Caci International Inc /De/ Q1 FY2022 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the CACI International Fiscal 2022 First Quarter Results. Today's call is being recorded. At this time, I would like to turn the conference over to Dan Leckburg, Senior Vice President of Investor Relations for CACI International. Please go ahead, sir.

Well, thanks, Ailee, and good morning, everyone. I'm Dan Leckburg, Senior Vice President of Investor Relations for CACI, and I thank you for joining us this morning. We are providing presentation slides, so let's move to Slide #2, please. There will be statements in this call that do not address historical fact, and as such, constitute forward-looking statements under current law. These statements reflect our views as of today and are subject to important factors that could cause our actual results to differ materially from anticipated. Those factors are listed at the bottom of last night's press release and are described in the company's SEC filings. Our safe harbor statement is included on this exhibit and should be incorporated as part of any transcript of this call. I would also like to point out that our presentation will include discussion of non-GAAP financial measures. These should not be considered in isolation or as a substitute for performance measures prepared in accordance with GAAP. Let's turn to Slide 3, please. To open our discussion this morning, I'll turn the call over to John Mengucci, President and Chief Executive Officer of CACI International. John?

Thanks, Dan, and good morning, everyone. Thank you for joining us to discuss our first quarter 2022 results. With me this morning is Tom Mutryn, our Chief Financial Officer. Let's move to Slide 4, please. Our first quarter results were in line with our expectations and represent a strong start to our fiscal year. We grew revenue by 2% organically, driven by technology revenue growth of 10%. Profitability was strong with adjusted EBITDA margin of 10.8%. We generated robust cash flow, and we won $2.4 billion of contract awards, representing a book-to-bill of 1.6x for both the quarter and on a trailing 12-month basis. Slide 5, please. Turning to the external environment, we remain very optimistic. We continue to see our capabilities and strategy align very well with the administration's priorities. The administration is pursuing an R&D-led agenda to develop capabilities geared toward near-peer adversaries and continued counterterrorism, while also supporting broad modernization investments. It is an agenda that increasingly focuses on technology, speed and flexibility. From a budget standpoint, we are under a continuing resolution through early December, which, as most of you know, is very common and historically has not impacted our business. While the government fiscal year '22 appropriations process continues to play out, discussions on all sides are still very consistent with the large and growing addressable market for CACI. Defense spending has been increasing as the budget process continues. As I've noted in the past, whether spending is flat or modestly higher, there continues to be strong bipartisan support for national security-related spending. CACI remains very well positioned in well-funded growth areas like cybersecurity, AI and IT modernization across the entirety of DoD, civilian agencies and the intelligence community. Slide 6, please. At CACI, the bulk of our enterprise and mission technology offerings are based on software. Software enables us to address our customers' most pressing challenges within the evolving technology landscape and threat environment. Challenges that require the delivery of new capabilities at the speed of technology and with increased agility, security, and usability. As an example, we were recently awarded a $200 million enterprise technology contract to modernize the Air Force's legacy financial systems using our agile software development capabilities and to migrate these systems to a scalable cloud environment. This award is a recompete win with additional new work. The program is regarded by our customer as a major step forward in delivering improved security, scalability, and efficiency. It's a great enterprise example of the desire to modernize, move to the cloud, and by doing so, significantly enhance application capabilities and overall cyber posture. This follows our other agile and IT modernization successes with the Army, DHS, and many other customers. In addition, in our mission technology area, software-defined everything and open architectures are at the heart of our industry-leading counter-UAS capabilities. We recently announced enhancements to our CORIAN counter-UAS system, extending the range of effectiveness, enhancing the ability to track and defeat swarms, increasing deployment flexibility, and enabling integration with other systems like AVT's electro-optical infrared technology. In addition, we introduced CORIAN Tactical, a streamlined configuration that can be deployed in less than an hour and which is based entirely on CACI funded intellectual property. These enhancements address new demands and increase our probability to win as we pursue new counter-UAS opportunities. This quarter, CACI also continued to demonstrate its leadership position in cyber, both offensive and defensive. In our first quarter, over $530 million of our awards came from unannounced classified contracts with a significant amount of cyber-related content. This includes a multi-hundred million dollar recompete to provide offensive cyber capabilities to a customer in the intelligence community. This opportunity originally came to CACI with our NSS acquisition, and our combined capabilities, performance, and synergies, including those from LGS, have ensured CACI remains the go-to provider through multiple competitions. Slide 7, please. With our focus on growth and margin expansion, CACI continues to generate strong cash flow. Our cash flow and overall financial strength provide the flexibility and optionality to deploy capital in a number of ways. First, we continue to invest organically ahead of customer need in the many areas we have discussed: counter-UAS, artificial intelligence, cyber, electronic warfare, and photonics, among others. These investments are differentiating CACI in the market and enabling us to win new high-value work. Second, during Q1, we acquired two companies that provide mission technology to sensitive government customers. Their capabilities include open source intelligence solutions, specialized cyber, and satellite communications. These are areas of significant growth potential over the next several years. One of the companies, Bluestone Analytics, is focused on open-source intel in the dark web, a domain of increasing importance, not only for law enforcement but also for every aspect of national security and intelligence gathering. Lastly, on the capital deployment front, we completed our $500 million accelerated share repurchase program at the end of our first quarter. We remain committed to evaluating all capital deployment opportunities based on the dynamics at the time, with a focus on driving long-term growth of free cash flow per share. As Tom will discuss in more detail shortly, CACI has ample capital to execute a flexible and opportunistic capital deployment strategy, delivering continued shareholder value. With that, I'll turn the call over to Tom.

