back into shape. It's not across every agency, but there are some that are delayed in their funding, and they have the funds even under a CR. Macro-wise, so Brian, I hate to say again, the world is a dangerous place. And much of what you all hear about comes about a month or 2 months after we hear of it. So it is a very dangerous place. That's why I can confidently say there's a lot of terrorism threats out there that just haven't gone away because we made a national statement and we're going to focus on China and Russia. If anything, the absolute pivots that we continue to talk on every time we say we pivot, it gives somebody the belief that it opens another door, okay, versus we've added another door that we have to guard on both front and back doors.

That makes a lot of sense. I get a lot of questions on capital deployment. You highlighted earlier about the amount of deals you've done, and I think you're typically considered to be the premier strategic acquirer if not the one, certainly the top couple. Let's maybe unpackage a few of these things. You also mentioned earlier on that you've been building out and focusing on this high tech and solutions-oriented business. Presumably, that strategy continues. It's been so successful along the way. How should we think about the impact of that strategy on M&A? Should we think that there's going to be more tuck-ins and smaller size deals that really amplify the tech side of the business? And would you consider any properties that are bigger that may have a more broader mix of the two?

Okay. Let me unpack that. Let's go back to the last couple of questions. But look, we have traditionally been a very strategy-based company. Strategy is a place where we come from. We do our strategic plans across the markets that we serve twice each year, and we study those plans judiciously for gaps. And when we find those gaps, we either will invest internally, we will partner or we will acquire. It actually is a strategic differentiator being part of a company that knows how to do acquisitions and not destroy value, but actually do them to be able to fill gaps. The only difference between an internal investment and doing an acquisition is time line. If we believe the federal government is going to spend an additional $20 billion in space, and that's going to start within 1 year. I probably don't have time to lay out what that technology road map is, but others have. So in that regard, we're always looking to fill gaps. I can tell you since I've been a part of this company, and I'm sure many, many years prior, we don't buy revenue, and I don't buy scale. I firmly do not believe that in the government services market where we've moved more into the technology realm, scale is not a differentiator. I've won plenty of competitions against companies that are twice our size. I think we have to learn to define the word scale. If I'm a $100 million company in this space going against a $6 billion company, I got a scale issue. Okay. I'm $7 billion company going after a $10 billion company, has a $7 billion one actually in more agile, I don't really want to hear about scale. So we're not going to do acquisitions for top line growth manner, and we're not going to do it for scale. Tied back to strategically, we have made some very key investments as we built out the technology part of our business. A lot of that has been organically grown. And the rest of it has been through our acquisitions. Did our first technology acquisition a major way in 2013. I think 2016, I stopped hearing about the multiple that I actually paid for it. Because to me, the multiple paid is that measure that we'd like to measure one time and then talk on. Frankly, it's about the intrinsic value of that and what kind of capabilities and customer relationships does that give us which is why M&A has always been the #1 capital deployment strategy for this company for a number of decades, because it was the founder's belief that by doing capability and customer relationship acquisitions, that gives a gift forever, over a long period of time. I seem to believe that I've added the investment thesis to it. We spend quite an amount of money investment bid in proposal and IR&D efforts as well as nongovernment recoverable IR&D where I want to own intellectual property. And in that mission technology field, we've actually gone from a business that was very highly focused on delivering people to actually delivering technology. And every time we do that, we find an expertise customer willing to stop buying people and transition that to a partial technology solution. I'd like to say there's nothing good about COVID. But with my business persons had on how it's changed the buying habits of our core customer, they're looking for much more technology and much less people because we don't know whether this generational pandemic is ever going to be gone. You talked about the part at the end...

I think you got that. But I actually want to transition because I know some of these -- I've known some of these companies you've bought when they were private. Really, really great businesses. I think maybe the audience could use a little bit of how you tie strategically some of these together. If I look at like SA Photonics, Bluestone, IDT, they seem to obviously fit squarely in the tech domain. But if I look at this, I think SA ties back to maybe LGS in some ways and you've got a formidable optical communications business. Just take us through that, but I think as people see the LEGO blocks, they might not quite realize from the outside.

