CACI International Inc (CACI) 2012 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the CACI International third-quarter fiscal year 2012 conference call. Today's call is been recorded. At this time all lines are in a listen-only mode. Later we will announce the opportunity for questions and instructions will be given at that time.

(Operator Instructions)

A special reminder to our media guests who are listening in, please remember that during the Q&A portion of this call, we are only taking questions from analysts. At this time I would like to turn the conference over to Dave Dragics, Senior Vice President of Investor Relations for CACI International. Please go ahead sir.

Thanks Kevin, and good morning ladies and gentlemen. I'm Dave Dragics, Senior Vice President of Investor Relations of CACI International, and we're very pleased that you're able to participate with us today. Now, as is our practice on these calls, we are providing presentation slides, and during our presentation we'll also make every effort to keep all of you on the same page as we are. So let's move to slide number 2.

Before we begin our discussion this morning, I'd like to make our customary but important statement regarding our written and oral disclosures and commentary. 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 results. Now, Factors that could cause our actual results to differ materially from those we anticipate are listed at the bottom of last evening's earnings release and are described in the Company's Securities and Exchange Commission filings, and our Safe Harbor statement is included on this exhibit, and should be Incorporated as part of any transcript of this call. I'd also like to point out that our presentation today will include discussion of non-GAAP financial measures, and these non-GAAP measures should not be considered in isolation or as a substitute for performance measures prepared in accordance with GAAP. Now let's go to the next slide, please, and to open up our discussion this morning, here's Paul Cofoni, President and Chief Executive Officer of CACI International. Paul?

Thank you Dave, and good morning everyone. With me this morning are Tom Mutryn, our Chief Financial Officer; Dan Allen, President of US Operations; John Mengucci, our new Chief Operating Officer, and Greg Bradford, Chief Executive of CACI Limited in the United Kingdom.

Please go to slide number 4. CACI announced record revenue and net income for the third quarter of fiscal 2012. In addition, we continue to deliver on important financial and operational metrics, such as funding orders and contract awards, which Dan will discuss in a few minutes. Our direct labor also reached the highest hiring levels in our Company's history. Today, we employ more than 14,600 outstanding professionals, up from approximately 13,700 we had at this time last year.

Slide 5, please. At the same time, we are beginning to feel the impact of the budgetary pressures affecting our clients. In our case, there are two factors that have contributed to the modest increase in our year over year revenue. First, we have seen a change in the dynamics of our clients' buying patterns, specifically, we're experiencing lower pass through ODC's, primarily associated with the drawdown in Southwest Asia. Pass through ODC's have been a good source of revenue for us, but for several years our strategy has successfully focused on growing direct labor to increase our earnings, which we did this quarter. The lower pass through ODC's have affected our top line, but our focus on direct labor has benefited our bottom line.

The other factor we're seeing is slower than anticipated procurement action. We are not experiencing any contract or procurement cancellations, and client satisfaction is as high as ever. In addition our pipeline of high-quality biz is at a record level and growing. So we expected an increasing bow-wave of pending awards for the high demand solutions we provide. Please go to the next slide.

We continue to have confidence in our long-term strategy. Addressing the simultaneous challenges of securing our nation and taming the budget requires our clients to make decisions based on strategic vision and fiscal constraints, which we believe works to CACI's advantage. We believe an effective and an affordable national security strategy will benefit from the innovative capabilities CACI provides. The key elements in our growth strategy still apply. We are fully focused on the high priority markets of defense, intelligence, homeland security, and government transformation. This includes special emphasis on our clients' growing requirements in government transformation, cyberspace, special operating forces, and healthcare IT.

Our positioning in our addressable market sets us apart. We have an extensive portfolio of IDIQ contracts, providing the vehicles to pursue significant business opportunities. Our commitment to operational excellence with more than 2000 trouble-free programs is a distinct component in our competitive success. We focus on innovation, finding new ways for clients to improve productivity, save money, and meet mission goals. We are a strategic consolidator, with an industry-leading mergers and acquisition program, giving us access to new capabilities, clients, markets, and solutions.

Finally, we have a high integrity-empowering culture that values teamwork, winning, and agility in responding to emerging trends and client needs. CACI also continues to attract top performers, such as John Mengucci, to our executive team, who want to be part of our strong culture, successful growth strategy, and commitment to innovation and operational excellence. John, our new Chief Operating Officer, has an outstanding track record of implementing growth strategies across large organizations. He's managed similar size business areas in the same defense and federal civilian market space in which we operate today, and he gives us additional leadership in leveraging our solutions and commitment to operational excellence to ensure our clients are meeting their mission goals. I'd like to ask John to make a few remarks at this time. John?

Thank you, Paul. Well, I'm very excited to be part of a Company with a solid corporate culture, an outstanding reputation for ethics and integrity. I see great opportunities for continued growth through our highly diversified business base, and look forward to contributing to our continued success. In addition to expanding our offerings in defense, intelligence, homeland security, and government transformation, I am looking forward to leveraging the robust capabilities CACI brings to the federal civilian sector in the increasingly critical markets of transformation, cyberspace, and healthcare IT solutions, all multi-billion dollar addressable markets. In addition to growth, I will continue to emphasize on CACI's lean business practices and streamlining our processes to optimize the efficiencies of the Corporation.

Thank you John, and welcome aboard.

Thanks, Paul.

Looking ahead, it's important to remember that we live in a world facing persistent global and asymmetric threats. Our services and solutions are needed to give national intelligence and our Armed Forces the technical edge, not just in Southwest Asia, but wherever national security is defended. For instance, our presence in Asia-Pacific can support DoD's increasing focus on this area. Our experience supporting military and national intelligence positions us to assist DoD as it steps up its focus on high priority targets and expanding US global intelligence operations.

