CACI International Inc (CACI) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome back to the Aerospace Defense Track at the 2024 JPMorgan Industrials Conference. I'm Seth Seifman, the aerospace defense equity analyst for the U.S. here at JPMorgan. And we are very happy to have with us this afternoon and very grateful to have CACI and the company's CEO, John Mengucci; and George Price is here from IR as well. And we're going to have, I guess, a little fireside chat here. We'll do some Q&A. I'll kick it off, but I'll try not to talk too much. And we can open things up to the group as well and see if anyone has questions.

But maybe kicking it off, let's think kind of big picture. One of the questions that I often get from investors about federal services is kind of what differentiates companies? And so when people think about CACI going forward, what should they think about as differentiating?

Yes. So first off, thanks for having us. If you look at the traditional government services space, what you should think about that as delivering expertise. So you have customers buying inputs meaning hours. So what differentiates us right off the top is we're a technology and an expertise company. So about 55% of our revenues come from delivering technology and 45% from expertise. I know there's a lot of talk throughout the sector, everybody is now delivering tech. So here's what differentiates us there, one, is we actually deliver tech. Secondly, we actually talk about tech and we have you come in and visit. What else differentiates us is what our focus point is, which is how we address customer needs. We will never stop delivering expertise. We'll always deliver tech, but it's the combination of those 2 parts of our business. We're a 62-year-old company, we're a $7.5 billion company. So what drives our tech investments is what the people and expertise side of the business tell us is the customers' greatest needs. So you can look at one part of our business, tip and queue in the other part. How we approach customers, we invest ahead of customer need. So we understand exactly where the customers need to go, and we'll invest our own dollars to show them a slightly different path forward. So whether it's providing better tech or whether it's replacing the expertise part of their needs with tech. So it's how those 2 parts of our business play forward. The last area is a very strong business development team. I know everybody says has that. I love what our win rate has been. This model does not work without the AD team. And it's really about when you invest ahead of customer need, you set the customer's preference. So you walk them through the art of the possible. And when they understand what the art of possible is, it's most times very different from what they would have asked for 2 years later. So we like to set that customer preference towards what we're going to deliver and what we can deliver, that drives a very different request for proposal, which means that the majority of times are out there bidding if we submit a compliant proposal, we're going to win more often than not. So it's an absolute focus on the markets we serve, delivering -- investing ahead of customer need, setting those tables so that it favors us because they've seen what the other possibility is and then winning that job.

And so speaking of wins, the company's awards recently have been pretty strong. We've seen the backlog growing. How do we think about the time frame in which those award wins turn into sales and the trajectory on the top line?

Yes. So this is another area that does differentiate our strategy. When we say that we deliver 55% tech, 45% expertise, the way revenue gets generated is very, very different in those 2 parts of our business. Traditional government services work, you win that job, you're providing N number of people. You hire those folks, the ramp-up period between award and revenue is very, very quick. It sort of ramps up to sort of this straight up level, and then it [ ported ] levels off the next 2 to 3 or 4 years, however, long that contract is. Technology revenue ramps up slower. You're going to do design work, you're going to do development work, you're going to get through qual testing and then you're going to deliver to N number of ships, N number of planes and the like. So the revenue model looks very, very different. So if you look at the last few jobs that we've won, 2 have been technology wins. One has been expertise wins. So you'll see a great growth in our top line growth because of the 1 expertise job, because that job was won last year, and it ramped up faster but the technology job is going to ramp up slower. What's different about our business is, we're absolutely focused on duration of contract. So we'll give 1 or 2 points up of top line growth to make sure we get clarity over a much longer period of time. So we're winning multibillion-dollar jobs that are 5 to 7 to 8 to 10 years. What that does in our marketplace is, we're recompeting less. So those of you who follow the U.S. government's services world, you win a job, it's got a 4- or 5-year duration and then the customer recompetes for that work. Why is that? Because the customer is still buying a unit of input, which is now at the cheapest price, okay? I want a business goal, let's say, commodity. You're going to differentiate on price, not what I want to be 100% in. I want to be 50-50. So if you look at how our awards ramp up, some give you the immediate pop and some give you a longer duration look, which when you look at our top line growth when people, Seth, others call us and say, "Geez, you won $7 billion of business sort of where is that [ revenue ]? It's a little bit different because it ramps up in a different manner. What we look for people to look from us is, how much are we winning and what's the average weighted duration of a contract in our backlog? The first half of this year, the first 6 months, the average weighted duration of program is 72 months. So the more we continually win those jobs, the less we recompete, which means that's the next step of driving better top line growth is that we're not having to fill in divots on work that we don't -- that we aren't successful when we [ recompete ] those wins.

