CACI International Inc (CACI) Earnings Call Transcript & Summary

[Audio Gap] annual Cross Sector Insights Conference. Today, we have this pleasure of speaking with John Mengucci, CEO of CACI, and we have Dan Leckburg in the audience to, I guess, field any questions from there. Thanks, everyone, for being here. And just to give a brief overview from my perspective on CACI. The company has gained a reputation as a premier government services provider with, I'd say, an increasing focus on technology and a good track record, maybe a great track record of doing acquisitions. So maybe with that, I'll hand it over to John if he wants to give an overview of the company, and then we can kick off questions.

Yes. Great. Thanks, Bert. Thanks, and thanks for the folks here for having us here. Yes, a $6 billion government services company. We have been transforming where we had since around 2012. We pretty much moved from being a company predominantly provided people or expertise over to one that provides both expertise and tech. We've moved that mix from a 80-20 expertise to -- tech to 50-50. We're really unique in the space and that we are consistently looking to grow top and bottom line. So we will never be that top line toward grower. But we're going to exquisitely grow top with a very strong focus on the quality of earnings. So you'll see our margins continue to move forward and part of that success we've had has been really looking -- being very judicious on the expertise business that we bid, making sure we're bidding more and more technology. Most of that where we own our own intellectual property, and we sort of built that business along the way. I'm sure we'll get to that when we're going through questions and answers.

Well, you had -- I mean, this wasn't really a prepared question, but now that you brought it up. You had a peer of yours yesterday seemed to have an interesting take on their business that was pretty similar to yours. Maybe just to kick things off, can you...

Flatter. If it's...

Yes. Flatter, exactly. Gives you form of -- so maybe just kick things off. Can you just give us an overview of how you think about technology versus expertise. And in the context of what you did with your guidance bringing it down a little bit for this fiscal year, which ends this quarter. Can you talk about why technology was maybe a little bit of a challenge there?

Yes, sure. A couple of pieces in that. Look, when we look to move the company forward, we'll be a 60-year-old company on July 9. We've seen a lot of different trend lines, we've seen trends change. And we love to hire senior leaders that have a growth gene. They're really watching about where the market is going. Well, it's a very dangerous place. It's always going to be a dangerous place. Sometimes budgets are at that mark and sometimes they're always catching up. But we really looked at the competitive pressures of being in an expertise business where you're providing people. And when Better Buying Power 1.0 and 2.0 and low price technically acceptable bids came out in the 2012, 2013 period and [ sequestration ] came out, you sort of sit here looking at -- I don't want to be in a commodity business. And it was clear that over time, couple of decades, that providing just people is going to turn into a highly commoditized business. You can only differentiate yourselves on price. So in 2012, we made that decision that instead of leveling investment and taking all investment out of the business so we can get the lowest rates so we can go win people-based business. Let's embark on building more of our technology side of our business where we own the intellectual property, we can differentiate based on solutions in an area where there's less competitive pressure. So that's where we made that trade in the 2012 time frame. Now of course, when you move to technology. Beyond systems work and delivering small boxes and small form factors, you get into a budget issue. We hit at the end of the third quarter, was something we hadn't seen in the last 10 years. We had a -- I think it's a $300 billion, 20% drop in funding. So, Jeez, John, you move from an expertise business to a good mix of tech and expertise. You've been growing top line, you've been growing bottom, bottom line, why budget. Totally orthogonal to where we're taking this company. We're working with a customer set that, frankly, is still working through COVID. If you want to hear about the great resignation wave, I believe that the government contracting officer for world is going through a great retirement wave. And there is a lack of active KOs who are there to put phenomenal budget numbers out in funding orders. So we lost 2 types of funding. We lost the high-margin stuff for some of our low swap powered devices, and we also lost some material buys. So really set this nexus up is that, look, we're not going to get through the year at our current guidance. So we did the only thing that we always do, we're very transparent and just shared that we're going to come out of our FY '20 to a little bit lower than where we would like. But some of that delay does set a much healthier stage as we look forward to FY '23.