We are also well-positioned to continue our services in Afghanistan, following the US-Afghan strategic partnership, which will support the transition in Afghanistan beyond the 2014 drawdown. In cyberspace, our capabilities offer a distinct competitive advantage for us in meeting our clients cyber challenges. We believe that funding for cyber activities will remain one of the nation's highest priorities. Even in a challenging environment, we continue to see many opportunities for growth in our specific markets and core capability. Now I'll turn the call over to Tom who will provide all of us more insight on our financial performance this quarter. Tom?

Thank you Paul, and good morning. Let's go to slide number 8. Overall, we reported another solid quarter with record third quarter revenue and earnings results. Our year over year revenue growth is 1.6%, but was lower than we had anticipated. Both our direct labor and our other direct cost drive our revenue performance. As we have indicated in the past, we have focused our strategy on growing direct labor, which is significantly more profitable than our ODC activity. For the quarter, direct labor grew by 8.1%, with a solid 4.1% organic direct labor growth. Other direct cost include the subcontractor labor, equipment, and material we use in our service solutions, as well as pass through other direct cost.

These pass through costs help our government customers procure equipment or services. During the third quarter, our other direct cost decreased by 7.7%, and were below our expectations, primarily due to a reduction of pass through ODC's related to drawdowns in Southwest Asia. In addition, delays in government procurement activity resulted in lower revenue than we had anticipated. Our revenue, therefore, was affected by the slowdown in the pass through activity, but the impact on our earnings was materially less. Since last year, we have been reporting results on a pro forma basis to remove the impact of adjustments related to contingent considerations for two domestic acquisitions we made in FY '10,

We recorded no adjustments this quarter, but we recorded adjustments in the third quarter of FY '11 that had been removed for pro forma purposes. Year over year, our third quarter pro forma operating income growth of 23.3% was driven by strong direct labor growth. As a result of this strong growth in the changing mix of our direct cost to include more direct labor, our operating margin increased to 7.8% from 6.8% in the third quarter of last year. The large fixed price contract I mentioned last quarter also added to third-quarter earnings. Earnings on this contract were greater than what we expected when we submitted our bid, and greater than what we had Incorporated into our initial and revised FY '12 plan.

The contract is now complete, and for FY '12 it has provided $12 million in pretax earnings and $7 million in net income, greater than our bid models. Our UK operation turns in net income margin of 6.5%, but absolute net income was down 26% from the third quarter of last year. Quarter three of last year was an exceptionally profitable one, driven in large part by the volumes of work from our Irish and Scottish census projects. Our third quarter this year was impacted by less favorable exchange rates and continued reductions in UK government spending. During the quarter, our UK operation acquired Tomorrow Communications Limited, which specializes in the design, implementation, and ongoing support of the data networks of large commercial companies. Tomorrow Communications generates annual revenue of approximately $30 million, has a staff of 170, and is accretive.

Slide 9, please. For the quarter, pro forma earnings per share increased 31% on 17.6% increase in net income and a 3.2 million share decrease of our diluted share count as a result of our August accelerated share repurchase program. Dilution associated with our convertible debt added over 400,000 shares per diluted earnings per share calculation purposes. Slide 10, please. Our operating cash flow for the quarter was $59 million, and $145 million for the nine months period ended March 31. Our free cash flow for the 12 month period ended March 31 was $207 million, or about $7.37 per diluted share. This translates to a free cash flow yield of 12% per share at a $60 share price.

Our DSO increased nine days from the third quarter of 2011 to the third quarter of 2012, it increased four days from the end of our second quarter. Several factors contributed to this increase. During FY '12 we decided to suspend our prompt payment discount feature, as we determined that the cost of the program exceeded the benefits of accelerating cash collections. This added an estimated three days to DSO. In addition, this quarter we encountered payment delays due to contractual negotiations and funding realignments with three specific customers, adding about two days to our DSO. All of these payments are in the process of being resolved, and we expect full collection during our fourth quarter. Our balance sheet remains strong. Our net debt at the end of the quarter was $524 million, and our net debt to trailing 12 month pro forma EBITDA leverage ratio was at 1.5 times.

Slide 11, please. For fiscal '12 we are increasing our GAAP net income guidance we provided in February to $163 million to $169 million, as a result of a lower tax rate, lower interest and indirect expense, and the positive impact of the UK acquisition. We are revising our revenue guidance range to $3.73 billion to $3.83 billion, due to lower than expected pass through revenue. For FY '12 we now expect our fully diluted share count to be 28.4 million shares, interest expense to be approximately $25 million, our effective tax rate to be 39.3%, and our GAAP operating margin to be at least 7.7%.

Slide 12. In FY '12 two material items positively impacted our full-year results. The first is a one-time commercial product sale that generated $6 million of net income in the first quarter. The second item is the greater than expected profitability on the large fixed price contract which I spoke of. We believe both these items were one-time and unusual, and that they should be adjusted from FY '12 to create a normalized space to better measure our growth performance going forward. With that, let me turn the call over to Dan.

Thanks Tom, and good morning to everyone on the call. Let's go to slide 13. This morning I'd like to provide operational highlights from our third quarter and first nine months of fiscal year '12. CACI's 23% increase in operating income is directly attributable to our ongoing strategy to grow direct labor and our continuous focus on operational excellence. Our direct labor growth was 8.1% over the same quarter last year, and continues to grow. Program performance is critical to our success, and we continue to experience trouble-free programs across our base of more than 2,000 contracts. By anticipating client needs, creating innovative solutions, and delivering excellent program performance we have established trusted business relationships in which our clients know they can rely on CACI to achieve their mission objectives.

We continue our solid performance in funded orders and contract awards. Our contract funding orders for the quarter were $800 million, up approximately 7% over the same quarter in fiscal year 2011. Our nine-month results were even better, topping $3 billion, and coming in at more than 10% over the fiscal year '11 nine-month period. We also recorded approximately $547 million in contract awards this quarter, a 16% increase year over year, and we have won more than $3.5 billion in contracts year-to-date, which is a 35% increase over the same period last year. We are well positioned in our addressable market, and we continue to invest in our capabilities. Investment in our people, our business, program management, and engineering processes, and our technical capabilities will enable CACI to meet current client priorities, and their emerging needs.