Okay. Excellent. And yes, those of us on the sell side are not typically a patient function.

I'm with that.

But, I guess, maybe just to help people out, so they conceptualize what you're doing. Those 2 awards you talked about on the technology side, what type of work is that?

Yes. So we had one in the Air Force area, it's called EITaaS. It's an -- overall it's a 10-year $5.7 billion job. We only booked $2 billion worth of awards that's all we have site to right now. And with that, we are modernizing the Air Force's way to deliver IT across the entire Air Force. So every single Air Force base and the like. The overarching view is let our airmen stop doing IT work and return them to being airmen. So make sure that all the network build-outs, how we support, how we add features is all going to be done by us and our partners. That's a technology job because we're looking at every single basis networks. We're going out and doing site surveys, understand how we can upgrade what they have and transition old systems to us so we can go up there and modernize them. So that one is going to start up slow and that one was going to ramp over when we hit 300 or 400 basis. Our other technology job is the Spectral award, that's a U.S. Navy job. It's a brand-new state-of-the-art signals intelligence electronic warfare job for all Navy surface ships, sort of sounds like Aerospace and Defense wins, so what's a government services company is winning that, that is the beauty of having moved to a 50% and 50% bid model. So on Spectral, we will be the prime integrator and the prime provider of taking all signals. Everything in the world emits a signal and what's the difference between life and death in the battlefield, ask anybody in the Ukraine right now, is understanding signals that are over your head, whether they come from space, air, drones and the like. We're building the next AI-based signals Intel Kit that will go below deck. That's every surface ship in the United States Navy. We started to shape that job in 2016. We invested ahead of customer need. That is a job that just about every aerospace and defense prime bid on. Only 1/1. We're not an aerospace and defense prime, Raytheon and Northrop Grumman are our partners there. Did an outstanding job, but that is a true look at how you can shape a customer away from buying hardware solutions. The problem with hardware solutions today is that the pace of war today changes every 72 hours and every 72 months. So large ACAT1, 8-year long duration programs to do a hardware monitor, ships you got to bring in the port and upgrade. That's not what the future is for the Navy fight. The future for the Navy fight is every 48 hours [indiscernible] are changing how they deploy [ drums ]. So in 48 hours, I can't get the ship more than 15 days away from a port. So how does that baseline become software-driven, Software is our superpower. All the technologies that we deliver has to have some level of software in it. So how do we continually look at new signals, reverse engineer those, put courses of action that you can defeat those signals either kinetically or non-kinetic but get those software updates out to every single ship like that. That is the pace of war today. That's why we were selected. That's why this company won a job and the more we're seeing customers move towards that, the better success rate we'll have.

Right. You kind of preempted one of the other questions I had there, which was about artificial intelligence. And just that that's obviously an area of increasing emphasis. We actually had a very informative session yesterday with the Head of Artificial Intelligence at JPMorgan, who's a former Marine Intelligence Officer, spent most of his career there, and it was kind of actually, the pace of all that, brief me out a little bit. But if you could talk about maybe the way that, that's spreading across the company, both in terms of the work that you're doing and also internally.