Thank you, John, and good morning, everyone. Please turn to Slide #8. Our first quarter results are a solid start to the fiscal year, directly in line with our expectations, keeping us on track to deliver another year of growth and margin expansion. We generated revenue of $1.5 billion in the quarter, representing 2.2% growth, with a 2% organic growth contribution. First quarter adjusted EBITDA margin was 10.8%. Adjusted diluted earnings per share was $4.24, up around 2.5% compared to a year ago, driven by our share repurchase and offsetting the tough comparisons against last year's temporary benefit from materially lower costs under COVID on a fixed-price program. Slide 9, please. First quarter free cash flow was $164 million, excluding our accounts receivable purchase facility, reflecting healthy profitability and strong cash collections. Our continued focus on collections resulted in DSO at 52 days, great performance for our business. As a reminder, the first quarter of last year included a $32 million benefit from the deferral of employee payable taxes under the CARES Act. Excluding this benefit, free cash flow would have been up 13%. We closed the first quarter with net debt to trailing 12-month adjusted EBITDA at 2.4x after the two acquisitions John mentioned, down from the start of the year with first quarter free cash flow greater than the purchase consideration. Our strong cash flow allows us to quickly deleverage, create flexibility and optionality as we consider all capital deployment options to drive more long-term shareholder value. Next slide, please. With our track record of growing revenue and expanding margins, as well as our focus on operational excellence, CACI is a business that generates strong and robust cash flow. A key metric to track both internally and externally is free cash flow per share growth. Over the past few years, CACI's 5-year free cash flow per share CAGR has consistently been in the double digits, driven by our disciplined capital allocation, including a combination of organic investment, M&A, and share repurchase. Slide 11, please. As John noted, we acquired two companies during the first quarter. Both are in the mission technology area of our business with high growth and high margins. We invested a total of approximately $120 million for these businesses, and we expect these acquisitions to add around $30 million of revenue and modest accretion in fiscal year 2022, given timing of close and associated one-time costs. Slide 12, please. We are reaffirming our fiscal year 2022 guidance. We continue to expect organic revenue growth of 4% and expect our full year EBITDA margin to be 10.9%. Our other assumptions remain materially unchanged. As a reminder, our free cash flow guidance includes a $230 million tax refund. We filed our associated tax returns in October and we expect a refund in the second half of the fiscal year, dependent upon government actions. In addition, we will repay about $45 million of the payroll tax deferral amount in December. Slide 13, please. In light of the U.S. decision to withdraw from Afghanistan, which we said represents approximately a 2% revenue headwind in fiscal 2022, we reviewed contracts in our backlog with related work. As a result, we reduced our backlog by $1.1 billion, due to contract value that we do not expect to convert to revenue given the withdrawal. Even with this reduction, our first quarter backlog of nearly $24 billion grew 9% year-over-year, driven by our strong contract awards of $2.4 billion. Turning to other forward indicators, our prospects remain strong. For fiscal year '22, we expect 89% of our revenue to come from existing programs, 7% from recompetes, and around 4% from new business. These metrics are consistent with historical ranges at this point in the fiscal year. We have $6 billion of submitted bids under evaluation, with over 80% of that for new business to CACI. And we expect to submit another $14.7 billion over the next two quarters, with nearly 80% of that for new business. In summary, we are expecting another year of strong financial performance with solid organic growth, continued margin expansion, and robust cash flow. With that, I'll turn the call back over to John.

