CACI International Inc (CACI) Earnings Call Transcript & Summary

All right. Everybody, thank you for coming. We have Dan Leckburg from CACI. Thanks for joining.

No, very good. Thanks. Thank you for having us.

Appreciate it. Well...

Sorry to interrupt, Thomas Mutryn, our CFO, was intended to be here. Something came up, and he couldn't make it. So he sends his regards and apologies for missing.

Appreciate you coming regardless.

We're good.

Well, maybe I'll just kind of dive right into it, into the weeds, and then take it back a couple of high-level questions, and we can jump around. But obviously, there was a lot going on in the quarter in terms of the CR and COVID and disruptions. It doesn't seem like a lot of your peers experienced the same funding dynamic you guys called out in terms of that significant March drop-off. Can you give us a little bit more detail on what happened there, if that was specifics to a few customers, just how that played out? And I know it's picked back up in April.

Yes. No, it has picked back up. So it's kind of an interesting dynamic to see play out. We got through our December quarter, and we talked through some of those headwinds that you mentioned. Obviously, COVID was an impact. Supply chain is still a challenge. Customer access, facility access was a bit of a challenge. Those things we expected to continue through the remainder of the fiscal year, through the March quarter, through our June quarter. They did. So they continue, and we see that continue a bit today. Even the Pentagon, for instance, is still at 50% occupancy, which is -- which can be frustrating. But what happened -- what developed in March, which was very interesting to see, as we look at funding through the March quarter, we sort of a normal January, February normal, a little lighter. And then March just sort of dropped off, which was sort of interesting. And as we kind of look at it and have discussions with customers, obviously, the timing as such, it was around mid-February, we saw the events in Ukraine developed. And our read is there was a kind of a significant about face and distraction, if you will, to sort of figure out what to do and what are going to be the priorities, are we going to be involved, what do we need to sort of dedicate to this new challenge. And that was March, February into March. And as you know, we're incrementally funded on a very regular basis, and that turns into revenue as we execute. And what we saw in the quarter and then expect the same to continue through the end of the year just sort of given our June fiscal year-end, we saw 2 buckets really as it relates to funding. We do some material purchases on behalf of our customers. So we may have an existing program where there's sort of a core level of delivery that is very consistent, reliable. And then there's one-off large material buys, which are revenue contributors but not so much on the profit side. Those turned off pretty immediately as there was kind of a distraction to Ukraine in a period. Your core business continued along, but it was those short-term kind of quick pop material buys as one bucket that turned off. Similar to that was on our -- was on the mission technology side of our business. So think pieces of equipment products, if you will. Similar to the material buy, we saw some of those products customers say, "I can hold off on that for a few months before I want to pick back up," again, given sort of our read is the distraction of the events sort of unfolding in Ukraine. So material revenue impact from that -- those material buys that we do. And then on the profit side, those mission technology sales could be quite profitable. So we did reduce overall full year EBITDA margin as well given those mission technology sales.

And you made the point that picked back up in April. So is your sense of that is just a timing shift? Or have they structurally changed what they want to buy?

Yes. Yes. So to your point, we did see it picked back up in April, and as we sit here -- and that continues through May as we sit here today. So we've sort of seen the customer set revert to more normal processing of funding through April and now into May. We see a couple of different buckets. And as we lay out our fiscal '23 plan, this will become more and more clear. One question that we have in our mind, again, it's a revenue contributor, not so much on the profit side, those material buys. If we have a customer that buys $50 million worth of material in a year, are they going to buy $100 million next year? Or are they going to buy that same $50 million next year? So we're sort of working through those dynamics. As it relates to the products and those mission technology sales, I mean, that demand does not go away. So those will happen. Whether they all happen on our fiscal '23 or this order push into '23 and others in '23 push out to '24, we're sort of working -- again, working through those dynamics as we lay out our fiscal '23 plan.

Got it. So it sounds like a bit of a mixed revision to guide in terms of the lower-margin supply chain, the higher-margin mission tech products? Is the margin impact of that outsized? Or is the larger portion of the guidance revision around that higher margin tech?