Yes. So if I go back 7 years, that's when our first touch with AI was. I'm not a hype curve CEO, frankly, I'm actually about -- we like to talk about things that generate revenue. And AI, all the different variants, whether it was computer vision, RPA, machine learning and now generative, we've been doing that work for quite a long time. So is it a set of great technology. The technology is absolutely sold. We couldn't deliver a spectral system that can take inputs from multiple sources, quickly and integrate that, make sense of it, tell a machine to look at every other time we've seen that signal and push those courses of action out that fast without it. The good news is we're already doing that. In fact, we're the company that was 6 years ago using version 2 of ChatGPT with a lot of our customers that we don't actually talk about. So is it a great technology? Yes. Is it uberly new? No. About 100 of our 200 programs involve AI in one way, shape or form. We never thought about making a major deal out because the technology part of our companies are to support national security, and there's a lot of customers who do that for that we don't openly talk on. But it's a great technology. You don't have to look far in many of our programs to find it, and there's plenty of experts in that. So is it a growth engine for us? It's the next step. Generative is going to be that next step. And just as importantly, we use it across our business. So how do we operate our own business? What are the metrics we run the business by? How do we use machine learning, how do we use our RPA to take out some of those tactical transactional tests processing lockbox checks every day, which used to be a team of 4 people. Now it's 1 individual for 15 minutes, just sort of checks what the bot's done. So we've really brought that into the company at the same time we've been introducing that to our customer set. So if half of our business is in tech and half of those programs UAI -- use AI, we can do that back of the envelope math, we're delivering -- generating a lot of revenue, delivering AI to our customers today.

Excellent. I guess, the thinking about another area maybe where there's some increasing overlap between what CACI is doing and maybe what people have thought about as traditional aerospace defense primes in the space area, after -- especially after the recent SA Photonics acquisition that they did. And so maybe you could talk a little bit about what the opportunity is -- you see in space and sort of where CACI fits in and what the time frame is for that to unfold?

Yes. So that's a great example of where we had people working with the -- what was now called Space Force, and SDA in the expertise world. And we started to hear about, hey, will we ever in the U.S. move to optics? We moved from RF links between satellites and satellite to ground, we ever moved optics. And you start to find out there. Hey, the U.S. assets are not the only assets up in space, there is other countries. And some are friendly and some are not. And some want to do harm and some will not. So if we want to talk about how to make space more resilient, one, area is to communicate via optics. So put data in light and push all the information back and forth via light. Is it hard? Is that hard? Yes, we get hard who have been doing it for about 15 years to one of the acquisitions we did about 6 years back. Yes. So there's a -- one of the acquisitions that we did was working in the area of Photonics for quite a long time. And it's really about getting the algorithms, right? So picture 2 beams of light going 22,000 miles an hour, rotating all over space and never losing lock. So never losing that connection, right? I lose my files connection sometimes, right? We can't afford to lose that link. So the hard part was getting the software down, making sure the algorithms were done correctly. Beyond that, now you have to produce something that may have cost tens of millions of dollars and now it has to fit a much smaller form factor. So we're through that now. We did purchase SA Photonics. We're a highly acquisitive company. For those who don't follow us closely, we've done 89 acquisitions in the last 20 or so years. This was one that was a dilutive one with a pretty hefty investment stream because the potential market out there is ginormous. It's satellites at LEO, 800 to 1,000 in the commercial world per constellation and U.S. government moving to LEO as well. So it is a true differentiated technology. We are the only U.S.-based company that's done design and production in the U.S. I believe that will come back in a very positive way when we talk about deploying these on all of our DOD satellites and to our intelligence customer as well. So I like that uptake. We're already taking orders now. We're a merchant supplier to a majority of the large satellite primes. And that will drive growth. The investment stream pretty much wraps up through the -- to our last quarter through the second quarter of '24. We're July to June company. And then we start to ramp down investment and then look to try to drive growth as we get out to FY '25 and beyond.

And is that content that goes on to some of the different SDA constellations?

Yes, that is -- there are the optical terminals that allow all of those satellite vendors to actually complete those links. So we're doing all of the all the optical work. So -- and they have to be at a price point, of course, that supports launching hundreds of satellites versus 5, right? And the nice part to that model is every 3 to 4 years we'll be launching new satellites. So it's just more and more -- it's a great follow-on business model.

Right. And that's an area where we've seen -- I mean, there are some of the traditional defense primes playing, some of the nontraditional players...