So my viewpoint on that has been when we look at it at least on the O&M side, and it's really the same on RDT&E, through the first 6 fiscal months of the year outlays where I think the lowest they've been in 20 years. Historically, outlays in the budget actually do line up pretty well within hundreds of millions of dollars, which would indicate there's going to be a ton of money spent in the second 6 months. However, I've not gotten that tone from you or any of your CEO peers. Is there something I'm missing? Like how are you thinking about that money and spend?

Yes. It's interesting how the federal government puts their outlays out there. I've been in this marketplace, this will be my 40th year. So I've seen a lot of CRs. I actually started this fiscal year off talking about, hey, it's a CR like every other CR. And then I'm the one CEO who -- every one while you regret something that you've said, the government's reaction was very, very different. Traditionally, when the government is under a CR, the contracting officers push funding out 1/12 a month what last year's budget was. So that's why when you hear government came out of a CR that can do new starts. That's where the incremental piece comes from. But traditionally, everybody across the federal government will take last year's budget, divide it by 12 and issue those amount of funding orders throughout the year. But it's a very different year. Recent election, one. Two, 25% of the contracting workforce in the office on any given day. Three, still working through COVID. Four, are we a near PureFight? Will we counter terrified or we both. And then the issues in the Ukraine come in. With a bunch of 5 to 6 months of unfunded requests, we've got to get support there. So it was the 5 or 6 different feature mix that I think hit this contracting force. We were saying in the first and second quarter, contracting officials were doing about 70% of last year's budget. And so it naturally drives people to when it's all they get flushed out. Some will get flushed out during the last government fiscal quarter, which is our FY '23 Q1, we're a July to June company. And I think you will see a fair amount of funding come out. But then you're going to have a midterm election, and that could also cause some areas. So we're not -- collectively, I don't believe we're bullish, but I do believe we're going to see funding start to pick up. And the only data I have on that from where CACI sits. When I talked about we were $300 million down or 28%, 20% down, through April and May, that has leveled back up. So we are starting to see that funding come out. Again, not everything we do is based on funding, but some of our high-margin devices that are out there selling. Those never hit the backlog, we'll get rewarded in January and by March, you've already delivered and those are relatively high margin, which is what's there to drive our bottom line growth. So there's a lot of factors in play, but as we go forward, FY 2023 is the precious budget is up. We're not IT and cyber company. We're watching DHS funding. They're our largest non-DoD customer, and then about 25% of our business is in the federal/civilian world. And that funding looks to be stable as well. So funding, funding, funding is what we're watching.

So I mean if we think about maybe not this year, but the -- this year plus the next 2 years, it would seem like the defense budget is going to rise maybe mid-single digits. If people might take the low end or the high end of that. But I think it's a fair way to think about it. How do you think CACI reacts in that sort of environment? Is that what you would -- if it is 5%, you grow faster than 5%? Or do you really not peg it to what defense budgets are doing?

Yes. What we peg our growth rate and our expectations to is our compound annual growth rate over a 5-year period of our addressable market. And that's sort of -- my rule of thumb is always take market share. So we would believe that the upcoming budget will probably be a mid-single-digit growth. Over a 5-year period, that probably gives us a 3% to 4% overall growth rate, which means we grow better than 4% top line, at ever-increasing margins. So we're very cognizant of making certain that we're not driving top line growth without paying an awful lot of focus on bottom line. As we made this transformation, why we do that is, if half our business is in expertise and half is in tech, every time I bid an expertise job at a lower margin, all it does for me is it gives me the honor of having rebid that job 18 months later. I'm taking a lot of investment dollars just to win last year's revenue again 2 years later. So we are very purposeful in what we bid in our expertise segment, very, very cautious. And every time we turn a bid away or we leave work behind, we take that money we would have spent on the recompete and push that directly into our tech business, which over a longer period of time is much higher quality of revenue.

