CACI International Inc (CACI) Earnings Call Transcript & Summary

All right, everybody. We're going to get things going here. Welcome back to sunny Laguna. It's good to be back in California again after a couple of years of hiatus. My name is Matt Sharpe. I'm the firm's government services analyst. And before I introduce the team here, there is a disclosure that I have to read for you all. For important disclosures, please see the Morgan Stanley research disclosures website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. Now with that, it's my pleasure to introduce the CACI team here today. With me is the CFO, Tom Mutryn; and Senior Vice President of Investor Relations, Dan Leckburg. Gentlemen, welcome.

Well, thank you very much, and good afternoon or good morning, everyone. And I appreciate people's interest in CACI.

So Tom, I wanted to start here at sort of a high level and go back over the last 5 years and talk about the business and what's changed. You guys have worked to reshape CACI, its market position over the last several years, improving its organic growth profile, its profitability and this, all despite sort of an inconsistent backdrop, right, COVID, CRs, Afghanistan, et cetera. So how does the company compare today relative to, say, that of 5 years ago? What has changed within the portfolio?

Yes. So thank you. So CACI, many companies continue to evolve over time and kind of get better and kind of transform itself. The strategy that we embarked upon was to ensure that we continue to serve our federal government customers, both mission customers and enterprise customers, with high level of innovation in technology. And for that, it means less commodity-like expertise work, but stickier, more differentiated technology work. And when we talk about technology, our definition is providing outcomes to the government. It could be a new human resources, human capital system. It could be more data visualization tools. It could be mission technology products, but focus on kind of more differentiated activities. That creates stickier business. And as more innovation in technologies put into our work, it comes at higher levels of profitability, higher margins. And so it allows us to propel organic growth at ever-increasing margins.

You said a few things there that I imagine will get teed up in this next question, which is the logical successor here. Pentagon leadership under the Biden administration is just beginning to codify its priority areas, what it's going to spend on, what it's not going to spend on. And they're doing so through obviously the budget was also strategic doctrine, right? So maybe just now thinking about where CACI is today, how is the reshaped portfolio aligned with some of those priority areas?

Several years ago, we've made really deliberate investments in areas with large electronic warfare, a kind of dangerous environment that we're in, near-peer adversaries kind of nonstate actors, employing technology that could be counter drone technology, signals intelligence, secured communication, wireless networks, 5G space-based communications. And over time, we've developed software-based technologies, which address a lot of those particular shows. So it's very much aligned with some of the DoD and intelligence agencies, priorities to protect troops in battlefield to give the U.S. advantage if we ever need to engage the adversaries. So that has come about through a combination of acquisitions. We bought a series of companies who had those capabilities as well as internal investments, research and development, making sure that we're partnering with the right parties as well.

Got it. So through those investments, you've expanded your addressable market, but the addressable market has expanded to some of these higher priority areas. So as the budget does start to begin moving around, you'll remain well aligned. It's not a pivot away from your core capabilities but more to your core capabilities.

Very much so. The 2 broad areas that we're focused on, one is enterprise modernization. Across the government, at large, there's a series of kind of digital solutions, internal systems and processes, cloud migrated to storage, agile software development. So that work is growing and expanding on the enterprise side of the equation, think IT modernization kind of broadly speaking. And then on the mission side, helping government agencies with specific missions, mostly focused on the DoD and the intelligence community, focus on some of their unique missions.

Got it. So given what we just outlined between the reshaped portfolio and the alignment, I want to talk a little bit about growth here this year. Obviously, it was just last month that you established your fiscal '23 guide. That includes 4.5% to 7.5% revenue growth embedded within I think a few points of inorganic contribution. Maybe you can just characterize this in the context of those quadrants that you've been alluding to in. And what are some of the key building blocks of growth into '23 here?

Yes. So we have a portfolio, and the portfolio is synergistic. Some of the work we do on the expertise side of the equation informs our technology. So we like all aspects of our business, and we aspire to grow in all parts of our business across the spectrum. And so there are growth opportunities. There's awards that we're pursuing across the spectrum of capability. What is going to propel growth is both winning new business. At the beginning of the year, we established how much of our business is ongoing existing business, how much is recompete business, which we need to win and how much is new business. So approximately 80% to 85% of our business is in existing business; 11% recompete and around 6% new business. And so let's focus on winning our new business to the extent that we win it at a higher percentage than we planned for or it occurs earlier that will propel higher growth. Then within our existing portfolio of work, there's always opportunities to expand the scope of work, providing services to the government. The government customer presumably happy with the work that we're doing. We can do more in this particular area where we have more capabilities to employ in a different area, and those will propel growth kind of greater than those guidance ranges that we spoke about.