Yes. So we started the year guiding to 10.9% EBITDA margins. We did see some -- obviously, some slowness in the December quarter. We added 2 very compelling acquisitions. But in the short term, we're dilutive to EBITDA margins for the year. And then we saw this recent again, push out of some of those mission technology sales in addition to the large revenue bucket. If I look at where we stand today, we guided to 10.5% EBITDA margins versus the start of the year at 10.9%. About 30 basis points of that reduction comes from those mission technology sales. The other 10 basis points was from the addition of the -- those 2 acquisitions that we spoke about. Gives you sort of a sense of relative -- the material contributors on the bottom line.

Got it. Okay. That's really helpful. And I mean I want to come back to margins, but does that -- does 10.8% then kind of the right starting point this year for your framework of long-term margin expansion? Or is that too soon to say.

A little too soon to say. Again, we're working through the specifics around how much of those mission tech sales push into '23, how many may push out into '24, what does that look like. And then, obviously, those material buys have an impact -- they're kind of pure revenue, but they'll have an impact on calculated margin, obviously. So we want to see how much of those come back into next year or push -- or continue to sort of push out. So a couple of dynamics still at play. Obviously, we remain committed to outgrowing our addressable market and margin expansion. That does not change, but sort of working through the specific dynamics as we look at '23.

Okay. So some timing still on the product tech. So how does the funding disruption in March flow through in terms of the next couple of months of revenue, just given the 3Q slide deck said you expect funding to revert to normal levels in early fiscal '23? So I mean does that mean March has a multiple month lingering impact?

Honestly, I think what we saw in March was seemingly so specific to a bit of a distraction with the developments in Ukraine. That was a big problem for a customer set to sort of consider and deal with. If April and May are dependable data points, that has reverted to normal. And so I think our customers have sort of adjusted to some need in Ukraine as well as sort of the normal course. So if we see that continue, I don't see any reason why that would change getting into our first fiscal quarter but the last quarter of the government fiscal year '22.

Okay. That's helpful. And then I know you're not specifically guiding fiscal '23, but thinking about the terms of your growth framework and you talked about outgrowing the addressable market, I think coming into fiscal '22, you guided the rolling end market at 3%. I think you said you're not updating that, but presumably, over the longer term, that number should be higher now based on the '23 budget request. So where is kind of the right starting point for the end market? Is it still at that 3% and you'll outgrow that?

I think -- so as we sit here today, we're at that 3%. We are working through the go-forward budget dynamics and how does that relate to our addressable market. To your point, I think indications are positive. We did see a nice fiscal -- government fiscal '22 budget. That's finally now appropriated, and we'll see how the remaining funds get spent through the end of the year. And to your point, indications on '23 are certainly positive. Obviously, a very supportive budget proposed by the President. And if we've seen -- if the past number of years are any indication, that tends to be the starting point, and we see something a little larger coming out of into a fully appropriated budget. So some of that will be -- obviously, we've seen some spending around stockpile, refresh and other things that we would not play in. But there are -- those kind of fast currents that we believe we're well aligned to, cyber, broad modernization, some of those mission technologies in signals intelligence and electronic warfare, those are -- those needs have not gone away. They've been quite -- supported quite well, and all indications are they'll continue to be in the out-year budgets. So it's looking positive. We'll update when we -- specifically when we put out fiscal '23 guidance, but indications are positive.

Great. That's helpful. And maybe in terms of that '22 omnibus plus up, are you seeing that funding yet? I mean is there a use it or lose it dynamic where they need to get it on contract this year?

There is a use it or lose it dynamic. So the hope is all funds get spent, and that is the typical customer behavior. Our customer set does not like to leave dollars obviously on the table. So the hope is that there's the time line for them to be able to do that. Obviously, appropriated mid-March, a bit of focus on Ukraine, we are seeing funding flow. So I believe we've sort of reverted a bit more to normal behavior that if it continues through the June quarter and into September, that would be a positive.