That's a nice mix.

But as you said, it's -- you're a merchant supplier, and so you're pretty agnostic as to...

Yes, we make slight design changes based on how the satellite primes have designed their buses and then we move to production. We're in the middle of moving our production facility from Los Gatos to Orlando. One, it's closer to the [ design focus ]. And two, it's at cheaper place for us to do production. So just ending the investment curve, just starting to get up on the volume curve still the only U.S. applier of them. We have kit in orbit. We have kit that has been deployed in orbit and some of our dSpace optics have been sending data from the distance of Mars to this building. So we believe that the optics that we've built and the hardware as well as the software algorithms are working very, very well.

And there's an opportunity there on the commercial side as well?

Yes. Yes. I mean it's a...

I mean, I would think that given the numbers of satellites, it's probably something that dwarfs the opportunity on the DOD side.

Yes, definitely. I mean, look, I think we're going to hear about other people building their own optical terminals. And when you look at the actual components, if you can take a commercial wireless today on the ground, and you can get that into space [ qualparts ] and you get that into it, you have the hardware build. The issue you're always going to have is we've got 15 years, $100 million of investments, getting how optics works and how [ dry roads ] work to make sure you can actually close that link. So that's what we believe software is our superpower. And we really like to -- we've been telling people and proving it to them that it's a software that's inside of those gimbals that actually make these links close.

Excellent. Maybe to take it down from there to kind of a [ accrude ] financial level, when we think about that ramping up and the returns that we see there. And we can make this maybe a broader question, just about Spectral and about optical capabilities that these are kind of new unique capabilities that CACI has. They're a little bit more in the -- I guess, a little bit more in the manufacturing or a little bit more in the productivity side versus the company's legacy. And you typically think about those being areas with a higher return on sales, but it's also a new area. And then there's often a process of maturing that needs to take place before margins can expand. So how do we think about with more of this type of work coming into the mix and what that means for margin rates at CACI?

Yes. So we're a free cash flow per share company, right? We've always been focused on cash flow. We've taken that in a couple of different bites. If you went back 6 or 7 years, we're an 8% EBITDA margin business. Today, we're in the high 10s. That's on a nonadjusted basis sort of peanut, butter and chocolate. There's no additives in that. So that was our first step at trying to grow quality of earnings. And what that did was allow us to exit some lower margin expertise work because it was my belief 8 years back that LPTA, low price technically acceptable, and better buying power and sequestration and the like was going to force the government to buy services work, buying into input 1/1 labor hour, buy it as cheaply as you absolutely can. And that's sort of that model that maybe doesn't show itself today, but over time, as the government keeps recompeting, they get roughly the same quality for slightly less price, what stops you from recompete. I would never stop doing that, just getting prices down lower. So that's the expertise piece. So it's true that on the technology side, if you look at the mix of our business, technology is at a macro level, a few hundred basis points higher -- 300 basis points higher than the expertise work. What's driven our margins from 8-ish to the high 10s has been that transformation of bringing more technology work in. We had some volume technology today. We still got a long way to go over there. And then you talked about optical terminals. So I don't think I have a low or a high point on margin. Way we're looking at our business now, we're reliably better than mid-single-digit top line growth company, which is different than what our model may have been 3 or 4 years back. So the combination of consistent long-term view of top line organic growth coupled with flat to increasing margins and then couple that with an absolute focus on capital spend, being very judicious there and then tie that to flexible and opportunistic capital deployment, be it through acquisitions or through share repurchases. We are really poised to drive a nice free cash flow per share for the foreseeable future based on the fact that we have good insights into what's in our backlog.

I'll take a brief pause here just look out at the audience and see if there are any questions in the room. Jon Ladewig.

Can you dig us through how perspective should -- over the last 2 or 3 quarters -- years maybe on M&A? It seems like it doubled it prior value. And the second part of the question -- like I'm now I'm loud. I also feel like in [ GovCon ] traditionally the M&A model has been focused on customers' capabilities and contracts. Sorry, to make you write this. I wonder in this environment, you mentioned kind of Photonics a little bit, is the focus a bit more, at least for your business, on the capability side. And once you build those out, the customers and contracts will come.