Got it. So is there anything outside of simply CACI's performance or execution? In other words, anything in the environment that needs to occur to allow you to get to the upper end of the guide. Or is it merely winning those opportunities within your pipeline and expanding that on contract business?

Yes. So there are some external factors. You rely on the federal government, which is a very large organization as our end customer. And so the government needs to adjudicate Jurys Awards. Here's the proposal, put the proposal along the street, adhere to particular deadlines, award appropriately and allow us to begin executing on those particular programs. And so that is kind of one factor. The other factor, which had been spoken about on our last couple of conference calls is kind of the funding environment. Once we win work, we need various contract actions, government contract officials, need to allocate funds to particular programs. And we've seen some headwinds associated with that in the last 6 months, where COVID, in some attrition in various government contracting workforces, slowed down some of that funding activity, more of a temporal phenomenon versus a kind of long-term trend, but that had created some headwind for us in the latter part of our fiscal year in the spring of 2022. As we put together our guidance for FY '23, we looked carefully at risk and opportunities where funding may or may not be, and we're comfortable that we'll have sufficient funding to allow us to execute on that plan. But that is an external factor. Inflation is an element which should not necessarily impact our ability to deliver, but the risk kind of wage inflation. We need to hire talented people to perform a variety of our kind of work efforts. A good portion of our work is cost-plus. And so by definition, we have a hedge, gets inflation for over 50% of our work. And other parts of our portfolio, we're doing kind of what we can to offset higher wages through driving efficiencies on in a fixed price program deliverable.

Tom, you mentioned that one of the things that needs to occur here is the government needs to adjudicate bids. And because of COVID-19 and other dynamics, we've seen a bit of a slowing of the procurement cycle, at least in some select areas. That's driving a dislocation, obviously, between the budget growth we're seeing and awards and subsequent outlays. Do you see that dynamic leading to any changes in either government behavior or how they go about the contracting or procurement cycle? The things get bundled together to minimize the volume of work that they need to adjudicate. Or how do you think they cope with this going forward?

Yes, so good question. If we -- what we are cognizant of various kind of delays or funding slowdowns, which impacts CACI. On the flip side, it's also impacting various government customers. And they have kind of mission needs, which are not presumably being delivered as quickly as they would like. There has been a trend, and it fluctuates over time. Sometimes contracts get consolidated. Let's have fewer contract actions by making larger contracts or greater duration. So we're not recompeting as frequently as in the past. And so there may be a trend to do more bundling of the contract activities. We haven't seen too much of that, but in the past, that has occurred. And then similarly, in the past, we've seen some contracts being disaggregated into smaller components. And so the pendulum continues to swing to try to make sure that the government customer needs are met. And I believe that the government is trying to address their contracting workforce, hiring people, very skilled workforce, a lot of expertise to kind of be a proficient, contracting authority at the government levels. So a certain amount of training and experience is necessary for them to come into speed and be effective in those roles.

Got it. And we're approaching sort of the halfway mark in September coming to the tail end of government fiscal year. And naturally, this is the high watermark for contracting activity as they push to get things outdoor and on contract. What can you tell us about sort of the level of contracting activity? Some people have speculated that there's going to be a big flush because of some of this pent-up bid adjudication. And others are saying, "Well, no, you still have the same bottlenecks in place." So what have you seen thus far this quarter?

So Matt, typically, we don't like to provide part of the guidance. You're being very specific on what's happening kind of with the quarter, there's 2 more weeks left in the end of the government fiscal year. But I can say historically, the government kind of needs to allocate it its budget by the end of the fiscal year. And typically, we'll be seeing increase in funding in the September time period. And there's no reason to think that, that activity will not -- will continue like it has in the past. That's on the funding side in the contracting offices side. In terms of the awarding contracts, that is less dependent upon the end of the government fiscal year. Government will put out an RFP, lay out a time line for receiving proposals and evaluating these proposals. And in many cases, whether that occurs in September or in October, not a factor on that side of the equation. So things are, I think, slowly getting back to a more normalized level. And even drilling through COVID, the wheels of the government still need to turn. They're still defined in needs by various government agencies. And we've seen very decent contract activity in awards throughout COVID. We've got multiple successive quarters of kind of $1 billion of award. Our trailing 12-month book-to-bill are kind of 1.1x. And so you're certainly winning sufficient work to allow us to grow at the rates that we articulated and at the same time, allow the government to meet some of their needs.

Got it. So one more question on the bidding dynamics at hand. And this one, I think, is an interesting one in that you guys provided a lot of nice transparency around the level of work you've bid as well as the level of work you plan to bid. I think at the end of Q4, you were around $12 billion worth of submitted bids. That was up 70% year-over-year. Your plan for the next 2 quarters was $17 billion, and that was up 40%. How should we interpret those numbers? Is it an ebb and flow of chunkier contracts in there that's driving that? Or is it back to what we just discussed sort of this pent-up adjudication?