Got it. Then maybe sticking on '23 for a moment just in terms of cash flow since this year has a bunch of headwinds and tailwinds, onetime items. What's kind of the long-term conversion rate target? Or what's the right starting point to think of comping against next year?

Yes. So this year, fiscal '22, we have one large onetime item. And this is related to a tax election we took last -- the end of last fiscal year. And so the net-net of that selection is a plus $60 million contribution to reduce taxes and increase cash net-net. So really compelling move to make. It does present some lumpiness in cash over the next -- last year, this year and looking over the next 2 years. This year is the largest though from a kind of onetime nature. About $230 million of our free cash flow guidance is a onetime pickup based on those back-to-back tax elections. That will not happen next year. Next year, we'll have a 50 -- about a $50 million outflow of cash, again related to that back-to-back tax election that we took. So there is some positives and negatives as we go through the years. But again, net-net, it's plus $60 million that we were able to realized based on that election. Those are kind of the big moving pieces. We also -- this year, we paid back half of the CARES Act payroll tax deferral. That was around $50 million. We'll have our second and final payment of the same $50 million at the end of next -- this calendar year, December, in our next fiscal year. So that's not a year-over-year headwind necessarily but kind of more onetime in nature, obviously, given those payback requirements.

And then gone after next year?

Correct.

One more I wanted to ask on the budget before moving on from there is the continuing resolution last year has obviously been far more disruptive than usual. Assuming we start next year or the fiscal '23 in a continuing resolution, is your sense that, that will be less disruptive than usual or still more disruptive?

I hate to predict. Budget [ ratiocination ] and then our customer sets behavior. But if history tells us anything, our customer set is more often than not, they're operating at the start of their fiscal year under a CR, I think it's been 3 out of the past 25, 30 years that we've been appropriated on October 1. It's typically always a CR. So they're used to operating under CR. This year did seem a little bit different. And again, there wasn't sort of added elements of distraction in COVID and Ukraine. And I think this was a bit of a different year. But again, if history tells us anything, they know how to operate under a CR. There are some impacts. But generally, excluding the Omicron and Ukraine and things like that, I think they do know how to operate under CR.

Got it. Maybe a high level then on the technology strategy, technology pivot. I mean just if you can go in a little more detail on how that's differentiated and why peers can't do that or replicate that?

Good. So an important -- so that technology side of our business -- our business is about 50% expertise and about 50% technology. And that has been a very purposeful strategy of ours over the past 10 years, to be quite honest, of adding more and more technology to our business. And it's an area where we can better differentiate and obviously drive both customer value and then shareholder value. It's higher growth rates on the technology side of our business and obviously brings with it healthier margins than the more commodity expertise-type work. So that has been a journey we've been on for quite a number of years and will continue to be on for some years. It's an area where we've invested quite heavily, both organically and capability development and through M&A, adding some really key kind of strategic capabilities in that area. I don't want to obviously speak for competitors, but that has been a very purposeful strategy for us as a company. I always remind folks that when we -- we do have a tendency to sort of always kind of gravitate towards the technology area of our business because it is where we find some pretty material differentiation when you look at us across a competitive set. But the expertise side is important as well. And so we will continue growing that technology side, but John will say, I like all 4 of our 2x2 quad framework. There's good reason to be on the expertise side. There's really good reason to be on the technology side. And there's a really good synergy between the 2, so a feedback loop between the 2, where we -- expertise informs the technology, the capabilities we want to develop. So what's the problem that the -- our folks, the expert -- an intel analyst working for one of the IC, what problems are they dealing with on a day-to-day basis? And then what technology can we bring to that problem to solve that? So a good feedback loop, having those analysts sitting side by side, working those missions, informing the technology side of our businesses, how can we solve that problem, what kind of technology can we introduce there, and then kind of pulling that technology back up into the expertise side is quite a nice synergy between the 2. So good reason to be in both. And again, that technology strategy has been something -- a path we've been on for quite a number of years.