Slide 14, please. I would now like to highlight a few of our third quarter awards that demonstrate the success of our growth strategy. I'll begin with the expansion of our portfolio of large, indefinite delivery, indefinite quantity contracts in high priority and well-funded government mission areas. These vehicles provide CACI continued growth potential, and we've added new three new vehicles this quarter. Most recently, we won a prime position on a five-year $3 billion contract providing tactical communication solutions for the Department of Homeland Security. This new business for CACI will ensure the viability of critical voice communications and enhance information sharing among federal, state, and local law enforcement and public safety institutions during natural and man-made emergencies.

We also won a prime position on a five-year $985 million consultant, advisory, and technical services contract to support the Air Force Medical Service. Under this new contract, CACI will offer management and professional services, evaluate emerging technologies, and provide systems integration and lifecycle management of field medical systems to ensure high-quality patient care. Our third IDIQ contract award was in our enterprise IT business, which is one of the lines of business contributing significantly to our earnings growth this quarter. This award is for a new prime position on the five-year $476 million US Government Omnibus Network Enterprise contract to provide network security, engineering, and systems designed for the executive branch, Defense Department, and other federal agencies.

Our strategic focus on government transformation resulted in several Q3 awards to help clients modernize their business systems and improve productivity. Standout contracts here include our five-year $78 million award to support the Air Force's civil engineering next-generation IT program. This program will modernize the Air Force IT systems that manage real estate, supplies, housing, energy, and related functions. We also won a four-year $41 million task order to continue as lead developer of the Defense Logistics Agency's Defense Agencies Initiative to provide a single accounting system and standard business processes across the DoD.

Our federal civilian market also grew with government transformation awards in this quarter. We won a five-year $15 million contract with a Department of Homeland Security component to provide operations, maintenance, and optimization support for its Oracle Federal Financial system. This award leverages our October 2011 acquisition of the Advanced Programs Group, or APG, and continues to validate CACI as a market-leading provider of Oracle e-business software solutions in the federal government.

Another third-quarter driver of our federal civilian business was our ongoing development of the virtual lifetime electronic health record program for the Department of Veterans Affairs. This reflects the success of our strategic focus on the high priority healthcare market, where we continually to organically target and win new business. During this quarter, we added new business to two of our existing federal civilian clients. With the Department of Justice, we're expanding their electronic files processing and cloud hosting capabilities, and with the Department of Housing and Urban Development we are providing IT software and services. We also expanded our support of the Special Operations Forces this quarter with a four-year $229 million task order to augment planning support, with services that include strategic integration, studies, and analysis.

Let's go to slide 15. Our opportunity pipeline remains strong, and the pace of our bid and proposal activities continues to accelerate. At the end of our third-quarter, we had nearly $9 billion in submitted proposals under evaluation, compared to $6.1 billion of proposals at the same time last year, with approximately 65% of these for new business. In addition, we are focusing on several large target pursuits, and we expect to submit more than $11.9 billion in new proposals during the next two quarters, with more than 57% of those anticipated proposals for new business. We are not seeing any large contract cancellations, and believe the current government delays in releasing our fees and awarding contracts will create a bow-wave of contract awards in our fiscal year '13. We are confident in our ability to compete and to win in our addressable market, where will well-positioned to respond with innovation and agility to emerging requirements. I'll turn the call back over to Paul.

Thank you Dan, and thank you Tom for your highlights and details. Let's go to the last slide. We remain confident in our long-term growth strategy. We are confident in our competitive position, our focus on the nation's highest priorities, and our program of operational excellence, which assures clients they can rely on CACI to get the job done right. We're also pleased that Fortune Magazine named CACI one of the world's most admired companies in 2012. We placed fifth among IT services companies and in the top 10 companies in Virginia. We remain a thought leader in the ongoing vital collaboration among academia, government, and industry to help counter asymmetric threats.

On May 8 we are co-sponsoring the annual Asymmetric Flex Symposium, which continues to advance the national dialogue on US and global security. We make it a priority to hire veterans, especially disabled veterans. They offer outstanding skill sets, and their dedication and expertise are real assets to our clients. CACI recruiters also continue to receive industry recognition for our programs to hire veterans. I also want to thank our 14,600 outstanding CACI professionals. They are committed to delivering innovation and excellence for our clients and their high priority missions.

We are in the early stages of developing our fiscal '13 plan. As is our normal practice, we will communicate our fiscal '13 guidance at the end of fiscal '12, this year on June 27, 2012, with a press release followed by a conference call on June 28. Our preliminary view is that we do not expect to realize the growth rates we have experienced in recent years, due to continued challenges related to uncertainty in the government, budget process, delays in government procurement activities, and the drawdown in Southwest Asia. We remain optimistic, however, in our agility and competitiveness in the high priority markets of defense, intelligence, homeland security, and government transformation, with the expectation of higher growth opportunities in business and government transformation, cyberspace, special operating forces support, and healthcare IT in this fiscal year and beyond. With that, Kevin, we'll open the call for questions.

(Operator Instructions)

We also ask that you limit yourself to one question and one follow-up. Our first question comes from Edward Caso with Wells Fargo.

Can I ask about pricing? I assume at least 35% of your pipeline and a fair amount of your activity is re-competes, and trying to get the sense of the level of price competition and the amount of discount you have to give to, one, protect your work, and two, to take work away from others?

Dan, can you help Ed with that?

Sure. Price overall is becoming a more important part of our clients' evaluation process. As we've looked at structuring and continue to the organization to be a lean organization, we don't see ourselves in a discounting mode. We see ourselves using the components of our price, and continuing to focus on managing those components of our price, maintaining the lean organization to be price competitive. So, we aren't anticipating a significant impact in our re-competes fund and financial performance going forward driven by those pricing pressures.

