CACI International Inc (CACI) Earnings Call Transcript & Summary

Okay. Good morning, everyone. Welcome back to the 2022 JPMorgan Industrials Conference. And we are very grateful this morning to have CACI International with us on the aerospace defense track. I'm Seth Seifman, the aerospace defense equity research analyst here for the U.S. And we're very glad to have Tom Mutryn, the CFO; and George Price from Investor Relations. And yes, we're going to have a Q&A about the company.

I think I'll probably kick it off with a few questions, but happy to turn it over to the audience as well and periodically look out to see if we have any questions from the group. Maybe, Tom, just to set the scene, I think in the services area, sometimes -- I think sometimes investors have -- it can be a little difficult for investors to understand what companies do, how to differentiate them. So maybe you could talk a little bit about CACI's strategy, what makes the company unique and what you do.

Yes. So good morning, everyone, and Seth, thank you and JPMorgan for inviting us to the conference. CACI has been a company with 2,200-some-odd employees, been around for over 60 years, providing a variety of services solutions, largely through the federal government -- almost exclusively to the federal government. And over time, what we do has evolved. And the best way to look at our company is through a framework we established 3 or 4 years ago, the way we look at the company. What do we do and who are our customers? What we do is provide expertise, which are qualified people kind of working on behest of the government to fulfill various government missions. That is somewhat the traditional government services you angle to our business. And we also provide technology. And technology is not providing inputs but providing outputs. An output may be a cloud migration solution. It could be a new payroll system. It could be a tool to analyze multiple sources of intelligence information. It may be a software-enabled device to detect RF signals of interest. So expertise in technology. Over time, we've grown the technology business very deliberatively through acquisition and internal investments. Probably 10 years ago, we were 80% expertise, providing bodies, if you will, to the government customers. And now we're 50-50 technology and expertise. And who do we provide those activities to or those services to is companies or government customers, which are focused on their enterprise. Every government agencies need certain enabling activities to run as an agency. They need an e-mail system. They need to pay their employees. They need contract management systems and IT support. So kind of ubiquitous across various government agencies. Then there's also customers, which are focused on the mission. The mission may be collecting tax revenue or monitoring pollutant levels or making the nation safe and looking for kind of bad guys kind of where they are. And so that is our framework. Very DoD and intelligence agency focused with a large addressable market, which we're prosecuting.

Okay. Very good. I guess when we think about where things are right now and what's been happening this year, I wonder if you could help us out a little bit because I think across the services group, we've seen growth fall a little bit short of expectations. And there are a couple of potential reasons for that, but I was wondering if you could talk about a couple of them and the way that they might be playing into this dynamic. So first is just the pandemic and whether, as the Omicron wave recedes, you're seeing more of your customers back in the office and whether that's allowing for some pickup in activity.

Yes. Yes. Kind of just coming to New York. It was 2 years ago almost to the day we were in New York when the world shut down, the NBA canceled the season, Broadway closed. So we've been living with COVID for a couple of years. In the October, November, December time frame, we saw the nation -- the surge in Omicron cases and that impacted a variety of kind of government agencies. When we win work from the government, there's a 2-step process. One is an RFP is put out to provide various services or solutions. In the federal acquisition organization, evaluates proposals and awards a contract to a particular company. Once the contract is awarded, that activity goes over to the program contract shop. And there's a variety of other actions to ensure that funding is put on contracts, it's put on certain line items of contract, a lot of administrative type of work. Prior to Omicron, we saw some kind of attrition and -- within that contracting officer workforce. So things were just getting done slower than we anticipated. Omicron forced people to kind of not come to work, work remotely, created some inefficiencies as far as that process. And that resulted in our kind of revenue expectations for this year to be down slightly from where they had been kind of originally. We anticipated that activity would continue throughout the rest of our fiscal year, which ends in June. And we're generally seeing that. What is further complicating it is a shift in priorities. You've got a great power versus terrorists. Is the government focused on Afghanistan and Iraq or kind of near-peer adversaries? And that created a little bit of uncertainty. Ukraine certainly adds to another of what are the priorities for various government agencies. And so that has slowed down some of those activities. So do not see much different than what we spoke to our investors about in January.