Well, what's the upper bound on tech, I think it's mid-50s percent of your business now? Like can that go to 70?

Yes. I mean, look, both of the parts of our business are extremely valuable. The expertise work that we're in, expertise informs tech and tech provides differentiated solutions for our expertise bids. So they're very symbiotic. I think I had a question last quarter, expertise grew at 2 and tech grew at 10, you must be happy. And I'm happy that they both grew at 10, right? So -- but it is true that the mix over the last 10 years has moved from 80-20 to 50-50. I think that's a good mix for us now. But again, it's about what's coming out. If we can see enough business on the tech side that's offerable to us and part of our addressable market, then we're going to put many more tech bids than we will in the expertise area.

So you just mentioned before that you hope to take market share. How do you think you take market share in this industry? Like what has been your -- historically, you have, how have you done that? And how do you think you can do it going forward?

Yes. Part of it -- look, we're a strategically based company. So strategy is a place where we come from. And you also mentioned in your opening comments we're highly acquisitive company. It is a core competency of CACI to either fill gaps through investments, through partnerships or through acquisitions. We just completed our 89th acquisition about the last 25 years. We never buy revenue. We're always building buying capability or customer relationships. And then that culture has to be the right fit. And by doing that, it expands our addressable market. When I got to the company in 2012, our addressable market was a little over $100 billion. We were a couple of billion dollar company. Our addressable market is over $240 billion. It's growing 4% to 5% each year, which should then drive growth above those numbers at respectful margins. So we're on the higher run in the government services base driving margin growth. We consistently talk about top line growth. Traditionally, the services sector has really rewarded for top line growth. I want to move this sector more towards rewarding both.

So you've done -- like you said, you've done a lot of acquisitions. Recently, they focused on, I would say, niche technologies. If I look at SA Photonics, ID technologies. On the face, it was like great deals. Obviously, you've talked about having to do some investments there, and that's maybe a little bit of margin pressure. Like how will you assess if those end up being good deals? And what do you think about like why did you gravitate toward optics? Why are you gravitating toward classified communications? Like how do you think about those as the right capabilities for you?

Yes. So when we embarked on this a number of years back, I spent 27 years at a major aerospace and defense prime. And so understanding what those companies need from others, looking at on the mission packages. And on the mission tech side, we had quite a long history in RF and EW. I believe that those 2 areas we're going to converge with cyber. And it was going to turn into devices that you can not only find things in the RF spectrum that the land war fighter and the airborne fighter were actually very interested in. But we could geo-locate them and then we could put effects back out. Today, that's 4 or 5 different devices and requires 2 or 3 different domains. So our plan is space-based airborne layer, ground layer, build simple devices that have an awful lot of compute power in them, very low power source requirements and can do multiple features at once. So it can be a signal detection and it can either put out a nulling payload. It can put out a cyber payload on the offensive side and make the ground war fighters job much, much easier. So we had a history in that. And it's just my absolute belief that in the EW spectrum, everything where we will combat in the next 10 to 20 years are still going to be RF-based. We've heard a lot about bombs and bullets, we're very much focused on bits and bytes. There are so many more damaging nonkinetic effects out there. There's as many as are in the kinetic space today. We want to be one of those major niche players that would address that market fully. We're a very agile company, being able to address that market and being able to buy smaller tech firms to bring their capabilities together was what our initial drive was. And proof about where M&A goes. Look, we were a $2 billion company at about 7% margins. We're a $6 billion company at almost 11% margins and very sustainable and allowing us to continue to grow.

Do you get concerned that you'll end up competing with defense primes as you move more towards this side of the spectrum? Or is this niche enough to not be in their radar?