My second question is for Tom. There was a comment about being in a strategic acquirer. Could you remind us of your dry powder, and what you're seeing in the market as far as availability of quality product, and where the pricing of those deals might be?

Yes, Ed. In terms of kind of dry powder again, we certainly have a strong balance sheet. Right now we're leveraged at 1.5 times. We would feel comfortable increasing that leverage by at least kind of 1 to 1.5 turns. EBITDA is approximately $325 million, and so if we wanted to borrow additional funds, we could have a material amount for acquisitions. Annual operating cash flow is $200 million plus. So we certainly have the financial wherewithal. Borrowing costs, as most people know, is relatively low as we sit here today. In terms of the pipeline, we are seeing some kind of interesting opportunities present themselves.

Overall we're seeing a high volume of potential transactions. I would characterize it as perhaps the quality is not quite as good as we have seen in the past. Some smaller opportunities, some companies with small business content, some companies with a large amount of subcontractor content to their business, but that being said, we are seeing a few kind of interesting opportunities, and we are also looking for ones which are a bit larger than we have seen in the recent past. Instead of doing the $50 million, $100 million transaction, there are a couple larger transactions in the marketplace that we are evaluating. So all in all is a pretty decent pipeline. We completed a UK acquisition in this quarter, and I think we'll continue to look at activity in the next 12 months.

Bill Loomis, Stifel Nicolaus.

Just one thing, my two questions I'll just ask them upfront. Your last call was two months ago, and pass throughs seem to drop off pretty quick. You certainly weren't talking about it then. So what really changed at the customer side so quickly? The second is just on the overall exposure to the Middle East area. In the past you've said it's a pretty small amount, but given what you're talking about today and the revenue reduction, it seems that it's larger than what you implied in the past. So if you can give us a sense of kind of what your overall exposure to Middle East action is, both directly and indirectly. So beyond just the people actually in the theater, but what do you do here that's being done on behalf of in-theater. Thanks.

Okay Bill. Let me start, and then Dan will jump in on the part of our business that's correlated to Southwest Asia. In terms of what happened this quarter with the pass through ODCs, historically the third and fourth quarters have been years of good growth or high growth of pass through ODC-type activity. That was further accentuated, I think, a little last year with the surge in Afghanistan. So we had expected our third and fourth quarter pass through ODCs to also be in a good growth mode, and we were surprised. Starting in the February, March time frame that they were coming in lower, and continue to come in lower.

We correlated almost completely to these pass through ODCs, which are ODCs that we don't add a lot of value to. They are done as more of a convenience for our clients. A procurement action is a convenience for our client, and it certainly is important to them. It brings a small profit with it, but as you know, we've been focused more on direct labor growth in recent years. So on the other hand, it is a big part of our business, and so we're paying attention to it and trying to evaluate it for fiscal '13 to have a better understanding of what the impacts could be. I think it's also fair to say that these come sort of in a unpredictable pattern. They come generally based on op tempo demands, and so they're not always predictable. Usually they're difficult to predict. Dan, do you want to address the question about Southwest Asia content?

Yes. Bill, Our exposure to Southwest Asia across the entire portfolio with programs that are supporting activities there, here in the Conus and overseas, is less than 10% of our overall business, and I think we've guided appropriately in '12 to assess any impact that we have there. As we look going forward, we are in the midst of a bottoms-up analysis that looks at each of our major programs, and with the revised partnership between Afghan -- the Afghan and US President, we're looking at each of those and aligning what we believe will happen on a program-by-program basis. Overall, we don't see a significant impact with the forces that remain going forward. I believe we're pretty comfortable with the ODC component, particularly the pass through component finding its way out of our plan, but we will guide and provide much more detail on that as we release our fiscal year '13 guidance in June.

Michael Lewis, Lazard Capital Markets.

I will just ask my two questions and let you go with them. First, Tom, I was wondering if you can give us the S3 in the quarter, and then also we say $11.9 billion being submitted, that you expect to submit over the next six months with 57% of that as new business. So, really, want to isolate in on the 43% that's existing. What are the largest contracts or tasks that are being re-competed there? If you could give us some content on that. Thank you.

Okay, Mike. I'll talk about kind of S3. I'm not sure if the question was kind of the S3 awards or the S3 revenue. I can tell you about the S3 performance. As you know, the primary customer on S3 is Army C-Comm, and a lot of the activity in S3 was related to Southwest Asia activities, and we've had a good amount of ODC pass throughs under the S3 vehicle. The fall off in those ODC pass throughs were largely coming from the S3 contract vehicle. So actually revenue for that particular contract deal will decline. That being said, direct labor content grew in the S3 vehicle. Still very profitable and a cornerstone of our strategy, but that fall off in ODCs was driven largely under the S3 vehicle.

Yes, I was looking for the awards, Tom.

Get us a second to try to -- about $24 million, Mike. Sorry for the delay there.

Thank you, sir, and then also with regard to the content on the other 43%, the existing business that's up for submission over the next six months, what's the content there?

Our pipeline, we're very encouraged by what we see in the pipeline. I think you captured the main new business opportunities that we're chasing. We're very encouraged that those are real, and making their way through the acquisition process. As we look at more of our established business and our established programs, there's a couple of them that have been long-term programs for us, the Omega program that we have with the Department of Justice, we've got a long-term relationship with the [go to its] routine cycle of acquisition that ties competition. Contract that we have today will be re-competed and ties. Those would be the two big drivers in volume, and then a big part of our broader set of our smaller vehicles and some of the task orders make up that other 40%, but the Omega is a very large program and it would be the number one item on our list.

Cai von Rumohr, Cowen and Company.

So two questions. The first one is you missed your sales by about $75 million. You told us that's pretty much pass throughs, but you pretty will hit your EBIT target. So is it fair to assume that the profit, because you said it was small on the pass throughs, was like in the 1%, 2% area?