Okay, okay. That's interesting. And so thinking about the situation in Ukraine, the Russian invasion, I guess there's one thought process that I wanted to ask about was whether among your DoD customers and in the intelligence community, if this actually kind of gets more people back to work and kind of speeds things up a little bit. On the other hand, I guess there's the potential that maybe it creates a whole other set of issues for those people to focus on that is not necessarily their day-to-day activity. And so in some ways, that kind of slows things down a little bit on the day-to-day side. It sounds like maybe it's a little bit more the latter?

Yes. I think it's probably a little bit of both. There are certain kind of DoD agencies, which are doing work. Let's say we have some contracts, doing onboard repairing of ships. When ships go into the port, making sure that they're retrofitted and maintained very quickly and get back out to sea. So arguably, activity in Ukraine should not impact that day-to-day activity. But there's other parts of the government, kind of European Command or -- which are focused on to these more current kind of geopolitical events. And some of that filters down through some of the ancillary agencies associated with that. So just another factor, which is adding to some lack of clarity in some areas. It's certainly not ubiquitous, but it is -- there's pockets of that.

Okay, okay. And then, one, I don't know if this is the case or not, but just as you kind of think about what's been happening, is there -- would you say that there's a difference in the approach of the current administration versus the former administration in terms of why maybe some task orders and awards are taking a little bit longer, whether it's -- not that it's an intentional effort to slow things down, but maybe it's a more deliberative process, maybe there's more consultation within the government? Maybe there was a thought process that before we kind of go out and deploy a lot of funds, we want to understand what the Build Back Better strategy and agenda is going to look like. And as a result, it's been hard to kind of get the train moving.

Yes. So for us, it's kind of less about the -- those day-to-day activities of the administration that you spoke about. And certainly from an outside perspective, when President Biden came into office there was a thought, will there be a shrinking DoD budget? We need less for protecting our nation and more for other activities. Last week, a $1.5 trillion kind of budget was approved with a 5% year-over-year increase in DoD spending. And at this point in time, the question is not, well, how much will the DoD budget go down? It has flipped. How much will it increase? I think it's become very self-evident for the vast majority of people that the world remains a dangerous place, and there are -- it's very kind of vitally important for the United States to have the sophistication, intelligence, weaponry systems to maintain a strong defense posture, both against kind of near-peers and as well as potential terrorist organizations. We all read the same headlines, kind of North Korea, Iran, et cetera.

Okay. And then on this topic, maybe the last one for now on this topic of just the overall growth environment and thinking about growth. You mentioned the process of, okay, you put out -- an RFP comes out. You put in your proposals. You get an award, but then there's a process by which those funds are actually -- have to get appropriated into a line item of the budget. The backlog -- your backlog is quite large compared to history, similar situation at several of your peers. But can you talk to us about unfunded backlog and what it means? And I guess despite having this much bigger backlog, do you feel like you have more visibility into the next, let's say, 12 to 18 months than you have in the past when the backlog was smaller?

Yes. So the way we kind of define backlog both funded and unfunded, and I'll kind of define some terms, assume that we win a 5-year award for $500 million, so that's $100 million per year. Very simply, we expect to realize $100 million, $100 million, $100 million, $100 million, $100 million per year. The way the -- so that's total backlog. The government has annual funding kind of processes. And so the most they will do is allocate $100 million at a time. And so there's funded and unfunded. So we have a large amount of backlog. Highly likely, the backlog will come into fruition. Some of those 5-year programs are sustainment programs or software development programs or important mission programs. The backlog in our sense gives us a high degree of confidence that the company has a very solid foundational base going forward. We've won a lot of work. It's highly likely we will execute on that work, and we'll be able to kind of generate profit and cash flow and revenue going forward. What happens at the beginning of the year, we look at next 12 to 18 months' worth of revenue. Some of that revenue is in backlog. Some of the programs that we have end. We want to implement a new software system, we're done. And so kind of revenue goes down. And so there's a little hole to fill. Sometimes we have recompete business where we need to win the recompete business and begin executing it. And we have some new business. At the beginning of a year, typically, 85% of our business for the next 12 months is on existing contracts. Probably 10%-ish is based on contracts we need to win or recompete on, and 5% in new business. And so a lot of visibility in total, but on the margin, whether growth is going to be 3%, 4%, 5%, it -- on the margin, there's that variability.