Thank you, Tom. Let's go to Slide 14. We delivered strong first quarter results with solid organic growth, healthy margins, strong contract awards, and robust cash flow. We are successfully executing our strategy to invest ahead of customer need, both organically and through M&A, and we are positioned to continue doing so for the years to come. As a result, we remain confident in our ability to create long-term value for our customers and our shareholders. Our employees' talent, innovation, and commitment to our customers' missions to each other and to CACI is at the heart of our success. I am proud of how our people continue to perform in these highly uncertain times. And I'm very honored every day to work alongside each of you. I also want to thank our shareholders for their continued support and confidence in us. With that, Ailee, let's open the call for questions.

Our first question today will come from Seth Seifman with JPMorgan.

We have analyzed the revenue growth distribution between expertise and technology, and it aligns with what you have presented. The decline in expertise is largely due to the withdrawal from Afghanistan. Looking towards the end of the year, as we anticipate an acceleration in organic growth, will expertise remain at its current level while technology potentially experiences double-digit growth to enhance the overall growth rate? Or might we see expertise start to level off?

Seth, this is Tom. When we provided initial guidance, I mentioned that for the full year, we expect both expertise and technology to grow, and technology will be growing faster than expertise. That will give us to our 4% organic growth kind of range. So we expect growth in both areas: more modest in expertise, more robust in technology.

Okay. Great. That sounds good. And then maybe if you could just update. It seems like some of the services companies have been talking about some of the labor-related challenges associated with the pandemic from the beginning, from the middle of 2020. And maybe those are abating a little bit. We're seeing some more of it maybe in manufacturing companies now. Can you update us on kind of where you guys stand with regard to all that?

Yes. Seth, this is John. Look, we've been saying for a number of quarters that demand for talent is high. It absolutely remains high, and the hiring environment remains competitive and extremely challenging. But it's really no different than it has been for the past several years. As we look throughout the COVID period, attrition rates were down, which you would expect. I mean, who wants to change jobs in the middle of a generational pandemic? So the next question is, how do we fare and how do we look as we come out of COVID and as we move forward? We put a couple of great programs in place a number of years back. One was #MakingMoves, and the second focus was to improve our referral program. The third leg is that we've continued to expand our internship program even throughout COVID. This past year, we had over 300 interns from a number of schools that we strengthened very much our relationships with, not only locally but nationally, with colleges and universities out there. Some specifics: almost one of every four of our openings is now filled internally. That's people moving around the company, driving their career forward, and also working with different customers. And on the referral trends, one out of three new hires is a referral. So if we take those two metrics, add 300 interns to it, many of which went back to their senior year with jobs already in hand from us. We really believe that we've been very focused and very captive audience and driver to make certain that as the CEO of a public company, I didn't find myself on an earnings call talking about the fact that it's really hard to find talent. So both on our expertise and on our technology side, we continue to hire what I would say is the right talent at the right time. And the last note on the technology portion is that they're very different staffing levels. We're able to modulate staffing levels on all of our technology deliveries given that we have that workforce captive, meaning that they can work on a number of different technology programs because I'm not providing an individual to a specific customer. So the more technology that we continue to win and we have to deliver on, the more fungible our entire workforce becomes, and that's what keeps CACI's risk of hiring down.

Our next question comes from Tobey Sommer with Truist Securities.

I was hoping to get your perspective on another labor issue, but a different one, perhaps. Really wage inflation, kind of what you're seeing and expecting on a go-forward basis? How much that may be contributing to your organic growth, not just this year's guide, but sort of more broadly? And what the margin impacts may be given your contract mix?