Cai, we always said that the margin on the pass through revenue is going -- very thin. Each particular contract deal will have different profit margins on it, but it's fair to say that the profit margin on the pass throughs is very thin. We did hit our EBIT target, and the decline in the margin associated with the pass throughs was offset by, as I mentioned, some other kind of reductions in SG&A expense and the like. So all in all, we were able to maintain our profit level.

Okay, and the second question is, if you look at your ODCs as a percent of COGS, they're probably a bit over 62% today. If we go back to 2002 to '05, they were running more like 50% to 52%. If this is the beginning of a trend, with a major fall off coming in pass throughs as we withdraw from Iraq and Afghanistan, what kind of incremental margin leverage will that have on your business? Can you sustain the profitability overall -- I mean, can the profitability move-up? Will it just be a 1% to 2% negative impact, or will it have more leverage if we continue to see this trend continue in the future?

Well, Cai, In the short term, there's no question that you've seen our margins improved as a result of our increased focus on direct labor and the good direct labor growth. It's really much more -- the margin's really much more correlated to that direct labor growth. As the ODCs come down, of course they have a lower margin. So they'll have some beneficial impact to -- in the short term they'll have some beneficial impact to our margin. However, keep in mind the government is always adjusting the contracting mechanisms, and the shift we have going on these days, which is away from time and materials, towards fixed price and towards cost recoverable contracts changes some of that dynamic and throws some of these ODCs into the pool, the cost pool, for which an overall percent fee is assigned. So I'd say in the long term it may not be correlatable 100%, in the short term it has been very correlatable.

Robert Spingarn, Credit Suisse.

To go through and approach your late June fiscal '13 guidance, how are you balancing all of the unknowns with regard to the CR, potential sequester? We understand this puts you in a very challenging position because of the unknowns, but how are you going to frame that?

Well, good. That's an excellent question. We've spent a lot of time, obviously, thinking about this, and we pay close attention to all of the planning coming out of the Pentagon, and we have, in fact Dan has commissioned a study that's been going on, really an ongoing study for about six months here to look at our addressable market space and, in particular, the potential effects of sequestration. So Dan, do you want to add a little here?

Sure. Maybe we'll talk a little bit about '12 and how that then extends into '13. One of the things that we are seeing, and we believe are somewhat impacting the slowdown in some of the new awards, when the budget was finalized in the December time frame, we anticipated that our clients would move out of the CR mode into a more traditional mode, the restraints would be taken off and they'd be able to spend to their '12 budget. Unfortunately the ambiguity uncertainty in the '13 budget caused them to take pause and to reassess priorities, and look at what actions they were taking in '12 and how do they extend into '13 and '14.

So to some extent, to a major extent today, we're seeing them behave somewhat like they're still in under a CR constraints. So going forward, we're expecting that to continue. As you look through most of next fiscal year, the budget uncertainty, the elections, and how that translates into stability that our clients can make decisions, we think they will be somewhat guarded in how they do that. Now, they still have a fairly large amount of money on their budgets that they do need to spend, even under a CR, and it's in their interest to spend that money, and we hear that in our engagements with them. They do not want that unused budget, to lose that unused budget. So there will be more tactical decisions, there'll be contract extensions, and we think that's going to be the core part of our approach, how we look through the next year.

Just to follow-up, and this is perhaps a little bit of an unfair question, because I'm not sure anybody knows the answer to it, but for the December quarter, do think that will be treated under a CR, like a fifth quarter of government fiscal year '12, or the first quarter of '13, meaning that potentially the sequester is retroactive to October 1? I'm trying to figure out if the CR actually does what you just said, it promotes spending, or the opposite happens.

Yes, it's a really tough question to answer. There are lots of varying views about that. We're not really able to speculate on what will happen. What we have done, though, is we have studied what would happen in the event of a full sequestration to our addressable market space. As you know, we have a very large $200 billion plus addressable market space, and we think it will come down about 5% over the period in a full sequestration. So while the sequestration itself might represent something approaching 20% of the defense budget in total over the 10-year period, for us because of where we are positioned in the market, we assess the impact to us would be more like 5% over the period, and it's a really large market. We are a $4 billion enterprise operating in a $200 billion plus market. So trying to get more precise than that is very hard at this point. We're all, like you, watching to see what happens.

Nate Rosewell, Morgan Stanley.

Morning Nate.

His line actually left the queue. I'll move onto the next question. Our next question comes from Joe Nadol with JPMorgan.

Good morning Joe. Joe's not there?

One moment. One moment. You may ask your question, Joe.

Okay. Hello, can you hear me?

Yes, Joe. Go ahead.

Okay, thank you. Must've been some technical difficulties. My question is on the bookings, and I'm wondering if you guys can give, now that your direct labor is still going up nicely and your ODCs are declining, in direct labor, that 40% obviously contributes the lion's share of your profits. Wondering if you can disclose, in terms of your bookings, how much of that is direct labor versus ODCs, both looking backwards, and maybe on a regular basis going forward? So in the quarter itself and then year-to-date.

Joe can we get back to on that one? We don't have that at our fingertips.

Well, can you characterize it? Is direct labor bookings still coming strong?

We would say right now that ODCs are declining and direct labor continues to increase. So we'd expect the ratio between direct labor and ODCs to continue moving more toward direct labor. So I can characterize it that way, but to give you a precise number of what's in the backlog or what's in the funding orders, I don't have that immediately available, but we can get that for you.

Okay, that would be helpful in terms of analysis, because otherwise it's tough to analyze what your bookings really mean, and backlog really mean. The second question is just if you look at the procurement vehicles, I guess S3 in particular, but any of the others, have there been real changes in what vehicles the customers are using, or is it just that the overall level of their demand is dropping? Are they migrating to other vehicles, or is this just demand that's dropping because of the reduction in operations?