Yes. Look, I think it's going to be a little bit of both, right? We will partner where we have to partner. We'll be a trusted sub where we desire to be a trusted sub, but inevitably, we will collide. And look, our market is not to sell more products than someone else. It's a software-defined radio kind of model, where I want to deliver a device, I hate to use this example, but it's the best one there is. When you buy an iPhone, it's the dumbest piece of the equipment you ever own until you open the App Store. And then it becomes a plethora of different options. That's what our model is. I don't have unionized workforces. I don't have 100,000 square foot production facilities. I'm not going to make money on every device that they're selling. It's more of a Software as a Service, put on a device that can come -- that we can pack as much computing into. We're also unique in that even for our size, we invest ahead of customer need. So we are involved in a lot of pre-customer demand investments showing them what the possible is. Not everybody in our industry does that. They're waiting for the next model to be purchased. So we're not delivering the next model and saying here's what you can buy. We're talking about what are the features you need and then we're building to that. The other piece I want to share on the expertise piece. You've got about 700 people on the wrong side of the wire each and every night. So you hear about chew-ons and [indiscernible] and these operational need statements, they come from many combatant commanders out there. Most of the times, that's our folks writing those. So we have an outstanding group of folks, former soft folks who are back out leading joint expeditionary teams and many really dangerous places around this globe. So you talk about first-hand knowledge, we don't have to wait 2 to 3 weeks or 2 to 3 months to get that feedback cycle, we get it in 2 to 3 hours once their ships done that really uniquely puts us in a much better.

If we think about that, not from the micro but from the macro perspective and just bringing it back again to budgets because what's going to move those trends. Do you think your exposure to O&M is sort of gravitated towards RDT&E? And do you see that as a good thing. It would seem to be a good thing that's growing faster.

Yes. In some areas, Bert, yes, okay? In other areas, customers like software using a lot of O&M dollars to continue to make mods to some of those devices, which is positive. So yes, we are bleeding more into the RDT&E, more in the space-based optics area, right? Those are much larger programs. But if you look at where the market that we're in today. It's my belief, it's our belief that ACAT I programs are not going to support every single flight that we're going to see in the next 10 to 20 years. A lot of O&M funding is going to support that. So these 8- to 10-year or 20-year development programs to build new platforms absolutely need those. And as a nation, there's 5, 6, 7 companies that do a phenomenal job at it. The issue is going to be as more issues become non-kinetic or they become kinetic. But I've got to find out where that shooter is. That's a lot of bits and bytes work. So that's rapid prototyping and rapid delivery of different devices, they're going to be on all of these platforms. I believe that's where the money is going to go.

So you've only sort of, I think, touched on cyber at this point. And I think you hear so much about it now. Can you help us separate hype from reality. Do you expect that to be like the fastest-growing business? Or do people just talk about it growing fast because clearly, it's an area where there's a ton of investment going.

Yes. I think when I was 35 I first heard the word cyber. And cyber budgets were going to be ballooning, right? I'm much older than 35 now. Cyber and how much cyber each company does is not a GAAP measure, right? So people like to count it however like to count it. The raw fact is cyber is real. This administration is putting more money on the network cyber part of all of our customer sets across the federal government than any other administration has in the past, which is a positive sign, actual true dollars there. The issue is when you talk about whether you're a cyber company or you're not. I would tell you that cyber is in just about every program that we deliver. I would guess 80% to 90% of the work that we do have some element of cyber. So it is 90% of CACI cyber, no, right? It's back from fiction. But what is important to recognize is on the network side, it's very important to our portfolio. On the offensive side, it's very important as well. So on our mission side, where -- we're out there doing counter UAS systems that were completely in the cyber domain. It's tough to talk about cyber if you're not talking about signal collection, if you -- without talking about EEW because it is a converged area. And that example is if I can find somebody who's emitting from a phone. And I can find I know where that phone is, an offensive cyber effects are pretty simple. And if I'm defensively protecting our links, I can easily get into somebody else's links. So it's why when somebody is talking how much of CACI is cyber, it could be 60% or 70% and it's very well-funded. So again, as more things go to bits and bytes, the more cyber spend is going to be out there. So I do believe the market is real. I'm not sure I believe the percentages of companies to say here how much their cyber work is. Because I do think in another couple of years is going to be so converged at if you're doing signals collection, you're also doing cyber.