Okay. And then, I guess, one of the things that's happened in terms of perhaps facilitating some of those contracts turning into revenue was the end of the continuing resolution and the passage of appropriations for fiscal '22. So I guess we saw that. Just this week, I guess the President signed the bill. When we think about what you've expected both for the March quarter and the remainder of your fiscal year for June, have the trends since your last earnings report been kind of consistent with that outlook?

Yes, it has been consistent with outlook. We were anticipating a continuing resolution to transition to a -- some funding. So it's happening in March, and we were expecting kind of the March, April time frame, so it's been a very inconsistent outlook. So really no update from what we guided to in -- kind of the end of the -- in the second quarter. The good news is that the DoD budget, as I mentioned, is greater than we anticipated or many people anticipated. There was additional funds for Ukraine. I'm not sure if that's actionable for CACI or not, but the government is kind of more than willing to invest in these particular areas. And I know we're focusing a lot on DoD space, but we also do a lot in the enterprise space. So modernization of systems in that -- those budgets continue to grow as well.

Excellent. Okay. You mentioned the 2 sort of verticals in the business in terms of expertise and technology. Within the technology area, there's a piece of that where CACI works on products, maybe it's traditionally thought of as a services company. Can you talk about -- a little bit about the products that you work on, why they make sense in the CACI portfolio and what your vision is for that part of the business over time?

Yes, yes. So the products that we have are very software-enabled products. Again, a deliberate strategy. A lot of it was driven by acquisitions. Probably 7 or 8 years ago, we bought a company, Six3 Systems, which had a lot of expertise in signals intelligence. There's a lot of -- you get RF signals in space. And the company we bought had a number of people with high levels of expertise, being able to understand what's in those particular signals. One of the solutions we have I'll highlight is counter-UAS, unmanned aerial kind of vehicles and systems, whereby the product, if you will, is buying some kind of antennas, capturing RF signals. You've kind of a laptop computer with a lot of processing power that basically understands what all these kind of noise and the spectrum means and is able to say, "Oh, it looks like there is a drone flying in this particular space," by just monitoring the space. And the technology is sophisticated enough that we're able to send signals to that particular drone and disable it. So we make it fall to the ground. And so here is a software-enabled solution. Buying the antennas, buying the laptop computer is relatively easy. Writing the code to be able to dissect those signals is challenging. We also have a company we bought a few years ago, Mastodon, in Rochester, New York, which make signals collection devices. I mean if you're a deployed troop in the field, what is going on in that -- in signal spectrum. Our people talking to each other on hand-held radios. Is someone set up a router, kind of an Internet hub? Is there other types of communication going on? It could be very helpful, protect troops and save lives. The last example I will use is several years ago -- a common theme about using acquisitions to jump-start some of this technology, we bought LGS, Lucent Government Services. A variety of activities they had involved, but one of them was photonics, which is a laser-based communication focusing on NASA deep space, highly classified solutions. Send out a kind of satellite into never-never land and provide that communication protocol. We're seeing a significant increase in space as a domain. And recently, we announced an acquisition of a company called SA Photonics, which is also in that photonics laser-based communication area. But as opposed to our bespoke, very expensive, complicated solutions, they have ones which are faster, cheaper, which would enable kind of LEO constellations to communicate with each other using laser-based communications as opposed to RF signals. So it's a device, which is highly software-centric, which helps a variety of kind of National Security missions. And so those are the types of products that we have, again, heavily software-enabled.

All right. No, that's very interesting. And one of the questions that I had on my list here was about SA Photonics. I mean that's fascinating what they do. I think it was kind of a -- it was a big acquisition, given the size of the company, but also you can see where the growth path is there. How do we think about the time frame for capabilities like that to develop? And also whether you -- are you -- do you end up with the Space Force as a customer there? Or do you end up working with a constellation provider? Or is it more agnostic and you have the government be the customer and put it on to a different constellation?