Okay. That's helpful. So no intent to actually kind of roll off or exit the expertise side, there's just more emphasis on the technology side?

Yes. There's, again, really good reasons to be on the expertise side as well, and those synergies are just so beneficial. The ability to pull technology and enable expertise is differentiating in our -- as we go off of that expertise. And then that feedback loop into the technology side is compelling.

And one thing John has talked about there, too, is your ability to grow without as much correlation to head count or much dependence on head count. I mean can you give us an example of contracts of maybe technology where you've been able to grow or expand without correlation of head count?

Yes. So the technology side of our business is -- those -- the talent, those resources are quite fungible across that -- the 50% of our revenue. So you're right, there is less of a correlation between heads to revenue. You don't hear us talking about direct labor. You don't hear us talking about heads, how many hires we've made in the quarter. A good example is if we have electrical engineers, digital signal processors, folks working our signals intelligence and electronic warfare mission technology offerings, obviously requires that kind of talent to build those tools and that equipment. We can use those same folks, those same resources to take that technology into space. And we recently announced 2 payloads going into space in January 2023. One is an alternative to GPS. One is taking that terrestrial SIGINT, EW, cyber capability and deploying it to space and utilizing that same type -- and we can use those same electrical engineers and digital single processors to work those on the ground, SIGINT, EW devices as well as space-based payloads.

Are some of those IRAD technology demonstration? Are those contracts that could have a lot of upside?

Yes. Combination of both. That one specifically is in IRAD, those 2 payloads. So partnership with York. We're riding on a launch, and we'll be up on one of their satellites. And that is to test these 2 technologies and get them space-qualified. But we do quite other work where it's more -- it's less IRAD or could be customer-funded IRAD through contract vehicle. Photonics is a good example there. Recent success with DARPA and SDA program. Mandrake 2 and successfully linked to optical comms in space, again, an SA Photonics success there.

How much have you guys increased IRAD over the last however many years?

Fairly materially. Talking about that 10-year period and how we've grown the technology side of our business. If you were wind to 10 years ago, we were probably 80% expertise, 20% technology and not a whole lot of IRAD in sort of internal investments and capabilities, as you can kind of imagine given the split. Today, 50-50, and that has been a kind of a steady progression of additional spend and additional investment, it's supposed R&D, IR&D, customer funded. So as we sit here today, we have not provided a specific number, but we -- IRAD R&D bid and proposal dollars in the $90 million range. So it's pretty material spend there around these capabilities. And we're doing that, frankly, while investing in our people and delivering margin expansion. So as we've grown the technology side of our business, we've been able to invest more and continue to achieve those -- that margin expansion commitment.

Can you talk about how M&A has both contributed to that and where you see yourselves taking M&A to continue to push the technology pivot?

Yes. So I can use -- we had 4 acquisitions this fiscal year. I can use those as examples of sort of what we're doing and the strategy there. A smaller company called Bluestone Analytics, open source intel, providing capabilities around the dark web, so law enforcement and intelligence agencies giving them the ability -- software-based, subscription-based capability to go surf the dark web and do that in a non-attributable way. So quite useful for that community. A small acquisition that we have not gotten too detailed in, but think satellite comms and technologies around that. And then the last two, ID Technologies, which is a provider of software-based, again, subscription service, CSfC, which is Commercial Solutions for Classified. So it allows someone to take a commercial Dell laptop and with their software securely connect to classified networks. So it's -- today, that's done with a hardware-based capability. So big, clunky laptop or desktop that's certified to connect to the classified network. Their software-based solution enables any commercial device and is also -- is approved by the NSA to access those classified networks. And then SA Photonics laser comms, talked about the success they had with DARPA and SDA recently. But this is an early investment in what we believe is going to be sort of a materially growing space market, where it's -- and SA Photonics specifically addresses the LEO. We have existing capabilities in photonics that invest -- that address GEO and other missions that provide those laser communications, and SA provides manufacturing -- broader manufacturing capability as well as the -- a smaller size, weight and power and cost point given LEO. LEO is going to be smaller, more proliferated, a lot more units up there with a higher refresh rate. So sort of a different model, but a nice kind of nice adds. Again, the -- as it relates to our technology strategy, those are areas where we see considerable ongoing investment in growth. So on ID Tech and CSfC, that is to address a dispersed -- much more dispersed workforce. That's around broad IT modernization. Marrying that with our existing IT modernization capabilities is quite compelling. And then SA Photonics, again, space-based laser comms, and we see that especially as LEO proliferates as a pretty compelling area to be. So again, as we look -- as we go through our strategy sessions on a regular basis, it's identifying where we see the market going and then what gaps might we fill from a capability or a customer perspective to address those demand signals.