If we think about your portfolio holistically, I know you historically have guided to fixed price exposure, wanting to grow that and that makes sense because that tends to be a way to expand margins. You've also recently talked about intel being about 30% of your portfolio. Those 2 tend to be on the opposite side of the spectrum. How do you think about growth from here? Is inflation making fixed price look more attractive? Or is it sort of having limited impact on that? And then now with obviously what's going on in Russia, Ukraine, is intel getting more attractive?

Yes. Okay. Let me peel that one.

Yes. I try to keep it simple. That was those layers. So...

Yes. About 30% of our business is in the intelligence community. If you look at the intel budgets going forward, up about 9% in the '23 budget, that's somewhere in the 7% to 9% [ NIP ], and 14% MIP so somewhere in that area. We provide -- I'm sorry here, contract type is an element of risk. If we're able to take on risk, we can get the government to go for a fixed price. If we want to share the risk, it's usually cost plus. We enjoy doing from a fixed price work. I've got some of the best tech people out there. And for any of the technology work we're out there doing, I would rather take that as from a fixed price. One, it keeps the requirements, mods down and two, we're able to deliver quicker. I'm also able to staff those programs the way I want to staff them. Cost plus programs are usually in an expertise area where the government gets to delay the spec down at people who are going to work on that job, and that's just not a good business for us. It's not so much just the contract type. I've got plenty of cost plus work and very bespoke, unique intel areas that are making double-digit margins today, okay? And that's per labor hour. So one element is the contracting type. The other element of it is we're taking on development programs where, again, I get to staff those jobs. We hear a lot about other folks in the sector is how hard it is to find talent. I'm that CEO that's not saying it's hard to find talent, because half of my portfolio is in technology. I get to hire those people. They're very fungible. They move from project to project. When you run into areas where people have a very high growth rate or high award rate and the revenue doesn't show and the issue is, I can't find people, my answer is stop bidding that people work. Because it's really hard to find folks. But it's always been hard to find talent. The number of STEM graduates is down. I'm a big trend line guy, and trend lines as STEM graduates coming out are down, therefore, don't bid work. We've got to go out and find 800 more of them. You have to really play to where this market is. So we're going to be very much focused on contract mix, we're going to be very much focused on contract type and very focused on those customers who are looking to take a different technology approach versus what maybe some of the established primes have ongoing, which is just to sell the next model. So it's a real mix.

Is there really a way out that you said we're not as exposed to labor. But if you're on tack, don't you get then more exposed to semiconductors or supply chain. Like is that -- I mean, has that been a restrictor?

Yes, the last 2 years, yes, right? The previous 12, no, right? So I definitely didn't predict a generational pandemic, right? So -- and we'll find our way through this. But it was clear to us that providing people to a government spec over the long haul, under Better Buying Power 1.0, 2.0 and LPTA was not the long-term growth plan. In companies who decided to cut all their expenditures and cut investments and be the low rate provider are now 8 to 9 years later, okay, tied on top line growth, not very attractive bottom line growth and a model where you stopped most of your investments. And I just didn't want to -- I want to be that company where people wanted to come to change the face of national security. You don't do that by zeroing investments to get the lowest cost structure. You actually get that by investing even more.

One thing that's been, I'd say, noticeable for -- or notable for CACI has just been -- you -- I don't think you break it out specifically, but you have your exposure to the Army. The Army has been and the budgets for the Army are growing slower than the Navy, Air Force and Fed/Civ. How do you think about pivoting that exposure? And -- or do you think about that positively because you're exposed to the right product?