Yes. So I think the answer to that specific question is both. The capabilities are kind of relatively kind of ubiquitous. If I take a step back, and this gets into our thoughts on acquisition and capital deployment, on a continuous basis, we look at the work we do supporting the U.S. government, and we look at the demand. We look at the competitive environment and we look at growth trends. And space is kind of an interesting area. We had some work supporting ground space systems with some contracts that we had. LGS gave us a focus on photonics. And over the next 3, 5, 10 years, kind of we believe and a lot of other smart people believe there's going to be a significant growth in kind of laser-based communications. We bought a company -- somewhat early stages of the company. They have manufacturing capabilities, which we do not have manufacturing at scale. Their technology complements our technology, the 1 plus 1 highly likely will be greater than 2, and this allows us to prepare for the future. So a reasonable investment, but preparing us, investing ahead of need is a good way to say that, and -- well, I'll leave it at that. Yes.

Yes. I mean, Seth, just I'd add that the -- they really brought that LEO focus, right? We had the sort of the exquisite geo focus. And so it's kind of like chocolate and peanut butter, right, I mean, together even better. And they also had -- they have done some work more so than we had on the idea of sort of airborne platform to low-earth orbit laser communications which you can imagine is a pretty interesting concept. So there's a lot there when you put it together, and we really believe that we're the largest U.S.-based provider of that technology. So when you're providing the sensitive government customers, that's a good place to be. But it's a -- this is a sort of 3 years, 4 years, 5 years from now kind of opportunity.

Right. Excellent. And then when you think about developing that opportunity and bringing it out, you've mentioned a lot of the capabilities here have come from acquisitions. Will there be a movement at CACI toward more internal development spending in order to generate future returns from these capabilities through things you can do internally?

Yes. Seth, thank you. So it's a combination of internal investments. We have kind of research and development on a number of programs and projects at any point in time where we're developing capabilities ahead of need. Oftentimes, we partner with other companies, commercial IT providers, be it ServiceNow or Salesforce or a whole host of software types of companies, which will facilitate some of the work we do. And then lastly, we'll invest through acquisitions. The advantage of investing through acquisitions is these are other companies who have made those early-stage investments, and it would take us 1- to 3-plus years to catch up. And so it's kind of good for them. They've focused on tough problems, and capitalism is great. They develop good solutions, and we're able to bring them into CACI.

Yes. Okay. Very good. Another thing about the 2 verticals, technology and expertise, I think you mentioned the technology business has been growing faster, and it's also -- on an organic basis, and it's also where the bulk of the acquisition capital is focused. And so when you think about that, are there strategic implications of that in terms of sort of what the company should be doing over time? And maybe you could talk a little bit about what the expertise side brings to the table as well.

Yes. So the expertise side has been a mainstay of CACI. From a financial perspective, it generates revenue and cash flow and margin, although the margins are lower than the technology margins. And so it's very good -- getting a solid business for us. Some of the work we've done historically supporting kind of the U.S. Army is providing expertise to work along with troops to focus on IADs or protection of the troops or intelligence gathering. So kind of really important things very qualified people are doing associated with that. So that becomes a mainstay. And it also helps inform us as a company. So if we're creating a counter-UAS device, which we're going to put into the field, we can sit in our offices in Chantilly, Virginia and try to design these particular systems. But having folks literally in the field on the other side of the wire, understanding how systems work, this is what the customer really needs in -- because the handheld device that you're providing gets clogged with sand or it doesn't operate in appropriate temperatures, providing that feedback between the expertise and the technology is quite useful to know. On the enterprise side, there has been efforts, which some have been successful to transfer pure expertise to technology. Expertise could be we would maintain a help desk. The government would say bring us 40 people to maintain a help desk, and the government would direct that help desk activities. They would provide the software. They would provide the phone systems. They would schedule the employees. And so that would be a pure expertise job. We're providing people to help support that help desk. What we have done is to say, let us take over the help desk operation. You pay us per call or how many end users are supported. We will establish certain SLAs and let us worry about how we staff it, what tools we use. We will provide an end solution to you. And the end solution would be we'll take care of your end users. And so we're transforming some of those expertise jobs to a technology job. It should be a win-win. I think we can do it most likely for a lower cost to the government. You take something off their plates. And when we differentiate our product offerings, they become stickier, which is helpful when work comes up for recompetes, and differentiated products generally generate higher margins.