Great. What are some of those gaps? And maybe focused on end market areas, product specifics, white space, augmenting existing capabilities.

So yes, I would say -- so ID Tech and SA Photonics are 2 good examples of augmenting existing capabilities. So we have very robust capability and a broad IT modernization, and that includes classified networks. Adding ID Technologies to that capability provides not only the broad IT infrastructure modernization, but now a software-based solution to go utilize a commercial device to access that classified network. So quite synergistic between the 2. SA Photonics is very similar. We have existing capability in laser communications through acquisition of LGS, again, they sort of -- they address a different area of the space comms laser market, and SA Photonics addresses LEO. So kind of not completely new capabilities, areas we know and plan but augment existing capabilities from sort of a slightly different angle.

Have you ever looked at -- or are you able to size space across the entire portfolio?

We haven't. But it's -- we do quite a bit. And it ranges from the things we've talked about around laser communications to those RF-based SIGINT and electronic warfare capabilities to space situational awareness to ground station management as well. So there's -- we haven't put out a specific number around space, but quite a bit of capability in space.

Got it. And then maybe on the M&A pipeline, just how robust is that and what valuations look like?

So yes, there's certainly a pipeline of M&A targets. We always like valuations to be lower. So -- and we're very disciplined. So if things are too high, it's easy to walk away, say no and look elsewhere. So there remains a pretty consistent pipeline. I do think valuations are a bit high. Now that said, this year, SA Photonics, IDT, Bluestone and [ Number 4 ], which we were able to close at valuations that were very compelling to us. So while perhaps valuations are a bit high, there still is certainly the ability to go find really good opportunities at compelling financials. Second part of your question, Gavin, was?

Valuations of pipeline.

Yes, and not materially different than they have been in the past couple of years.

Okay. And maybe just on IDT. That one was margin dilutive, but I know it's EPS accretive. It sounds like there's -- that portion of the business has a great long-term growth opportunity. If it's software, I assume that's likely at a higher margin. Is that -- at this point, you had a little bit of margin dilution this year, but is that an outsized margin growth driver as that software mix is up?

Yes, that will be -- assuming they deliver on what we expect of them, that's going to be -- that's going to be a nice contributor to both growth and margins. Again, CSfC, it's sort of the right time to have that capability. They are in a bit of an investment phase similar to SA Photonics currently. But that long-term growth trajectory, our belief is that's quite compelling, and those software sales. There's 2 areas of their business. One is a value-added reseller, with margins below our corporate average. And then that CSfC software-based, quite high margins. So that was the really strategically valuable area that we wanted to buy ID Tech. SA Photonics is a similar situation. So margin dilutive in the short term. They're going through an investment phase at the moment for good reason. And yes, as we look at fiscal '24, '25, '26, we -- our belief is that, that really kicks in as LEO proliferates and there's demand for the LEO space-based comms.

So maybe this is a bad comp. But it felt like Mastodon was maybe a lot more various situation-specific, hardware, special forces. These have longer -- bigger, longer-term growth opportunities?

Well, so they do, and I would say the same for Mastodon. I think that's -- what they're selling and that capability is -- they have a broad customer set, important to the special ops command, important to the intelligence community. There's quite a bit of potential there, continued growth potential. Again, those are handheld, those are vehicle mounted, those are airborne assets, payloads capabilities. But signals intelligence and electronic warfare and their convergence with cyber capabilities, that's not going to slow down.