As we're looking at tracking the opportunities, we're actually just seeing them be delayed or slip to the right. We don't see our clients going to new vehicles, or the opportunities shifting to other vehicles, or going away. It's a slowdown in the process of getting through the acquisition process, getting decisions made, awards made that's driving that. Circling back to our core strategy with really pursuing those large ID/IQ vehicles that support the clients at the markets, the missions that we're targeting, we're well positioned there. So in most cases, if there would be that type of action, we would be positioned to go pursue it, and S3 is a good example of that. The client put S3 in place over five years ago with a goal of having a single efficient vehicle. As time is progressing, the organizations that are part -- work up at C-Comm are beginning to establish their own vehicles, and you will see more of that come out over the next year or two.

Tim Quillin, Stephen's Incorporated.

Tom, on the $7 million in net income impact from the fixed price contract, I think you said last quarter that there was a $3 million benefit in 2Q. Was the other $4 million all in 3Q?

Yes. So let me provide some more details on that. As I mentioned, that large fixed price contract generated more profit than we anticipated when we submitted our bid, a year plus ago, and also when we provided our guidance during FY12. So compared to what we bid, if I break it down by quarter, we realize about $1 million in additional pretext profit in the first quarter, approximately $7 million of pretax profit in the second quarter, and $4 million in the third quarter. That's the amount we should be adjusted out of FY12 to derive that normalized base that we spoke of, and that equates to the $7 million of net income, so pretax and net income, and to be clear, in the last call I quoted $5 million pretax number. That variance was what had been in the prior guidance. So I was comparing a different base, and so the numbers appropriate to use in terms of pretax, $1 million in the first quarter, $7 million in the second quarter, $4 million in the third quarter.

Got it, and then with regards to ODCs, and I understand that hopefully you'll have more insider visibility when you give guidance for next fiscal year, but it sounds like that you think you're going to have this trend, as Cai said, from a 60/40 split of ODCs to direct down to 50/50 over the next three years, or at least you didn't argue with that. I'm just wondering if that's kind of the rational way to look at things. Thanks.

Tim, this is Dan. I think we do expect the mix of direct labor to ODCs to continue to focus, or shift towards direct labor. That's going to be driven by two major factors. One we've talked a lot about, and that's the real reduction in pass through ODCs. Equally, our clients are buying more along the lines of systems, or buying in deliverable products than they are by labor hours, and as we look at some of the vehicles that we are performing on and pursuing, as they bundle those things into end item deliveries, that brings with it more of a CACI value added services, program management, engineering oversight, and so forth, and also allows us to look at margins differently. The more systems-type work tends to be able to demand higher margins. So we see that as a trend. We think that is a good thing, and that's part of our strategy to expand that systems part of our business. The question is that we have not yet rolled into our '13 plan and forward is at what pace that'll happen.

James Kupferberg, Jefferies.

This is Ahmed [Sing] for Jason Kupferberg. My question is regarding the revenue guidance. In your guidance, how much of revenues do you expect to be from acquisitions? I know even though the revenue guidance has gone down, the EPS guidance has remained strong, or at the same level, and you mentioned that that was primarily due to tax, interest, and UK acquisition. Would you be able to quantify the effect from these items?

Yes. So we have (inaudible) several puts and takes in terms of the kind of earnings guidance. With a lower level of ODCs, pass through ODCs, they generate a modest amount of profit. They're not coming out of loss, they're coming out of slightly small enough of a profit, and so as these went down, that had negative impact on our P&L. We were able to offset that by those items that I mentioned. The UK acquisition adding approximately maybe $0.01 to our earnings per share for the quarter, interest expense was probably a little bit less than $0.01, our reduction in SG&A costs, approximately $0.01 or so. So those are the order of magnitude. None by themselves were that material, but they all added up to offset the reduction in the gross margin associated with the ODCs. Your first part of your question dealt with the federal composition of the revenue in the guidance. The acquisitions that we did in the past 12 months, and including the most recent UK acquisition, are adding approximately $100 million to our FY12 performance.

Perfect, thank you, and just a quick second question. You talked about the effect of budget uncertainty and the sequestration on the top line, but are you doing anything on your expense side to prepare yourself for the cuts? Maybe reorganizing the workforce, and also maybe, again, top line prioritizing the type of projects you bid on?

Sure. This is Dan Allen. Managing our expenses, I think we had discussed earlier, one of the features of CACI is our focus on our markets and our clients, and the fact that we have a fairly lean organization. We, on a continuous basis, are looking at how do we ensure that we align our strategy with where our clients are going, and that we're appropriately prioritizing discretionary resources to be successful with those clients, and that's an ongoing process. We are, as we go into fiscal year '13, we do an annual assessment of that. If there's anything more significant than the ongoing process, and we're in the works, in the process of doing that now. So there'll be more to come, if that's needed.

I will make one other comment. Most of our expenses are direct costs, either direct labor or other direct cost. We hire people to bring them to work for a particular government project. Typically we do not create benches where we hire people in advance of a specific contractual need, and so in terms of our labor utilization of direct labor, it's very, very high, just given the nature of our work. So there's really not a lot of opportunities to prepare in advance for some unknown activity, since the direct labor is very, very tightly managed. The other piece of the equation is in direct overhead expense, and as Dan mentioned, we have a very kind of lean organization. As part of our culture for the past many years, we've been focusing on continuous improvement, driving efficiencies, measuring the performance on a very regular basis to always ensure that we have a very efficient workforce. So We do not -- always room for improvement certainly, but we do not see kind of access expense in our organization.

George Price, BB&T Capital Markets.

Many have been asked, but Tom, I guess I wanted to just kind of follow up on the prior questions around the one-time items you called out in fiscal '12, just to make sure I understand what the numbers represent. Those pretax numbers, are those that you gave related to the contract outperformance, are those sort of excess benefits or beyond normal profitability, or does that represent the total contribution from that contract?