Yes. And Agile software development is another great example. One where we have demonstrated particular industry leadership now, basically running the 2 largest Agile software development programs in the government, BEAGLE one being one of them. So instead of just giving the people, it's like, okay, now we understand the requirements, and then we deliver different pieces of software. We iterate that very quickly, and it's a much more efficient process. But we control more of how that's done.

Excellent. And Tom, you mentioned -- towards the end of your last response, you mentioned software-related work and the margins that it brings. You guys, as a company, talk about ever expanding margins as a goal. I guess can we put a little bit more definition around ever expanding? And what's the trajectory? The company has done quite well in recent years, I think, as a result of both the changing mix and good execution of expanding margins. What's sort of the trajectory from here? What's realistic to think about?

Okay. So several years ago, 3, 4 years ago, our EBITDA margin was approximately 8.5%. Today, it's anywhere between 10.5% and 11% type of range is the appropriate range. And so we've made significant improvement in our margin during that time period while growing revenue at the same time. It's easier to do one, let's expand revenue and not worry about margin. Or expand margin and not worry about revenue. It's a challenge to do both. And so we're focused on doing both. One is if we grow technology at a disproportionate rate, that helps. As we have more fixed price programs, products come at very high margins. So that helps margins as well. And always a continuous focus on indirect expenses across a greater base, that helps. I'm going to be somebody ambiguous to your answer, what does ever increasing means? It means that on a year-over-year basis, it's going to be higher. A few years ago, we -- we're more specific quantifying it, 10 to 30 basis points a year, which had some degree of ambiguity in it, but -- and now we're talking about the ever increasing. And so we do think that the things that we're focused on will drive that higher margin, which in turn at the end of the day drives cash flow. And ultimately, that's what we really care about. So the revenue growth times the margin is going to drive that cash flow, and the cash flow metrics of the company are something that we pay a lot of attention to, and we believe most investors care about that as well.

Yes. Absolutely. And I think that they do. On the -- I guess another question is about inflation. I know you've been the CFO at CACI for some time. How is this environment with inflation? Is this something that you've seen before? Are you finding that you have to approach things in different ways than you have? I assume that a lot of the inflation that you see at CACI relates to people and their salaries, but there is also a product component. So if you could sort of address how the company is managing that now.

Thank you. By far, the largest expense we have is human capital, so labor expense. And then going down next one, we have real estate. And oftentimes, real estate has fixed in kind of rental terms for an extended time period. So we haven't seen too much kind of related to that. Then a whole host of other types of items. So the big piece is labor. The labor market is competitive. It has been competitive for a number of years. We're looking to hire, in many cases, people with specialized engineering, computer science, kind of engineering skills. Many of our employees have clearances. And so that narrows the pool kind of even further. We've done a number of steps to both retain our existing employees and provide improved hiring practices. We're viewed as a best place to work for a number of surveys, a number of internal programs to allow internal mobility, internal referral programs and the like. So trying to create that culture where people want to work for CACI and their stickiness. To your specific question with regards to kind of wage inflation, approximately 60% of our contracts are cost plus. So when we contract with the government, the terms of the contract are we will incur certain costs and build them back to the government, plus certain margins associated with that. And those contracts have a natural hedge in terms of kind of inflation. The government kind of, by definition, agreed to bear inflation risk when they set up those particular contract terms. Kind of the remaining 40% of the contracts, if there is increasing cost, that's kind of borne by CACI. What we've been doing is to recognize that in order to get the work done, it's paying a person a salary times the efficiency of getting that work done. And if we offset higher labor cost with efficiency where we'll be doing fine. George mentioned Agile software development. We have one program -- a contract with Customs and Border Protection where there's over 300 people doing Agile development for a number of applications for that agency. And we have a very sophisticated Agile kind of development activity, coordinating, kind of using some sophisticated kind of workflow technology to build that software in a very efficient manner. And so using those types of techniques we feel should provide a hedge against those types of cost pressures.

