File inflation belongs to the same category of megatrends as the never-ending cycle of government interim funding bills: there is very little, if anything, companies can do to affect it as a whole.
But here’s how CACI International and Northrop Grumman explained some of what they’re doing in the meantime during their latest quarterly earnings calls with investors on Thursday.
The nature of cost-plus contracts means that a government client shares the financial risk that a company assumes for a program, while other types of contracts, including fixed-price contracts, essentially put everything on the contractor. .
During CACI’s first fiscal quarter call, CEO John Mengucci acknowledged that added labor costs are a fact of life in today’s environment.
Wage inflation has always been a factor entrepreneurs need to bear in mind given all it takes to bring in what Mengucci called “the best talent with specialized tech skills, with the right certifications and correct permissions”.
Competing for high is certainly not a new concept, but inflation has effects on how companies attempt to achieve their optimal cost structure.
Nearly 60% of CACI’s revenue, headquartered in Reston, Va., comes from cost-plus contracts. Mengucci said that means higher wages are passed on to the client under those contracts.
“But then again, our client is asking us to find the best and the brightest, and that’s what the best and the brightest cost,” Mengucci said.
The remaining 40% of CACI’s sales come from other types of contracts that are not cost-plus, which makes the contractor more susceptible to higher labor costs.
CACI’s long-term journey to becoming a company that combines mission expertise with technology products means that revenue and headcount are not fully correlated to each other.
Revenues are split roughly evenly between expertise and technology, Mengucci said, with the former being entirely labor-based.
“The other part is on the tech side where we can write the labor categories, we book the full rate of who we’re going to hire and how we’re going to pay them,” Mengucci said. “We are also looking for efficiencies.
“Software is a superpower. It allows us to deliver so much more capability, much higher productivity, potentially less supply chain issues as well.”
First-quarter revenue of $1.6 billion increased 7.7% over the prior year period, with that growth almost evenly split between organic expansion and acquired sales. Profit climbed 5.7% year-over-year to $170 million in adjusted EBITDA (earnings before interest, taxes, depreciation and amortization).
CACI’s guidance for its 2023 fiscal year which began July 1 calls for a revenue range of $6.475 billion to $6.675 billion, representing growth of between 4.5% and 7.5%. The earnings outlook is for an adjusted EBITDA margin in the mid to high 10% range.
High labor costs are certainly a watchdog for this blue-chip defense materiel company, just as they are for CACI and other more IT-centric systems integrators.
Northrop could characterize its own headwinds and those of the defense industrial base as a whole as spanning these two broad categories: people and parts.
But people are moving in the direction Northrop wants and has previously called it a priority.
During Northrop’s third quarter phone call, Chief Financial Officer David Keffer said the labor revenue picture was clearer after the company added 1,000 net new employees in the second quarter. and more than 2,700 additional people on the third.
“We’ve talked about it throughout this year as being a bit of a headwind for us in the first half,” CEO Kathy Warden said. “We weren’t adding headcount and keeping them at the level we needed to fuel our growth, and that started to turn the corner this summer.”
Inflation presents a completely different picture, or perhaps the lack thereof, even as Northrop looks at the various economic indicators.
“Your guess is as good as mine as to when this inflation really starts to modulate,” Warden said when asked by an analyst on the matter.
“I don’t see it as a big opportunity or a risk. I think we’ve probably covered this one pretty well, but we’re watching it.”
On the health and stability of supply chains: Warden said Northrop assumes many of these challenges will persist into 2023, particularly delays in shipping parts for its development programs.
Warden noted the Department of Defense’s efforts to work with industry on supply chain issues, including adjustments to certain contracts and the vulnerability of small and medium-sized businesses.
“We, as an industry, are doing our part: certainly looking at these investments and managing some of our cash in the supply chain in a way that we have never done in the past to keep these companies in good shape. health,” added Warden. “We’ve been doing it now for several years, really since the start of the pandemic, and I expect us to continue doing it.”
Third-quarter revenue of $9 billion was up 3% from the year-ago period, while net income of $915 million was down about 14% year-on-year on the other.
Northrop expects its financial results for this year to be in the lower end of these outlook ranges: $36.2 billion to $36.6 billion in revenue on an operating margin of 11.7 to 11. 9%.
All of the above general factors explain why Northrop guides itself and investors this way, even with this lack of optimism in the company’s initial outlook for 2023: sales growth between 4% and 5% and a margin operating from mid-to-high 11%.