Yes, those represent those excess benefits.

Over performing.

Overperforming, yes. So we bid on a contract, assuming a certain profit level on this particular fixed price contract, and we believe that was the normal expectation. It turns out that when we executed on the contract, our team did a very superlative job of providing services at a materially lower cost and significantly quicker than the government customer kind of needed, so it generated this abnormally high level of profit. We do not believe that that level of profit is sustainable or repeatable, given the unique nature of that particular fixed price contract.

Right, okay. I just wanted to make sure. I just wanted to clarify that. I guess two things on that just as follow-up. First, I mean, those are -- you performed better, basically on a contract that's core operations part of the business, which admittedly does set up a higher hurdle in fiscal '13, but it's normal course of business. Could argue the same for the product sale. I mean, those together, I believe, are about $0.46 in EPS that you're kind of suggesting to ignore for purposes of the fiscal '13 comparison. I'm not sure why investors should do that. I mean, you guys did a better job than you expected, just sets a higher bar for fiscal 13.

Yes, we can have kind of, again, a debate or a disagreement about how to characterize that. The way we're looking at our business ourselves is that FY12 is a very strong year. These two large kind of one-time singular events added $0.40 some-odd to our kind of earnings per share, and given the nature of the work, and unfortunately we cannot be very specific as to the nature of the work since we do not typically talk about any specific contract. Given the unique nature of the work, we do not see that re-occurring. We very much believe it's one-time, and so when we look at our performance, we are adjusting the FY12 basis, we encourage you to do that as well, but you're going to have to make your own decision. We're just try to provide some good information and transparency there.

Okay, and just lastly, given the reported EPS in fiscal '12 all in, I mean, could EPS possibly be down in fiscal '13?

We provided some information on that by '13, basically saying the levels of profitability, or the levels of growth, will most likely not be sustained in FY13, and basically we'll provide additional details on FY13 when we get to the guidance call in June. So I'm going to defer answering that question specifically for a couple of months.

I think the one-time adjustments we all understand. These one-time adjustments, we're not considering going forward as part of a run rate. We just don't -- these are so unique, they're special, we're happy to have had that business, but they won't recur, and so that's for sure. In terms of the comment about our growth rates, it's really a comment that's in reference to that reduced baseline by taking these two one-time items out. So we don't expect to see the double-digit earnings growth from the reduced baseline.

Nathan Rozof, Morgan Stanley.

Apologies about the technical issues before. So if you've answered these questions while I was off the call, then I apologize, but I'll ask them both upfront, just a little bit of a multiparter. I wanted to go back to some of the comments you've made about the behavior of your clients, particularly as it pertains to sequestration. The two kind of questions I have around that are first off, can you give us any insights into what clients are prioritizing more versus less, as it pertains to that spent? So based on ODCs going down, it looks to me like products are being potentially hit harder than services, and secondarily, as it relates to the upcoming concerns about sequestration and next year's CR, are we going to see any change in seasonality in CACI's business, either from awards or a revenue perspective as we move forward into fiscal '13? Thank you.

So the first question on any insight that we may provide on our government setting their priorities, I think I'd have to differ that to our clients, so I'll just leave that there. Seasonality, I think the rhythm that we are in will be constant as we go forward, with the main driver being our Q1 as it aligns with the end of the government's fiscal year. That tends to be the highest awards booking period for us. I think we'll see that seasonality continue. Q2, Q3, they tend to be driven by some timing of some major events like CR in this case. Next year might be driven by how the sequestration plays out. Q4 begins the ramp up to our Q1 again, so I think that seasonality will be enduring.

Dan, we also have a little bit more billable hours in the back half because of the holidays, the way holidays split between the front and back half. I think that generally runs it around 5% or 6% higher in the back half, just in terms of that. That seasonality obviously will stay. Going back to the first part of the question, just thinking about it a little bit, the one thing I can say, we don't have insight, as Dan pointed out, we don't have insight into the detailed prioritization that our clients are currently going through. We'll have that eventually, but we don't have it right now, but we do know what the President and the Secretary of Defense have told us, which is that the focus going forward is going to be in areas of C4ISR, special operating forces, cyber, which we know is a big, big issue for us, and we would just add to that list ourselves the healthcare IT issue, because it affects so many in the military and veterans, that will be a continued important growth area.

So those are really, those come out of the statements and strategy redefinition by the Secretary of Defense, and fortunately, we have positioned ourselves, our Company into those swim lanes, and so we think, while we're not invulnerable to reductions from sequestration, we feel that's the reason why we'll have less impact then potentially others. We're also not a product company, and we have a smoke few small products, but we're not a platform company, and therefore we're not going to see an impact from a major platform cancellation. There's no program of record out there that could get cancelled that would have a significant impact on us. We don't have any one program that's more than, any one program more than $100 million, I think you said, Dan. So we're very well diversified over those 2000 contracts as well. I hope that helps.

Mark Jordan, Noble Financial.

A question. I think, Tom, you had talked about the M&A landscape. Could you talk about what the management's philosophy might be moving through 2013 relative to the buyback, in light of the large one-time share repurchase this past August?

Yes. Our first priority for our capital deployment is toward acquisitions, Tom's characterized that market. We are very aggressive in that market. We're a strategic consolidator. We've done 54 acquisitions in the last 20 years, all of which are very successful, and have been an important part of our growth strategy right along. So that will continue to be a major thrust area for us. We don't do acquisitions to add bulk, we do acquisitions to fill strategic needs, either a special capability, a technology area, or a client that we haven't had access to in the past, or geography sometimes.

So they're always done with an eye toward the overall five-year strategy that we maintain, and that is our first priority, because we actually believe our experience shows us with having done 50-some of these, that's how we get the good returns and the growth for the shareholders. Of course, the Board considers from time to time both share repurchase, and they've thought about dividends, but share repurchase, we see that as a valuable tool in certain instances to return value to shareholders, especially when the prices look attractive on our stock.