Tobey, as I mentioned earlier, the market for talent continues to be challenging. However, I have stated many times that I am willing to invest in top talent with specialized technology skills, certifications, and other qualifications we seek in new employees. Additionally, we are often hiring highly accredited individuals, and I'm pleased to offer competitive salaries. Since 60% of our revenue operates on a cost-plus model, increased wages will be reflected in what we charge our customers. This is not merely a casual observation; it reflects market realities and our necessity to compensate our employees fairly. Moreover, our focus on technology allows us to be more efficient and flexible in our hiring processes and talent utilization. The way we deliver our services is increasingly important compared to input costs like wages. With Agile software development, we have numerous tools and methodologies at our disposal, allowing us to handle large-scale projects with fewer personnel. Programs such as BEAGLE and our Air Force Agile software development award exemplify our ability to find and secure top talent. On the indirect side, our Shared Service Center in Oklahoma City has implemented strong processes and effective automation, providing another means for efficiency and cost control. Therefore, as I mentioned earlier, I am not overly concerned about wage inflation. While it is a real issue in running a public company, we have positioned ourselves very well to manage it.

Building on that response, could you talk about the mix of employees sort of in the D.C. metro area versus other places, perhaps with different associated costs today and what that may look like over a 3- or 5-year period? Do you expect to grow your headcount sort of disproportionately in other geographies?

Yes, Tobey, thanks. Several years ago, during Ken's tenure as CEO, we took a moment to consider the future of the Northern Virginia marketplace. We both realized that we could hire skilled employees from across the country. Consequently, we implemented a strategic plan around five to six years ago to establish a strong network nationwide, focusing on finding digital signal processor engineers, software engineers, and systems engineers in various locations, including Rochester, New York; Sarasota, Florida; Denver; and Colorado Springs. This expansion allowed us to address our challenges related to wage inflation by identifying additional talent sources. We also mapped out relevant schools in these areas to recruit interns and develop our workforce across the U.S. Our customers have been supportive of this approach. In the past, many requests for proposals required development work to be conducted within a specific distance of their facilities. However, our customers have come to understand that the competition for talent extends nationwide, not just limited to their locations. While we have a strong presence in Northern Virginia, we are also active in many other areas, with a roughly equal distribution of efforts. Overall, we've managed to navigate the competitive talent landscape effectively. Tom, do you have anything to add?

Yes. I would add, Tobey, that what COVID has done across the nation is to accelerate a trend, which is working remotely. So besides direct employees, indirect employees can work anywhere. So if we have an opening for a person in accounting, HR, or contracts, we can look across the nation to fill those particular positions. And so that provides a broader base of employees and also the ability to take advantage of lower prevailing wage rates.

Our next question comes from Gavin Parsons with Goldman Sachs.

Guys, a few of your peers have recently given multiyear margin targets that are kind of flat to down. So wanted to ask if that's a dynamic you're seeing at CACI or if you think you can kind of continue to expand margins for the foreseeable future?

Yes, Gavin. I can't really comment on what my competitors are discussing. However, I want to emphasize that we're very satisfied with how our business has been positioned, especially regarding our consistent financial performance over the past 18 months, particularly in light of COVID. We believe we've been providing long-term guidance for many years. We started with a commitment to grow revenue faster than our addressable market, meaning we intend to continue capturing market share while expanding our margins. In my discussions with Tom each quarter and year, we’ve been achieving this. It's a long-term commitment we've maintained for several years, and we've been successfully winning more than our fair share of new business, with a recompete rate exceeding 90%. Ultimately, our focus is on driving free cash flow per share. Tom, do you have anything to add?

Yes. And Gavin, at a high level, the reason why we're confident in making the ever-increasing margin statement is our focus on technology. We do have differentiated technology, and that differentiated technology is going to come at higher margins. It's the way economics in markets operate. And as we grow technology disproportionately, that will drive kind of margins. That will continue to drive efficiencies from a cost perspective and the like. So there is some substance behind those stated goals.

Okay. I appreciate that detail. Then on the backlog write-down related to Afghanistan, I think you'd initially said that the headwind is going to be about 2% to revenue this year. The backlog write-down looks like it's a larger portion of backlog than that. So maybe two questions here: one, is the Afghanistan headwind larger than you expect? And two, if not, can you just remind us on kind of how the booking methodology works there?