Yes. So let's unpack that. So flexible opportunities, say, capital deployment is really down to acquisitions, long-term growth. We're a 62-year-old company. So those provides great baselines for us to continue to grow. We're a strategy-based company. Strategy is a place where we come from. We serve 7 markets across the federal government. We're a $7.5 billion business. We got $250 billion addressable market. So when people ask me, where is the eighth market? I'm like, let's drain the first seven first, let's stick what we're really good at. And then it comes down to, do we do acquisitions? Do we do share buybacks? Do we do both, okay? It truly is not going to be balanced. It's going to be flexible and opportunistic. Given a lot of variables at whatever time that is, we believe our stock is undervalued, which it's always undervalued, who wouldn't say that, right? But then what are those key capabilities or customer relationships, we buy acquisitions to fill a capability or customer gap. We don't buy revenue. We'll never buy revenue. I will beat you in the open marketplace mercilessly because I trusted a deep bench business development team, a great set of solution architects, investing ahead of customer need, letting the customers say what are their preference, write the RFP angle more towards me than everybody else, may not be fair, or I'm good by not being fair and we'll win the majority of things we have to go out there and bid on. So I don't want to burn capital out there buying revenue, making me 70% market share versus 50%. I'll just -- we'll get there. On the M&A front, so the last couple of years, multiples in valuations and the like just haven't been what we like to see them at. There are some good properties out there. They could have filled some nice small- to medium-sized capability gaps that we have, but not for the valuation numbers that are out there. And even in light of higher interest rates and all the like, those valuations do not come down back into line. I sort of struggle with that. So there's not an acquisition we have to do. We're a very discriminating buyer. You never bid against an irrational bidder, and we're pretty good at not getting pulled into that. So -- and as John mentioned, it's customer relationships or capabilities. So if you looked at where we built this technology business out, we did that mostly through our acquisitions. And then there's some sprinkling of internal investments along the way, right? We have a gap we're going to invest internally. If we have the time line to build whatever their intellectual property is. If we don't, because the market's coming upon us, we had a great Photonics business, high end. We need one that I could be producing that in volume, bringing SA Photonics. It was a dilutive acquisition. We were very clear on that, but I wanted to buy that at the knee of the curve because time was of the essence. So we will continue to do. The last couple of years though, the actual the valuations, some of the targets were just too high. So you would say, so the last couple of years, CACI bought a lot of stock back. I get plenty of advice. I'll just keep buying back shares, great, right, maybe. But we're sort of looking at what's there in the long-term view. It's not M&A first and if not, then go do share buybacks. It really is an even weighted game. We used to be a company that would always do an acquisition first and very rarely buy back shares. But that's not realistic because it was our estimation at some point, we hit a market -- M&A market that wasn't frothy and wasn't able to fill our gap. So since January, we bought back 6% of our shares on the open market. We have another $350-or-so million left on the last authorization to buy it in the market. So a lot more flexibility in our capital deployment plan going forward, but that's what drove the last couple of years. And I should also say we're of the size that we can do both. Three years ago, we did a $0.5 billion share buyback, and I have a $1 worth of acquisitions that brought us ID Tech and brought us as a SA Photonics.

Do you see with the things you're looking at when you think about valuations, I think now we all look at what's going on in the private markets. And a follow-up question on this. But there's this idea out there that the defense market needs more Silicon Valley asset technology. And as a result, we're seeing some high -- very high valuations in the private market. Does that kind of affect the things that you're looking at? And is that kind of the high valuation levels that you're talking about?