Yes, it's more the former kind of the ebb and flow of chunkier contracts. As we've gotten larger and having the appropriate level of past performance are bidding on kind of larger contracts. It was not too distant past, you mentioned 5 years ago, we bid on contracts for $100 million -- $200 million, and those were large contracts for us. Now we're kind of bidding on and winning contracts, had it well in excess of $1 billion of recent contract when you kind of headline value in excess of $5 billion. Kind of -- and so the statistics you mentioned, those year-over-year increases, are more of the function that some of that contract activity is somewhat lumpy and choppy. And if I smooth it out, though, you will see a trend that as we get bigger, as our addressable market is healthy, kind of we're bidding on a good amount of activity. I will caveat that with, at any point in time, we could bid on more activity. But the next incremental bid by definition is less attractive and a lower probability of wind. If we look at all our opportunities on our order, we're going to focus on the ones which are most relevant to our strategy. We have the capabilities and the technology to have a high probability of win. And as we go down that list, to be becoming less and less so. So we wanted to really judiciously use our resources. We have to work that is kind of more meaningful to us.

Got it. So with that, I want to transition to a little bit of a discussion around the budget here. As I mentioned, getting towards the tail end of the government fiscal year, are almost always beginning the fiscal year in a CR. What is your expectations in terms of CR this year, budget growth? And how does that or will that potentially impact how you see your operate your business?

So the last several years, there's been continuing resolutions, always challenging to forecast what's going to happen in Washington, an election year, which happens on a regular basis every 2 years in off-cycle presidential election year. But both House of Representatives just in the Senate may or may not change, somewhat partisan environment in Washington. That being said, there appears to be strong bipartisan support for kind of DoD intelligence priorities. And best of the concern with budget deficits. And so we expect to see healthy budgets, both in IT modernization as well as kind of mission activity supporting DOD intelligence, highly likely able to continue resolution. The government fiscal year begins October 1. I don't think we'll have a budget by then. And time will tell whether that continuing resolution extends kind of November, December, that a good -- extended to get it again. That being said, we continue -- we've operated in the past, most of the time, with that continued resolution in environment. We're able to kind of grow and kind of win business. And so it's not a major concern of ours.

Turn now to sort of to profitability of the business. You mentioned ever-expanding margins earlier. Margin levels over the last few years have been quite impressive, especially in the context of history. You've done a nice job over the last several years of expanding, expanding, expanding. That said, the whole industry has experienced a dynamic as a result of COVID-19, where certain expenses gone away, and margins have expanded as a result of that. You've also made some investments in the business by way of a couple of the acquisitions you made, I'd say, photonics and IT technologies, amongst others. Help us understand here what normalized margins should look like given the portfolio? And how it's constructed today? And how those 2 dynamics, COVID-19 on one hand and the investments in your -- in some of the acquisitions and internal technologies on the other hand, has affected things in the reversal of that, what that might do going forward.

Yes. For our fiscal year '23, which began on July 1, we guided to margins between 10.5% and 11%, providing a range of margin activities. A couple of years ago, we had some margin benefits related to COVID-19. COVID-19, obviously, had a lot of kind of very negative kind of ramifications throughout kind of the world and the United States. But there was some kind of short-term profit helped to CACI. Less travel, people were not kind of using medical benefits as much that they had. We had a fixed price program. We were able to deliver a materially lower cost because of COV19. Those have largely kind of went away, and I think we have a kind of more normalized level. And we also have a more normalized level of investment. We had some margin dilution associated with a couple of recent acquisitions, which were in the very early stage of project kind of development. And again, that's largely kind of behind us at the time. And so I think a good takeoff point for margins going forward is what we see this year, 10.5% to 11%. And going forward, there is a potential to increase margins. So as we grow the business, we can operate more efficiently, making sure our indirect spend is less in embracing RPA for internal processes kind of driving efficiencies. And at the same time, from a portfolio perspective, our technology business has been growing at faster rates than our expertise business. In technology, which is more differentiated, comes at higher margins anywhere between 300 and 500 basis points higher margins. And so that portfolio shift will help going after more fixed price programs, which should be helpful at margins as well. So there's opportunities to continue to focus on margins. So what we ultimately focused on is cash flow -- free cash flow per share. It becomes key metrics for CACI. And how do we drive that stronger cash flow? You generate more revenue at higher margins, and so that drives net income. You kind of collect money faster from the government, and you make sure you're very judicious in terms of capital spend, and all those elements go into that free cash flow. But that margin is a key characteristic. And the margin also, in our mind, is an indicator for the quality of work that we do, kind of less differentiated, less commodity-like, kind of more sustainable work. And so there's no specific metric, what is the quality of the work that we do as a company, but kind of margins is a good proxy for that.