Yes. Okay. You've got a goal as a company to grow faster than your addressable market. And it seems like for 2022, you ended up with some more money in the defense budget than expected. I think the expectation for 2023 is probably now that the defense budget is going to grow kind of mid-single digit. I guess does that become the target for CACI's revenue growth? Or do we still see some of these maybe factors that are slowing things down persist?

So I'm going to be reluctant to talk specifically about FY '23 and putting some numbers out there. We're in the midst of developing our plans of very elaborate internal processes. Every year, we, along with some outside consultants, dissect the government budget and determine what is the appropriate growth in our portions of the addressable market. So the headline number may be one thing. Some of that higher DoD spending is kind of military pay as an example where we spoke about wage inflation. So all the members of the military expect pay increases as well. So the headline kind of needs to be kind of viewed within that context. The last time we did the study, and we'll resume it now that we have a budget, was our addressable market was growing at approximately 3%. And so kind of more to come on what we think those numbers are. And then as we guide to FY '23, we'll be more specific about those numbers.

Okay. Very good. On cash flow, I know that this year has been an elevated year. When we look forward, we've got some puts and takes in terms of taxes. There's some -- I think there was a refund this year. You had some -- on the other hand, you've got to repay some payroll taxes from the 2020 pandemic. What are the big moving pieces for cash flow? And I guess if we put aside just the underlying revenue times margin, what are the other things that we can kind of isolate to get a sense of the trajectory from here?

Yes. So this year, in FY '22, we had a couple of large puts and takes. We engaged a kind of tax planning strategy, which resulted in a tax refund or lower taxes this year of approximately $230 million. Many people recall that one of the provisions of the CARES Act allowed employees to defer a portion of their payroll tax. That has to be repaid. And so we're repaying approximately $50 million of that. So this year, we had a $230 million good guy and a $50 million bad guy associated with taxes. We guided to operating cash flow of around $720 million. So one could adjust for that to get an ambient level. Next year, in FY '23, we are going to repay the second half of the deferred payroll tax of around $45 million, $50 million. And that large tax refund we got this year of $230 million, some of that will result in some higher cash taxes next year of approximately, I think, the numbers maybe $50-ish million. So some puts and takes. So it provides some confusion talking about it, but I think the underlying theme is just really strong cash flow based on operations and collections and running a very efficient organization.

And just to add, the net of that, Seth, remember is over a 4-year time frame, net-net, the idea is we'll have those tax elections get a $60 million approximately more dollars than we otherwise would have. That was the idea there.

Right. It's the positive change over time.

Yes, yes.

Cool. I know we're inside of a minute here, but I did also want to ask on capital deployment. It's a question I know that you're both involved in. And I guess after earnings, you saw some pressure on services stocks. You probably got a number of questions asking you if you were going to buy back stock. Stock's done well since then. Maybe just your updated thoughts on share repurchase versus M&A, what the M&A pipeline looks like.

Yes. So it's an and. And so in the last 12 months, we did an accelerated share repurchase, $500 million. We deployed around $600 million to buy a company. So we're doing both. And kind of right now, we will continue to look at kind of both those options, kind of looking at the acquisition pipeline, ambient debt levels, all with the concept of driving long-term shareholder value. Share repurchase kind of one and done. It's accretive. It's helpful to investors. Acquisitions of -- as our former Chairman like to say, it's the gift that keeps on giving. You develop these exclusive technologies. SA Photonics is one where we expect significant value at the long term. So it's really a -- kind of let's focus on doing both.

Excellent. And with that, I think we're out of time. So we'll wrap up here. But Tom, George, thanks so much for being here. Really appreciate it. And yes, we'll talk with you soon.

Okay. Good. Thank you, everyone. Appreciate your interest in CACI.