Yes. So the headwind is 2%. So you know that's pretty solid. The way we calculate backlog is we will get contract awards and look at those contract awards and add that to backlog. Sometimes, the government on various programs is creating awards which have some aspirational niche to them or kind of just in case. We're not sure what the needs in Afghanistan are instead of having a contract value of X, let's make it X plus a buffer, if you will. And in particular, when the government is doing something so unpredictable, OCONUS operations, we saw that. And so the $1 billion write-down is greater than this year's run rate, but that's the nature of those particular contracts.

Yes. And that backlog was to cover a number of years looking forward. So the absolute revenue impact this year is going to be 2%. And that clearly drops to zero as we go forward, and we just thought it was prudent and the right thing to do since we look at our backlog number each and every quarter to ensure that once we knew we were completely out of that area, this was the right time for us to relook at what we had in our backlog and make that unfunded backlog change now.

Our next question comes from Matt Akers with Wells Fargo.

This is Eric Yan speaking on behalf of Matt. I noticed that your orders seemed to be somewhat weaker than usual for Q1. Did the COVID Delta wave have any effect? Were there specific areas that were more affected than others?

Yes, Eric. I'm going to stick by my decade-old comment of awards are lumpy. No, there isn't anything that we should read into it. We had another outstanding awards quarter, 1.6x, which is right on top of our trailing 12-month number. There’s not one customer or one award. I think I shared the last couple of quarters that every one of our customers has their own award personality. When they award and when they don't, and some award right on time and some award later. We haven't seen that. We still do see some residual task orders on major awards we've already won, and those come out a little slower than what they used to. And I’m assuming that as our federal government colleagues are working through COVID and its variants, that’s going to put some level of delay in. But no, nothing that we can point to. It's just more around awards being lumpy. And the first day to the second quarter for us looks just like the last day of the first, and that’s sort of what happens.

Our next question comes from Matt Sharpe with Morgan Stanley.

John, you mentioned in your opening remarks, I think, $530 million of unannounced classified contracts. I think this is the first time, at least in quite a while, that you've mentioned that or called that out. I was hoping you might be able to talk to what percentage of your business is classified today? And then how that component of the business has trended relative to the broader business over the last year or so?

Thank you, Matt. We’ve never disclosed the portion of our business that is classified as we need to protect what our customers do. Occasionally, we have a significant number of awards that we are unable to discuss publicly. In the past, we've often grouped these together. While we might not have done that last year, historically, this has been our approach. As I mentioned in my prepared remarks, what’s important about these awards is their strong ties to cybersecurity, reflecting a shift from a focus solely on counterterrorism to addressing near-peer challenges as well. This indicates that we are securing a substantial share of funding for both offensive and defensive cyber initiatives. This also ties into some acquisitions I referenced earlier, one of which is in the space domain that is receiving increased attention moving forward. Unfortunately, I can't provide much more detail about that acquisition. In terms of business breakdown, we categorize it into DoD, federal civilian, and commercial sectors to provide relevant insights, but I can't differentiate between classified and unclassified segments.

Yes. And we also talk about the percentage of employees who have different levels of clearances. As you know, there's a variety of clearance levels. Right now, approximately 70% of our employees have some level of clearance.

Got it. Okay. That's helpful, fellows. And then maybe just quickly on the subject of COVID-19. I believe the FAR Council has directed most federal agencies at this point, if not all federal agencies, to incorporate either a clause into RFPs or language in a contract mod that mandates vaccination for all employees by December 8. So my question to you is, are you seeing that language showing up on your end yet? And then is there any risk come December 8 to your staffing levels? Or how do you handle that when the time comes?

Yes, Matt. Thank you. The President's executive order requires all federal contractors to be fully vaccinated or have an approved exemption by December 8. We are actively communicating with our employees about their vaccination status and encouraging them to get vaccinated. On a positive note, we are approaching a 90% vaccination rate within the company. However, the situation remains fluid, and we continuously monitor updates. We receive changes from various agencies related to how they will implement the executive order, and different customers are responding in unique ways. We prioritize safety, access to government facilities, and the continuity of our operations. I believe, and we all agree, that the executive order's intention is not to disrupt mission-critical activities or displace skilled workers in a competitive labor market. This is factored into our guidance. If we thought there was a significant change based on current information, we would adjust our guidance accordingly. As we receive more information, we will remain transparent, as always. The current environment is dynamic, and we continue to feel confident in our guidance range, but we need to stay vigilant and aware.