So you mentioned cash flow. And so I want to talk a little bit about what you do with that cash flow, capital deployment. The company has demonstrated an increased level of flexibility with respect to deploying cash flow, right? You've been willing to repurchase shares. Last year, you had an ASR that you executed. What's the framework given where you are, given the backdrop and the opportunity for the operating environment that you're now in? What's the framework by which you determine, "Hey, I'm going to go and allocate dollars to M&A versus share repurchase versus CapEx versus unit."

Yes. So ultimately, we're very much focused on driving value to shareholders. And one of the metrics that we've embraced is free cash flow, free cash flow per share. Share repurchase, it's relatively easy to calculate the increase in free cash flow per share. It's a relatively simple calculation, and things occur pretty quickly. And so we can kind of measure that. Acquisitions, you often take some time to kind of realize that long-term shareholder value. So there's a different time horizon. But we've been very successful in the past of adding to our capabilities through acquisitions, completing kind of well over 80 acquisitions in the last 30-some-odd years. And for us, it's a tried-and-true measure of driving value. So we're continuing to look at both of those. And at any point in time, we'll look at our ambient leverage levels. Right now, it's relatively modest, 2.5x, interest rate environment, M&A pipeline, relative stock valuation and dynamically make a decision or review of what we want to do in terms of capital allocation. In the past, in 18 months, we've allocated approximately $500 million to a share repurchase. You mentioned that in ASR, we did a year ago in March. And during that same period, we deployed approximately $600 million of our capital for acquisition. So somewhat balanced. Now that somewhat balance is more coincidental. So depending upon the timing of circumstance, we'll be opportunistic. And we do not have a 50% goal, but we want to do what we think is best to drive that shareholder value. And again, a lot of that is driven by the M&A environment. If interesting companies come to market, which are actionable, which fits squarely into our strategic framework, that will create some choppiness. So at a certain point in time, we may have more M&A and less of something else.

Yes. You mentioned your leverage. I think, last quarter, exiting 2.5x, you're going to generate $415 million plus of cash this year. You've been carrying a decent amount of cash on the balance sheet. It sounds like there's ample dry powder. That said, since the pandemic began, most companies have sort of taken a more conservative approach to capital deployment, just given the volatility. As pandemic fades, is there an opportunity here to either get more aggressive with that? Or how do you see things changing, if at all, as the environment normalizes?

So no, I don't think it's going to change much for us. Given the nature of our business, sell into the government, a good portion of our portfolio is existing business, very dependable cash flow is we're never going to see kind of major spikes in demand or cash flow versus a retail kind of business or other types of businesses. And so we've never really -- we're concerned about our ability to continue to generate positive cash flows. We have a -- it's still a very attractive credit profile. So confident we'll be able to finance our needs, have a sizable credit facility, extending out for close to 5 years. So a lot of protection associated with that. So kind of leveraging up opportunistically is something that we're quite comfortable with.

Got it. Got it. There's a dynamic at play here that I want to touch on has become increasingly important for the entire industry. And it's always been important, but increasingly so over the last few years. And that's human capital. Your ability to attract and retain talent is one of the various keys to success in this market. That said, the markets have been really tight, obviously, over the last several years. And so given the overlap between your technology needs in the commercial space as well as the tightness of the market, that's created some challenges getting people in the door for that, like I said, industry as a whole. So I just want to hear, given some of the changes we've seen in the macro environment over the last few months, what you're seeing with respect to attracting or retaining as things ease a bit? Or what can you tell us?

Yes. So the hiring new appropriate people from -- in our organization has been a continued focus for us over the past 5, 10, 15 years. We're looking for people generally with high levels of skills, electrical engineering, computer science and the like. A good number of our people have security clearances, and so that kind of limits the pool as well. We've taken a -- fundamentally, let's retain the people that we have. Let's create a strong culture. We fund a number of awards, best places to work, competitive kind of paying benefits, internal core mobility kind of training programs, tying people emotionally into the company. Our attrition levels are less today than they were prior to COVID. And so we're doing a pretty good job of keeping people and at the same time, trying to attract kind of new people to the organization. But we are dependent upon quality people to perform for us, and that has been a priority. And I think we do a nice job of kind of building the right team for CACI.

Fantastic. I think we're up against our time stops, but I do have one last question for you. Given on incremental dollar of IRAD, where would you spend it? What technology? What area?

Yes, it's a good one to take, a series of interesting opportunities, probably somewhere within the area of electronic warfare. It could be photonics, it could be secured communication, it could be 5G protocols, but there's a plethora of very interesting technologies, which we're investing. And I wish I could think of a clever answer to that question but a lot of opportunity-rich environment.

Fantastic. gentlemen, with that, thanks so much for joining us.

Okay, Matt, thank you for your time. And everyone who is listening, thanks for your attention as well.

Great.