Yes, it's more about what the forces are actually spending on, right? It's the same trick on the opposite side but where we talk about next year's duty of what it could be $100 billion. I'm always waiting for the third indented bolt and the fourth indented bullet, right? If you're spending more on building satellites or more on delivering next generation fighters, that growth in the budget really isn't going to talk to us. It's really about how much does it grow our addressable market. That's the very important measure for us. The Army is a phenomenal customer for us. They are continuing to buy small handheld devices which is our high-end mission tech area. We've done -- we've won over the last 2 years, many network modernization programs for them, both OCONUS and base level across the U.S. That is a really important next step building as the government continues to spend money in network modernization, moving networks that can only handle unclassified data to handle classified secret and top secret level data. The ID Tech acquisition provides a CSFC model, which is commercial devices running on classified networks. We have a software solution for that. So you can buy a Dell laptop and you can put our software, SaaS solution on it. You can take that laptop from an unclassed network to a top secret network and then back off. And that is extremely important to the intelligence community as well as the Army and the Air Force and the like. And we also are building the largest HR system across the federal government, a program called IPPS-Army, very successful thus far. It is the chief's #1 program throughout the entire army. So it's other parts of the Army that are spending money that's very relevant where we spend. So Army being a major bill payer at a macro level is one measure, but it's that CACI addressable market that stands a little north of $240 billion, that's what we're watching.

Okay. I know we're getting closer on time. This year, if all things continue to go as expected, it would seem -- or this calendar year, it would seem like your leverage ratio is going to become historically favorable. How should investors think about capital allocation from here? Would you get more aggressive on stock buybacks again?

Yes. I think [ royalties ] will continue to be flexible and opportunistic. That's the million dollar question, right? And it's really a focus of ours. We changed how we talk about capital deployment over the last couple of years. Just what happened is last year, we did 4 acquisitions, spent about $600 million there, did a $500 million share buyback. But I don't want people to take balanced because balance doesn't work either. It's more of how cheap is capital, what's the valuation of our stock, are there M&A targets out there that are going to drive more longer-term capability and customer relationships. So it's really a 5 to 6 dimension measure. And if there's -- if it's a frothy M&A market, but one that we don't want to enter into because we're pre discriminated on what we're willing to pay. And we believe our stock is not at full value, then that would tend more towards share buybacks. But I want to leave the other model open. We're big about free cash flow per share, frankly, Bert. And doing a share of buyback gives us an immediate push, doing an M&A gives us that longer-term growth model. And we've done 9 acquisitions. We've been growing quite successfully year-over-year. So it's really a -- it's flexible and opportunistic. If you'd asked me that question 3 years back, I would be saying M&A is our very first capital deployment priority. And it's just not. It's really this nice opportunistic and flexible that we have going forward.

To wrap things up, I've been pulling or I'm going to continue to pull all the management teams this week on 2 questions. So one, what is your expectation for the duration of a continuing Resolution 23. And then two, plus or minus 6% or defense spending growth, would you take the over or the under?

All right. Top -- when does the CR? Are we under a CR and how long does it go?

No, we'll be under a CR. I think that's pretty well concluded. But how long do you think it lasts? And then defense spending then going be over or under 6%?

If I had to throw a dart, I would say February because of the midterm election. Second question over, under on a budget...

Budget growth 6%.

Yes, I'm going to be looking at how far -- whatever budget we have drives a CACI addressable market growth, frankly. I hear a lot about $800 billion budget. I'm still looking for the next level down to find out how it impacts us. I'm often asked last to last year, $750 billion defense budget or $700 billion, which one sounds better. Depends where they're going to spend it. I don't get too high on a higher budget. I don't get too low on a lower one until we've scrubbed it and scrapped it and looked at what actually -- how do our programs stack up. So we're not a macro budget company, we're much more of where does the government spend and we do a pretty good job of shaping budgets, very good job of shaping customer likes and dislikes, making certain that the programs we want to grow in a very [indiscernible] way and are well enough funded.

But if you had to choose. Fair enough. Okay. Well, thanks very much, John. And thanks, CACI for being here and for everyone for listening in.

Thanks, Bert. I appreciate it.