Our next question comes from Mariana Mora with Bank of America.

So as we think about the post-COVID world, you already commented about the labor market. But so far this quarter, defense companies have highlighted challenges related to the supply chain. Could you please give us some color on CACI's exposure so far and actions taken to mitigate them?

Yes, thank you. Supply chain disruption is a challenge affecting many companies across various sectors. For us, the main issue pertains to compute and computing power, particularly regarding FPGAs. The most significant impacts will be felt in our counter-UAS tactical and BEAM 3 product releases. Although the volumes are not large, they are substantial enough to slow our planned ramp-up, which we have already considered in our fiscal year 2021-2022 guidance. Last fiscal year, we mentioned AVT facing supply chain issues and customer delivery delays. To address this, we ordered ahead for most of our long lead items that we anticipated receiving orders for this year. Should we exceed those planned levels, we might encounter some impacts later in the fiscal year, but it is too early to determine. Unlike commercial items, we view supply chain issues in our market more as a timing concern rather than a complete threat; delivery still needs to occur. We are continuously reassessing the entire delivery timeline, which includes production, training, deployment, installation, testing, and sell-off. We are looking for ways to shorten timelines, implement more electronic training, and prioritize training ahead of delivery to ensure we meet our final delivery date. There are many moving parts, especially in the FPGA area, but it represents a smaller segment of our business.

Our next question comes from Sheila Kahyaoglu with Jefferies.

It's Scott Forbes on for Sheila. I mean, you guys grew 2% in Q1, but guidance for the full year is obviously a little higher than that in the 4% range. Can you talk about some of the moving pieces that kind of help growth accelerate through the year?

Yes, Scott. There isn't one specific issue. We constantly manage several programs, some of which reach the end of their useful life, leading to a gradual reduction in certain activities. Meanwhile, other programs are growing, and we are achieving on-contract growth. This has been a significant focus for us, ensuring we maximize the potential of our current work while also securing new opportunities. It's really about the combination of these factors across our portfolio, where we will outline our plans quarterly for the year. Our planning process includes a monthly forecast that we update regularly, detailing revenue, costs, and profits by program each month. This provides us with a high level of visibility.

Yes, Scott. And this year, so far, is playing out. During our guidance call, Tom gave some loose directional quarterly guidance, knowing that the Afghanistan 2% hit would take its fullest impact in our first quarter as we would look at last year's first quarter. So we had planned this year with growing quarter-over-quarter; we're still on that plan.

And then you've spoken a lot about cyber; maybe from a high level, how do you think about that portfolio relative to your peers? And what are your broader expectations around that space?

Yes. I mean, cyber to us is part of everything, right? It used to be a separate deliverable. If we look at offensive versus defensive cyber, everything we do on the defensive side, at some point, the way we're structured, the fact that we're focused on technology and not just providing expertise to our customers, every time we can defend against something, that gives us new insights into how to move that to an offensive side. So we've been very much engaged in that. When you hear us talk about software-defined everything, you can think about devices and mission technology being delivered that not only can find the threat, but it can find that threat, understand it, decipher it, turn that around and deliver it as potentially an offensive payload cyber effect as well. So whether it's cyber, whether it's AI, whether it's machine learning, the majority of our mission tech, again, is going to be focused on software and software-defined everything devices and the like. So we see that in the intelligence community, and we like the hand that we're playing on the Department of Defense work. In the federal civilian world, clearly, as we look at DHS and the CISA there, being one of the very few folks who are building that architecture out. And you really can't talk about Zero Trust without talking about cyber as well. So really like the book of business we have. I like the fact that the folks in CACI, the folks that we are hiring, are coming highly credentialed, and that just tends to be able to drive further and further growth within the cyber domain.

This concludes our question-and-answer session. I'd like to turn the call back over to John Mengucci for any closing remarks.

Thanks, Ailee, and thank you for your help on today's call. We would like to thank everyone who dialed in or listened to the webcast for their participation. We know that many of you will have follow-up questions. Tom Mutryn, Dan Leckburg, and George Price are available after today's call. Stay healthy, and all my best to you and your families. This concludes our call. Thank you, and have a great day.

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