Especially with Russia and Ukraine.

That near peer is quite relevant.

So maybe one more on capital deployment. I'll open up to the room if anybody has any. But just as you think about buybacks and M&A and at the end of the year, guidance implies you're somewhere around 2.5x levered. So what do you think of as your capacity to do capital deployment and your appetite for buybacks versus M&A?

Yes, very good. Yes. So we closed the March quarter 2.8x. So yes, if nothing else, you're right on kind of the ballpark by the end of the year. So capacity-wise, $1.5 billion to $2 billion. And that puts us in the 4.5x range is sort of kind of where we see as comfort level. Obviously, that can change given the interest rate environment. But for now, that's sort of kind of how we think about it. So there's a lot of -- frankly, a lot of capacity there. But capital deployment broadly -- we used 2 terms very purposefully, flexible and opportunistic. And this is a bit of a change in tone for us and a very purposeful change in tone about -- rewind about a year ago, March of last year, we've really started talking about capital deployment a little differently, and flexible and opportunistic. Flexibility is all options are on the table, and then opportunistic is based on the dynamics at the time, we want to utilize those options to create the most value -- long-term shareholder value. March a year ago, we did do the accelerated share repurchase, about $500 million buyback. Flexible and opportunistic was we didn't -- there was not a compelling set of acquisitions in the pipeline. Valuations were quite compelling in our equity, and we -- that just made a lot of sense to us, and I think the timing has worked out quite well. Those options remain on the table. And the commitment remains flexible and opportunistic. It's an and. It's not buybacks or M&A, it could be both. It could be one or the other. But that will all be determined based upon the set of dynamics at the time. Our underlying goal that sort of drives all of those decisions we make is free cash flow per share growth. And what's going to deliver that long-term free cash flow per share growth. At times, it's going to be buybacks. At times, it's going to be acquisitions. At times, it may just be debt reduction. But all those options are on the table at any one point in time.

Great. Makes sense. If anybody in the room has any questions, raise your hand, and we can walk a mic over. Well, then maybe just one last one on -- just on inflation. I think you guys have covered it pretty extensively, and I think it's relatively self-explanatory on the cost-plus side. But can you talk a little bit about how that impacts fixed price and whether or not there's margin risk there and maybe mechanically how some of those contracts work?

Yes. So -- and it's -- you're talking specifically wage inflation, it sounds like.

Wage or commodities on some of the hardware products.

Okay. So yes, you're right. So let's talk wages first. 60% is cost plus. So that, by definition, is sort of a natural hedge. As wages may increase, we pass that along to our customer. On the fixed price and T&M side, we have not seen a material impact there, honestly, in any way for a couple of different reasons. These are 5-year programs. When we build that program, we're building in -- typically 5-year programs, we're building in escalations over those years. So that may be 3%, 4%, but we're going to build in some level of wage growth over those years. We've -- year after year, our employee population enjoys merit increases on an annual basis, and we're going to build that in. And to the extent that we see perhaps wage growth beyond simple merit, we may factor that in as well. So there's an opportunity for us to do that. On the fixed price side as well, it's back to our fungibility of people discussion. Again, it's less about any more people, more people to do it. It might be about pulling technology into that program that allows for you to deliver with, frankly, less people. And John will say I love paying top dollar for top talent. And it's -- I'm going to do that every day because I want the talent. And we're going to -- whether it's our bidding strategy, whether it's utilizing technology, whether it's fungibility of resources, we're going to kind of manage through wage inflation if there is. Yes. On the more material commodity type bit of manufacturing area of our business, supply chain is certainly a challenge. So there are times where we perhaps maybe paying a little bit more to get something a little sooner. That's completely manageable. And again, those mission technology sales come at quite nice margins, pretty compelling. So yes, not a material impact there either.

Got it. Great. Well, thank you very much, and thank you, everybody, for joining.

Thanks for having us. Thank you.