Also, we've used it as a tool, a tactical tool, to keep the share count about the same so that the comparables on earnings per share sort of consistent with the comparables on net income. I think that will continue to be our philosophy. We've done this one very large share repurchase, which we thought was -- because we just thought it was an opportune time for the Company to do that, but our first preference is, of course, for strategic consolidation, merger and acquisition program.

Thank you. Like a little clarification on, you talked about the exposure in Southwest Asia being, I believe you said it was less than 10% of revenue. Could you break that down relative to, is it 10% of revenue and what is the direct labor and ODC component relative to that number?

Roughly, overall, the characterization was at the revenue line. I don't think we're prepared to break that down into more detail. What we would like to do as we go into the June guidance, give you some more color on that exposure, as well as the timing of what impacts might affect that as the Administration strategy rolls out. So ask you to maybe just to hold off until June.

We have obviously built the FY12 component of that into our guidance. So what you see in our guidance reflects any effects in fiscal '12. What's Dan's saying is that we'll give you the best guidance we can at the end of June about '13.

Tobey Summer, SunTrust.

Follow-up question on your share repurchase strategy. Given the volatility that can exist in shares, what is your preference, having just experienced kind of one rifle shot approach where you bought a lot at a specific price versus a more persistent repurchase effort over time where you don't have to get the price quite as accurately?

So let me explain how the accelerated share repurchase program worked. Basically we entered into a transaction with a counter-party whereby they delivered us 4 million shares in this particular case, and we gave them an initial payment for those kind of 4 million shares. Over a approximate nine-month period, the counter-party would be in the market kind of purchasing shares, and at the end of the nine-month period, we will pay the Volume Weighted Average Price during that nine-month period, less a small discount.

That's how a accelerated share repurchase program works. So we are actually not paying a particular price at a point in time, but an average price over an extended time period. That is how we chose to execute this one accelerated share repurchase program. The advantage is we're able to retire those shares immediately. In the past we've done things more tactically, entering 10b5 programs with upper and lower levels with regards, share price and the like. So tactically there's a variety of ways to execute those share repurchase programs, and our tactics have changed over time, depending upon kind of what our needs are, or our views of the market.

Right yes. I guess I understand how they work. I'm asking you what your preference is, now that you have experienced both methods. Thank you.

I mean, clearly our preference when we did accelerated share repurchase program was an accelerated share repurchase program. If we wanted to do another very large one that seems to has a lot of advantages for it, but again, the market conditions change and situations continuously change, and so if we get another share repurchase program, kind of the Board would consider a variety of alternatives and pick the best one, given the facts and circumstances at the time. I'm being not responsive to your question but it's hard to say how we would behave in the future.

Okay, and then my last question, because most of the other ones have been asked. You mentioned in the early stages of fiscal '13 planning, preliminary views is you don't expect to realize the same rates of growth, but those rates of growth have been pretty heady and very successful and above what many public peers have achieved. So the range of potential growth below those rates is very wide and extends into negative territory. Can you give us any more color as to what those words mean?

Well, I think what we can say is we expect to continue to be very, very competitive going forward. So our degree of success and our positioning in the marketplace will continue, we believe, as is. The exact growth rate, or what that number will be, is something we'd have to defer until June when we have our plan developed. It's just not available right now because we're in the middle of the planning cycle.

Michael Lewis, Lazard Capital Markets.

Thanks for taking the follow-up, especially as we're at over the hour. Tom, I was wondering if you could give us what your expectation is for the fixed price contract in Q4, and then also I had quick follow-up for Dan.

I'm sorry. Could you repeat it? I didn't get all of that, Mike.

I'm sorry. I was hoping that you could give us what your expectations is embedded in Q4 from that fixed price contract.

Virtually nothing.

Okay, and then Dan, last quarter you had several hundred million of S3 in the pipeline. Could you give us an update on the trend or standing of those opportunities?

Yes. Several of those opportunities have slipped out of this fiscal year. The pipeline in S3 remains. We still have about $100 million of activities that we are pursuing, but there were two major ones that have moved out of this fiscal year into our next fiscal year.

(Operator Instructions)

Cai von Rumohr, Cowen and Company.

So one simple question. I can certainly understand why you cannot provide estimates on total revenues next year. Do you expect to be able to continue to grow your direct labor billings next year?

Yes. Again, I think I'm going to give the same answer is that we're in the middle of the planning cycle, and I'd be speculating to give you an answer to the question. We've tried to give some idea of what we expect next year, that we won't have that same kind of double-digit earnings growth rate. Beyond that, we just don't have the visibility, Cai.

Tim Quillin, Stephens Incorporated.

Sorry for taking us into overtime, but just the fun with numbers question on acquisitions. If you look at what you thought the revenue was from Pangea and Paradigm and APG and Tomorrow at the time of the acquisitions, it looks like you kind of add that up and it should have contributed something like $33 million in revenue in the quarter, but there was $28 million from acquisitions in the quarter. Was one of the acquisitions annualizing at a lower rate than at the time you announced those deals? Thanks.

Yes, as we look at the acquisitions, we kind of do some, obviously, pretty detailed forecast, trying to determine kind of what the profitability of the acquisitions are, and the acquisitions are performing, in total kind of in fine, more than fine, performing quite well. We spoke about delays in some government procurement processes and shifting awards to the right. In the acquisitions that we -- the companies we acquired are experiencing some of those kind of the same phenomena we're experiencing. So we expect to get some awards, some large material ones. We're still confident that they will come, but they have shifted a bit to the right.

I'm not showing any further questions closing comments

Think you, Kevin, for your help here today, and I'd like to thank everyone who dialed in or logged onto the webcast for your participation as well. We know that some of you will have some follow up questions, and Tom and Dave will be available in the next few minutes to take your calls. This concludes our call. Think you, and have a great day.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.