So as I mentioned, we're very strategically focused. We're very disciplined growth company. We looked at the space domain in the 2017 time frame and looked forward, that was beginning, some of it is going to be a Space Force. So we're going to have both NRO Space and Air Force space in becoming closer together. Space was not a U.S.-only domain or talks about contested space. So it's how can we play within that market. LGS, if you looked at protecting communications in space. LGS brought to us a larger scale, more bespoke optical communication solution. Think about deep space, think about NASA missions, Geobelt and then beyond very bespoke, highly classified missions, where you've got to connect that link 99% and 12.9% of the time has to be pure. Think of millions of dollars per device at reasonable margins. And then we looked at where the market was going to go once we could prove that theory that you could do optical comms in a more cost effective manner, but it's going to go more towards LEO and eventually airborne comms devices. If we can get optical comps to work at GEO/MEO in LEO, we can return protective space back to the assets that we are well known for. SA Photonics worked with our folks at LGS over the last year. While we found we had some very exclusive algorithms to sort of keep 2 heads of a pin to be content to each other and find each other 60,000 kilometers away. And we also found that they had a great producibility engine that they could build lower-priced units faster than we'd be able to get there. So strategically putting those 2 companies together made an awful lot of sense. It allows us to be the largest U.S. supplier of optical comms devices now. We're well aware across the globe. There's other companies that are in that space. We're also highly aware that if we're going to look at a near-peer competitive threat model that the last people I would want to handle my classified space-based data is over somebody else's country optical comps. So we firmly believe that, that data should be carried over U.S.-built modems and like, and we'd like to see the Hill and others support it. So that's one connection point. I detect quickly there. CSFC, Commercial Solutions For Classified kind of put a commercial device onto a classified network. Today, the answer is yes, if you use an NSA approved Type 1 device, think of much heavier laptop, 8 to 10x at cost, and the government wants to get to a point where they can buy a commercial item and put it on a classified network. ID Tech has a commercial solution, just approved by the NSA. Both of those companies we bought very early on. So they're still in the investment phase. So we've gotten tons of fan mail around the fact that those 2 acquisitions are EBITDA margin dilutive. Thank you for that. I recognize that, frankly, IRRs are in the high teens, low 20s. We've done 89 of these rodeos, we understand how to buy value. But those acquisitions really produce a lot of great long-term growth '24, '25 and beyond.

They certainly put together some great assets over the years. I want to talk a little bit about -- you highlighted early on, I want to talk kind of the profit end of that evolution from expertise only or heavily dominant expertise to expertise in tech and really think about this presumably, we continue to inch up, not that expertise ever goes away. But what does that mean for the long-term margin structure of the business? Are there self-help stories along expertise that you can drive margins from that group plus obviously, the natural mix shift towards tech.

Yes. So one, the easiest is mix shift between expertise and tech. Margins that we get on tech are 300, 500 basis points greater than we get on that expertise. You would imagine that we have in our investor deck, a nice quad that explains where our expertise is going. The more commoditized something is becoming, it's hard to differentiate. You're only going to buy based on price sort of time to "exit that area." Unless you want to stay in it, but that just drives margins down. So it is the mix of business that's been driving, driving margins. Volume, on the technology side will give another bump to our margin growth. And then the last area is, are there expertise customers who've been able to drive more towards a technological solution? The answer is absolutely yes. It takes longer. We've had some great expertise customers that we have transitioned off of buying 200 people in a network operations center to buying 20 people and let technology handle the rest of that mission. What customers find is that they're able to pay less. So the cost to them and price to them is less, my margins are up. The customer cares less about my margins if they're paying less. So that actually is with the federal government a way to get a great win-win model in there. Yes, we're really, really hard at it. We also have to be one of those companies that understands the value of expertise, understands exactly how and when to transition somebody away from x number of people to buying a unit of output. And when that happens, there's been some great case studies out that we've done, Customs and Border, with NGA and with a couple of other expertise customers that are now buying an awful lot of tech from us at much better margins. It's a lower risk for us to be able to support their mission as well.

Great. That really marks the end of the prepared Q&A. John, this is your traditional, as you know, from doing these with me, this is your drop the mic moment. Why should this group buy your stock? And what's different about CACI, C-A-C-I and then we're going to adjourn to the breakout room.

Yes. I guess the one thing we didn't cover is free cash flow, right, free cash flow per share within this company is outstanding. It is what we measure. We talk a lot about doing acquisitions or doing internal investments, talk about growing top line or talk about growing bottom line. And everybody knows that every one of those things drive free cash flow per share. You sprinkle in getting days sales outstanding back in 2012 from north of 70 days to just about 50 days and you work with better paying customers. You'll bring more technology. It just is a much better book of business. We've worked on quality of our earnings over the last 7 to 10 years, it's shaping up very, very well. Where is the end for margins? We don't have that high-end tag point. They have to be sustainable. So that's very important. I have in a couple of years at 200 basis points greater than bringing it back down. It's not what we're about. There's enough of that going on throughout the rest of the sector. We just like to make sure that we are incrementally driving top and bottom line growth. We're a long-term company. We're not based quarter-to-quarter. It's why we won't do acquisitions to just pick up revenue. That's why we will not do a simple expertise or recompete at very low margins, so we can show better top line growth. We're not going to do that. We've never done that. We will continue not to do that. We'll skip a couple of quarters if we have to, to make certain that long term year-over-year, we're doing the right kind of profitable growth.

You've certainly compounded free cash flow at an amazing rate over the last decade and even longer.

Thank you, Brian.

Thanks so much, John. I appreciate everyone's interest. Thank you.