Yes. I mean part of that is, right? I actually think that there's really smart people on the right-hand coast also, right? I've been doing this for a long, long time. So the fact that we have to go out to the West Coast to get the [ new age tech ] out. I'm not sure I buy in all of that. There's a lot of great tech being done all over. I think what it is, there are folks who would like to take commercial technology and bring it into the federal government. It doesn't mean anybody is wrong to try it. It's just really hard. It's hard, it's different. It's not that the federal government couldn't use some of that if it's a SaaS model and tools off the shelf. But in our enterprise IT business, we use a lot of tech in those. We'll -- we partner with Splunk. We partner with AWS and others to bring those kind of great large dollar investments, so we can provide better scale to the U.S. government, that works great. So there are places for it. But you also have to recognize that when we're talking about AI and we're talking about building these large engines out in data analytics and all, we're not looking for the cheapest blue polo shirt at the mall. We're actually looking across the entire globe for somebody who's looking to do us harm. So we can't be right like 75% of the time, right? We all use our mobile phones. They sort of connect 90% of the time. Sometimes we get a fast busy when that's on the warfighters' hands, it's going to connect 100% of the time. There's no like 1 miss. So the theory is, let's take something that's cheaper and produce -- reproducible, bring it in, but it doesn't meet the specs, right? So I think it's a nice blend of us being able to partner with commercial companies and either get a leg up in our technology business so we can start further ahead. That model works extremely well for us.

Yes. And maybe one other question with regard to capital deployment and thinking about internal investments, thinking about the direction you're going and some of the capabilities that you're talking about. Is there a different kind of CapEx requirement for the company going forward or expensed R&D?

Yes, there's definitely a different level of CapEx spend, right? And that's sort of that other clue, right, that when people in the sector say, we do tech, well, let's look at the CapEx spend. Let's look at sharing how much -- what percentage of your business do you want to sign up to sales tech versus expertise? And that discussion sort of wanes off, right? Yes. So we have a higher CapEx spend with the slowdown of the investments because we're just about completing SA Photonics in our optical comms business, you should see CapEx come down to "some normalized level." Thus we're going to stop investments in other areas, but there will be something that you can measure there. But look, at the end of the day, if we're looking at free cash flow per share, we're going to measure all of that, right? And we're going to manage all of that as well. And on the free cash flow side, industry-leading in our sector, DSOs of 47 days. That's an absolute focus that says if we went back 7 or 8 years, our DSOs were in 70s. Okay. There's no reason for that, not in our marketplace. We have one of the best paying customers there is. We can debate whether budgets are always clear, but whatever budget we have today is good enough for us based on our size. But it's really about making sure everybody in the business understands that more cash sooner is better and really managing that. So it's the combination of how we manage capital and how we manage cash that is going to drive really nice future free cash flow per share.

Excellent. Maybe I know I'm looking at, George, right now, and I know we got to keep you on schedule. So we've got a few minutes left, but I think we might have to cut off just a couple of minutes earlier. Maybe if I could sneak in just one last question. I think it's just another kind of financial question, but I wanted to ask it, we look at the second half of the year, and it's a pretty significant ramp-up in earnings that's coming for the second half of the year. And so I think people look at that and they're like how much risk is around that. But maybe you can tell us some of the things that give you confidence in the guidance for this year and why the second half of '24 can be much stronger than first half.

Yes. So when we give guidance every August, again, we're a July to June company. We do our best to try to shape the year. We may not do a great job of shaping the quarter, right? And we usually say, "Hey, this year, second half is going to be stronger than the first." Some people stronger is like [ decaf ] and some are regular caffeinated and some are bold, right? This year, our back half is probably on the bold side versus the decaf side. We've raised guidance twice. We've raised free cash flow per share, 7% since our year started. The fact we're raising guidance and we're driving the company forward, we're in a nice position to finish the year strong. Although I will admit, when you look at the numbers, margins got to go from X to X plus a lot. Part of that is mix. It's a little richer mix in the back half of this year. And the other part is we fund the investments in our optics business right off of our own P&L. So every dollar of investment is $1 less than we can throw to the bottom line. The first half of the year and that ramp starting to come down. So it's a little artificially lower, right? But every dollar we don't invest in the second half gets driven down into the profit line. So that's the way I would look at things. We got our third quarter ramping up here in the next few weeks and feel nice and confident that we'll finish the entire year within our guide.

Excellent. Very good. Let me let you get going. But John, thanks very much for being here. Really appreciate it.

Seth, thanks so much. I appreciate it, everybody. Thanks for coming.